The Surprising Regressivity of Grocery Tax Exemptions

By Jared Walczak of The Tax Foundation. Excerpts:

"Key Findings

• Exempting groceries from the sales tax base reduces economic efficiency without achieving its objective of enhancing tax progressivity.
• The poorest decile of households experiences 9 percent more sales tax liability with a grocery tax exemption than they would if groceries were taxed and the general rate were reduced commensurately.
• Grocery tax credits provide actual progressivity at a lower cost than the broad exemption of groceries. Under a revenue-neutral expansion paired with a $75 per person credit, the poorest decile of households would save 31 percent on sales tax liability.
• Sales taxes are more stable and pro-growth than many other forms of taxation, especially income taxes, so policymakers have an opportunity to increase tax progressivity, enhance revenue stability, and improve economic competitiveness by taxing groceries, providing a credit, and using the remaining revenue from base broadening to cut income taxes."

 

"This narrative, however superficially compelling, is marred by several flaws. Most importantly, it either neglects or fails to appreciate the full impact of the universal policy of exempting from sales tax any purchases made using federal food-purchasing assistance programs, primarily the Supplemental Nutrition Assistance Program (SNAP), but also the more narrowly targeted Special Supplemental Nutrition Program for Women, Infants, and Children (WIC). States’ receipt of federal grants to administer these Food and Nutrition Service-funded benefits is contingent upon exempting these purchases from sales tax, and all states do so—even if groceries are otherwise in the sales tax base. This policy alone dramatically reduces taxable consumption for the lowest income deciles.

Additionally, the conventional wisdom underestimates the degree to which higher consumption of groceries does scale with income. Higher earning households purchase not only more, but higher qualities of, groceries. Low-income households, in fact, are more likely to purchase taxable substitutes to what states classify as groceries, a category that traditionally only covers unprepared foods. For lower-income working families, prepared foods—rotisserie chickens, deli items, fast food, and more—are often more economically efficient than buying raw ingredients and making home-cooked meals, but prepared foods are taxed, whereas ingredients are exempt when states adopt a grocery tax exemption. The result is that a household in the fifth decile spends almost 70 percent more than a household in the first decile, and a household in the top decile spends over three times as much as a household in the lowest.

Finally, while low-income households spend more on groceries as a share of income than do the highest-income households, they do not necessarily spend more on groceries relative to other necessities. Compositional effects matter. If lower-income families spend moderately more on groceries, as a share of income, but substantially more on other household goods, then they will be worse off under a tax code which exempts groceries but with a higher rate than would be necessary were groceries included in the base. Given not only substitution effects—prepared foods for unprepared—but also, crucially, the exemption of SNAP and WIC purchases for many low-income households, this is not just a hypothetical but the reality for many families."