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April 2000
Volume 18, Number 4

The End of Sales Tax

by David Laband and Richard Ault

The Virginia legislature has been toying with the idea of curbing or even abolishing sales taxes. The idea comes in response to merchants who fear that they are losing because of the availability of untaxed goods purchased over the web. Whether big changes in the tax code happen this year or five years from now, clearly the battle over net taxation has just begun.

Proponents of taxing the net argue that retail stores will lose business and be at a disadvantage if they are taxed and e-commerce is not. This is indisputably correct. Opponents respond that taxation would restrict web-based sales and stunt the economy's growth. This is also correct. What is really important is that in all likelihood, e-commerce will sound the death knell for sales taxes.

Although Wal-Mart is headquartered in Arkansas, patrons pay sales tax on their purchases at the rate established by the state in which they reside. The sales tax is collected at the point of purchase and paid by the retailer to the state government. But the net changes this situation dramatically-the retailer no longer has a fixed location, and it is not very costly for the consumer to observe merchandise locally but to purchase over the net.

The consequences of net tax freedom are not hard to imagine. Consumers get a discount on goods bought from a virtual store over the net as compared to purchasing the exact same items in a real store. The size of this discount equals the sales tax rate prevailing in their state. This realized price-tax savings surely has played a major role in the explosive growth of e-commerce.

Some people believe that there is a natural limit to the proportion of sales that can be handled through e-commerce because of the expense or impracticality of shipping certain items and because of a lack of customer access to the web. In truth, neither shipping costs nor lack of access will prove to be an impediment to growth in web-based sales.

In those states where groceries are subject to state sales taxation, grocers will have an incentive to restructure the checkout. Customers at a particular store will place their orders over the net and be instructed to pick up their merchandise at their local store. This means that net shopping will not be limited to customers who have personal access to the net. Stores will provide access to all customers.

Vendors of heavily taxed items like gasoline will have an especially powerful incentive to structure sales. Oil companies can sell coupons tax-free over the web that purchasers can redeem at any affiliated station. The implied tax savings to customers (and tax revenue losses to states) will be enormous. But taxing e-commerce leads inexorably to the same results: shriveling sales tax revenues.

Why? Because now that they can shop electronically, it is virtually costless for consumers to "flee" to low-tax states for their purchases. Firms conducting e-commerce from states with relatively low state sales tax rates will have an advantage over those from high-tax states. Competition will induce companies to migrate to low-tax states. Wal-Mart can create an Internet sales location anywhere in the United States for a few dollars.

Can states maintain viable sales taxes at any tax rate greater than zero? It seems doubtful, for two reasons. First, states might attempt to enter into an agreement under which they would all agree to a common sales tax rate. However, as with any cartel, each and every state would have an incentive to "cheat" by lowering their sales tax rate in an effort to attract commerce with the associated tax revenues. Second, even if sales tax rates were uniform across states, consumers would be able to "migrate" to locations based in Mexico, Jamaica, and a host of other foreign locations that, by definition, are not burdened with U.S. sales taxes. Duty-free shopping no longer will require you to travel to Barbados; it will be as easy as clicking a mouse in your home anywhere in the United States.

The development of web shopping provides consumers with extraordinary shopping mobility, which, in due course, renders sales taxes incapable of being a reliable source of substantial tax revenues. We should not be wasting our time arguing over whether or not to tax e-commerce; the sales tax is dead either way.

David Laband and Richard Ault teach economics at Auburn University.

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