Challenging Progressive Tax Dogma

Posted by Bob Lord

I always see it as a breath of intellectual honesty when a progressive takes on a tax policy position adopted by progressive politicians.

Along those lines, Polly Cleveland has an interesting post at inequaity.org, Grover Norquist Is Right to Oppose Internet Sales Taxes, in which she takes on the conventional progressive wisdom that we should tax internet sales. I'm not sure I agree with her. The essence of her argument is that sales taxes are so insidious that we should put aside concerns regarding fairness and oppose any proposal to increase sales taxes. She argues that the effect of taxing internet sales could be to make state legislators more brazen in increasing sales tax rates across the board. She may very well be right.

But whether she's right or not, her analysis is stellar. She explains how sales taxes not only are regressive in their impact on consumers, but also unfair in their impact on small businesses, and why taxing internest sales could open the floodgates to further sales tax increases:

As most of us know, sales taxes are “regressive.” That is, when sales taxes are “passed on,” they fall harder on poorer customers than on richer ones. That’s why many states exempt food and medicine, as does New York, except for restaurant food. But sales taxes are also “passed back” onto retailers and service providers. In fact, sales taxes are shared between customers and retailers in inverse proportion to their ability to shop or sell elsewhere.

It’s the “passed back” portion of sales taxes that do the most damage, because — unlike profit taxes — they take a bite from gross revenues before expenses. Moreover, a uniform tax rate does not mean uniform impact. As Anatole France wrote, “The law, in its majestic equality, forbids the rich as well as the poor to sleep under bridges, to beg in the streets, and to steal bread.” Sales (and VAT) taxes fall hardest on small, labor-intensive retailers, with high volume and low profit margins.

Consider two New York City businesses: One is a furniture store; the other is a Sabrett’s hot dog cart. Assume for simplicity the “passed back” portion of the 8 ½ percent sales tax is 5 percent. The furniture store invests $9,000 a year in an inventory of sofas, which it sells for $10,000, earning a $1,000 before-tax profit. A 5 percent sales tax is $500, half of profit, and 5.5 percent of the $9,000 investment.

The hot dog cart invests $200 a day in buns, dogs, and labor. It earns $210 a day, or $76,650 a year in sales and $3,650 in profit. A 5 percent sales tax collects $3,833, wiping out profit and amounting to 1916 percent of the $200 investment! Moreover since most of the cost of the cart is labor, the tax adds 5 percent to the 18 percent or so in payroll taxes!

In short, sales taxes kill small businesses — precisely the kind of businesses that provide the most jobs per dollar invested. And by killing competition, sales taxes may drive prices up by more than the tax rate.

Sales taxes are also insidious — it’s always so tempting to politicians to raise them another quarter cent, and hope no one notices. Up to now, the threat of tax competition from neighboring states and localities has kept those politicians in check. That is, as long as customers can easily shop elsewhere, most of the tax will be “passed back” onto merchants —whose complaints will make politicians think twice about increases. The European VAT has crept so high precisely because shoppers can’t avoid it by crossing borders.(Tennis ball smuggling isn’t cost-effective).

In recent years, the rise of effectively untaxed internet sales has helped check increases of state and local sales taxes. If the Marketplace Fairness Act passes the House, it will release that check on sales taxes and lubricate our way towards European-style VAT taxes! “Fairness” shouldn’t mean raising sales taxes on internet merchants, but reducing them on local businesses. For once, though for the wrong reason, Grover Norquist is right.

You can disagree with her conclusion, because, after all, fairness is important. But you have to respect her reasoning. It's at a level you rarely see in the political world, whether on the progressive side or the conservative.

0 responses to “Challenging Progressive Tax Dogma

  1. Re your first paragraph, I think it depends on the product. If you’re talking about gasoline, for which demand is inelastic, you’re more or less correct. But think about what sales taxes do to the demand curve. They push the whole curve downward by the amount of the sales tax, which causes the point where it intersects the supply curve to be at a lower price. That price differential is borne by the seller.

  2. This, and other, discussions of sales taxes make a very fundamental error. Sales taxes are not paid by businesses, they are paid by the purchaser of the goods or in some cases services! Businesses act as “pass-through” agents and in most places get a small cut of the tax for their trouble.

    If we had truly progressive income taxes and did away with sales taxes we’d be better off.