Who Pays the Sales Tax? Did Rothbard and Woods get it Wrong?

Until now I’ve critiqued very smart non-Austrians for whom I have a lot of respect. If anyone doubts that I hold these folks in high regard they can put those doubts to rest, because today I am critiquing Dr. Thomas Woods, whom I have the greatest respect for and believe has done more for the cause of liberty than anyone else of his generation. He’s written 13 books, hosted more than 900 podcasts, and has dozens of lectures archived over at the Mises Institute. In all of that content, this is the only point of real disagreement I have with him concerning libertarian theory or economics. So while this is no trifling matter, you can rest assured that he is an author and speaker who I consider to be well worth your time.

Where Woods veered off the path of sound Austrian Economics was on the Contra Krugman Show. His co-host, Dr. Robert P. Murphy, who is one of the leading thinkers of the Austrian School, didn’t do much to correct Tom’s error. He cited Murray N. Rothbard (1926-1995), who himself was known as Mr. Libertarian, as he made his point. So it may well be that I am in the wrong. In fact, if I were a betting man, I would bet that I am wrong and Rothbard, Woods, and Murphy are in the right. But we can’t rely solely on authority for truth; an argument must stand or fall on its own merits. If it were anyone else making the comment that Tom did, I would be all over it. It is only because I consider him to be such a respected libertarian thinker that I have given so much thought to the matter before writing.

In the episode of the podcast, Woods summarized an article by Rothbard that explains that it is the producer and/or seller who bears the burden of a sales tax rather than the consumer. The argument is that if consumers are willing to pay $107 for a product, then they are willing to pay $107 for that product whether it costs $100 plus $7 in sales tax, or $107 with no tax. Without the tax, the extra $7 would go to the producers and retailers rather than the government.  The point being, if customers are willing to pay $107 why wouldn’t the producer/retailer just charge 7% more in the absence of a 7% sales tax?

My answer is that this is a good analysis in the short run, or if there is a monopoly of some type. Consider if, in the days before internet, TV, and satellite, the tax on cable were removed. Then, quite naturally, one could expect that the cable company would increase their prices to the same pretax-cut level.

But in the rest of the world, in the world of gasoline, cigarettes, and pickup trucks, an elimination of the sales tax only benefits the consumer if we look at the long run. If tomorrow, taxes on gasoline were eliminated, the price wouldn’t immediately drop by 20 cents a gallon, but in time, one oil driller, refinery, or gas station is going to decide that selling to more customers with only a 15 cent per gallon surplus is preferable to their current market share at a 20 cent per gallon surplus. Then someone else will decide that they can gain market share by dropping their price another 5 cents, and so on, until the price drops down to the current price pre-tax price.

My question is, if companies are currently making a profit by charging their current, taxed prices, and the tax is removed, why wouldn’t competition push the prices back down to where they are in the absence of a tax?

And this brings us to the tricky question of Carrier. If it is the consumer who bears the burden of sales taxes (or corporate income taxes, as I would also maintain) then why is it that Trump’s special tax break deal with Carrier only benefits Carrier and not the consumer?

One of the hallmarks of a market economy is profit and loss, the two are tied together, and both demonstrate how efficient a company is at turning a less valuable good into a more valuable good. When they are efficient at this, the firm earns a profit; when they are inefficient, they suffer a loss. If the costs of their inputs exceeds the revenue from their sales, they suffer loss. Taxes are one of those costs. At first it would look like I am backpedaling on everything I’ve said up ’til now, but hang in there, Carrier doesn’t have a tax problem, they have an efficiency problem. A tax is no different than any other expense that a business has to pay: rent, utilities, salaries, etc. Does the consumer not pay for these, too, in an indirect way? And if a firm is able to get a competitive advantage in one of these cost areas, do they not leverage it to undercut their competitors? Carrier has been unable to trim their costs in any other area, and so they opted to move to Mexico and trim their tax and regulation costs.

Consider the case of a store owner in a city mall, let’s say AE outfitters. (That’s Austrian Economists’ Outfitters, not to be confused with American Eagle Outfitters.) One day, by a chance of fate, the store owner manages to save the life of the mall owner. As a result of this heroism, the owner of the mall decides to waive the rent for the owner of AE indefinitely. In such a case, would this benefit the consumers who shop there? No. Because only the one store would be operating rent free, while every other store in the mall is still paying through the nose for rent.

But, consider if after another brush with death, the owner of the mall decides that he doesn’t much care for money anymore, and he stops charging rent to all of the tenants in his mall. Now this is a different deal entirely. No longer a boon for a single firm, competition between Old Navy, A&F, American Eagle, and Austrian Economists’ would push down prices, and the savings in the cost of rent would in fact be passed on to consumers.

The mall analogy may seem theoretical, but Carrier is in the position described in the first scenario. They have achieved a competitive advantage that only benefits them. If all their competitors were given the same tax breaks, they would no longer be in such a good position and would be forced to look at other cost-cutting measures such as moving to Mexico, or possibly even be filing for Chapter 7 bankruptcy.

There is one very important contribution Murphy made to the discussion, about which both Tom and I agree, and that is that a tax is going to have the same effect regardless of where exactly it is imposed. In other words, it doesn’t matter if a tax is put on a tobacco company for every ton of tobacco it produces, or if a tax is placed on a consumer for every ounce of tobacco he buys; the result is the same. They also agree that a tax is going to hurt everyone involved. Tom would say that consumers are hurt indirectly because there will be less competition or less R&D, and I say that the company is hurt in an indirect way by the fact that their sales will be reduced.

While Rothbard’s point about the Austrian subjective value theory is important, he has completely missed the effects of competition on price.

4 thoughts on “Who Pays the Sales Tax? Did Rothbard and Woods get it Wrong?”

  1. “In the episode of the podcast, Woods summarized an article by Rothbard that explains that it is the producer and/or seller who bears the burden of a sales tax rather than the consumer. ”

    I’m not sure that’s quite the argument made. I think they were saying that the tax is not immediately passed on to the consumer, but producers must take into account the effect that raising the price would have on the quantity demanded. Some companies operating at the margin will not be able to raise the price and go out of business, and the remaining companies will have to determine, by market mechanism, where the new price will settle. All this takes some time and meanwhile a lot of moving parts in the economy are changing.

    I think they’re in agreement that taxes will affect the consumer, but it’s not a direct, immediate effect that can be calculated.

    1. I suppose I should listen again. But even if they are right, I think Rothbard is still wrong.

      Rothbard writes, “Consider: all prices are determined by the interaction of supply, the stock of goods available to be sold, and by the demand schedule for that good. If the government levies a general 20 percent tax on all retail sales, it is true that retailers will now incur an additional 20 percent cost on all sales. But how can they raise prices to cover these costs? Prices, at all times, tend to be set at the maximum net revenue point for each seller. If the sellers can simply pass the 20 percent increase in costs onto the consumers, why did they have to wait until a sales tax to raise prices? Prices are already at highest net income levels for each firm. Any increase in cost, therefore, will have to be absorbed by the firm; it cannot be passed forward to the consumers. Put another way, the levy of a sales tax has not changed the stock already available to the consumers; that stock has already been produced. Demand curves have not changed, and there is no reason for them to do so. Since supply and demand have not changed, neither will price.”

      This just won’t do.

      1. In the paragraph you quote, Rothbard is talking about a general sales tax on all consumer goods.

        In the two paragraphs that follow, he clarifies that in the case of a partial excise tax (i.e., a tax on only certain goods, which in a certain way approximates the Carrier case), there can be some long term adjustment, but it is an adjustment and not necessarily painless.

        In the paragraph that follows, he explains that a general sales tax cannot be passed on. Instead consumption will drop and labor and wages will be affected.

        1. And I am working on making my point and my reasoning more clear. I do not think that wages are affected. Indeed my thinking is consistent in holding to an idea that employers being the “consumer of labor” so to speak, pay higher wages as a consequence of the income tax than they otherwise would. But this is going along way from the question at hand.

          If firms could cut costs, why would they wait for a sales tax to force them to do so?

          This is the crux of the problem. Whetherb firms absorb to sales tax if the consumers absorb it’s

          Rothbard said that the firms absorb it. I say that the consumer absorbs it.

Leave a Reply

Your email address will not be published. Required fields are marked *