Sales Tax Loophole and a Local Business

I received an email from a client of mine asking me how to respond to his situation.  He runs a local brick and mortar store with products that range from a few dollars to around $10,000.  He received an email from a customer saying that the customer would save $260 in sales tax by purchasing a product from an online dealer rather than my client’s store.  This gives the online store a competitive advantage.  My client said he receives similar emails weekly.  He is forced to make a deal for specific customers or lose their business because they are the rational utility maximizing online consumers.  His customers are indifferent to the products and realize that they can have the same utility from a product that they can buy cheaper online than the one at his store. 
The products my client sells are homogeneous with other products.  The exact same products are available elsewhere.  The way that my client can differentiate himself from the internet is by having classes in his store, which still does not differentiate his main product.     Before the internet, my client had somewhat of an oligopoly market in Utah, his store being the largest of few that could compete.  With the internet, not only does he have to compete with more firms, but he has to deal with the advantage that the government has given others on the internet.

For years, politicians have been prodded by brick and mortar store owners to level the playing field for them in terms of sales tax (Reuters).  There are laws for citizens to report use tax on their individual income tax returns but few do, and auditing individuals for this purpose would be next to impossible while privacy laws exist.  So, the way the current laws are written, the government has given an advantage to stores that sell without sales tax.  This gives my client these managerial options: Reduce profit margin to compete with online stores or lose customers with a lowest price no matter what ideology.


Dave Tufte said...

Cam: 94/100 (two capitalizations in the last sentence).

I sympathize with your client.

Having said that, let me tell you about a consulting job I did about 20 years ago. This was in Louisiana, where much of the sales tax is at the parish level (that's what the call counties). Sales people who are based in, say, St. Charles Parish are supposed to charge the correct sales tax if they make a sale in St. James Parish. But because the tax is primarily at the parish rather than the state level, the legal authority charged with enforcing that is in St. James Parish, and has no jurisdiction over St. Charles Parish. So the sales people can't be prosecuted unless they're caught in the act in the other parish ... which just about never happens. Of course, this raises big complaints from the companies within a parish, because the competition from the outside has an advantage.

My point is that this issue is only superficially about the internet.

What it's really about is strategic behavior in a prisoners' dilemma game. The "prisoners" are the two jurisdictions. The strategies are, say, a tax or no tax. The best strategy choice for a jurisdiction is to have a lower tax rate than its competitor. But the end result of this game is for both jurisdictions to end up with no taxes.

Now, my biases may be showing here, but I tend to think that government attracts people with control issues. And those sort of people are likely to try and use the powers of government to control their situation. For practical purposes this means that they end up in denial about the strategic game they're in, and its likely outcome. So they end up putting business people into a moral hazard situation: follow the law and do what's worse for your firm, or do what's best for your firm and break the law. This isn't good.

I don't have any advice for your client.

But I do have advice for the rest of you students, as future managers. I think there's a positive role for government here, where they can add value. Specifically, this is a situation where a higher level of government should exercise jurisdiction over the two lower forms, and work to impose some reconciliation of sale tax rates on them. In the U.S., it is a failure of our federal government that they don't take care of this issue.

Pedro said...

What I would like to know is how many of these emails is your client receiving in a week? If is a significant amount it would make sense that he add an internet price match guarantee, or something similar. That would at least give him the opportunity so sell more items and possibly attract more customers.

As for the federal government stepping in and helping to level the playing field, I just don't see that happening. Even if it might be good for some, it would become another political issue of big business versus the little guy.

Dave Tufte said...

Pedro: 50/50

That seems like a good suggestion.

I agree that getting the Feds involved might be a public relations problem, but I still think this is something they can usefully broker a deal on.

Anonymous said...

I agree with Pedro’s idea that your client could add a price match guarantee to his products in order to retain his customers. Another option would be to build brand loyalty using one or more of the techniques outlined by Forbes. Creating a sense that your client’s products are worth the difference in sales taxes will ensure that his business will continue to thrive in today’s economy.

Dave Tufte said...

Susie: 50/50

I like what Susie has added. I kind of left that area wide open, and she filled it neatly.