Would Clothing Sales Tax Cuts
Pay For Themselves?

The Independent Budget Office (IBO) has analyzed a legislative proposal contained in New York City's recently adopted budget for fiscal year 1998 and currently under consideration in Albany that would eliminate sales taxes on apparel items priced under $500. Clothing purchases in New York City are now subject to an 8.25 percent sales tax, composed of a 4 percent City tax and a 4.25 percent State tax (which includes a 0.25 percent surcharge for public transit). This analysis measures the potential economic and secondary tax revenue impacts that would result if all or part of under-$500 clothing sales taxes were eliminated in New York City. Our principal findings are:


Retail clothing sales in New York City are now subject to a 4 percent City sales tax, a 4 percent State sales tax, and a 0.25 percent Metropolitan Commuter Transportation District (MCTD) sales tax. The centerpiece of the City's 1998 tax program is a proposal to eliminate (effective December 1997) all sales taxes on apparel items priced under $500. Under the proposal, New York State would enact legislation that would permit localities to eliminate their sales taxes on items priced under $500, and the State would drop its own sales tax on such items as well.

There are two main arguments offered in favor of this proposal. First, it would provide especially strong tax relief to lower-income households, who spend a greater share of their incomes on clothing; this would make the overall sales tax burden less regressive. Second, the clothing exemption would increase New York's retail competitiveness, especially with respect to New Jersey, which already exempts clothing from its sales tax. This would give a boost to the City's entire economy. It has been suggested that this economic impact may be very large, leading to overall increases in City tax revenues large enough to offset a substantial portion of the direct costs of the exemption.

To date, there has been little quantitative analysis of these feedback effects. In this fiscal brief, IBO provides both a reestimate of the direct cost of the City clothing tax exemption and an estimate of the secondary economic impacts and offsetting revenue gains that might reasonably be expected to result from the proposed tax cut.

The major finding of this fiscal brief is that the proposed clothing sales tax cut would increase New York City economic activity, but not nearly enough to have the tax cut pay for itself. Secondary City tax revenue increases attributable to the impact of both City and State sales tax reductions would offset no more than 14 percent of the direct City cost of the tax cut.

The first section of the fiscal brief presents IBO's reestimate of the direct City cost of the proposed reduction in retail sales taxes. The next several sections are based on the assumption that all under-$500 clothing sales taxes are eliminated statewide. The effect of the City sales tax cut on sales, output, and secondary City tax revenues is examined first, followed by the effect of the State sales tax cut on City tax revenues. The next section covers the effects of City and State sales tax cuts on State tax revenues. The fiscal brief also examines alternative scenarios, including one in which New York City eliminates its under-$500 clothing sales tax but other New York localities do not. The brief concludes with a summary of IBO's major findings and raises important issues for further consideration.

Direct Cost Estimate

IBO's direct cost projection is based on product sale data provided by the U.S. Bureau of the Census and New York City Department of Finance's estimate 91 percent of clothing sales receipts are from items costing under $500. Adjustments are made to account for clothing sales that are currently untaxed (such as sales of items delivered out of the City) and for anticipated marketing responses to the new tax exemption (repackaging more expensive ensemble items to take maximum advantage of the exemption).

Our projection also takes into account difficulties that merchants would have in raising prices when such increases would push items over the exemption threshold. Consumer resistance would come from the very high marginal sales tax rates for items priced at or slightly over $500. (At the extreme, a price change from $499 to $500 would incur a sales tax change from $0 to $41.25-a marginal tax rate of 4125 percent!) As a result, the share of sales going to items priced under $500 is projected to remain roughly constant over the first few years following implementation of the exemption, instead of declining due to inflation.

Given these data and assumptions, IBO projects that under-$500 taxable apparel sales in New York City will be $6.9 billion in 1998, rising to a little under $7.6 billion in 2001. Based on this, IBO forecasts that the proposed City sales tax exemption for clothing under $500 would directly reduce New York City sales tax revenues by $161 million in 1998 and $285 million, $294 million, and $303 million over the following three years. IBO's direct cost projections are slightly higher than the estimates contained in the 1998 adopted budget and financial plan.

Although growing price distortions at the $500 exemption threshold would ultimately force retailers to make price adjustments lowering the exempt share of total clothing sales, these adjustments would not remove the price distortions around the exemption cutoff. Indexing the exemption cutoff for inflation would mitigate some, but not all, the problems associated with the exemption cap. One alternative would be to impose sales taxes on just the additional sales value of items priced over some inflation-adjusted threshold. (For example $100 of a $600 item would be taxed, $150 of a $650 item, and so on.) By taxing just the additional sales, the marginal rate spike problem would be avoided and price distortions would be reduced.

Secondary Impacts: An Overview

The rest of this fiscal brief analyzes the secondary impacts of the proposed clothing sales tax cuts, first on sales, then on economic output, and then on taxable transactions, incomes, and wealth. The analysis holds the level of government outlays (and the economic impact of those outlays) constant while the level of taxes (and the economic impact of taxes) changes.

The immediate effect of the sales tax cut would be to lower the after-tax price of under-$500 apparel purchased in New York City. This would impact consumer expenditures in three ways. First, it would enable consumers to buy more for their money-in effect, increasing the real income of those consumers. This income effect would raise overall sales of consumer goods and services. (That is, sales would be higher in New York City and at least as high as before in the rest of the metropolitan region.)

Second, the clothing tax cut would make under-$500 apparel a better buy relative to other goods and services sold in the City. This substitution effect could shift some consumer spending away from other goods and services to apparel, but it would not substantially change the overall volume of sales in New York City or in the metropolitan region.

Finally, the sales tax cut would also make apparel sold in the City less expensive relative to apparel sold elsewhere in the region-except, of course, in other localities that are also cutting clothing taxes. This additional substitution effect again would again hardly change the overall level of sales in the metropolitan region, but it would increase sales in New York City by giving the City a larger share of regional apparel sales.

If there were no substitution effects, the income effect produced by the clothing sales tax cut would raise consumer expenditures in New York City by about as much as the City is losing in sales tax revenues, and these new expenditures would generally follow current patterns of consumer spending by City residents. However, because of the first substitution effect, a roughly equivalent amount of spending is likely to be shifted within the City from other goods and services to under-$500 apparel. The net result of this is that there would be little new spending on anything other than apparel. Then with the added impact of the second substitution effect, the total increase in retail apparel sales in New York City would be larger than the direct cost of the clothing tax cut.

Retail markets are largely local or regional markets. This sets an outside limit-ultimately given by the total income in a region-to the sales increases or shifts that can follow a local sales tax cut. The critical issue in terms of the overall economic impact of the proposed clothing sales tax cut is how large the second substitution effect would be, that is, how much apparel sales would be shifted from the rest of the metropolitan region to New York City after the cut.

The potential for a significant intraregional shift is suggested by the present clothing sales "gap" between New York City and New Jersey. In 1992, northeast New Jersey accounted for 33.8 percent of total resident personal income in the New York City metropolitan area and 36.6 percent of total apparel sales, while New York City itself had 41.6 percent of the region's resident personal income and only 38.4 percent of the apparel sales.

New Jersey's disproportionately large share of the region's total clothing sales is often cited as evidence of the competitive cost advantage provided by its own clothing sales tax exemption. If the sales tax differential is the entire reason why the City is losing apparel market share to New Jersey, then fully eliminating the City's 8.25 percent sales tax would get the City a total apparel sales increase of 11.85 percent-that is, 8.25 percent in new apparel sales from the income effect (modified by the first substitution effect), plus another 3.6 percent in sales shifted into the City by the second substitution effect. In short, every $1.00 cut in the sales tax would raise under-$500 apparel sales by $1.43. (11.85 percent 8.25 percent 1.43.) With the additional sales shifted from New Jersey, the latter's sales tax advantage and disproportionate apparel sales share would both be eliminated.

There are several reasons why this may overestimate the potential for increasing New York City apparel sales. For one, insofar as the City's clothing sales gap reflects differences between after-tax retail apparel costs in New York City and New Jersey, the sales tax differential is not the only source of the City's disadvantage. Retail labor costs are also substantially higher in the City. In 1992, total retail labor costs accounted for approximately 15.9 percent of apparel retail sales revenues in New York City, compared with 13.4 percent of apparel retail sales revenues in New Jersey. New York City retailers also have higher real estate costs (including commercial property taxes) and higher utility costs (including utility taxes).

Perhaps even more telling, New York City suffers a comparable clothing retail sales "gap" versus Long Island, which has 15.9 percent of the region's personal income but accounts for 17.5 percent of clothing sales. Yet Long Island's 8.5 percent sales tax rate is actually 0.25 percentage points higher than the City's. (Again, retail labor costs on the Island are-as in New Jersey-only 13.4 percent of apparel sales revenues, substantially lower than in the City.)

Beyond the matter of differences in nontax retail costs, New York City's retail sales gaps (in apparel and elsewhere) also highlight the importance of store competition around things like selection and convenience in determining market share. All this makes it extremely unlikely that the sales tax cut alone would "level the playing field" for New York City apparel retailers. While this does not absolutely rule out 11.85 percent growth in apparel sales following elimination of the clothing sales tax, it makes the prospect of any increase larger than that unlikely.

City Tax Cut Impact on Sales and Output

The next two sections consider only the potential secondary impacts of the City's portion of the sales tax cut. It is assumed here that under-$500 clothing taxes are eliminated in other New York localities at the same time they are eliminated in the City. This means that after-tax apparel prices in the City would fall relative to prices in New Jersey (and in Connecticut), but not relative to prices on Long Island or elsewhere in New York. This assumption is relaxed in the section on alternative scenarios.

On the assumption that New York City apparel sales would rise 11.85 percent when all clothing taxes are eliminated, cutting the 4 percent City sales tax itself would yield a 5.75 percent sales increase (4 percent x 1.43 5.75 percent). Lines 1-3 in Figure 1 show the results of assuming a sales impact of that magnitude. For 1998, 5.75 percent growth in under-$500 apparel sales would work out to a $231 million sales increase, including $161 million generated by the income effect and $70 million shifted to the City by the substitution effect.

Figure 1.
Proposed Sales Tax Exemption for Clothing Purchases Under $500: Impact of City's Share of Tax Cut on Sales and Output in New York Citya (In millions of dollars)

 RIMS II multipliers 1998 199920002001
Impact on apparel sales and output  
(1) Net new sales (from income effect)   161 285 294 303
(2) Sales shifted into NYC (from substitution effect)   70 124 127 132
(3) Total change in NYC sales receipts   231 409 422 434
(4) Retail marginb   97 171 176 182
(5) Wholesale margin   15 27 28 29
(6) Transportation costs   1 2 2 2
(7) New local merchandise valuec   20 35 36 38
(8) Total change in local value addedb   133 235 243 250
(9) Memo: new imported merchandise valuec   62 111 114 117
Multiplier impacts on total output:  
(10) Retail marginb 1.6686 161 286 294 303
(11) Wholesale margin 1.5727 24 43 44 46
(12) Transportation costs 1.9018 2 3 3 3
(13) Local merchandise value 1.6534 33 59 60 62
(14) Total change in NYC outputb 1.6567 220 390 402 414

Sources: Independent Budget Office; U.S. Department of Commerce, Bureau of Economic Analysis.
Notes: a) Assumes government outlays held harmless as taxes are cut. Does not include additional impacts of concurrent State sales tax cut on New York City sales and output.
b) Excludes indirect business tax prtion of retail sector output.
c) New output and new producer value from the income effect only: the substitution effect shifts existing output.

In 1999, the first full year of the tax cut, sales would rise $409 million, including $124 million shifted mainly from New Jersey. By 2001, the increase in sales associated with the City clothing sales tax cut would be $434 million, including $132 million recaptured from New Jersey.

Output multipliers for New York City are provided by the Regional Input-Output Modeling System (known as RIMS II) constructed by the U.S. Department of Commerce's Bureau of Economic Analysis. These multipliers measure the additional impacts on City economic output of an initial change in output in a given sector. In the case of an initial change in retail sales, however, an output multiplier should not be applied to the entire increase in sales revenue. Rather, it must be applied specifically to the portion of the increase in sales revenue representing locally produced output or value added. This includes the value of the local retail, wholesale, and transportation inputs used in the new sales of apparel merchandise in the City, plus the value of the merchandise itself if it has been newly manufactured in New York City.

Altogether, local value added makes up about 61 percent of current apparel sales revenue in New York City, and it would make up the same share of new apparel sales generated by the income effect. The retail margin (the difference between what retailers pay for merchandise purchased for resale and what they receive upon final sale) is almost 42 percent of apparel sales and wholesale and transportation costs are about 7 percent. Products manufactured by the City's own clothing industry comprise another 12 percent. The non-local value added remainder comes from imports of apparel merchandise produced elsewhere. The portion of increased local retail sales revenue that pays for imports does not add to the gross product of New York City but rather to the gross products of the exporting regions.

In the case of apparel sales shifted into the City by the second substitution effect, no new manufacture of merchandise (either local or nonlocal) is actually involved; the additional sales of locally manufactured goods in New York City is merely the counterpart of reduced sales of those same goods elsewhere in the region. Therefore the local value added share of these shifted sales is just the 49 percent of the sale price representing local retail, wholesale, and shipping costs.

For the entire sales increase resulting from both income and substitution effects, the weighted average local value-added share is 58 percent of total sales revenues, of which locally made apparel goods contribute about 9 percent. As shown in lines 4-8 of Figure 1, the local value added shares of new sales add up to approximately $133 million in 1998, $235 million in 1999, and $250 million in 2001.

The 1995 multipliers for the retail, wholesale, transportation, and locally produced apparel components of apparel sales are shown on lines 10-14 in Figure 1. Applying these multipliers to the respective local output shares of new sales, the total private output increase in New York City would be approximately $220 million in 1998, $390 million in 1999, and $414 million by 2001 (Figure 1, line 14).

City Tax Cut Impact on Revenues

IBO's estimate of the impact of increased economic output on City revenues is based on forecasts of overall City tax revenues and changes in revenues relative to Gross City Product (GCP). Gross City Product is a measure of the total value of goods and services produced in New York City and is the basis of the transactions, income, and wealth taxed in New York City. Excluding under-$500 clothing sales taxes, New York City will collect about $5.15 in taxes for every $100 in Gross City Product (GCP) in 1998.

However, secondary revenue impacts from the sales tax cut would initially be smaller relative to new output, with new revenues rising from $3.30 per $100 added output in 1998 to $4.10 in 2001. Secondary revenue impacts would be relatively small in the short run because, as noted above, there are lags between changes in economic output and corresponding changes in tax collections.

The lags between expansion of output and growth in tax collections would be shortest in the case of transaction taxes (sales and excise taxes) and longest in the case of wealth-related taxes (real property taxes). In the latter case, rise in calendar year 1998 market values would be reflected in the January 1999 assessment roll which would, in turn, not begin to impact billable values and actual collections until fiscal year 2000. However, only a small fraction of the impact of the calendar 1998 market value increase would actually be felt in fiscal year 2000 because over two-thirds of all taxable assessed value changes are subject to a five-year phase-in-and most of the remainder are subject to caps. Thus even if increases in economic activity in 1998 lead immediately to increases in real estate market values, a 1998 market value increase would not be fully reflected in property tax collections until 2004.

Figure 2.
Proposed Sales Tax Exemption for Clothing Purchases Under $500: Direct Costs and Secondary Revenue Offsets in New York Citya (In millions of dollars)

 1998 1999 2000 2001
City tax cut cost and revenue offsets  
(1) Direct cost of City sales tax cut -161 -285 -294 -303
(2) City revenue offset from City sales tax cut 7 13 15 17
(3) City cost net of offset from City sales tax cut -154 -273 -279 -285
(4) City revenue offset from State sales tax cutb 8 13 16 18
(5) City cost net of all revenue offsets -146 -259 -264 -267
State tax cut cost and revenue offsets in NYC  
(6) Direct cost of State sales tax cut in NYC -171 -303 -312 -321
(7) State revenue offset from State and City tax cuts in NYC 26 443 45 46
(8) State cost of NYC net of all revenue offsets -145 -259 -268 -275
Total tax cut cost and revenue offsets in NYC  
(9) Direct cost of City and State sales tax cut in NYC -332 -589 -607 -624
(10) Revenue offsets from State and City tax cuts in NYC 41 70 75 81
(11) City and State costs in NYC net of all revenue offsets -292 -518 -531 -543

Source: Independent Budget Office
Notes: a) Assumes City and State government outlays are held harmless as taxes are cut.
b) State sales tax includes Metropolitan Commuter Transportation District surcharge.
Line 9 = line 1 + line 6. Line 10 = line 2 + line 4 + line 7. Line 11 = line 5 + line 8.

Once the increases in property tax collections are fully phased in, total secondary revenue impacts would actually be 10 percent larger in proportion to output than overall tax collections. This is because total GCP includes government sector output (which is substantially tax-exempt), whereas the local gross product increases connected with the rise in apparel sales would consist entirely of private sector output (which is substantially taxable).

As Figure 2 (line 2) shows, all this translates into modest but significant offsetting secondary revenue increases-$7 million (4.5 percent of the direct cost of the City sales tax cut) in 1998, $13 million (4.4 percent of the direct City cost) in 1999, and $17 million (5.6 percent of the direct City cost) in 2001. In 2005, the offset would rise to $24 million, 6.7 percent of the projected direct cost of the City sales tax cut.

Impact of State Sales Tax Cut

The previous section looked at the economic and secondary revenue impact of the City's portion of the clothing tax exemption. The proposal, however, calls for eliminating all sales taxes on clothing priced under $500. There would be an additional boost to the City economy from the accompanying State sales tax exemption. This would also produce tax revenues for the City, but it is important not to lump these into the calculation of the secondary offsetting gains from the City tax cut. To do so would exaggerate the "dynamic scoring" capacity of City tax reductions.

State tax cut impact on City tax revenues. The analysis of the impact of the State sales tax exemption largely follows the analysis of the secondary revenue impact of the City exemption. The City revenue offsets from the State exemption would be a little larger than the offsets from the City tax cut itself, since the combined State and MCTD sales tax rate (4.25 percent) is higher than the City sales tax rate (4 percent); thus the State/MCTD exemption would generate slightly more new sales revenue and output in New York City.

As before, lags between economic expansion and increases in tax revenues cause City revenue offsets from the State reduction in sales taxes to increase over time, rising from almost $8 million (4.8 percent of the direct City cost) in 1998 to $18 million (6.0 percent of the direct cost) in 2001 (Figure 2, line 4). As property tax revenue impacts are fully phased in, there would be a further rise in revenue offsets to $25 million in 2005 (7.1 percent of direct City costs).

Combined City and State tax cut impact on City revenues. IBO estimates that in 1998 the combined effects of City and State clothing tax exemptions would increase City sales receipts by about $477 million, including $145 million shifted mainly from New Jersey. In 1999, the sales increase would be $844 million, including $255 million in sales recaptured from New Jersey. By 2001, total sales would be up $896 million, with shifted sales contributing $271 million.

Given the proportions of local value added in New York City clothing sales, these sales increases would encompass increases in apparel-related City output of $274 million in 1998, $486 million in 1999, and $515 million in 2001. This in turn would yield increases in total City output in these three years of $455 million, $805 million, and $853 million.

A comparison of tax cut impact estimates: IBO and EDC

The New York City Economic Development Corporation (EDC) has stated that new economic activity generated by the clothing tax exemption would enable the City to recover nearly 40 percent of the direct costs of the tax cut. IBO's estimates of the impact of eliminating under-$500 clothing sales taxes on New York City sales, economic output, and tax revenues are all considerably lower than the estimates provided by EDC. The sales increase estimates derived from EDC's model are almost a fifth larger than IBO's (close to $1.1 billion versus just under $900 million in 2001); the output increase estimates two-thirds larger ($1.4 billion versus $850 million in 2001); and EDC's secondary revenue impact estimates are nearly three times the size of IBO's (38.6 percent of direct costs versus 13.9 percent when revenue impacts are fully phased in).*

EDC's sales impact estimate is larger because their model assumes a higher percent increase in apparel sales for every 1 percent reduction in sales tax rates in the City. EDC's 1.7 tax elasticity is taken from the Washington State Excise Tax Noncompliance Study. But that estimate was for all retail trade; when analyzing the effect of sales tax differentials on major components of retail, the Washington study detected high impacts for durables and autos but found that "for the case of apparel sales, however, there is not sufficient statistical evidence that Washington border counties lose sales to the lower tax states."** IBO's more conservative assumptions regarding the responsiveness of sales to changes in clothing tax rates are more in line with this finding.

In estimating the impact of increased clothing sales on overall economic activity in the City, EDC uses a smaller multiplier than IBO, but applies it to the entire change in sales. This exaggerates the local impact of the sales tax cut because, as noted above, over two-fifths of the value of apparel sold in the City is non-local output.

Finally, EDC's estimates of output and tax revenue growth imply over $8.20 in new City tax revenues for every $100 in new output. This is far higher than the 1998 City average of $5.15 in tax revenues for every $100 GCP. After all property tax impacts are phased in, the tax cut should yield slightly higher than average tax revenues per $100 new output (since this new output would be entirely private sector output)-but not more than one and a half times higher than average. It is not clear how new economic activity could generate so much more tax revenue than an equivalent amount of existing economic activity.

* The EDC model is presented in Economic Benefits of Reducing the Sales Tax on Retail Clothing in New York City (New York City Economic Development Corporation, January, 1997). That report estimates the impact of a 4 percent clothing sales tax reduction; the results have been adjusted to the case of a full 8.25 percent clothing tax reduction.

** Brown, Lorrie Jo, "The Effects of Tax Rate Differences on Retail Trade in Washington Border Counties" (appendix D of the Washington State Excise Tax Noncompliance Study, Washington State Department of Revenue, 1990), p. D4.

Based on these increases in economic output, the total City revenue offset to the direct cost of the City tax cut-the offset generated by the City exemption plus the offset generated by the State exemption (line 2 plus line 4 in Figure 2)-would be $15 million in 1998 (9.3 percent of direct City costs), $26 million in 1999 (9.1 percent of direct City costs), and $35 million in 2001 (11.6 percent of direct City costs). Net of all revenue offsets, the clothing sales exemption would cost the City $146 million in 1998, $259 million in 1999, and $267 million in 2001 (Figure 2, line 5). The total secondary revenue offset would recover $54 million, 13.9 percent of direct City costs, in 2005.

Tax Cut Impact On State Tax Revenues

Just as the City's increased economic activity from both City and State sales tax cuts would have secondary impacts on City tax revenues, thereby offsetting direct City tax cut costs, so it would also have secondary impacts on State revenues, thereby offsetting direct State tax cut costs. A full analysis of the fiscal effects of the tax cut should include-but carefully distinguish between-the impact of City and State tax cuts on both secondary City tax revenues and secondary State tax revenues.

Lines 6 through 8 of Figure 2 show how the stimulation of the New York City economy by City and State sales tax cuts would effect State tax cut costs. Since the State is projected to collect slightly more revenues per $100 output than the City, the State revenue offset is proportionally a little larger than the City revenue offset. Since the State does not have a property tax, the State offset is also less lagged than the City offset.

Lines 9-11 of figure 2 show the total City and State direct sales tax exemption costs and offsetting revenue increases in New York City. By 2001, combined City and State revenue gains would offset 13 percent of combined direct City and State sales tax cut costs in New York City. After City property tax revenue impacts are fully phased in, the combined offset would be 14.1 percent of combined direct costs.

Alternative Scenarios

The Mayor has indicated that New York City will request legislative authority to go ahead with it's own clothing sales tax cut even if State sales taxes are not reduced. How this would effect retail sales and secondary revenue offsets in the City depends on whether or not other New York localities follow the City's lead and also cut their own sales taxes on clothing.

All localities cut clothing sales taxes. The impact on retail sales of a City sales tax cut is slightly smaller when the State sales tax is not also cut. When only local apparel sales taxes are reduced, the income and substitution effects from the City's tax cut would be unchanged, but some of the new spending on apparel in the City would be absorbed by State sales taxes on the increase in apparel sales. As a result, the increase in before-tax sales attributed to the City tax cut (as opposed to after-tax expenditures) would be not be as large. With a smaller increase in sales, the City sales tax cut impact on output and secondary City tax revenues would also be reduced-but only by a very slight margin.

Only New York City cuts clothing sales taxes. If other New York localities do not cut their sales taxes on under-$500 clothing, then the City sales tax cut would lead to recaptured sales from Long Island and the northern metropolitan region counties as well as from New Jersey. While the spending shift from New Jersey would result from eliminating sales tax differentials that serve to the disadvantage of the City, the shift from the surrounding New York counties would be the result of creating sales tax differentials favoring the City.

The size of the shift is a function of the impact of reduced New York City sales tax rates on after-tax price ratios under the different scenarios. When the before-tax apparel prices in the region are equal they can be set equal to 1. Then the after-tax price in the City is 1.0825 (one plus the clothing tax rate in New York City), the after-tax price in the rest of the metropolitan region is 1.0335 (one plus the weighted average tax rate in the rest of the New York-New Jersey region), and the after-tax price ratio is 1.0825 1.0335 = 1.0474. That is, after-tax apparel prices are, on average, 4.74 percent higher in New York City than in the rest of the region.

Figure 3.
Impact of Tax Cuts on Apparel Price Ratios and City Sales Under Alternative Scenarios

  (A) (B) (C) (D)
price in NYC
price in rest
of region
After-tax price
ratio (A / B)
shift of
sales to City
(1) Current sales taxes 1.0825 1.0335 1.0474  
Scenario I
(2) All State and local apparel sales taxes cut 1.0000 1.0000 1.0000  
(3) Percent change from current -7.62% -3.24% -4.53% 3.59%
Scenario II
(4) All New York local apparel sales taxes cut 1.0425 1.0171 1.0250  
(5) Percent change from current -3.70% -1.64% -2.14% 1.70%
Scenario III
(6) Only New York City apparel sales taxes cut 1.0425 1.0335 1.0087  
(7) Percent change from current -3.70% -0.00% -3.70% 2.93%

Source: Independent Budget Office
Note: a) Rest of region includes Long Island, metropolitan counties north of New York City, and northeast New Jersey.

Figure 3 illustrates the impact of alternative sales tax cuts on the price ratio and on New York City retail sales. Current after-tax prices in the metropolitan region and the price ratio are shown on line 1. Under the basic scenario in which all New York under-$500 clothing taxes are reduced to zero (Scenario I), the average price of clothing falls 7.6 percent in New York City (line 3, column A) and 3.2 percent in the rest of the metropolitan region (line 3, column B). This reduces the price ratio by 4.5 percent (line 3, column C), and on the assumption that this closes the City's retail gap with New Jersey, this corresponds to a 3.6 percent shift in apparel sales into New York City (line 3, column D).

When local sales taxes are cut statewide (Scenario II), a 4 percentage point New York City rate reduction is accompanied by a 2.1 percent decline in the apparel price ratio (line 5). Given the relationship between the change in the price ratio and the shift in sales assumed in the first scenario, the 2.1 percent drop in the ratio yields a 1.7 percent rise in retail sales (plus some additional spending absorbed by State taxes). This again consists mainly of sales recaptured from New Jersey.

When only the New York City sales tax is cut (Scenario III), the 4 percentage point reduction in the tax rate on under-$500 clothing sales now yields a 3.7 percent decline in the apparel price ratio (line 7). In line with our previous results, the 3.7 percent decline in the ratio corresponds to a 2.9 percent shift in City retail sales (again net of State taxes). The much greater sales shift in the third scenario as compared with the second reflects the additional spending that the City would capture from the metropolitan New York counties if they do not also cut their clothing sales taxes.

The key to this result is the fact that when only the City sales tax is cut, the percent reduction in the price ratio is as large as the percent reduction in the City price itself, whereas when all New York sales taxes are cut, or when local taxes are cut, the price ratio reduction is less than three-fifths as large as the City price reduction. Thus the impact of the City's tax reduction on relative apparel retail costs is significantly stronger when sales taxes are not cut elsewhere. The resulting rise in City retail sales would be $268 million in 1998 (including $113 million shifted from the New York and New Jersey metropolitan region counties), $474 million in 1999 (including $201 million shifted), and $503 million in 2001 (including $213 million shifted).

The accompanying secondary increases in City revenues would be $8 million (a 5.1 percent offset of the direct cost of the cut) in 1998, $14 million (5.0 percent) in 1999, and $19 million (6.4 percent) in 2001. By 2005, $27 million in fully-phased in secondary offsets would recover 7.6 percent of the direct City cost. Thus, leaving the State's clothing tax in place, the impact of the City clothing tax cut would be boosted by almost a fifth if other New York localities refused to cut their own clothing sales taxes.

Phased-in tax reductions. The State Senate has passed a bill (S.B. 2) including an alternative clothing sales tax cut proposal. Here, State and local sales taxes on under-$500 apparel would be phased out over four years. Incremental one percentage point reductions in the State tax (and proportionate reductions in local taxes) would start on June 1, 1998, and taxes on under-$500 apparel would reach zero on June 1, 2001. Thus, the first fiscal year in which under-$500 apparel would be fully tax exempt would be 2002. Under this scheme, the direct City sales tax cost would be $14 million in 1998, $86 million in 1999, $162 million in 2000, and $242 million in 2001. After 2001, the direct costs would be the same as under the proposal in the City's adopted budget.

Secondary City revenue offsets-from both City and State sales tax reductions-would be a little over $1 million in 1998, and rise to $23 million (9.7 percent of the direct cost) in 2001. By 2005, secondary revenue offsets would reach $45 million (12.8 percent of the direct City cost), which would be about $4 million less than under the Mayor's proposal. Given the phase-in of the tax reductions and the lagged response of property tax revenues to output increases, it would take until 2009 for the secondary revenue offsets under the Senate bill to reach the same level as under the City's proposal.


The above analysis shows that eliminating sales taxes on apparel priced under-$500 would increase New York City sales and economic output. The higher output would result in increases in other City tax revenues, although the full impact of these secondary tax effects would not be felt until 2005. Assuming that all taxes on under-$500 apparel are eliminated statewide, the full secondary tax revenue impacts from eliminating the City sales tax would offset about 6.7 percent of the direct cost of the tax cut. Secondary City revenue impacts from eliminating the State sales tax would offset another 7.1 percent of the direct cost of the City tax cut, for a total offset of nearly 14 percent.

In contrast, were New York City alone to eliminate its sales tax on under-$500 apparel, the secondary revenue impacts would offset 7.3 percent of the direct City cost. The higher impact of the City cut would result from apparel sales shifting to New York City from Long Island and upstate New York.

An important caution must be attached to all these results, however. The above analysis abstracts from any impact that sales tax cuts might have on the outlay side of State and City budgets. This might be justified for 1998, when the impact of the tax cut on the City's expenditure budget would be mitigated by the year-end budget surplus being rolled over from 1997. In subsequent years, however, tax cuts contribute to already large projected City budget deficits and increase the size of required gap-closing spending reductions.

Spending reductions mean less money paid to households from government payrolls, transfers, or purchases of goods and services. Thus, while a community's real disposable income is increased by cutting sales taxes, it is reduced by cutting government spending. Insofar as sales tax cuts required corresponding reductions in government outlays in New York City, we would have to assume much larger substitution effects-much larger sales shifts in response to the reduction in the tax differential between New York and New Jersey-to continue to obtain secondary revenue offsets as large as the ones we have estimated here.

Care must also be taken not to assume that the relatively modest economic stimulus and secondary revenue offsets projected here for the clothing tax reduction would apply to other tax cuts. The secondary impacts of the clothing sales tax cut are relatively modest because retail expansion is constrained by regional demand and because much of the additional output sold by City retailers after the tax cut is imported from outside the City rather than produced locally. Cuts in other City or State taxes could produce proportionately larger secondary fiscal impacts by generating greater increases in local value added.

Finally, although the clothing tax cut is not projected to pay for itself, it is important to emphasize that it may be desirable on other grounds, even when impacts on government outlays are considered. Other important benefits of the proposed tax cut include increasing tax equity and stimulating growth in jobs, both of which would especially aid lower-income New Yorkers. By providing an independent estimate of the fiscal impact of the proposed tax cut, IBO hopes to provide policy makers and the general public with the data required to make an informed decision.