Impact of Sales Tax Increases on Different Income Groups

Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

Charging consumers a percentage of their purchases on different types of goods and services is a common way municipalities raise funds for public services. In this lesson, we'll learn how increasing this sales tax impacts different income groups.

Income Groups

In this lesson, there will be a lot of talk about 'percentages.' To help make the lesson a little clearer, let's get some percentages out of the way up front. The IRS has seven different tax brackets that are based on family-type and income. Because we are going to look at how increases in sales tax impacts people in different tax brackets, let's pick two different situations to use as examples throughout the lesson.

The first, James and wife, make the national average in the United States - about $48,000 per year - which puts them in the 15% tax bracket. The second, Nate, is a single guy working at an investment bank and makes $150,000 per year, putting him in the 28% tax bracket. To save some time, let's (1) make the assumption they both take the standard deduction and (2) we use an online tax estimator to get James' take home monthly pay about $2,400 and Nate's monthly take home pay of about $8,500.

Sales Tax Differences

Sales tax rates differ between states, and cities and counties can even add their own sales taxes. Typically these tax rates differ between the type of goods and services being purchased. Most states have slightly lower rates for food, prescription drugs, and over-the-counter drugs. While those rates are lower, they usually aren't zero.

So let's add a little more information to our example with James and Nate. The USDA says the average adult male has a monthly grocery bill of about $300 while the average adult woman has a monthly grocery bill of $260. So, that means James' and his wife pay $560 per month in food while Nate pays $300.

To start out simple, let's assume both of our friends live in Illinois - Chicago for Nate and Springfield for James. So, with a tax rate of 2.25% how much does Nate pay in sales tax? Take his $300 spent in food times the 2.25% = $6.75. Chump change, right?

Okay, how about James? His $560 in food times the 2.25% rate = $12.60. So Nate's $6.75 in tax compares to James' $12.60. James pays $5.85 more a month in sales tax. Annually, that ends up being $70 more per year than James pays than Nate, even though his income is about 1/3 of Nate's.

Increases in the Sales Tax Differences

Now, we can play a few different 'what if' games with our friends, Nate and James. For example, what if one of them lived in Mississippi where there is no discount on the sales tax rate for food, so it costs the full 7%, while one lived in Oregon where the rate was 0%? That could certainly make a difference.

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