The Incidence of State Sales Tax Exemptions on Over-the-Counter Drugs and Potential Cross-Border Responses

• In Event: Cross-Border Shopping and Tax Induced Mobility

Abstract

This paper investigates the incidence of state sales tax exemptions on over-the-counter (OTC) drugs, focusing on how both consumers and retailers respond to tax changes when cross-border shopping is a viable option. In the United States, many states exempt OTC drugs from the sales tax altogether, while others tax them at full or reduced rates. Using Connecticut and its neighboring states as a case study, I explore whether eliminating sales taxes on OTC drugs shifts the burden of taxation through changes in retail prices (tax elasticity of price) and consumer demand (tax elasticity of demand), and whether these effects are mediated by cross-border shopping behavior. Since consumers may respond to tax differentials by purchasing OTC drugs in neighboring states with lower or no sales tax, the empirical strategy leverages this geographic variation to identify the effects of tax policy changes. The study employs a difference-in-differences and event study approach and uses a panel dataset of weekly retail scanner data of OTC drugs sales from 2014 to 2016 from the Nielsen Retail Scanner Data. This research is among the first to evaluate the incidence of sales tax exemptions for OTC drugs by explicitly modeling cross-border shopping as a mechanism through which tax policy impacts both market outcomes and consumer decisions. The findings fill an important gap in understanding how health-related goods are influenced by subnational tax policy variation.

Author

• Shuangyu Chen, Indiana University Bloomington