Taxes Matter

Taxes Matter

June 1, 2006 Posted by J. Scott Moody - No Comments

Believe it or not, taxes matter. They matter in the sense that people change their behavior in regards to activities subjected to taxation. For example, about ten years ago the federal government levied massive tax increases on the luxury boat building industry . . . practically wiping out domestic boat building as buyers fled to foreign boat builders. Taxes matter.
That being said, proving that “taxes matter” is not as easy as it would seem. In the economics profession there is this tension between “economic theory” and “economic evidence.” Theory tells us that taxes distort behavior, but econometrics (the toolbag economists use to measure the world) may not be able to find such distortions. Does the lack of evidence mean the theory is wrong? Of course not! Does anyone actually believe OJ was innocent even if the evidence could not prove it?
So I am starting a “mini-series” in my blog posts called “Taxes Matter” that will highlight important studies–new and old–that find evidence of tax distorted behavior. The first installment is based on a brand-new paper by Glenn Ellison and Sara Fisher Ellison published by the National Bureau of Economic Research (NBER) titled: “Internet Retail Demand: Taxes, Geography, and Online-Offline Competition.” The full study can be found here.
They find that:
“Our most basic conclusion on sales taxes is that they are an important driver of e-retail activity. Our state-level regressions show clearly that [on-line] sales are higher in states that levy higher sales taxes on traditional retail purchases. The fact that the websites we study sell so little in California is strong evidence that what we are picking up is a tax effect and not some artifiact of unobserved heterogeneity.”
“. . . applying the sales tax to e-retail sales could reduce e-retail demand by one-quarter or more.”
“In terms of sales taxes, for example, it is quite easy for consumers, in high tax states, especially, to learn the general principle that buying things online saves on taxes, and we find clear evidence [online] sales being higher in high tax states.”
While Maine’s state sales tax rate is about average, this study suggests that Maine’s policy-makers might want to think twice about raising the state sales tax rate and/or allowing local option sales taxes–consumers can easily shift purchases to the internet to avoid the tax. In addition, based on anecdotal evidence, Maine already losses considerable sales tax revenue to New Hampshire (which has no sales tax).