Study Suggests People Spend Less When Taxes are Hidden

April 23, 2008

One of the ten principles of sound tax policy is transparency: tax decisions should be made openly, and it should be clear who and what is being taxed. This is to ensure that the benefits and costs of our tax system are understood by those who have the power to change it.

Currently, many taxes are not transparent; instead some are embedded in prices. For example, many state sales taxes are applied not only to final retail sales but also to business inputs, so the final purchase price reflects not only tax on the sale, but taxes paid during production which are being passed on. Consumers think they pay fewer taxes than they actually do, because the receipt does not total up these embedded taxes.

The National Bureau of Economic Research (NBER) recently studied how consumers respond when taxes become embedded in the price:

For taxable items, like cosmetics and other non-food products, stores customarily do not include the sales tax in the price tags on the shelves. Instead, the tax appears only on the sales slip when the purchases are rung up at the cash register, making them less salient to the consumer. In the targeted store, the researchers adjusted the price tags to display prices including the 7.375 percent sales tax. The result was a decline in sales of those items by 6 to 8 percent. Reminding shoppers of the tax at the time of purchase made for more cautious consumers, suggesting that most of them do not normally take into account the sales tax on such products.

A second experiment referenced in the paper looked at liquor taxes, which are usually embedded and hidden in the price, and often then subject again to the more visible sales tax. The researchers found that increases in the embedded tax reduced purchases more than increases in the visible tax.

Hidden taxes may therefore distort consumer behavior, with people spending differently than they would if our tax system was more visible. Here we discuss gross receipts taxes, which are the most problematic with the embedded taxes problem. And here’s more on tax burdens in general.

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