Which tax cut is the right tax cut?
For an average South Dakota family, the grocery tax cut would have returned more money. But a tax expert explains that, on the axis of long-term economic health, the overall sales tax cut had merit.
PIERRE, S.D. — On Tuesday, Feb. 21, the South Dakota House of Representatives made clear its preference between two interchangeable tax measures, with the chamber’s budget committee opting for a $100 million cut of the overall sales tax rate from 4.5% down to 4.2%.
Left behind was a $100 million repeal of the state sales tax on food items.
Though almost identical on the top-line savings to taxpayers, on an individual level, the two are not exactly interchangeable.
The difference between the two policy proposals includes both where the savings fall on the income distribution and how the cuts fit into the long-term fiscal health of the state.
On the latter point, lawmakers made the responsible choice, according to Ed Gerrish, an associate professor of public administration at the University of South Dakota.
However, if the goal of policymakers was purely to leave more money in the pocket of the average South Dakotan, opting for the grocery tax, at least in the short term, may have proved a better choice.
Sales tax cut keeps effective, stable tax system in place
Unlike a carve-out of food or any other class of goods or services, lowering the overall sales tax rate keeps in place a major strength of the South Dakota taxation system, which, despite a low overall rate and relative regressivity, has some of the highest and most predictable sales tax collections in the country.
“Although we don't have an income tax, we have a very broad-based sales tax, which also applies to many services and acts as almost a pseudo income tax on transactions,” Gerrish, who focuses on the adequacy and efficiency of tax systems in his finance research, told Forum News Service. “And most tax economists want a broad-based sales tax because everything applies and, for example, businesses can't evade the tax by categorizing certain sales as services.”
That reality played heavily into the House’s decision.
“We really looked hard at the mechanics of each of [the cuts]: the incidence and the amount,” House Majority Leader Will Mortenson, of Pierre, told reporters at a Feb. 23 news conference. “And ultimately it was a real priority in the House Republicans that we have a broad tax base and low tax rates.”
Cutting the sales tax on food could make state revenue more volatile and, according to Gerrish, potentially lose the state more dollars than anticipated due to some unforeseen business practices under the new rules.
“Say you go to a restaurant and they sell you a salad to-go. The question is, is that prepared food or a grocery?” Gerrish said. “Right now the business doesn't have to think about that, they charge you the same amount of money no matter what. But if you exempt groceries, now these businesses that were categorizing that as prepared food, they have an incentive to categorize that as groceries.”
Another benefit, in Gerrish’s mind, is the flexibility it offers the state in the event that revenues are not as high in the future.
“It’s probably easier to return to 4.5% [than to add back the full grocery tax] if it turns out we don't have a structural surplus,” he said.
Grocery tax potentially superior for average South Dakotan
In pushing the ultimately doomed grocery tax, Gov. Kristi Noem and others in her administration made the case that her preferred tax cut was better for average South Dakotans.
“It’s my job to get up every single day to look at the hard-working people who live here, who go and buy groceries and see what I can do to help them keep more dollars in their pocket,” she told the House Appropriations Committee on Feb. 21.
To think about why the grocery tax cut would potentially be a better option from the perspective of most families and individuals in the state, it’s worth doing a bit of math.
In a world where the Gov. Kristi Noem-backed grocery tax passed, a family that buys $100 worth of groceries pre-tax would be saving $4.50.
Under the overall sales tax reality, that family would have to spend $1,500 on goods prior to tax to save that same amount.
Essentially, any entity that spends more than 1/15th of its income on groceries would save more money under Noem’s tax proposal, and vice versa with a budget spending less than that, likely, but not exclusively, belonging to businesses and higher-income families.
A variety of data sources indicates that the average South Dakota family would be better off, in terms of tax savings, in the grocery tax scenario, since a majority of lower and middle-income families and individuals in the state spend more than 1/15th — or about 6.7% — of their budget on groceries.
“It’s probably accurate that spending on groceries isn't linear with income,” Gerrish said. “The more income you have, you don’t necessarily spend more money on groceries. You go out to eat, spend money on prepared food or, at some point, you only can consume a certain amount of food.”
According to the USDA, in 2021, households in the lowest fifth of income spent about $4,800 on food, about 30% of their spending. Households in the highest fifth spent around $14,000 on food, representing 7.6% of income.
In the middle fifth of income, spending on food was about $7,500, around 12% of total spending.
Yet those numbers might be partially misleading about exactly how much these households spend on unprepared food items, the category covered by the grocery tax cut.
According to the Bureau of Labor Statistics, the average family in the Midwest spends about 65% of their food budget on “food at home,” a close approximation of the items covered by the sales tax on food, though that percentage also shifts up and down the income scale.
“[The grocery tax] generally would be a larger sales tax savings for what I would call middle to low-income families, not actually the lowest income families,” Gerrish said.
The reasons for this observation are two-fold. First, families and individuals with the lowest incomes are more likely to enroll in supplemental nutrition programs, which are tax-free.
Second, according to Gerrish, those with the lowest incomes are more likely to be unable to prepare food at home, making it more likely for them to opt for cheaper prepared foods, which are still taxed under the grocery tax proposal.
While the savings might be more robust in a vacuum in the grocery tax world, Rep. Chris Karr, of Sioux Falls, the main backer of the overall sales tax cut in the House, said his proposal would spur economic activity among all businesses and end up helping families on top of direct savings.
"This impacts households and businesses, which is going to impact everybody," Karr said. "If a business saves money that's going to get passed on to the consumers as well. So this is good for everybody. It's a huge trickle effect."
Jason Harward is a Report for America corps reporter who writes about state politics in South Dakota. Contact him at 605-301-0496 or firstname.lastname@example.org.