An Efficiency Analysis of Proposed State and Local Sales Tax Reforms

With few exceptions, state and local general sales and use taxes are levied primarily on tangible goods. Secular trends in production and consumption of goods and services, as well as legislated exemptions and exclusions, have eroded sales tax bases. A number of reforms designed to reduce base erosion have been proposed, including base broadening, conversion to a consumption tax, and wholesale replacement of sales taxes with income taxes. Each proposal has potential to shore up sales tax bases. From an economic perspective, the policy choice should turn on efficiency, equity, and simplicity. This paper reports on a computer analysis of efficiency effects. The results suggest that (i) base broadening can increase economic efficiency, (ii) converting to a consumption tax base dominates base broadening, (iii) replacing sales taxes with higher income taxes could produce large efficiency losses, (iv) base broadening could generate efficiency gains even if untaxed remote sales become a “sizable” fraction of total sales, and (v) even partial base broadening could produce sizable efficiency improvements.     

Optimal expectations and the extreme information assumptions of ‘rational expectations’ macromodels

‘One might reply that the rationality of a person's choice does not depend upon how much he knows, but only upon how well he reasons from whatever information he has, however incomplete. Our decision is perfectly rational provided that we face up to our circumstances and do the best we can.’ (John Rawls, A Theory of Justice)