{"id":2346,"date":"2020-04-08T09:39:48","date_gmt":"2020-04-08T14:39:48","guid":{"rendered":"https:\/\/illinoistax.org\/?p=2346"},"modified":"2020-04-08T11:02:17","modified_gmt":"2020-04-08T16:02:17","slug":"an-illinois-sales-tax-conundrum-high-rates-and-low-receipts-dr-natalie-davila","status":"publish","type":"post","link":"https:\/\/illinoistax.org\/?p=2346","title":{"rendered":"An Illinois Sales Tax Conundrum: High Rates and Low Receipts – Dr. Natalie Davila"},"content":{"rendered":"

An Illinois Sales Tax Conundrum: High Rates and Low Receipts<\/u><\/strong><\/h3>\n

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March 2020 (73.3)<\/strong><\/p>\n

by Dr. Natalie Davila*<\/p>\n

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Illinois\u2019 economic activity and its personal income, on a per capita basis, exceed national averages.\u00a0 One would expect that consumption, as reflected in sales tax collections per capita, would also exceed the national average. However, that is not the case. Our recent publication \u201cTax Facts: An Illinois Chartbook\u201d indicated state and local sales tax revenue as a percentage of Gross State Product (GSP) is low in Illinois, according to data from the U.S. Census Bureau\u2019s Survey of State and Local Government Finances, where Illinois stood 17th<\/sup> lowest out of 50 states.\u00a0 Why is that?\u00a0 In this report we try to explain the reasons behind Illinois\u2019 low sales tax collections by using publicly available data and looking in detail at a neighboring state\u2014Iowa \u2013 and examining several oft-suggested hypotheses.<\/p>\n

Illinois\u2019 Sales Tax Collections Don\u2019t Match Our High Tax Rates<\/u><\/strong><\/p>\n

Looking first at state and local sales tax together, Chart 1 <\/strong>illustrates that Illinois collects $1,126 per capita compared with a national average of $1,201.\u00a0 Illinois collections were below the national average despite the fact that its population-weighted average state and local sales tax rate of 8.64 percent was higher than the national average of 6.49 percent, according to the Tax Foundation\u2019s publication, \u201cState and Local Sales Tax Rates in 2017.\u201d<\/p>\n

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Looking only at state<\/em> sales tax we find the same disparity.\u00a0 Illinois state sales tax collections per capita were $888 compared to a national average of $925 (Chart 2<\/strong>). Illinois collections were below the national average despite the fact that its state sales tax rate of 6.25 percent was higher than the national average of 5.1 percent, as shown in Chart 3<\/strong>.<\/p>\n

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Why?<\/strong><\/p>\n

What explains Illinois\u2019 low state sales tax collections?\u00a0 Many hypotheses have been suggested, but most have not been examined in any great detail.\u00a0 This research attempts to determine, where possible, how much each of the following factors contributes to Illinois\u2019 lower than average sales tax per capita:<\/p>\n

    \n
  1. Rate and base differences, generally<\/li>\n
  2. Taxation of services<\/li>\n
  3. Tax exemptions<\/li>\n
  4. On-line tax collections<\/li>\n<\/ol>\n

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    In this article we will test these various hypotheses by comparing detailed data from Illinois and Iowa. We select Iowa because not only is it frequently used as a model for how Illinois might consider taxing services, but also it is the Midwest state that ranks closest to Illinois in term of sales tax per capita.1<\/sup><\/p>\n

    If we can identify the reasons Illinois\u2019 tax collections lag other states, we will know whether those differences are attributable to sound tax policy decisions, and could offer policy makers options to raise the below-average revenue, reduce the above-average rates, or both.<\/p>\n

    Comparing Apples-to-Apples<\/u><\/strong><\/p>\n

    To try and get to the bottom of this high rate\/low revenue phenomenon in Illinois we first need to calculate a measurement that controls for differences in population and sales tax rates across the states.\u00a0\u00a0 This will allow for a more apples-to-apples comparison between and among states. We make this adjustment by dividing total state sales tax collections from the census bureau by population to get a per capita figure. We then divide that figure by the state sales tax rate to arrive at a unit of comparison that shows how much state sales tax is generated per person for each 1 percent in sales tax rate.\u00a0 We can then compare this figure that we will call \u201cPer capita tax \u2013 1%\u201d among states. We apply this same approach as we evaluate the various hypotheses explaining why Illinois has high tax rates but low receipts.<\/p>\n

    The basic calculation for Illinois and Iowa, our comparison state, is highlighted in Chart 4<\/strong>.\u00a0 Illinois, even though its combined state and local rates are significantly above average, displays middle-of-the-pack and below average sales tax receipts per capita.<\/p>\n

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    To simplify our analysis, we will focus only on state sales tax collections.\u00a0 We do this because local sales taxes are not applied uniformly within or among states.\u00a0 Only 38 states allow a local sales tax.\u00a0 In addition, even in those states that allow local sales taxes not all taxing jurisdictions actually impose a local sales tax and those that do can do so at different tax rates. For example, in 2017 the local sales tax rate in Illinois ranged from 0 percent to 4 percent.<\/p>\n

    Income and GSP per capita is higher in Illinois than in Iowa.\u00a0 Everything else being equal this would presumably mean Illinois\u2019 per capita sales tax revenue would be higher than that in Iowa.\u00a0 However, when we account for differing sales tax rates and populations, we find that in 2017 Iowa sales tax revenue per capita for each 1% in tax rate is $28 higher in Iowa than in Illinois.\u00a0 This translates into a whopping $2.4 billion less in tax at the 6.25 percent rate.<\/p>\n

    1.\u00a0 Rate and Base Differences, Generally<\/u><\/strong><\/p>\n

    Our first step in examining the disparity in tax collections between Illinois and Iowa is to make some adjustments for several differences between the way the states tax major categories of goods, either through exemptions or lowered rates.<\/p>\n

    Food, drugs, and autos\u00a0 <\/strong><\/p>\n

    Two major categories of otherwise taxable goods are subject to different rates of tax in our two comparison states:\u00a0 food and drugs, and automobiles.\u00a0 We need to make adjustments in our calculations to reflect these differences.\u00a0 Illinois taxes food and drugs at a 1 percent rate, money that is all returned to local governments but is nevertheless part of the state 6.25 percent sales tax, whereas Iowa totally exempts food and drugs.\u00a0 To make the states comparable, we must take out revenue associated with Illinois\u2019 1 percent tax on food and drugs.\u00a0\u00a0 Meanwhile, in Iowa autos are taxed at 5 percent rather than the general sales tax rate of 6 percent, so we calculate the value of a 1 percent tax on autos and add it to the Iowa base.\u00a0 These adjustments intended to align the states\u00a0 do not eliminate the disparity and in fact widen rather than narrow the gap between the two: one percentage point per capita of $137 in Illinois compared to $174 in Iowa, as shown in Table 1.<\/p>\n

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    Utilities<\/strong><\/p>\n

    As we indicated in the Illinois Chartbook, some states include utilities in their general sales tax base \u2013 Iowa is one such state.\u00a0\u00a0 Others, like Illinois, tax utilities under a separate utility tax.\u00a0 So, we need to subtract communications, electric and gas, and water and sanitation from the Iowa sales tax base.\u00a0 These revenue sources totaled $320.3 million for Iowa in 2017.\u00a0\u00a0<\/strong><\/p>\n

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    When we take utilities out of the Iowa base the per capita – 1% disparity between the two states is reduced from $37 to $19.\u00a0 This goes a long way towards explaining the disparity between the states (and readers should be mindful that Illinois collects taxes from utilities through separate excise taxes, so this is not foregone revenue).\u00a0 The tax impact of the remaining difference, however is still $1.4 billion\u2014definitely worth further exploration<\/p>\n

    Gasoline <\/strong><\/p>\n

    There is one additional significant base difference: Illinois includes gasoline in the sales tax base while Iowa does not.<\/p>\n

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    Making a base adjustment to account for Illinois\u2019 gasoline sales increases the disparity, accounting for rounding, from $19 to $27 per capita for each 1% in tax rate.<\/p>\n

    2. Taxation of Services<\/u> <\/strong><\/p>\n

    Iowa subjects a number of services to sales tax, while Illinois generally excludes services from taxation. Some of the services taxed in Iowa that generate the largest revenue, according to a breakdown from the Iowa Department of Revenue, include:<\/p>\n