Budget & Tax

Increasing Oklahoma’s Sales Tax Is Bad for Business

October 1, 2016

J. Scott Moody, Wendy Warcholik, Ph.D.

Increasing Oklahoma’s Sales

Tax Is Bad for Business

By J. Scott Moody and Wendy P. Warcholik

The sales tax is perceived as a “good tax” because it taxes consumption and therefore minimizes tax-induced distortions in the rest of the economy. For example, a do-it-yourself homeowner who goes to Home Depot to buy a hammer to hang a picture is doing so for personal use, i.e., consumption.

Yet, that same hammer could have been bought by a local carpenter who will use it to build cabinets that will be installed in new homes. In this case, the hammer is a business investment.

But the sales tax does not distinguish between who buys the hammer and for what purpose.

This is not an academic exercise. This process plays out for millions of products that are sold in Oklahoma each year—products that could be used by consumers or businesses, ranging from printer paper to lawn mowers to smartphones, just to name a few. In fact, according to a recent study from the Council on State Taxation, 47 percent of Oklahoma’s sales tax was paid by businesses in fiscal year 2014.

Alas, the negative impact of the sales tax on businesses does not end there. During the manufacturing of the hammer, the sales tax was actually paid multiple times as it moved through the production process. The business buying the raw wood to make the handle, or buying the metal to make the head, paid the sales tax on the transaction. (We use this example for illustrative purposes; states try to avoid this negative impact by exempting many products from the sales tax, so the extent of sales tax exemptions varies by state.)

This is called sales tax pyramiding, and it results in the final user not only paying for the sales tax at the register, but also for some or all of the previous sales taxes paid during production which are embedded in the final price of the good or service. Depending on the industry, the extent of sales tax pyramiding can vary dramatically.

For instance, Washington commissioned a study to examine the pyramiding issues in that state’s gross receipts tax (a sales tax with few exemptions). The study found that manufacturing was hit particularly hard, ranging from a high of 6.7 times for food production to 2.6 times for printing and publishing. As such, the sales tax burden unfairly hit some industries harder than others.

Adding insult to injury, sales tax pyramiding can negatively impact the cost of living by raising the overall cost of goods and services. One comprehensive study published in the National Tax Journal found that many products exhibit sales tax over-shifting where “an increase in [sales] tax revenue of one dollar per unit increases the price by more than one dollar.”

Oklahoma already has the 6th highest state and local sales tax in the country, according to the Tax Foundation. This high sales tax rate can drive consumers to do their shopping in neighboring states or localities—since Oklahoma and many neighboring states allow complex local-option sales taxes. The Internet also entices consumers with sales-tax-free online shopping. Such cross-border or virtual shopping created from sales tax differences hurts local businesses that must contend with high sales tax rates.

Overall, further increasing Oklahoma’s sales tax from its already-nosebleed levels will create a significant, negative blemish on the state’s business climate. Manufacturing, in particular, will spend precious resources avoiding the higher sales tax rate and resulting sales tax pyramiding rather than investing in new equipment and hiring new workers.

OCPA research fellow J. Scott Moody (M.A., George Mason University) serves as chief executive officer of Federalism in Action. Formerly a senior economist at the Tax Foundation and a senior economist at the Heritage Foundation, he has twice testified before the Ways and Means Committee of the U.S. House of Representatives. Moody is the co-creator (with Wendy P. Warcholik) of the Tax Foundation’s popular “State Business Tax Climate Index.” His work has appeared in Forbes, CNN Money, State Tax Notes, The Oklahoman, and several other publications.

OCPA research fellow Wendy P. Warcholik (Ph.D., George Mason University) directs the Family Prosperity Initiative for the American Conservative Union Foundation. She formerly served as an economist at the U.S. Department of Commerce’s Bureau of Economic Analysis, and was the chief forecasting economist for the Commonwealth of Virginia’s Department of Medical Assistance Services.