NCPA - National Center for Policy Analysis

Dump The Sales Tax

March 8, 2001

A current debate in Washington is over whether to allow states to impose a tax on Internet sales once the Internet Tax Freedom Act of 1998 expires in October. But some economists suggest states should drop the sales tax entirely and substitute other ways of raising revenue. Most sales taxes are a relatively recent phenomenon, enacted between 1935 and 1937 as temporary revenue measures during the Great Depression. Critics argue they have three major defects.

  • Since only 40 percent of expenditures are actually subject to sales tax, economic theory shows the distortion of economic activity resulting from an increase is the square of the tax rate -- thus a 3.2 percent tax on all consumption is less disruptive than an 8 percent tax on 40 percent of sales.
  • Businesses pay about 40 percent of all sales taxes collected, the costs of which are passed along to customers; thus almost half of our consumption expenditures are taxed twice.
  • Finally, the sales tax distorts business location decisions; for example, put a warehouse in Nevada to handle California sales even thought locating in California would be more convenient, but Amazon wants to avoid the hassle of collecting California taxes.

So why are sales taxes so popular? Critics of the tax believe politicians like it because it's a hidden tax.

One alternative is to take a different approach to taxing consumption by making savings tax-deductible, rather than directly taxing consumption. For one thing, the administrative costs would be much lower.

Source: Hal R. Varian (University of California, Berkeley), "Economic Scene," New York Times, March 8, 2001.


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