The U.S. government taxes people mainly on the money they make, not on the money they spend on consumption. Yet most tax experts argue that this policy badly distorts incentives. Someone who earns income and then invests that income for the future gets taxed twice: once on the original sum and again on any earnings made from the investment.

So a system that taxes income rather than consumption discourages people from saving and investing, instead providing an incentive to spend their income today. And encouraging savings and investing is an important policy goal for two reasons. First, empirical evidence shows that Americans tend to save too little for retirement and health care expenses in their later years. Second, savings and investment both contribute to economic growth.

Moving from a system that taxes income to one that taxes consumption would solve this problem. In fact, the governments of many countries get much of their revenue from a value-added tax, or VAT, which acts like a national sales tax. In some countries VAT rates are very high; in Sweden, for example, the rate is 25%.

The United States does not have a value-added tax for two main reasons. One is that it is difficult, though not impossible, to make a consumption tax progressive. The other is that a VAT typically has very high administrative costs.

The amount of money an American owes in federal income taxes is found by applying marginal tax rates on successively higher “brackets” of income. For example, in 2013 a single person paid 10% on the first $8,925 of taxable income (that is, income after subtracting exemptions and deductions); 15% on the next $27,325; and so on up to a top rate of 39.6% on his or her income, if any, over $400,000. Relatively few people (less than 1% of taxpayers) have incomes high enough to pay the top marginal rate. In fact, more than 75% of Americans pay no income tax or they fall into either the 10% or 15% bracket. But the top marginal income tax rate is often viewed as a useful indicator of the progressiv-ity of the tax system, because it shows just how high a tax rate the U.S. government is willing to impose on the very affluent.

Figure 7-11 shows the top marginal income tax rate from 1913, when the U.S. government first imposed an income tax, to 2013. The first big increase in the top marginal rate came during World War I (1914) and was reversed after the war ended (1918). After that, the figure is dominated by two big changes: a huge increase in the top marginal rate during the administration of Franklin Roosevelt (1933–1945) and a sharp reduction during the administration of Ronald Reagan (1981–1989). By comparison, recent changes have been relatively small potatoes.

Solutions appear at back of book.

In 2014, comparison shoppers in about half of the United States found that the final price of a book on Amazon was cheaper than on its competitor, BarnesandNoble.com. Why? It’s simply a matter of taxes—or, more specifically, in which states BarnesandNoble.com is compelled to collect state sales tax on customer orders while Amazon is not. This difference arises as a result of interstate tax law. Sales tax is levied on transactions of most nonessential goods and services in 45 states, with an average sales tax bite of about 8% of the purchase price.

According to the law, online retailers without a physical presence in a given state can sell products without collecting sales tax. (Customers are supposed to report the transaction and pay the sales tax, which they—not surprisingly—fail to do.) In order to exploit this advantage, Amazon has historically maintained a physical presence in only five states. As a result, it collects sales tax only from customers in those states, including Washington state, home to its corporate headquarters. And Amazon has taken extreme measures to avoid collecting sales tax in other states, for example, forbidding employees to work or even send e-mails while in those states. In 2011 it terminated a joint advertising program with 25,000 California affiliate sellers in response to tougher sales tax collection laws in that state.

In contrast, the bricks-and-mortar book retailer, Barnes and Noble, the parent company of BarnesandNoble.com, has physical bookstores in every state. As a result, BarnesandNoble.com must collect sales tax on all of its online orders. This confers a significant advantage to Amazon, as the following example shows. The final price of A Deadly Indifference, by Marshall Jevons, shipped to California, is $20.69 if bought on Amazon versus $22.14 from BarnesandNoble.com. The $1.45 difference comes from the 7.5% California sales tax assessed on the BarnesandNoble.com sale (see Table 7-6).

As reported in the Wall Street Journal, interviews and company documents show that Amazon believes that its avoidance of sales tax collection has been crucial to its success in becoming the dominant retailer of books in the United States. Estimates are that Amazon would have lost as much as $653 million in sales in 2011, or 1.4% of its annual revenue, if it had been forced to collect sales tax.

Since 2012, however, after vigorous pressure from state authorities, Amazon’s ability to avoid collecting sales tax has been greatly curtailed. As of 2014 the number of states it collects sales taxes in has risen from 5 to 19. It’s part of a new strategy by Amazon, to build warehouses in the states in which it collects sales taxes, reasoning that faster delivery will keep customers loyal despite having to pay sales tax. Yet, it’s not hard to understand the view from BarnesandNoble.com that being forced to collect sales tax when Amazon is not deeply hurt its business.

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