Economics 201

Case of the Day: The Washington Sales Tax and Interstate Competition in Retail Trade



This case study is based on a Reed economics senior thesis entitled "The Sales Tax and Washington State: Who Bears the Burden?" by Jason Gura, 1994.

Vancouver, Washington is located directly across the Columbia River from Portland, Oregon. The two cities are considered by the U.S. Census Bureau to be part of the same metropolitan area. Apart from daily traffic congestion on the two bridges, there is no effective impediment to moving people and goods between the two cities.

The state of Washington collects a significant share of its state revenues through a state sales tax. A tax of 7.4 to 8.1 percent (depending on exactly where the purchase is made) must be added to purchases made by Washington residents in Clark County (in which Vancouver is located). For simplicity, we'll treat the tax rate as 8.1%, since that applies in most of the urban part of the county. Oregon and Portland, in contrast, have no sales tax.

The Washington tax is actually a "sales and use" tax, which means that consumers are liable to pay the tax on goods purchased out of state but used in Washington. However, this provision is difficult to enforce, so Washington residents frequently make untaxed purchases in Oregon without getting caught. Only on large items that must be registered in Washington in order to be used, such as cars and boats, is the "use" part of the tax easily enforced.

Let us think of a good’s price as the price including the sales tax. We shall thus think of the tax as a cost of production to the retailer. Thinking about the problem in this way, Washington retailers have (marginal) costs that are higher than those of Oregon retailers by 8.1 percent of the before-tax price, other things being equal.

Gura investigated the question of who bears the burden of the Washington sales tax using tax-free Oregon as a "control." Do Washington consumers simply pay higher prices for goods and services than they otherwise would? Or do Washington retailers reduce their before-tax prices to keep the after-tax price the same, thereby bearing the cost themselves?

His methodology was to compare prices at Oregon and Washington stores of goods that had relatively high value, but that were easily transportable---goods for which one might expect consumers to comparison-shop and to be willing to drive a substantial distance to purchase. To his surprise, he was unable to carry out the study as designed. He was unable to find a sample of sellers located in Clark County who were selling the most expensive of his goods---those costing $300 or more. As a striking example, the Meier & Frank (now Macy's) department store in Vancouver Mall was the only one of the company’s eight stores that did not have an electronics department. The furniture department of the Vancouver Meier & Frank adopted a policy in July 1993 of paying the sales tax for the customer, so that the customer’s out-of-pocket cost would be the same as that of an Oregon consumer buying the same item in an Oregon store.


Questions for analysis

1. Suppose that the retail industry in both states is perfectly competitive. Consider first the case where there is no cross-border mobility, so that we can consider the Washington market in isolation. Suppose that the retail-trade industry is perfectly competitive with constant costs. What does the long-run supply curve of such an industry look like? Now suppose that the state imposes a sales tax. What will happen to the supply curve? What will happen to the price paid by consumers, the price received by retailers, and the quantity sold? Who bears the burden of the tax in this case?

2. Next, suppose that goods are perfectly mobile across the border (there is no cost to consumers in transporting goods between the states), so that Vancouver and Portland are part of the same perfectly competitive market. Why does this imply that the price (including any tax) must be the same in the two sub-markets? If the industry is perfectly competitive, what will happen to Washington sellers?

3. Use the models developed in the three previous questions to explain the following three observations relating to Meier & Frank’s pricing policies: (1) Meier & Frank does not sell electronics in Vancouver; (2) Meier & Frank will pay the sales tax on furniture, reducing the price it receives by the full amount of the tax; and (3) Meier & Frank sells Godiva chocolates for the same (before-tax) price in Vancouver and Portland. Which model applies to each case? What evidence does this provide about the competitiveness of the retail market for each of the three goods and about the mobility of the three goods across the border? Does common sense support these conclusions?