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The problem with an online sales tax
What would a level playing field for the high street and e-commerce look like
What would a level playing field for retail look like? The popular view holds that Business Rates, which are set at roughly 50% of commercial rents, put traditional high street retailers at an unfair disadvantage compared to businesses that sell online.
This idea has prompted Tesco’s CEO Ken Murphy to call for Amazon and other online retailers to be hit with a 1% online sales tax to fund a commensurate reduction in Business Rates. If recent reports are true, his call to the Chancellor won’t fall on deaf ears. A ‘close ally’ of the Chancellor told the Sunday Times that Sunak “does accept that the way we tax online sales at the moment is killing the high street and something needs to be done on it”.
But the problem with the conventional wisdom on the death of the high street is that it assumes whoever legally pays business rates is also the person who bears the burden. But in tax policy, economic and legal incidence are not always one and the same.
A good example is the Soft Drinks Industry Levy, also known as the Sugar Tax. The legal incidence of the tax is clear: manufacturers must pay 24p per litre of drink if it contains 8 grams of sugar per 100 millilitres. But who really bears the burden is less clear. Manufacturers in a position of market power may choose to pass on the full costs to consumers and simply hike prices. Alternatively, if consumers are indifferent between sugary and sugar-free drinks, then Coca Cola and co will be forced to suck it up and keep the price the same. In reality, the burden of the Sugar Tax is split between manufacturer and consumer. One study found that around a third of the cost was passed on to consumers in higher prices: a 7.5p rise instead of a 24p rise, with manufacturers bearing two-thirds of the burden.
To figure out whether or not Amazon and Tesco are competing on a level playing field, it is not enough to know that Amazon’s Business Rates payments as a share of total retail sales (0.37%) are around a tenth of what high street retailers pay (2.9%). To answer that question properly, we need to know who bears the real burden of business rates.
It might seem unintuitive, but economic theory predicts that commercial landlords are the real victims of Business Rates. Due to the UK’s restrictive planning system, the supply of commercial property is relatively fixed and as a result unresponsive to changes in demand. If, for example, overnight the demand for offices halved, it wouldn’t lead to a wave of conversions and demolitions for the simple reason that councils would grant permission for it. When the supply of a good is fixed, price is determined solely by demand. In other words, the price is the maximum someone is willing to pay. Think of fine art. Leonardo Da Vinci will never paint another Mona Lisa. If there was a ‘Mona Lisa Consumption Tax’, then the burden would fall entirely on the seller who would end up fetching a lower price at auction. In the case of business rates, rate hikes should restrict the rents commercial landlords can charge. Retailers may sign the cheque, but it is their landlords who will feel it in the bank balance.
That’s the theory, but is that what happens in practice? The answer is “yes, but…”
The most persuasive evidence comes from a study that looked at six London boroughs in 1990 – the year Business Rates replaced the old system of local property taxes. Back then, rates were not set on a uniform basis but varied from council to council. This meant that the shift to uniform Business Rates led to the property tax burden increasing in some boroughs and falling in others. Nigel Medhi, the study’s author, looked at the impact on rents and property values. Boroughs where the rates burden increased saw rents and property values fall proportionately, and vice versa in boroughs where the rates burden increased. In the long run, total occupancy costs (commercial rates plus business rates) were unchanged.
But markets don’t adjust instantly. For pretty obvious reasons, we don’t have Uber-style surge pricing for commercial property. Tenants and landlords lock themselves into long-term contracts, so an unexpected change in rates takes a while to filter through to lower rents. The best evidence from the British Property Federation suggests it takes about three years for a 75% adjustment in rents.
There’s a further complication. Planning reforms are making it easier to convert shops and offices into housing. On the whole, this is a good thing. Eliminating any regulatory constraints on housing supply will contribute to solving the UK’s housing shortage. Plus, mixing land-use (e.g. flats, shops, offices, bars, and restaurants) can breathe new life into an area, while cutting congestion. But as residential property is taxed at a lower rate than commercial property, there is a risk that commercial landlords will convert to residential simply to avoid taxes. This would, in effect, shift the tax burden from landlords to tenants. To avoid this scenario, which would mean a collapse of some high streets purely for tax arbitrage, it would be sensible to require commercial landlords to continue paying business rates post-conversion or alternatively a one-off fee equivalent to the long-run difference between council taxes and business rates.
Business Rates have other problems. They discourage landlords from making property-value increasing improvements and can create unnecessary complexity. It’s a particular problem for manufacturers where it can act as an additional tax on investment.
In an ideal world, rates would be based on land values only to avoid this problem. They’d also be paid by landlords directly instead of the businesses renting the space, which would cut bureaucracy (there are fewer landlords than tenants) and avoid the awkward adjustment periods for businesses when rates change. But all in all, while business rates attract constant criticism, they are one of the less bad taxes out there.
If the burden of rates falls on landlords not tenants, and that in their absence the full cost of renting commercial property would be unchanged, then it is hard to see how the status quo tilts the scales against traditional bricks-and-mortar retail.
In other words, it is simply wrong to blame business rates for the death of the high street. Online retailers were winning market share, even before the pandemic, because they were offering a cheaper, more convenient product. Amazon and co’s strategy of selling goods from cheaper out-of-town warehouses is simply competing on the merits.
An online sales tax by contrast would be tilting the scales against e-commerce. Consumers would be worse off, forced either to pay more, switch to more expensive high street retailers, or put off purchases altogether.
It is unlikely to help SMEs either. At first glance, Tesco’s proposed online sales tax would only be paid by businesses selling more than £1m worth of goods each year. Yet, once again the key lesson of tax policy is that who legally pays the tax, and who really ends up worse off are not one and the same. Take the Digital Services Tax. The aim was to hit tech giants with a 2% tax on UK revenues. In fact, you only had to pay it if you had more £500m per year in worldwide revenue and your first £25m of UK revenue. It’s hard to think of a more targeted tax. Only a handful of firms qualify.
And yet, it was SMEs that ended up paying the price. Amazon passed the 2% tax onto the seller’s fees for SMEs who use their platform. Any online sales tax will end up hurting more than e-commerce giants like Amazon and ASOS.
But it’s fair to say over the past year or so, e-commerce has benefitted from the pandemic. Lockdown restrictions on traditional retailers, combined with a general reluctance from consumers to shop as normal, have accelerated a long-term shift towards e-commerce.
Elsewhere, I’ve argued that we should try, as much as possible, to preserve the pre-pandemic economy so that it can pop back to life after we're all vaccinated. It would be a disaster to lose the products, processes, relationships, and brands that businesses have built over years, if not decades. That’s why I was an early advocate for the furlough scheme and supported business rate holidays.
Yet we shouldn’t try to undo all of the new consumer and working practices we’ve picked up over the past year. Using the tax system to reverse shifting ways of work, whether by taxing remote work or taxing e-commerce, would be a mostly futile attempt to slow progress. We should be trying to bank the productivity wins from the pandemic, while keeping alive businesses that were viable before the pandemic.
One area where traditional retailers can feel aggrieved is in the impact of e-commerce on congestion. Congestion is under-priced almost everywhere. Even where we have congestion charges, they are blunt instruments and fail to distinguish between a delivery van out all day long and a short trip into the congestion charge zone at an off-peak time (e.g. 2pm).
The Resolution Foundation has suggested a home delivery congestion charge to correct for this. I would prefer a more radical option. Sooner rather later the UK will need to redesign the way we tax cars. As we switch to zero-emission vehicles, fuel duty revenues will decline and we will need to find a new way to fund the roads. A proper system of road pricing for all vehicles where they are taxed based on the impact on air pollution, carbon emissions, wear and tear, and congestion would remove e-commerce’s unfair advantage.
It might not save the high street, but it would help even the scales and ensure online and offline retail compete on the merits only.
Update: I originally described the Resolution Foundation proposal incorrectly as a per-delivery tax, in fact they advocate something close to my system, but limited to delivery vehicles at the moment.