Abstract
Rapid growth in e-commerce has altered the ability of jurisdictions to enforce commodity taxes on a destination basis. This results in different effective tax rates depending on the way in which goods and services are purchased and the characteristics of both the products and the sellers. We discuss the arguments for the destination principle as the appropriate place-of-taxation rule for consumption taxation of cross-border trade. We analyze various recent reforms to the value-added tax in the European Union in response to e-commerce. We then examine various policy options in the USA—maintaining the status quo, changing nexus rules, states adopting information reporting, and national reforms that require firms to remit taxes regardless of physical presence—and relate them to the recent European reforms. We conclude based on our analysis and the recent European Union experience that reforms at the national level appear to be the important next step to enforcing commodity taxes at destination in the USA.
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Notes
See US Advisory Commission on Intergovernmental Relations (1994).
See “Retailers Back GST for Online Overseas Shopping,” New Zealand Herald, March 18, 2015.
Under the EU VAT, problems of enforcement differ on business-to-business and business-to-consumer transactions because of the self-assessment method on business-to-business transactions.
Authors calculations using data from http://www.census.gov/econ/estats/2013/all2013tables.html.
The US Supreme Court established the physical presence requirement in the 1967 case of National Bellas Hess, Inc. v. Department of Revenue. The 1992 ruling commonly referenced [Quill Corp v. North Dakota (504 US 298 (1992))] simply reiterated that holding. Indeed, in the case of Quill, several Justices concurred solely on the basis of the doctrine of stare decisis (literally “let the decision stand,” and more generally the doctrine that requires respect for precedent). Supreme Court Justice Kennedy recently argued that the decision should be reconsidered [Direct Marketing Association v. Brohl, 134 S. Ct. 2901 (US 2014)]. Justice Kennedy referred to the revenue loss for state and local governments in his argument.
Both households and businesses can owe use tax on their purchases in certain cases where the sales tax was not collected. Specifically, the use tax is levied when (1) out-of-state purchases are taxable in the destination state, (2) the items are brought into the destination state for use or storage and (3) the sales tax was not paid at point of purchase or was paid at a lower rate at the point of purchase in another state. Use taxes are also imposed when a firm makes exempt intermediate purchases, such as for resale, but converts the item to a taxable use.
In email correspondence with us, Walter Hellerstein writes (with only light editing by us): Legally, use taxes were enacted to shift the legal incidence of the tax from the “sale,” which was thought to be constitutionally barred when the sale was in “interstate commerce,” to the in-state “use,” which was constitutionally unobjectionable. Use taxes were not legally designed to shift the collection responsibility from the vendor to the purchaser. However, there have been changes over the years that have attempted to do this (including the line on some state income tax returns that asks purchasers to self-report the use tax) and in certain instances (e.g., use tax on cars purchased outside the state upon registration).
See McLure (2003) for discussion of some VAT-related issues in the European Union.
See the European Commission’s discussion of “Mail order and distance purchasing” available at http://ec.europa.eu/taxation_customs/taxation/vat/consumers/mail_order_distance/index_en.htm.
Some jurisdictions in the USA have also extended taxing authority to products streamed to businesses and consumers (the so-called “cloud tax”). See “Chicago Extends Taxing Power to Online Movies, Music, More,” Chicago Tribune, July 2, 2015.
This statement is not strictly true since some differences exist as state statutes have been slow in adapting to changing technologies. For example, digitized transactions such as music or video may not be taxable in some states, while the tangible version of the same content (CDs, DVDs, etc.) is taxable. Mazerov (2013) summarizes some of these differences. Also, local use taxes are not always equal to local sales taxes.
Many studies (Goolsbee 2000; Ballard and Lee 2007; Ellison and Ellison 2009; Alm and Melnik 2010; Goolsbee et al. 2010; Alm and Melnik 2012) analyze the sensitivity of e-commerce to differential effective sales tax rates. Although the estimated elasticities vary across the papers, the majority of this literature finds large responses of online transactions to sales taxation, suggesting that sales taxes and e-commerce have important economic interactions.
Fox et al. (2014) find that more transactions take place from a greater distance at higher sales tax rates, apparently evidencing the greater capacity for evading the use tax as distance from the destination state rises.
Uniform commodity taxation is often optimal if an income tax is also available, as is typically the case, and the Ramsey rule on inverse elasticities is applicable only under very narrow circumstances.
Further, the case for disparities in taxation for the same input obtained in stores versus e-commerce relies on firms viewing these goods as different so that the elasticities of substitution are altered between them. Presumably, producers are less likely than consumers to have qualitative linkages to how goods are obtained, and generally purchase based on lowest total costs though even businesses may be inclined to think of digitized products as different from physical ones.
The theoretical logic is that taxes on e-commerce have a greater distortionary effect than taxes on in- store sales. Much of the reasoning is that the inability to tax leisure means that efficiency loss is not minimized by taxing all goods uniformly because the substitutability between leisure and various goods differs. The optimal second best tax system rests on taxing goods that are complementary with leisure more heavily (Slemrod 1990), so the case for tax-favoring e-commerce must be based on a presumption that e-commerce is more highly substitutable with leisure than in-store sales.
As noted in correspondence with David Wildasin: There is a case for differential taxation of identical goods (random taxation). Suppose that the demand functions for electricity are the same in different regions and the (compensated) demand is strongly convex. If we arbitrarily impose a high tax rate in one region and a low rate in the other, so as to maintain constant revenue, We can produce an efficiency gain, raising more revenue in the market where elasticity (at the margin) is low, and less where it is high. Thus, it is conceivable that differences in tax rates on e-commerce and brick/mortar could be efficiency improving, not because the commodities are different, but because the demand curve is sufficiently convex.
Only nine firms in the 2012 sample of 293 relatively large firms selling via e-commerce (and often through other channels as well) in a survey used by Bruce et al. (2015) do not have a sales tax collection responsibility in any state. The nine firms operate from non-sales-taxing states.
The data in Bruce et al. (2015) include 164 firms with nexus in fewer than 10 states and only 69 firms with nexus in more than 40. Dollars of e-commerce sales and a count of number of states where nexus exists are positively correlated so the current tendency toward nexus in a small number of states would be much larger for the population of e-commerce firms, which would include a much greater concentration of small e-commerce firms.
Small companies are defined as ones with revenues between $150,000 and $1,000,000, medium companies are defined as ones with receipts between $1,000,000 and $10,000,000, and larger companies are above $10,000,000.
For the non-competitive tax setting, Diamond and Mirrlees (1971) suggests that the destination principle is preferred on production efficiency grounds with competitive firms. However, Keen et al. (2002) show that harmonization of taxes may be Pareto improving under the destination principle but is definitely Pareto worsening when the preferences of the countries are identical and taxes are levied under the origin principle.
Fox and Yang (2016) use the state corporate income tax apportionment formula to demonstrate that movement toward destination taxation enhances economic growth and tax revenues, though the economic effects are modest and are concentrated in the manufacturing sector.
One example is the “mini one-stop shop” established in the European Union that we discuss later in the paper.
See, for example, Mintz (1995), Bird (2012), and Keen and Smith (1996). Bird notes, “Quebec is the only subnational jurisdiction in the world to operate a destination-based VAT.” Bird and Gendron (1998) argue that destination-based VATs are possible in a federal system and may help alleviate cross-border trade problems when accompanied with a federal VAT.
Appendices summarizing these findings are available from the authors.
Some proposed solutions to carousel fraud include conducting background checks or site visits of firms registering for VAT and making firms that are aware of the fraud liable for some of the lost revenue.
Of course, e-commerce presents some additional concerns for the CVAT that were even recognized at the time of its proposal. At what level should the compensating rate be set? If set at the rate of the lowest state VAT rate in the federation, households may shift to mail order or e-commerce transactions that are subject to the low-tax CVAT. This is problematic if e-commerce is a substantial portion of transactions and if the lowest state tax rate is well below the average tax rate. A minimum state tax rate would reduce the problem but may not be feasible in the USA. Setting the compensating rate at the highest state tax rate reduces the incentive to buy online, but may burden inter-state commerce (McLure 2000).
Taxamo, a commodity tax compliance firm, tracks changes in the taxation of digital software for its clients. The tax changes summarized in this section are explained in more detail on their Web sites “International Plans for the Taxation of Digital Services” and “International Digital Tax Laws.”
Bruce et al. (2015) provide evidence that higher sales tax rates reduce the tendency to create nexus in a state, but that size of the market is the most important factor in determining the states where firms choose to locate.
Such a policy in the USA is likely to have many different winners and losers so that it is unlikely such an agreement would take place. Nonetheless, Congressman Bob Goodlatte, Chairman of the US House of Representatives Judiciary Committee, has proposed an origin-based tax on online sales. The tax would be collected by the origin state at the origin state’s rate, but the revenues would be distributed to the destination state.
Amazon is collecting in some of these states because of changes in state laws and in others because of decisions by Amazon. See “Which States Make You Pay an Amazon Sales Tax,” Wall Street Journal, October 1, 2014.
Some businesses might structure their local presence as a separate corporate entity (albeit controlled by the out-of-state vendor), which sometimes allows vendors to have it both ways, at least in the absence of legislation or case law establishing that the presence of an affiliate in the state constitutes sufficient nexus for tax collection purposes.
Tennessee and Amazon agreed that the presence of several fulfillment centers would not be used to establish nexus for three years, after which Amazon would begin to collect the tax on Tennessee purchasers. Initial analysis suggests an increase in use tax returns in each month when the e-mails were sent, but erosion in subsequent months.
In the Quill Corp v. North Dakota ruling, the Court specifically reaffirms that Congress has the authority to legislate what constitutes an undue burden on cross- border transactions and can define when a state can impose taxes on remote sales (subject to due process considerations). Congress can enact legislation that allows states to require remote firms to remit taxes and the Supreme Court encouraged Congressional action to create a bright line for nexus in the Quill decision (and more recently in Justice Kennedy’s statements mentioned above).
Sales are sourced to the location indicated by instructions for delivery, and if these are not available, to the consumer’s address or location for payment. The sale is sourced on an origin basis if none of this information is available to source on a destination basis.
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Acknowledgments
The authors are grateful to Nathan Anderson, Richard Bird, John Brooks, Walter Hellerstein, Jeffery Hoopes, Matthew Murray and David Wildasin as well as participants at the National Tax Association Conference on Taxation for comments on earlier drafts of the paper. The comments of two anonymous referees and the editor, Albert Solé-Ollé, improved the paper. A longer version of this paper containing more US-specific institutional details and more extensive literature coverage was titled “Sales Taxes in an e-Commerce Generation” and is available online or from the authors. The authors are responsible for all remaining errors.
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Agrawal, D.R., Fox, W.F. Taxes in an e-commerce generation. Int Tax Public Finance 24, 903–926 (2017). https://doi.org/10.1007/s10797-016-9422-3
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DOI: https://doi.org/10.1007/s10797-016-9422-3
Keywords
- Destination taxation
- Origin taxation
- Commodity taxes
- Online shopping
- E-commerce
- Tax competition
- Digital products