Unintended Consequences of Local Sales Tax: Capitalization of Sales Taxes into Housing Prices

Abstract

Local governments are under pressure to look for alternatives to property taxes as their main revenue source. One response has been to adopt local sales taxes. Prior studies offer little guidance on whether and how much local governments enhance their revenue capacity with local sales taxes. This article unveils the underlying mechanisms by exploring the capitalization of sales taxes into housing prices as a property tax base measure. The empirical analysis reveals a capitalization of local sales taxes into housing prices, indicating the reduction of property tax bases in higher sales tax areas from the long-term perspective. The findings suggest that a sales tax rate increase might not raise local revenue capacity as much as policymakers intend.