How Sales Taxes Affect Customer and Firm Behavior: The Role of Search on the Internet

Abstract

When a multichannel retailer opens its first retail store in a state, the firm is obligated to collect sales taxes on all Internet and catalog orders shipped to that state. This article assesses how opening a store affects Internet and catalog demand. The authors analyze purchase behavior among customers who live far from the retail store but must now pay sales taxes on catalog and Internet purchases. A comparable group of customers in a neighboring state serves as a control. The results show that Internet sales decrease significantly, but catalog sales are unaffected. Further investigation indicates that the difference in these outcomes is partly attributable to the ease with which customers can search for lower prices at competing retailers. The authors extend the analysis to a panel of multichannel firms and show that retailers that earn a large proportion of their revenue from direct channels avoid opening a first store in high-tax states. They conclude that current U.S. sales taxes laws have significant effects on both customer and firm behavior.