The Analysis Of The Possible Effects Of A Sales Tax Placed On Online Orders In Florida

Online shopping has been an increasing market over the last decade. It is predicted that retail sales will double from 2016 to 2020 (Duncan) . The number of Americans that purchase goods online is staggering. In 2017, 40% of internet users said that they purchased goods from online retailers multiple times in a month. Out of the population that researches goods online, 42% purchase the product over the internet and about 14% purchase the product in a brick and mortar store (Duncan). With the wide availability of additional discounts, reviews, and social media influence, many customers find utility in making purchases online. Normally, all purchases made in brick and motar stores are taxed according to state and local taxes.

With the rise of online shopping, state leglislatures have begun the discussion of implementing a tax for products sold online. Because consumers might change their behavior, how this tax is to be implemented and how it would effect both online and physical businesses is unknown. In June 2018, after the South Dakota vs. Wayfair case the U.S. Supreme Court ruled that the collection of tax from internet sales is left to the individual states if they should tax those retailers that do not operate within the state and do not have a large online presence such as Amazon. With this internet sales tax, retailers would be responsible to pay a tax if their customers reside in a state that enforces this law. This law in Florida currently follows the “default rule” where tax will be collected from online sales if the business has a physical presence within the state. Physical presences are defined as a warehouse, an office, a store, or a sales repesentive (Steingold).

Florida statutes state that the business that have a “nexus” or a connection within the state, a direct seller, a media representative, or even advertisement in a magazine or on the radio must follow the default rule of physical presence within the state. When sales taxes are not applicable a “use tax” which is paid by the customer is required on purchases made online. The following analysis will review the possible effects of a sales tax placed on all online orders in Florida. What are the potential effects to consumers and the businesses that they purchase from? Model In the simplest terms, we will we will look at the perfect substitution for a good (maybe a shirt or a DVD) and the functions for a traditional customer who prefers brick and motor stores and for a new age customer that prefers online shopping. The good in question is or is almost identical for both medias of purchase and we will assume that it is non-perishable.

In this example, good X will be a shirt purchased from a boutique website in Maryland that has no connections to Florida. This business does not currently apply to the “default rule.” Good Y, will be a shirt that is for sale in our local brick and motar department store. These shirts are identical and we will have no preference between them. The utility function that used is: In this equation, the beta and the alpha represent the utility that is provided from that product and in this case the course of action taken on how the product is purchased. Alpha within this model represents the utility from ordering the shirt online without the Florida tax. This first basic model will assume that the normal sales tax for Florida does not apply to the brick and motar store. Each of the customers will have different alphas and betas, also the way that these react with prices will determine what choice that the customer makes. This will also create the demand functions for x and y. It is possible to derive this from the original function of .

The customers income will also effect their purchasing power so the function will be used in the lagrangian as a constraint and will be written as an implicit function. There are 3 types of solutions with perfect subsitutes. One will be an interior solution which is where which may allow an indifference curve to lay over the budget constraint or with in as shown in graph 2 in this case the consumer is indifferent to good x or good y. If we will have a corner solution and all of the income will be spent on good x and none on good y this will put the indifference curve meeting with the budget line at a corner in graph 3, the demand functions that will equal . It is significant to note that the budget line is not tangent to the indifference curve at this point and actually has a flatter slope. This is because the “market exchange rate” for the goods x and y is lower (1:1, if it is an almost identical good) then what it would be to the consumers marginal rate of substitution which is higher.

In an opposite instance, if then there will be a corner solution where good Y would be purchased. The demand function would switch to the visual representation of this can be seen below. At these corner solutions the utility maximization will be at a point where none of one good is consumed and all of the income will be spent on the other good. Graph 1: This example has 3 types of customers: Customer 1 is indifferent and has no preference between internet and retail sales. Bargain shoppers are included within this category, these shoppers do not care about the way that they get the product but just want the best price. The parameters for this customer is . The customer get equal amounts of utility from the way it is purchased. The customer will ultimately choose the cheaper product. The solution will be and will fall on the budget curve or will become an interior solution. Graph 2: Customer 2 prefers online sales or shopping in physical stores exclusively.

The parameters for an online shopper would be so when the price of the shirt is cheaper online then in stores and the customer will purchase online. At this decision there will be a corner solution at . The parameters for a physical store customer will be reversed. Graph 3: Customer 3 prefers physical stores but lives far away from actual locations so the cost that is included in shopping would be time, gas, etc. which makes online shopping more convienent and less costly. The parameters will be but the cost added to Py will be larger and and the customer will shop online at a corner solution at which will look like graph 3. Adding an Online Sales Tax If a new customer prefers shopping online like customer type 2, for example, and there was a tax imposed then it is possible for this tax to change their preferences. The amount of the online tax added would have to be greater than the preference to do online shopping. At this point the customer will switch to traditional retail shopping.

Preferences for this customer would move from: to . Similarly, if the tax added to online shopping makes it significantly more expensive then customer types 1 and 3 will start to purchase their goods in a traditional manor. All the customer types described above will have an indirect utility function that looks like: in this case. The demand fuctions will be placed back into the original utility function solving this will produce the indirect utility function. This function will allow the calculation of the utility provided by both products at the same income level. The customer will ultimately purchase the product that has the higher utility. To get to this point we will take both the derived demand and that are not 0 and put it back into the original equation and . In perfect subsitutes we will spend all of our income only on one good. To show this characteristic the indirect utility function will equal the maximum of the utility provided by one of these goods.

The good in this equation that produces the most utility from purchase will be what the consumer decides. From this indirect utility function, we will use the consumers income to determine if they should buy online if is larger or in a physical store if is larger. To show the effect that a tax would have on online sales it can be shown when adding to the price of good X (the online good). In this case, then the consumer may switch to a physical store depending on the alphas and betas for this particular unique customer and the utility that they get from the way that they purchase their goods. Some consumers may still purchase their goods online because their utility from that way of shopping might have a larger effect on their overall decision then a tax would on that good. Every consumer will be different, the overall effect for every consumer cannot be compared because everyone’s utility will be different for the way that they shop, and it might be different for different goods. Some goods can have a different utility from the way that they are bought and shipped.

Some of these goods can be possibly omitted from this model in extreme cases such as comparing a mattress, as it would not be easier to bring home from the store versus being able to test and see the good in a showroom. With all things being considered in taxes, stores and customers would need to also examine that physical stores within Florida are subject to local and state taxes. The amount of tax that is placed online would need to be comparable to the tax placed on goods sold in the state physically to see no difference in shopping trends based solely on preferences and taxes. Currently, the proposed sales tax for online goods is equal to the sales tax for Florida . So, there will not be a difference between online and brick and mortar stores. Similarly, if they were not to place a tax on online goods, Florida taxes are normally pennies on the dollar, which when examined for small goods such as shirts or DVDs should not have as great of an effect on customers decisions compared to electronics or high dollar items such as laptops and cell phones that can also be purchased online.

The difference would be a few cents vs the possibility of almost $100 depending on the price of the electronics. This would be an incentive for consumers who prefer purchasing online but would be a loss for the state in income. Free shipping is already considered something that makes a company competitive. wheather, it being spending a minimum amount or shipping goods free regardless of price which is a strategy that Walmart has adopted. It might change the utility for some consumers who don’t need the good right away or don’t get a benefit from holding a physical product at checkout. However, retailers need to consider shipping charges as an additional cost to which could change the consumers preferences yet again. In this case we assume that meaning that this shipping cost is positive. Or if the company decides to opt for free shipping with all orders the good from the online seller vs the physical store will then should be the same cost and the consumer will make a decision based on the utility that they get from the way that they purchase the good.