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Do Tax Policies Place Local Retailers at a Competitive Disadvantage?

Kellogg School of Management Professor says yes—new research shows that Internet and catalog retailers have an edge

1/4/2007 - A new study led by Associate Professor Eric Anderson at the Kellogg School of Management at Northwestern University finds that retailers with physical store locations are at a disadvantage to Internet-only retailers. Current United States tax laws do not require retailers without “bricks and mortar” in a state to collect sales tax on purchases from consumers living in that state. However, a retailer with a physical store must collect retail sales tax on all transactions in that state, including catalog and Internet purchases, which puts them at a competitive disadvantage.

The researchers, including Anderson, Nathan M. Fong, Duncan Simester and Catherine Tucker from MIT’s Sloan School of Management, examined whether the obligation to collect taxes places retailers who establish a local market presence at a competitive disadvantage when they compete with out-of-state retailers who sell products using catalogs or the Internet.

“This research carefully quantifies how retail sales tax policy affects both consumer purchase behavior and retail store expansion decisions,” said Professor Anderson.

This was documented two ways: First was an experiment in which an Internet/catalog retailer opens its first store in a state, and the researchers found that the obligation to collect retail sales tax reduces consumer purchases by 5%. There is substantial difference in the loss in demand across channels and customers; Internet demand decreases 16% and new customer demand decreases 11%.

The second way in which this tax discrepancy may affect retail competition is by the expansion strategies of multi-channel retailers. The research shows that multi-channel retailers who conduct a majority of their overall business using the Internet and catalogs are less likely to open retail stores in states with high sales tax rates.

This evidence shows that the tax discrepancy influences out-of-state retailers’ store location decisions and confirms that the obligation to collect state sales tax places local retailers at a competitive disadvantage.

According to Professor Anderson, “These findings contribute to the public policy debate over the obligation of out-of-state retailers to collect local sales tax."