Sales Taxes

Under a sales tax, the government mandates that a portion of the payment on certain transactions is owed to the government. E.g. if there is a 5% sales tax on all restaurant meals, then diners who order $100 worth of food and drinks must pay $100 to the restaurant, but then an additional $5 to the government. In practice, the restaurant collects the entire $105 from the diners at the end of the meal, and sets aside the $5 to be sent to the government at periodic intervals.

Sales taxes distort the economy because they force consumers to face incorrect prices. In our example, the diners must ultimately pay $105 instead of only $100.

Some people might say it is good to put sales tax on items such as alcohol, but consumers themselves would judge themselves worse off or at least narrowly conceived.

Many economist advice governments to adopt uniform sales with low marginal rates, in order to minimize these types of distortions. For example, instead of levying a tax of 10% on half the items in the marketplace, they would suggest to levy a 5% tax on all the items in the marketplace. However, keep in mind that in a pure market economy, prices mean something: they are indicators of real scarcity. Any kind of sales taxes will distort the economy.

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