Information and Updates on Current Issues
March 27, 2001
Revenue Gains and Job Losses in New Hampshire
Jeanne Shaheen of New Hampshire has proposed the imposition of a 2.5%
sales tax as part of her EXCEL NH (Excellence in Learning for New Hampshire)
program, which would provide a "long-term funding and improvement
solution" for state public schools. (1) Governor Shaheen expects the new tax to yield $365 million in
net revenue to the state in fiscal year (FY) 2003.
of this analysis is to provide independent estimates of the new revenue
the tax would raise and of the expected effects on New Hampshire jobs.
Table 1 provides our revenue estimates. (2)
of Effects of Proposed New Sales Tax on New Hampshire Revenues, FY2003
with Tax Base Erosion
with Tax Base
and Collateral Damage
Revenue from Sales Tax
that, when all incidental effects of the tax are considered including
tax base "erosion" and "collateral" revenue losses
from other related tax sources, including gasoline, tobacco, liquor
and meals the state could expect to add no more than $288 million
to its FY 2003 revenue collections by imposing the tax. Should the economy
slow below its expected normal rate of growth, it could expect to add
no more than $283 million.
two economic growth scenarios: Normal Growth, which assumes the growth
rates that we currently expect for the New Hampshire economy from now
through 2003; and Slow Growth which assumes lower growth rates. We then
break our estimate for each growth scenario ("Normal" and
"Slow") into three steps. In Step 1, we estimate the revenue
the state could expect to raise by imposing the tax, if there were no
"erosion" of the sales base on which the tax was imposed and
if there were no "collateral" damage to revenue collections
as a result of the new tax. For Normal Growth, we find that this new
revenue would be $371 million.
New Hampshire retailers rely on out-of-state shoppers for a substantial
portion of their business, the imposition of a New Hampshire sales tax
could be expected to cause a substantial portion of that business to
shift toward retailers in other states. The sales tax would also raise
the cost of goods to New Hampshire shoppers, some of whom (particularly
those who reside in New Hampshire) could be expected to shift their
earnings from purchasing goods and toward saving. Both effects would
erode the sales tax base. In Step 2, we estimate the revenue the state
could expect to raise, given the expected erosion of the tax base but
still assuming no collateral damage. For Normal Growth, we find this
to be $318 million.
of the sales tax would cause the state to lose tax revenue, as nonresidents
make fewer trips into New Hampshire to purchase the newly taxed products
and thus make fewer purchases of other products, such as liquor and
meals, from which New Hampshire derives revenue. These "collateral"
revenue losses are estimated to be $30 million. This leaves us in Step
3 with a bottom-line Normal Growth estimate of $288 million.
2 summarizes our findings regarding another form of collateral damage.
The imposition of a New Hampshire sales tax would cause job losses in
retail sales and related sectors, particularly wholesale and transportation.
It would cause further job losses in other sectors as potential workers
are deterred from working in New Hampshire because of the reduced purchasing
power of their earnings. Under Normal Growth, we expect the new tax
to destroy a total of 32,992 jobs, of which 22,117 would be in retail,
wholesale and transportation.
of Effects of New Sales Tax on New Hampshire Employment, FY 2003
Lost in Retail, Wholesale and Transportation
are three steps to predicting how the imposition of a new tax (or an
increase in an existing tax) would affect future tax revenues: (1) estimation
of the future tax base; given that the tax is not imposed (or increased);
(2) estimation of the effect of imposition of the tax on the tax base
and (3) estimation of imposition of the tax on other tax revenues. When
the tax is broad-based, as with a sales or income tax, Step 1 depends
on assumptions about expected economic growth over the period between
the baseline and the year for which the prediction is made. Step 2,
in which we measure erosion, requires us to estimate the "elasticity"
or sensitivity of the tax base to the tax. Step 3, in which we measure
collateral damage, requires us to estimate the elasticity of other elements
in the state economy to the tax. We detail these steps here.
1: Estimation of Tax Base
about Step 1 can be found in the Report of the New Hampshire Commission
on Education Funding, which was issued on January 8, 2001. The
Governors estimate of $365 million in new revenue for FY 2003
is based on estimates offered there for a "narrow-based" sales
tax. (4) The Commission assumed that the sales tax
base would grow by 6.7%, 6.3% and 6.1% in calendar years (CY) 2001,
2002 and 2003, respectively, in making these estimates.
between our FY 2003 prediction and that of the Governor stems from our
determination that the slowing pace of the economy requires these assumptions
to be revised downward. We assume that the base would grow by 5.3%,
5.4% and 5.5% in CY 2001, 2002 and 2003 under the "Normal Growth"
scenario. The corresponding growth rates for the "Slow Growth"
scenario are 3.2%, 3.8% and 5.0%.
difference stems from the manner in which the base was constructed.
In order to collect $365 million at 2.5¢ per dollar of sales, the state
must have $14.6 billion in sales to tax. Given the elasticity of 3.4
suggested in commission work papers, the tax base would have to be $16.0
billion before the tax is imposed if there were to be $14.6 billion
in sales to tax after the tax is imposed.
likely, however, that the commission estimated the tax base before the
specifics concerning the contents of that base were known. These specifics
are now spelled out in New Hampshire House Bill 767. (5) Our reading of this bill leads us to conclude that the sales
tax base would be substantially less than $16.0 billion, even before
considering the erosion of the base that the tax would bring about.
into consideration the goods and services excluded from taxation by
House Bill 767 and using the most recent U.S. Census data on the size
and origin of New Hampshire retail sales, we estimate the pre-tax FY
2003 base to be $14.8 billion. (6)
2: Estimation of Erosion
of the tax base with respect to the tax rate is defined as the percentage
decrease in the tax base that results from every 1 percentage-point
increase in the tax rate. The commission recognized, in accordance with
economic theory and evidence, that imposition of a sales tax could be
expected to cause erosion of the base on which the tax is imposed. As
mentioned, the commission appears at one point to have assumed an elasticity
the literature on sales taxes in other states and found estimates ranging
from 2.0 to 7.0. (7) We believe the elasticity pertaining
to New Hampshire falls at the upper end of this range, perhaps even
substantially above the upper end. First, New Hampshire currently imposes
no sales tax while it is bordered by three states Massachusetts,
Maine and Vermont each of which imposes a sales tax of 5%.
New Hampshire depends to an unusual degree on retail sales to fuel its
economy. The ratio of retail sales to gross state product is 42% for
New Hampshire and only 30% for the four-state economy that consists
of New Hampshire and its three neighboring states. The ratio of retail
sales to GSP is only 26% for Massachusetts, the largest of the four
states and an important source of customers for New Hampshire retailers.
On the basis of our examination of the literature and of these comparisons,
we estimate the elasticity of taxable sales to the sales tax to be 5.69.
assess the reasonableness of this estimate by considering a study of
West Virginia cross-border grocery sales, in which the authors found
an elasticity of 5.88. (9) Groceries are untaxed in
Massachusetts and would remain untaxed in New Hampshire under the new
tax. Because nonresidents who shop in New Hampshire typically shop for
items that exceed, in price, the cost of a normal trip to the grocery
store, and because these nonresidents are the source of a substantial
portion of New Hampshire retail sales, we expect the elasticity could
well exceed 5.88.
apply our elasticity of 5.69 to the base of $14.8 billion, we find that
imposition of the tax would cause that base to shrink by 14.2% to $12.7
billion. FY 2003 revenue would fall to $318 million. Because our elasticity
is probably lower than the true elasticity, this probably underestimates
the erosion of the sales tax base and overestimates the revenue that
the state would collect once that erosion took place.
3: Estimation of Collateral Damage
of a sales tax has effects beyond the erosion of taxed sales. In order
to determine the effect of a sales tax on state tax revenues, it is
necessary to consider how imposition of that tax could affect revenues
from other sources and cause erosion of economic activity outside the
making $40,000 per year can, absent any taxes, purchase $40,000 worth
of New Hampshire goods. With a sales tax of 2.5%, however, his earnings
permit him to buy only $39,024 worth of goods. The tax reduces the purchasing
power of his earnings by almost $1,000 and, to that extent, deters him
from entering the New Hampshire labor force. The imposition of (or increase
in) a sales tax can, on this reasoning, be expected to reduce the number
of workers who are willing to enter the labor force of the state imposing
that tax. (10)
to determine the share of this job loss that can be attributed to shrinkage
in the retail sector and in related (wholesale and transportation) sectors,
we assume that retail employment decreases by 100% of the shrinkage
in the sales tax base and that wholesale employment and transportation
employment decrease, respectively, by 25% and 10% of the shrinkage in
the sales tax base. This yields an estimate, under Normal Growth, of
a loss of 22,117 jobs in these sectors, about two-thirds of the total.
remains, then, the problem of determining collateral revenue losses.
Because there will be job losses throughout the New Hampshire economy,
not just in the taxed retail and nonretail sectors, there will be corresponding
losses in state revenues derived from economic activities that take
place outside these sectors. Here, though, we consider only revenues
associated with items that strongly complement taxable purchases by
out-of-state shoppers. These are motor fuels, tobacco, meals and alcoholic
that, under Normal Growth and absent a sales tax, New Hampshire will
collect $519 million in revenue from these sources in FY 2003. We further
estimate that, because of the sensitivity of this revenue to the expected
shrinkage in taxable retail sales, the applicable elasticity is 1.25
times the elasticity applicable to jobs. Thus collateral damage equals
1.25 x .0462 x $519 million or $30 million. When this damage is taken
into account, the revenue gain to the state shrinks to $288 million.
between the Step 1 revenue estimates and the Step 3 revenue estimates
is about 22%. Additionally, Governor Sheehans estimate of the
net gain to the state from the proposed sales tax is also about 22%
too high. In the light of what we know now about the slowing of the
economy and about the applicable elasticities, her estimate probably
exaggerates the true revenue gain by an even larger margin.
of New Hampshire, Governors Office, "Governor Announces EXCEL
NH," February 7, 2001, available from http://www.state.nh.us/governor/media/020701schoolfunding.html.
See Appendix for more information on the derivation of these estimates.
Due to the slower growth of the economy considered in Scenario II, there
would be a smaller employment base in 2003 affected by the imposition
of the tax. Fewer jobs to begin with mean fewer jobs lost under this
Ibid, 79. The Commission estimates that, for each percentage point increase
in the sales tax rate, the state would get $142 million and $150 million
in CY 2000 and 2003, respectively. The Governor estimates FY 2003 revenue
of $365 million by averaging these amounts and multiplying by 2.5.
An Act establishing the excellence in learning in New Hampshire school
funding and improvement program and making an appropriation therefor.
The U.S. Bureau of the Census provides data on retail sales by state
and by type of establishment most recently for 1997. See http://www.census.gov/prod/ec97/97r44-nh.pdf.
We estimate that 53% of 1997 retail sales would have been taxable under
the bill. Taxable retail sales comprise only a portion of the tax base,
however. We assume that nonretail sales comprise 20% of the base. Thus
we compute the tax base by multiplying taxable retail sales by 1.25.
A review of the literature can be found in New York State Department
of Taxation and Finance, Office of Tax Policy Analysis, "The Effects
of Tax Differentials on Cross Border Sales," available from
We obtained this estimate by determining the erosion of New Hampshire
sales that would take place if its retail-GSP ratio fell from 42% to
30%, the four-state average. Assuming that this erosion would take place
under a 5% New Hampshire sales tax and that the entire tax base consists
of retail sales, the elasticity would be . Because we assume nonretail sales to comprise
20% of the base and because those sales are less sensitive to interstate
differences in sales tax rates, we adjust this elasticity downward by
Michael J. Walsh and Jonathan D. Jones, "More Evidence on the
Border Tax Effect: The Case of West Virginia, 1979-84,"
National Tax Journal, 41 (June 1988), 261-65.
This is a consequence of the "inefficiency" effects
of a sales tax. George R. Zodrow, State Sales and Income Taxes: An
Economic Analysis (College Station, Texas: Texas A&M University
Press, 1999), 13, explains how, in this connection, "Sales and
excise taxes on consumption commodities typically distort individual
consumption decisions as well as the choice between labor and leisure."
See http://www.beaconhill.org for further detail.
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