Wednesday, February 21, 2018

Do Sales Taxes Get Passed On To the Consumer?

At the post, Seattle Residents Will Outsmart the Socialist 'Behavior Control' Soda Tax, Peter Kapeel asks:
How is this story reconciled with Rothbard's discussion in MES on sales tax. Rothbard (Austrians) said that sales taxes do not get passed on to consumers because prices are determined by the consumers, not the cost of production. Is this simply an immediate run effect that will lead to a decline in prices at these stores?
 RW response:

The issue of sales taxes is a very complex one. The best short answer is that you can't just pass a tax on to consumers.

That said, after a tax is implemented sometimes prices will climb sometimes they won't.  It depends on the demand schedule for a good and also the products involved in producing a good.

Let us say, by way of example, that ice cream is made up of just two ingredients, milk and sugar.

Let us further assume that the milk and sugar are non-specific goods, that is they have plenty of uses well beyond making ice cream and the market for the ingredients is robust and not dependent on ice cream demand.

So if, say, a 10% tax is placed on ice cream, ice cream producers won't be able to "push" the tax back down on milk and sugar producers because the milk and sugar producers have plenty of other outlets where they can sell their product and they won't budge on price.

If margins are tight at the ice cream maker, the only thing he will be able to do is raise his price by 10%. Depending on the demand schedule, this could very well result in some marginal buyers no longer buying ice cream. So it is not really increasing the price to all consumers, it is pushing some consumers out of the market.

Let us consider another situation. There are three ingredients that make up ice cream, milk, sugar and, just for illustrative purposes, a special glue that holds ice cream together, Unlike milk and sugar, this special glue does not have other demand, it is a specific good for ice cream and that is all. There is no other market.

So let's say that the 10% tax is put on. The ice cream maker doesn't really want to raise prices because he will lose the marginal buyers,  but this time, unlike in the first example, he has options.

The milk and sugar producers still won't negotiate with him to lower their supply prices because they have other markets where they can sell their products, but the special glue maker has no other markets. Therefore the ice cream maker can go to the glue maker and say, "Hey, I have to cut what I pay you buy X amount because of this tax." Since the special glue maker has no other market to sell to, he takes the hit and absorbs the tax.

These two examples are just generalizations to give a sense of what can occur, you can really spin out many, many permutations. The point is, it is not as simple as slapping a sales tax on and the consumer gets hit with the tax.

Many things can happen. Indeed, in Rothbard's discussion, he recognized such when he wrote about another possible permutation:
It is true that a tax can be shifted forward, in a sense, if the tax causes the supply of the good to decrease, and therefore the price to rise on the market. This can hardly be called shifting per se, however, for shifting implies that the tax is passed on with little or no trouble to the producer. If some producers must go out of business in order for the tax to be "shifted," it is hardly shifting in the proper sense but should be placed in the category of other effects of taxation.


  1. It looks like Seattle’s “sweetened beverage tax” is being passed on to consumers. This is what happened in Berkeley and Philadelphia and in Mexico when they enacted similar taxes. These taxes have resulted in decline in the sales in the taxed drinks and increase in the consumption of drinks that are not subject to the additional taxes.

    Seattle claims they will spend the proceeds from their new theft program on programs for low income families to eat healthier. If what happened in other places with similar taxes happens in Seattle, Seattle will not collect the taxes they projected and their ostensible goal will not be realized and neither will their real goal.

    I know two ice cream ingredients was used to illustrate a point but most ice cream has more like 15 ingredients.

  2. Was Rothbard just dealing with a straw man here, or have people actually sincerely suggested that fining consumers for buying a particular product might not affect the bottom line of that product’s producer? It just seems hard to imagine that anyone could believe that.

  3. Producers are able to pass sales taxes to consumers because all of them are equally affected, so offsetting tax with higher price doesn't disadvantage any of them compared to their competition. It does, however, reduce aggregate demand, which would place some pressure to lower prices to offset some tax, but that also eats into margins, killing weaker producers and resulting in less supply (and thus increased clearing price thus restoring margins though at a lower volume - which also implies lower economies of scale). The end result is pretty much passing tax to consumers AND reduced economic activity.

    1. Excellent bottom line illustration of end result of increased taxes on any product or business activity.