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What Gift Cards Can Teach Us About Tax Policy

1 min readBy: Alan Cole

Every once in a while, the economics of taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy make an appearance in real life. If you purchase a gift card at a grocery store – say, a gift card for a pizzeria – you might be surprised to see that there is no sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. charged on the gift card. If that’s true, then congratulations! You live in a place that understands a principle of good tax policy!

With a little bit of thinking, it’s easy to see why this is. If you pay sales tax on the gift card, and then you pay sales tax again on the pizza you purchase with the gift card, you end up paying sales tax twice. This is why we do not tax the gift card.

This is part of a more general principle in which we try to avoid creating a telescoping series of taxes for a single good.

Once you understand that, it becomes easier to understand why some other transactions go untaxed. For example, if you levy a gross receipts taxA gross receipts tax, also known as a turnover tax, is applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. (a tax covering all business revenues) then you might end up taxing the sale of an item that isn’t for final consumption. If you levy a tax on the revenues from a lumber yard, and then the revenues from a sawmill, and then the revenues from a furniture store, you would tax the value of the timber in triple.

In other words, gross receipts taxes, such as the Medical Device Tax from Obamacare, make the same mistake that one would make by taxing the gift card for a pizzeria.