Tax Policy

As of July 1, the city of Chicago now has the highest tax rate of any major city.  The general sales tax on all nonperishable goods was raised to 10.25%.  Illinois sales tax law mandates a general 6.25% sales tax, with 5% going to the state, 1% going to the city, and 0.25% going to the county.  Chicago is permitted to charge additional sales taxes on top of this level.  In addition, Chicago has an incredibly convoluted list of other random taxes that can be found here.  There is, for example, a $1 tax on every new tire sold, and an additional 1% tax on food and beverages sold in the downtown area.

It is easy to lambaste such a list of taxes as being arbitrary and excessive, when in fact there may be legitimate reasons for having obscure taxes to correct specific externalities.  It is also easy to accuse the local government of inefficiency and waste.  But while I am often sympathetic to higher taxes, I sincerely doubt that Chicago's taxation can be justifiable.  Firstly, although any large city needs to have many services to support infrastructure, education, and the urban poor, other major cities like New York City, Los Angeles, or Boston do this with a lower level of taxation.  It is not clear that Chicago does a better job than any of these other cities at providing basic services.  In fact, there is evidence that it may do a worse job: the city's notorious experiences with police brutality and public housing are just a couple examples.  Additionally, although governments are always accused of inefficiency and corruption, there is very strong evidence that Chicago is more than a standard deviation or two above the mean.  The fact that the second Richard Daley is now in his 6th term is alone cause for some concern, aside from the regular charges of corruption levied against his administration.

Beyond the simple question of whether taxes need be so high, there is the question of whether they are assessed in the correct manner.  This is largely a normative issue, but it is worth describing so that the reader can form his own opinions.  There is considerable economic evidence that consumption taxes are favorable to income taxes.  So Chicago has done well in this regard.  For whatever reason, people in the US generally favor a strongly progressive tax structure.  Chicago's tax code would seem to be quasi-progressive.  Since poor people spend a large amount of their income on food and consumables, which is taxed very minimally on average (the rates are very complicated: I pay a tax on some food items, none on most food, and a different tax rate on soap, and a different tax rate on clothes), they pay very little in taxes.  The middle class spend most of their income, but much of it is spent on non-perishable goods.  The wealthy have a much higher savings rate than other income brackets, so they probably pay a lower effective tax rate on the middle class.  On the one hand it is surprising that the middle class would pay the highest tax rate, given that this is generally politically unpopular.  On the other hand is should not be surprising because they are probably the most politically under-represented income group in Chicago.

My final critique concerns transparency.  As I have already alluded to, Chicago has a very convoluted tax code, with multiple tax rates applying to different items in different places.  One of the benefits of having a consumption tax is that they are generally very transparent to the consumer.  But this benefit is largely lost in the Chicago system.  It is unlikely that most taxpayers know all of the rates for various items.  I spent about 30 minutes looking for a comprehensive listing of sales tax rates, and it was not even clear to me what the structure was.  Moreover, the tax code is frequently irregular and irrational.  The city charges a $0.05 tax on every bottle of water sold, but a 13.25% tax on soda.  It is completely unclear why one is an excise tax and the other is an ad valorem tax.  If the motivation for the law were to internalize environmental externalities, then both would have a similar tax, with soda perhaps taxed at a higher rate.  But a $0.50 can of soda has a $0.07 tax, while a $0.50 water has a $0.05 bottled water tax plus a 2.25% tax of about $0.01 cents for a total of $0.06 tax (such prices are attainable by buying in bulk).  

It would be interesting to see what the economic effect of Chicago's taxes are.  Unlike a state sales tax increase, municipal sales tax increases may actually have an even more adverse effect on local economies.  It seems that the costs of moving a business across a city boundary or opening a shop in across the street from Chicago in Evanston instead of in the far north side are much less than moving a business to another state.  Since businesses can keep all of their same customers and employees by relocating or expanding just outside Chicago instead of just inside, the economic effects of local sales tax hikes may be as negative as they come.  Indeed, this event would serve as a very interesting natural experiment to test the effect of sales tax on economic activity.  I'm sure this has been done before, but perhaps not on the municipal level where sales taxes are generally not levied.