The exemption of food from the state sales tax is lauded and maintained because it mitigates the regressivity of the sales tax. This may in fact be the case, but it's a poorly targeted remediation that is a massive drain on state revenues.

In 2005, states collected $213 billion in sales tax revenue. According my back-of-the-envelope calculations (based on data from the Consumer Expenditure Survey), the food exemption costs state governments some $22 billion per year. This represents more than 10 percent of sales tax revenues. And of that $22 billion, $9.4 billion goes to households earning more than $70,000. Furthermore, these upper-income households ($88,774 is the threshold of the top income quintile) represent about 30 percent of all households yet receive over 40 percent of an exemption that is intended to benefit lower-income households.

But this is a bit of a sticky wicket for state policy makers. In order to preserve this element of progressivity in the overall tax scheme, the removal of the exemption would have to be replaced by either a tax credit or a spending program targeted to low-income families. And this is of course the object of progressive fiscal policy - the transfer of wealth from those who need it least to those who need it most. Unfortunately, it's the former who are more effective in seeing their policy preferences expressed in the political system.

I offer no solutions today, only a chart.

Click on image to enlarge

On Oct. 31, President Bush signed the seven-year extension of the state and local Internet access tax moratorium, an issue we've written about here, here, and originally here.

In that original blog, Cybertax: A Digital Divide of Historic Proportions, we quoted Mark Murphy, Fiscal Policy Analyst , Department of Research and Collective Bargaining Services of American Federation of State, County and Municipal Employees (AFSCME), as follows:

As our economy and society evolves. [B]y definition more and more economic activity will be innovative and advanced. It cannot all be made tax-exempt. One can imagine that if this approach to tax policy had been taken earlier in our history, then manufactured goods, or the automobile and gasoline, or airline service would be 'tax free,' while only agriculture would be left to bear the tax burden.

But the debate on the premise of barring state and local taxation of companies providing internet access never materialized in Congress. Instead, an NFL record for longest extension of a tax moratorium may have been set, when a "compromise" seven-year extension was agreed upon by the House and Senate, after the chambers had previous insisted on four and six years, respectively.

Nevertheless, there are some silver linings in the conclusion of this round of the moratorium. The new law: