Why I Sell Sales Taxes

Photo by Markus Spiske on Unsplash

A sales tax is a form of consumption tax imposed by the government and applied to the sale of goods and services. It is typically applied at the point of sale, where it is collected by the retailer who then remits it to the government

Like any other tax, the purpose of a sales tax is for the government to fund services like roads and schools. I think sales taxes are one of the silliest forms of taxation that exist, and governments should do away with them.

Why I sell the Sales Tax

Its a regressive form of taxation

Sales taxes have a disproportionate impact on lower-income individuals. To understand why this is true, consider the economic concept of Marginal Propensity to Consume (MPC). MPC measures our change in consumption as a result of a change in income.

If you were given a $1,000-dollar bonus in addition to your current income how much of that would you spend and how much would you save?

If you spent $800 on a new TV and put $200 into savings, you would have an MPC=0.8. Meaning you allocate 80% of every additional dollar you make to consumption.

High-income individuals have a lower MPC than low-income individuals because their consumption needs are already being met. If you give a dollar to a rich person, they are more likely to save it. If you give a dollar to a poor person, they are more likely to spend it.

Since low-income earners have a higher MPC than high-income earners, they are hurt more by a sales tax.

Sales Taxes hurt Consumers and Businesses

Sales taxes are paid for by consumers and businesses. If a business can set its own prices it will pass 100% of the cost of the sales tax down to the consumer through increased prices. This puts a strain on everyone’s personal budget, particularly low-income earners (as just discussed).

If a business has no ability to set its prices it will pay 100% of the sales tax. This directly impacts the business's profitability and its capacity to reinvest and hire more workers.

Usually, the cost of the sales tax is paid for by both consumers and businesses. The business will pass along as much of the sales tax as possible through higher prices but typically cannot raise prices enough to fully offset the sales tax.

The following is a graphical representation of the impact of a $1.05 sales tax on the price of a hypothetical good.

  • The sales tax of t=$1.05 per unit sold shifts the supply curve upwards from “supply 1” to supply 2.
  • This causes the equilibrium (where supply equals demand) from e1 to e2.
  • the price of the good increases from $3.30 to $4.00.
  • 66% of the tax falls on consumers through 70 cents increase in prices
  • 33% of the tax falls on producers who now only receive $2.95 per unit after tax. This represents a 35 cents reduction in its selling price.
  • The government collects $216.3 dollars in tax which is represented by the yellow rectangle above.

Sales Taxes Provide Poor Economic Incentives

Apart from the market distorting effects sales taxes have, they provide poor economic incentives.

  • Nearly 70% of GDP is derived from consumption
  • Sales taxes are a tax on consumption
  • Taxing consumption provides an incentive to consume less
  • Therefore, we could increase consumption and economic growth by removing sales tax

If the government wants to disincentivize the consumption of specific goods that have a negative impact on society like cigarettes and alcohol, go right ahead. But we want to encourage rather than discourage general consumption in the economy.

Proponents of the sales tax would argue that sales taxes capture revenue from tourists and therefore lessen the tax burden on local taxpayers. The concept of having foreigners help pay for roads and bridges sounds appealing but most of the sales tax is paid by local residents.

Additionally, foreign money can still be captured indirectly through income taxes. If local tourism picks up in an area with no sales tax, the money spent by tourists will increase the profits and incomes of local businesses and individuals. If a progressive income tax system is in place, this will lead to increased tax revenue.

Bottom Line

Sales taxes are regressive, market-distorting and provide poor economic incentives. The rational thing to do would be to do away with them completely and focus on more progressive forms of taxation like the income tax.