Did Distortionary Sales Taxation Contribute to the Growth of the Service Sector?

Since the 1950s, the sales tax has become much more widely used as a source of state government revenue and the average sales tax rate has greatly increased. During this period, the service sector has grown rapidly relative to other sectors of the economy. We hypothesize that increased sales taxation has played a role in the growth of the service sector, because states typically exempt sales of services from the sales tax unless explicitly enumerated, while final purchases of goods are taxed unless explicitly exempted. Our empirical results suggest that increased sales taxation is responsible for as much as one-third of the decline in the retail sector and one-eighth of the increase in the service sector during the 1982-92 period.