Abstract
California’s Legislative Analyst Office recently pegged the state’s deficit at $20 billion for fiscal year 2010-2011. Amongst the revenue-raising proposals under consideration is an expansion of the sales tax base to include services. Due to a paucity of research on the subject, policymakers tend to use crude estimates of the additional revenue that could be raised by taxing services. This thesis is an attempt to ground and refine these estimates. I compiled a panel data set of sales and use tax revenue for 43 states over a period of 15 years in order to capture revenue fluctuations across multiple business cycles. To investigate the relationship between sales tax base and revenue, I used service base data available from the Federation of Tax Administrators and adjusted it to reflect the relative market size of each service industry in each represented state. Additionally, I controlled for a host of state-specific factors including, though not limited to, sales and use tax rate, household population, racial demographics, and per capita disposable income. For the econometric analysis, I employed a fixed effects regression model. There are three major findings. First, potential revenue yields vary greatly both within and across particular service base categories. For example, estimates for admission and entertainment services range from $0.6 to $7.7 billion, while taxing transportation services could raise $4.8 to $20.2 billion. Second, according to an alternatives matrix calculated for California, transportation, lease and rental, and automotive services offer the best combination of political feasibility and revenue returns. Third, in the short-run, tax rate increases yield more revenue than base expansions.