Consequences of Consumer Sales Taxes in Light of Strategic Suppliers

Taxes levied on retail sales are a ubiquitous form of taxation, both in the US and abroad. While considerable study has examined the economic effects of such sales taxes vis-a-vis consumer demand, surprisingly little attention has been focused on the effects up the supply chain. In this paper, we consider a parsimonious model of retail products sold in a variety of consumer markets (each of which may face different tax rates) when retailers rely on strategic suppliers for inputs in the products they sell. We find that when suppliers have and use pricing power, the imposition of sales taxes at the retail level has reverberations on supply markets – sales taxes undercut consumer demand which also makes retailers more price-sensitive, and suppliers respond to this by cutting prevailing input prices. Not only does this "soften the blow" of sales taxes on retail profit in the market (tax jurisdiction) in question, it also boosts retail profit in other markets since the retailer is able to parlay the lower input prices into greater margins therein. Besides reversing several conventional views of economic consequences of sales taxes, the results may also provide key implications for tax policy when firms operate in and care about multiple tax jurisdictions.