SIOUX FALLS, S.D. (KELO) — Inflation isn’t always the bad guy when it comes to sales tax revenue.
The state of South Dakota depends heavily on sales and use tax revenue to pay for expenses in the general fund budget. Gov. Kristi Noem’s proposed fiscal year 2024 budget has 64% of the revenue for the general fund coming from sale and use tax.
So, as the cost of goods increases with inflation, more sales tax is collected. For example, if an item cost $50 and now costs $60, the state’s 4.5% sales tax would apply to that $60.
“When there is inflation in that charged cost to the customer, that would cause our sales tax to be higher,” said Kathryn Birkeland, the associate dean of the Beacom School of Business at the University of South Dakota. “High inflation should cause our sales tax revenue to go up. We would expect to see that in dollar terms.”
“In South Dakota, the biggest source of revenue is from our sales and use tax. The fact inflation was 9.1% during the last fiscal year, means that part of the increase in revenue in sales tax is a result of that. Inflation is mostly going to affect sales tax,” said Reynold Nesiba, an economics professor at Augustana University. Nesiba is also a state legislator from District 15 in Sioux Falls.
Specific to inflation and sales tax, prices rise before incomes rise, Birkeland said. So, for states like South Dakota, they see sales tax revenue increase as prices go up, Birkeland said.
For states that have more revenue generated from income tax, incomes don’t increase until after prices go up, Birkeland said.
The sales and use tax amounts for November of FY2023 are 14% higher than in November of FY2022, according to the South Dakota Bureau of Management’s financial report for December 2022.
Noem’s FY2024 budget projects $310 million in revenue growth.
Nesiba said over the past two years the state has seen higher levels of income which typically translate into higher expenditures which translate into more sales tax revenue in South Dakota.
The flip side of inflation is that it could decrease the consumer’s appetite for buying.
“Higher inflation can also discourage consumption and can have a negative effect,” Nesiba said.
If inflation causes consumers to reduce spending, sales tax revenue can decrease.
Birkeland said the Federal Reserve’s recent increase in interest rates is intended to slow down spending which helps to reduce inflation.
“Their entire purpose for raising the interest rates is to get people to spend less,” Birkeland said.
What if people do spend less in South Dakota and what does that mean for the governor’s budget?
Birkeland said eventually, the price of goods will grow slower but they won’t fall. It’s key to remember that prices won’t drop, she said.
The proposed state budget factors in inflation and projected spending, Birkeland said.
“We’ll probably still have reasonable 3% to 4% inflation probably through the end of 2024,” Birkeland “It’s not likely it’s going to slow down dramatically to 1%. That does give the Governor some reasonable assurance in how much we can estimate we can see in dollar terms of revenue in the coming years.”
“We are going to see slower wage growth, we are going to see slower job market growth, because that’s how it works at the federal level,” Nesiba said. “We would expect to see it reduce the number of job openings.”
Part of the slowdown will include job losses, even in South Dakota, Birkeland said.
While many workers may get a cost of living increase to help counter inflation, it doesn’t happen as quickly as inflation rises, she said.
The experience people have in terms of inflation will be different because of different sectors and different areas of the state, she said.
“I think we are in a better position in South Dakota to handle some of that pullback that the national economy is experiencing,” Birkeland said.
Birkeland said the state seems to have enough businesses that want to locate here and it’s not seeing the layoffs that are being experienced on the coasts and larger cities. Even if unemployment increases it will still likely be lower than the national average, Birkeland said.
“I think we have a mostly good system in South Dakota, we use two different approaches,” Nesiba said of how the state projects revenues and expenses.
The BFM is forward-looking at job growth and other factors and do an estimate of sales tax revenue. The Legislative Research Council uses a backward-looking model to predict from what’s happened in the distant and more recent past, Nesiba said.
The forecasts for the last couple of years have “been way too low” but the use of two methods is still a good process, he said.