Consumer demand is not affected as much by sales taxes that are tacked onto purchase prices, as opposed to excise taxes that are included in the purchase price, according to a new study.
The research, which appears in the spring issue of the Journal of the American Taxation Association, a publication of the American Accounting Association, found that close to one-third of consumers pay little or no attention to percentage sales taxes in making spending decisions.
“Sales taxes do not operate similarly to low-value consumer add-on components," said the study, referring to price-boosters such as service warranties or shipping charges or product-color options. “Demand is higher when the add-on is a sales tax [rather than] a consumer-good component."
Demand is also higher, the study found, when price and tax are discrete items rather than lumped together in "an all-inclusive price that includes either an excise tax or a mandatory add-on consumer-good component." While sales taxes are typically distinct add-ons to stated prices, excise taxes (for example, on cigarettes or liquor or gasoline) are folded into the stated prices of the goods being taxed.
"Given the prevalence of national consumption taxes in Europe—most commonly value-added taxes, or VATs—it is not surprising that interest in something similar is increasing on this side of the Atlantic," said Cynthia Blanthorne of the University of Rhode Island, who collaborated on the new study with Michael L. Roberts of the University of Colorado at Denver. "Whether a national consumption tax dampens consumer spending would depend not only on how high it is, but on how it is structured. Our study suggests that, if it was folded into the price of products, as VATs are, it would likely have more of a dampening effect than if it was a distinct percentage add-on, as is typically the case with state and local sales taxes. In fact, given our study's finding that sales taxes expressed in percentages have relatively little effect on people's purchase decisions, a national consumption tax could conceivably increase consumer spending if counterbalanced by tax reductions that would enable people to keep more money from their jobs."
The researchers conducted an experiment with 208 participants recruited randomly from a courthouse jury pool in a state with a 7 percent sales tax. They were asked to assume that a new job enabled them to afford a refrigerator to replace a malfunctioning one at home and that they could choose between two units that were only slightly different, Refrigerator A being a bit larger but Refrigerator B having an extra year's warranty. The latter, serving as an experimental control, was offered to all participants at a price of $740 including taxes and choice of color. Refrigerator A was offered to subgroups in one of five ways: 1) for $740 all-inclusive; 2) for $699 with choice of color, plus 6% sales tax; 3) for $699 with choice of color, plus $42 sales tax; 4) for $699, tax included, with 6% mandatory surcharge for choice of color; or 5) for $699, tax included, with $42 mandatory surcharge for choice of color.
In addition, after participants made their choices, they were asked to indicate, without referring to the information provided, the total cost of Refrigerator A. Since the total cost in all five conditions was the same (that is, about $740), the subjects’ answers, it was reasoned, would provide insight into how their calculations differed from one condition to another.
The recalled cost estimates suggested that about one-third of the subjects paid little or no attention to the effect of a percentage sales tax on price, based on the finding that 32.6 percent of the subjects estimated the total cost of the refrigerator to be within 0.5 percent of the base price of $699, compared with 17.1 percent when the sales tax was conveyed in dollars. In addition, 56 percent of the latter group, but only 25.6 percent of the former group, estimated the total cost to be within 0.5 percent of $740, leading the researchers to conclude that “consumers are more likely to use math processing when sales taxes are expressed in currency of tax as compared to a percentage add-on to the base price.”
The muted effect of percentage sales taxes also emerged in the choices that the different subgroups made between the two refrigerators. Subjects were asked to indicate their preference on a scale from -5 (definitely will buy Refrigerator A) to +5 (definitely will buy Refrigerator B), with zero signifying no preference. The strongest preference for Refrigerator A (the price of which was expressed in varying ways in contrast to an unvarying all-inclusive price for Refrigerator B) occurred when the price was given as $699 plus 6% sales tax; that subgroup produced a mean score of -2.3. In contrast, participants had virtually zero preference for Refrigerator A when the price was expressed as $699, tax included, plus 6% mandatory surcharge for choice of color. These results, the authors believe, “are primarily due to the fact that consumers discount, even ignore, the sales-tax component of a partitioned price when compared to a non-tax component.”
Blanthorne and Roberts also found a significantly greater preference for Refrigerator A at $699 plus 6 percent sales tax (-1.4) than they did at $740 all-inclusive (+1.3), a result, they write, that "should encourage policy-makers to reconsider the drag on the economy caused by the imposition of excise taxes." They add that “looking forward, our findings are relevant to discussions about adding a national consumption tax such as a sales tax or value-added tax (VAT).”
