The Effect of the Sales Tax on Retail Prices and Employment: Evidence from Exemptions on Clothing

Using frequent state and local policy revisions of apparel tax exemptions in Connecticut, New York and Vermont, I study how the sales tax affects the retail market for apparel. First, I present new evidence on the effect of the sales tax on pre-tax prices, the pass-through rate. Unlike the previous literature on this topic, I employ detailed item-level data on prices, use large good-specific changes in the tax rate and explicitly control for policy endogeneity related to business cycles. Using triple-difference IV estimation, I find that the pass-through rate is generally small and negative. This implies that consumers fully bear the burden of the sales tax with some exceptions. The burden partially shifts onto suppliers for certain apparel groups—non-seasonal goods, girls apparel, and footwear—with arguably higher elasticities of demand. The almost full shifting onto consumers is surprising given the well-documented fact that the demand for apparel at local stores is quite elastic. The lack of response suggests even more elastic supply and also that equilibrium output and, hence, inputs should decrease in response to a tax increase. I use the Quarterly Census of Employment and Wages along with apparel exemptions and estimate that county employment in the retail apparel sector decreases by 0.40% following a one percentage point increase in the sales tax. This effect indicates that a 4% sales tax exemption in New York State leads to about 2,150 new jobs, which is approximately the average county employment in this sector. To my knowledge, this is the first evidence of a strong connection between sales tax and employment. Finally, using the Consumer Expenditure Survey data, I find that a 5% sales tax rate generates a 17 average deadweight loss for every tax dollar collected.