Tuesday, January 22, 2013

Sales Taxes and Borders

I had an interesting conversation yesterday about sales taxes, state borders, and the pricing and availability of products on either side of the border.

Here's the background -- Washington has a sales tax, but Oregon does not.  In addition, the Portland metropolitan area spills over into both states, which provides some fertile ground for thinking about this issue because there is a lot of economic activity taking place on either side of the border.

An interesting feature of the Washington sales tax law is that it is a tax on use, not just point of sale.  Thus, Washington residents who buy refrigerators, stereos, cars and other durable goods from Oregon retailers are technically supposed to pay sales taxes on those items because they will be used in Washington.  My impression is that the same would go for groceries (at least the groceries that are not eaten before returning to Washington!).  In practice, however, people are not likely to pay a sales tax if they are not likely to be caught.

On the flip side, the fact that Washington's tax is a tax on use means that Oregon customers who shop in Washington can waive the sales tax at the point sale just by showing an Oregon driver's license.  Putting yourself in the shoes of a Washington retailer near the border, you may want to cut your prices to compete with the Oregon retailers (so that your tax inclusive price is more competitive), but this price cut applies to all of your customers.  As a result, it might be the case (theoretically) that the Oregon customers find cheaper products across the border in Washington.  It would be weird, but it is possible.

A final -- and very important consideration -- is whether it is worth crossing the border to buy the product.  If the transaction and transportation costs are too high, you would not cross-border competition.  For example, who is going to drive half an hour for an 8 percent discount on Godiva chocolate?  An 8 percent discount on a flat screen TV, however, could be worth it.  From my conversation, it turns out that this distinction matters, but not for all expensive products.  As the products become more expensive, they also become easier to detect (as a general rule).  The problem is that a 70 inch TV may have to be delivered, and in that case, Washington can more easily enforce the use tax (just implement the tax on delivery).  A related issue occurs with cars -- they'll have to be registered in Washington state, and you get hit with the tax at that point.

As you can imagine, the tax structure of the region may affect a firm's decision to locate on one side of the border versus the other.  More generally, borders are an interesting setting in which to study economics.  A couple of examples: Here (gated) is a recent paper I came across that thinks about cross-border shopping, and here's a (now) classic article that uses cross-border cross-time variation in advertising law to think about the effect of advertising.

The ideas in this post are based on a conversation with a Reed College professor, Jeff Parker, who had a student whose undergraduate thesis fleshed out these issues.  If I can get my hand on a copy of that thesis, I'll share a link.

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