Association for Public Policy Analysis & Management

I employ state and local sales tax exemptions for clothing to estimate the effect of sales taxes on retail prices and employment. Unlike previous literature on this topic, I use (a) confidential item-level Consumer Price Index data, (b) specific-to-apparel tax changes induced by frequent state/local policy revisions of sales tax exemptions in Connecticut, New York and Vermont, (c) an innovative empirical approach that allows me to control for price trends within states and (d) link sales tax data with employment data. I find that the effect of the sales tax rate on pre-tax prices in local stores, tax incidence, is essentially zero, rejecting any positive tax incidence. In some cases, the burden partially shifts onto suppliers for apparel groups with arguably higher elasticities of demand: retailers experience a 21% tax shift for non-seasonal goods, and 38% and 24% shifts for girls apparel and footwear respectively. Almost full shifting of the sales tax onto consumers is surprising given the well-documented fact that the demand for apparel at local stores is quite elastic, and it suggests that the supply of apparel at local stores is even more elastic. The absence of a response in a price dimension implies that local stores should increase output and, hence, inputs when facing an exemption. To test whether stores employ more labor, I use the data from Quarterly Census of Employment and Wages and estimate that county employment in the apparel retail sector increases by 0.33% following a one percentage point drop in sales tax changed by both state and locality. This is the first evidence in economic literature of a strong connection between sales tax and employment. Finally, using Consumer Expenditure Survey data, I compute the deadweight loss induced by a 5% sales tax to equal 5% of overall sales tax collections on apparel ($671 million).