The Impact of Sales Tax on E-Commerce
The cost of integrating off- and on-line operations may be more than companies bargained for
Research by Austan D. Goolsbee
Wal-Mart, the nation's largest retailer, announced in January the spin-off of Wal-Mart.com. The new company, jointly owned with Accel, is an independent e-commerce retail entity. By establishing a separate company, with physical operations only in California and Arkansas, Wal-Mart will be able to avoid collecting sales taxes for most of its on-line transactions.
Under current state laws, companies are not required to collect sales taxes from consumers making out-of-state on-line or mail order purchases. Payment responsibility falls solely on the customer and enforcement is difficult, creating a de facto tax-free environment. Moreover, there are substantial tax penalties for integrating brick-and-mortar and on-line operations.
So companies, like Wal-Mart, avoid these penalties by establishing separate subsidiary on-line entities. However, to satisfy legal requirements, the two operations truly must be separate. That means a purchase made on-line cannot be picked up at a local store. If a company wants to integrate both off- and on-line operations, appropriate sales taxes must be charged, regardless of where the purchase is made.
In recent research, Austan Goolsbee, an associate professor of economics at the University of Chicago Graduate School of Business, examines the effects of sales taxes on e-commerce. The central issue of sales taxes is a critical one. In the current tax-free e-commerce world, consumers do not pay sales tax, which directly affects the price of goods on-line. "Charging sales tax is the same as increasing the price of a product or service," says Goolsbee. "If you increase prices, people will stop buying."
If sales taxes were charged, according to Goolsbee, Internet retail sales could decrease by up to 24 percent. Therefore, existing brick-and-mortar businesses looking to expand their markets need to think twice before setting up shop on-line. Given the current tax situation, retail companies that feel the need to establish an on-line presence will not benefit from integrating their operations, says Goolsbee.
Sensitive to Price
In his study, "In a World Without Borders: The Impact of Taxes on Internet Commerce," Goolsbee examines the sensitivity of consumers to on-line prices. Drawing approximately 25,000 Internet users from an extensive proprietary survey conducted for Forrester Research, a market research company in Cambridge, Mass., Goolsbee establishes the importance of price or taxes on consumers' on-line purchasing behavior.
When choosing between making a purchase on-line versus at a store, consumers compare relative prices. Assuming that the individual avoids paying tax on the on-line transaction and that local sales taxes do not affect local retail prices, that person will be more likely to buy on-line the greater the savings.
Furthermore, data on consumers with the same observable characteristics and living in the same metropolitan area but across state boundaries showed that for this demographic group, the likelihood of on-line purchase increases if they face higher taxes, Goolsbee found. "It's not just that the people living in high-tax areas are more technologically sophisticated," he says. "Because they are no more likely to own a computer or spend additional days per month on the Internet. But they are more likely to buy on-line."
The perfect test case would take the same person in terms of education and income level, and move that person from a state like New Hampshire that charges no sales tax to one like Massachusetts, where there is a 5 percent sales tax. All of the benefits of shopping on-line are the same, such as shipping costs and convenience. "The only difference is that the person in New Hampshire has no additional incentive to buy on-line," says Goolsbee. "But the person living in Massachusetts now has an additional 5 percent incentive to purchase on-line."
Examining the Goods
The next question that Goolsbee examines is the impact of sales tax based on types of goods that are purchased on-line. Several types of on-line goods were reported in the Forrester data. Goolsbee's results show that sales tax does have an impact on on-line purchases, with two caveats.
The first caveat relates to fixed costs. The most common fixed cost of buying on-line is the first-time user's fear of giving out credit card information over the Internet. If a person decides to make his or her first on-line purchase because of lack of sales tax, and a credit card is used to make the purchase, this raises the probability of buying other items in the future, regardless of tax savings.
The second caveat is that the limited volume of most categories of goods purchased over the Internet makes the tax impact on individual goods difficult to measure precisely. As a result, Goolsbee grouped the goods into three categories.
The first category includes goods where buying on-line avoids sales tax for the buyer. These are the standard goods that easily could be purchased in a store. This group includes books, computers, software, computer peripherals and clothing. In addition, Goolsbee notes, these products are likely to be purchased with a credit card.
The second category he examines is composed of products where the buyer is unlikely to avoid sales taxes, but the goods still are likely to be purchased with a credit card. This category includes airline tickets, movie tickets, automobiles, flowers, and groceries. Sales tax does not apply to airline and movie tickets. The other items almost certainly require a physical distribution site, so a tax must be paid in the state where the goods are delivered. In either case, the buyer does not save money on the sales tax by purchasing on-line. Because these items usually are bought with a credit card, however, a fixed cost associated with credit card security implies that taxes will influence purchase decisions in this category.
The final category that Goolsbee examines includes goods where the purchaser does not avoid sales tax, but these goods also are unlikely to involve use of a credit card. This category is composed of financial products, including insurance, stocks and mutual funds. In this case, there is no reason for taxes to influence such purchases.
The results of his study prove that taxes have a large and significant effect on the likelihood of buying goods where the purchaser avoids sales tax. Taxes also have a significant effect on the purchase of goods that do not save the buyer sales tax but incorporate a fixed cost arising from credit card security issues. Most importantly, for the goods with no fixed cost and no tax savings, there is no significant impact of taxes on the likelihood of purchase.
As the debate over Internet sales tax continues, Goolsbee's research suggests that charging sales tax for on-line purchases would hurt the still growing arena of e-commerce. Moreover, companies who fear on-line competition overestimate the impact of Internet sales. "Retail internet commerce is still really small," says Goolsbee, "and will remain so for the next three to five years." Therefore, for the short term, on-line retail sales will have very little impact on most off-line businesses.
Austan D. Goolsbee is an associate professor of marketing at the University of Chicago Graduate School of Business.