Shopping for Lower Sales Tax Rates

Abstract

Using comprehensive high-frequency state and local sales tax data, we show that shopping behavior responds strongly to changes in sales tax rates. Even though sales taxes are not observed in posted prices and have a wide range of rates and exemptions, consumers adjust in many dimensions. They stock up on storable goods before taxes rise and increase online and cross-border shopping in both the short and long run. The differences between short- and long-run spending responses have important implications for the efficacy of using sales taxes for counter-cyclical policy and for the design of an optimal tax framework. Interestingly, households adjust spending similarly for both taxable and tax-exempt goods. We embed an inventory problem into a continuous-time consumption-savings model and demonstrate that this seemingly irrational behavior is optimal in the presence of shopping trip fixed costs. The model successfully matches estimated short-run and long-run tax elasticities with an implied after-tax reservation wage of $7-10. We provide additional evidence in favor of this new shopping-complementarity mechanism.