Profits from the sales tax make up a large percentage of overall revenues in many states, making the estimated $10 billion lost each year to tax-free internet purchases particularly concerning. Liran Einav, Dan Knoepfle, Jonathan Levin, and Neel Sundaresan examine just how much the presence (or lack thereof) of a sales tax influences consumer behavior. He finds that online purchasing goes up by 1-2 percent for each percentage point increase in the state sales tax, and that an online sales tax does lead to a decline in purchases

Einav, Liran

Knoepfle, Dan

Levin, Jonathan

Sundaresan, Neel

LSE Research Online

blogs.lse.ac.uk http://blogs.lse.ac.uk/usappblog/2014/01/14/sales-tax-internet/Credit: Luke Dorny (Creative Commons BY NC ND)Consumer behavior in online shopping is affected by sales taxProfits from the sales tax make up a large percentage of overall revenues in manystates, making the estimated $10 billion lost each year to tax-free internet purchasesparticularly concerning. Liran Einav, Dan Knoepfle, Jonathan Levin, and NeelSundaresan examine just how much the presence (or lack thereof) of a sales taxinfluences consumer behavior. He finds that online purchasing goes up by 1-2percent for each percentage point increase in the state sales tax, and that an onlinesales tax does lead to a decline in purchases. The tax treatment of online commerce has been hotly debated. In the United States,the current legal regime effectively makes a sizeable fraction of online retail tax-free,at a time when there is significant pressure on state and local governments togenerate tax revenues.In conventional retail sales, sellers must collect the applicable state and local salestax. When a U.S. buyer purchases from an out-of-state seller, however, the buyer’s home state cannot compel theseller to collect sales tax. Instead, states require buyers to self-report and pay an equivalent “use tax.” While thisconceivably might amount to the same thing, use tax compliance is extremely limited and is estimated to be only inthe single digits.Merchants are classified for taxpurchases according to whetherthey have a physical presence(known as “nexus”) in a givenstate. The 1998 Internet TaxNondiscrimination Act made itexplicit that Web presence alonedoes not constitute nexus,placing online commerce in ananalogous situation to mail-ordersales. As a result, “brick andclick” retailers, such as Wal-Mart,Best Buy, or Barnes and Noble,that have stores in essentiallyevery state must collect sales taxon their online sales. However,smaller online retailers, such assellers on eBay or other e-commerce platforms, and larger Internet-only retailers, such as Newegg and Amazon,must collect tax on relatively few of their online sales.When the Internet was new, some argued that favorable tax treatment would facilitate the growth of onlinecommerce. Of course, from the perspective of states with stressed budgets, this translates into forgone taxrevenue. Sales and use taxes on retail purchases are substantial are the largest single component of overall statetax revenue, more than 30 percent. Estimates suggest that the “missing” taxes on Internet sales could amount to$10 billion a year. Current policy debates about online taxes are taking place at both the federal and state levels. Discussions at thefederal level revolve around harmonizing the varied system of state and local taxes, with the goal of lowering thetransaction costs of collecting taxes on interstate sales. Debates at the state level have tended to involvechallenges to the legal definition of nexus, as states attempt to classify more retailers, especially Amazon, ashaving nexus and hence being responsible for sales tax collection.August 1, 2012 Online Sales Tax Hearing. Witnesses (from L to R): Paul Misener (Amazon), StevenBercu (BookPeople, Austin TX), Scott Peterson (Streamlined Sales Tax Governing Board), and SteveDelBianco (NetChoice) Credit: John D. Rockefeller IV (Creative Commons BY)An unanswered question in the policy debate is how much sales taxes actually matter in determining where andhow consumers shop. Although some have argued that favorable sales tax treatment has helped spur the growthof online commerce, others point out that sales taxes may not be very salient to consumers and that factors suchas convenience and variety could be much more important in driving retail purchasing decisions.In recent research, we used the data from eBay’s massive online marketplace to estimate the importance of salestaxes. As one part of our study, we looked at tax changes that have occurred over time at the state and local level,and examined whether (untaxed) online purchasing by state residents increased when their applicable offline taxrate rose. We found that for every 1 percentage point increase in state sales tax, online purchasing increases by 1to 2 percent. For example, if a state raised its sales tax rate from 8 to 9 percent, our estimates suggest that thiswould lead to an increase of 1 to 2 percent of online spending by state residents and a likely correspondingdecline in offline sales. Another interpretation of the estimates, farther out-of-sample, is that if the law changed torequire collection of home-state sales tax on all internet purchases, internet purchasing by state residents mightfall by 8-9% in a state with a typical 5-6% sales tax.In a second part of our study, weinvestigated exactly how muchconsumers actually pay attentionto sales taxes. Offline studieshave found that consumers tendto treat sales taxes as a “hidden”price and respond less to taxesthan to regular retail prices. Weused detailed browsing data fromeBay to find hundreds ofthousands of “micro-experiments”in which individuals clicked on anitem only to find that there was asales tax collected (if they lived inthe same state as the seller) orno tax (if they lived in a differentstate). We compared theseinstances to see if the tax woulddeter some purchases. We doindeed find a non-trivial decline inpurchases when tax is applied,and substitution to similar goods being sold by out-of-state sellers (where the purchase would be untaxed).However, the tax sensitivity is perhaps only a third or even less than what we might have expected from anequivalent increase in the retail price.The uneven application of sales taxes also has a second potential consequence. It may help to determine thegeography of online commerce, by encouraging online shoppers to purchase from sellers that are located indifferent states and by encouraging sellers to make their location decisions to obtain favorable tax status.To assess this, we tried to estimate the extent to which Internet consumers shop “out of state” to avoid sales taxand how this might affect the flow of goods in online commerce. A somewhat surprising finding is that contrary tothe popular idea of “frictionless” Internet commerce, online shoppers seem to exhibit fairly strong preferences forbuying from nearby sellers and in particular for buying from sellers within their home state. The effect issufficiently strong that, according to our estimates, a California seller who moved across the state border intoOregon to reduce her tax liability on California sales might lose enough of her California sales to nearly offset thetax benefit!This calculation suggests that online retailers face a trade-off between locating near their customers and locatingfar enough away from their customers to limit their taxes. Amazon famously resolved this in favor of limiting taxes.Two of Amazon’s distribution centers are located just on the Nevada side of the California/Nevada border. In fact,none were located in California or in New York. Of course, the company’s recent agreement with California tocollect taxes has changed the calculus, and it now opened new centers in California. If the state and localinitiatives to apply sales tax across the Internet succeed, effects on retail location decisions could prove to betransitory.This article is based on the paper “Sales Taxes and Internet Commerce,” which appeared in the AmericanEconomic Review, January 2014, pp. 1-26. Please read our comments policy before commenting .Note:  This article gives the views of the author, and not the position of USApp– American Politics and Policy, norof the London School of Economics. Shortened URL for this post: http://bit.ly/1kzRpAS_________________________________________About the authors  Liran Einav – Stanford UniversityLiran Einav is a Professor of Economics at Stanford University. His current research focuses onempirical work in insurance and credit markets, and his broader interests include industrialorganization, micro-economic theory, applied econometrics._Dan Knoepfle – Stanford UniversityDan Knoepfle is a PhD student in the economics department at Stanford University. His researchfocuses on online markets and on experimental studies of strategic behavior. He received hisundergraduate degree in economics from Caltech in 2007._Jonathan Levin- Stanford UniversityJonathan Levin is Professor and Chair of the Department of Economics at Stanford University,and Professor by courtesy in Stanford’s Graduate School of Business. His research is in the fieldof industrial organization, particularly the economics of contracting, organizations, and marketdesign._Neel Sundaresan - eBay Research LabsNeel Sundaresan is the Senior Director at eBay Research Labs where he leads the researchteam in areas like Search, Machine Learning, Big Data Science, and Vision, among others.  Priorto joining eBay he was a founder, CTO of a network CRM company and prior to that he was amanager of the eMerging Internet Technologies group at IBM Almaden Research Center.CC BY-NC-ND 3.0 2014 LSE USAPP

Consumer behavior in online shopping is affected by sales tax

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