What Will It Cost If Voters Reject the One-Cent
Sales Tax Hike?

Arizona voters will be asked to approve a temporary one-cent increase in the sales taxes on May 18, 2010. This will raise nearly 1 billion of the 3 billion dollar budget gap projected for fiscal year 2010-11. What if voters reject this referendum? What will be the effect on Arizona's economy?

The answer is a two-sided coin. According to estimates from the Governor's office, the tax will raise $918 million annually, thereby draining that same amount from private-sector spending. But those dollars don't disappear. Government doesn't bury (or burn or flush) the proceeds - it spends those dollars thereby pumping money right back into the economy. That spending by the public sector adds to aggregate demand just as private sector spending does. So what's the value of public spending - and how does it compare in magnitude?

Using a model that tracks the flow of dollars through the economy as they are spent and re-spent many times over, we find that the cost of increasing the sales tax by one cent, as measured by lost jobs, is less than 7,400 jobs1.

If the measure fails, the Governor has proposed some 867.5 million dollars in spending cuts. Those cuts will trigger a loss of federal matching dollars totaling an additional 442.5 million dollars. After careful analysis of detailed agency budgets that show how dollars are spent, we find that the proposed cuts will cost Arizona 20,500 jobs2.

Approving the sales tax increase will save over 13,000 jobs!

Why such a large difference? Obviously, the loss in federal matching dollars substantially contributes to the finding that job losses are larger with expenditure cuts than with a sales tax increase. But even without the federal matching money, expenditure cuts reduce jobs substantially more than comparably sized tax increases. There are three major reasons why a cut in government expenditures result in a larger economic impact than an increase in the sales tax rate.

First, the government is a service provider and, generally, services employ more persons per $1 million of expenditures than do non-services providers. Consequently, a larger portion of government expenditures is paid as labor income than most sectors of the economy. Sometimes the state government provides services directly, such as parts of higher education, sometimes the state government subsidizes other government entities to provide the services, such as K-12 education, and often the state government contracts with private entities to provide services, such as health care, day care, and social service providers.

Second, from the taxation side, a portion of the sales tax is paid by out-of-state visitors, so only slightly under 90 percent of the tax is paid by Arizona residents.

Third, the sales tax is imposed primarily on the sale of tangible goods, rather than services. Very few of the good purchased by Arizona consumers are produced in Arizona. For most sales, only the retail margin (the difference between final sale price and the wholesale cost of the item) is retained in the state. Retail margins can be as low as 27 percent of the total sales price for purchases made at general merchandise stores.

For a discussion of the economic model used to estimate economic impacts in this article, please refer to:

Sales Tax Increase vs. Expenditure Cuts: an Economic Impact Study. Alberta H. Charney. March 19, 2010.

More research on Arizona's budget situation and fiscal issues.

Notes:

1. A widely-quoted number citing the Goldwater Institute as the source estimates that the sales tax will cost 14,400 jobs. We are unable to replicate that number and find the impact to be only half that amount. See A. Charney, "A Technical Note: Comparison of UA, REMI and STAMP Simulations of Tax/Spending Increases." March 30, 2010. Economic and Business Research Center, Eller College of Management, University of Arizona.

2. Excluding the federal matching dollars, the job loss totals over 14,000. For more details of the methods used of the study, see A. Charney, "Comparison of Tax Increase vs. Government Spending Cuts." March 19, 2010. Economic and Business Research Center, Eller College of Management, University.