Tax competition, tax coordination, and e‐commerce

• DOI: http://doi.org/10.1111/jpet.12254
• Author: Maya Bacache Beauvallet
• Published date: 01 February 2018
• Date: 01 February 2018

Received: 22 March 2016 Accepted: 16 April 2017

DOI: 10.1111/jpet.12254

ARTICLE

Tax competition, tax coordination,

and e-commerce

Maya Bacache Beauvallet

TelecomParisTech

MayaBacache Beauvallet, Telecom Paris-

Tech,46 rue Barrault,75013 Paris, France

(maya.bacache@enst.fr).

This paper contributes to the political debate on commodity tax

coordination in Europe. It examines, within Nielsen’s setting, the

impact of online shopping on taxes and tax competition and con-

trasts destination-based taxation with origin-based taxation. Het-

erogeneous consumers surf the Internet at a cost. It is assumed

that fiscal leakage occurs during transactions on the Internet either

because of tax evasion or of the existence of a tax liability thresh-

old.Whereas cross-border shopping effectively results in taxes being

levied at origin, this model by adding e-commerce shows that tax-

ing online tradebased on the origin principle softens tax competition

and allows sustaining the destination principle on brick-and-mortar

shops. Taxcompetition is reduced if tax is origin-based, because the

Internet helps the small country expand its tax base, which induces

tax convergence.

1INTRODUCTION

The Internet is perceived as a tax haventhat allows economic agents, both firms and consumers, to avoid paying taxes.

This is due to several causes: either because sales taxesdo not apply to online shopping, or because sellers are house-

holds or small sellers who are not obliged to declare their economic activities and are exemptfrom taxes such as VAT;it

could also be the consequence of illegal activities if sellers fail to declare their sales to local authorities. Fiscal leakage

is the revenue loss caused by consumers purchasing from online sellers who either are exemptfrom sales tax or cheat

in collecting sales tax. Such leakages do not benefit governments, and e-commerce can threaten to decrease tax rev-

enuesfor all countries. For instance, in France, fewer than 1000 e-shops are subject to VAT, whereas more than 715,000

websites are active (French Senate, 2015). Bruce and Fox(2000) estimated that e-commerce may have caused a 10-

billion-dollar tax revenue loss in the United States in 2003. The Internet is also a global marketplacewhere consumers

buy from sellers all around the world and can thus compare commodity taxesacross countries if taxes are origin-based.

However,e-commerce is not necessarily a free zone. Agrawal (2016) draws attention to the fact that the Internet can

representboth a tax haven and an enforcing mechanism for destination-based taxation. If, on the one hand, the Internet

puts downward pressure on taxes because of fiscal leakage, on the other hand, it could help to collect a more efficient

tax. This is because the Internet allows for a sales tax according to the location of the consumer,which was impossible

before the Internet in an integrated Europe where consumers could travelfreely. In this sense, the Internet could help

fight cross-border shopping and tax evasion.

Journal of Public Economic Theory.2018;20:100–117. wileyonlinelibrary.com/journal/jpet c

2017 Wiley Periodicals,Inc. 100

BACACHE BEAUVALLET 101

Not surprisingly,there is disagreement over the design of the fiscal system of online trade. More precisely, the issue

at stake involves determining which goods or e-service to tax and which country’s tax rate to apply.The European

Union has gone back and forth from the origin principle to the destination principle and has recently aligned all taxes

on the destination principle. In January 2015, the VATrate for the sale of e-services in the EU, which had used the

rate of the provider’s permanent establishment, then became that of the consumer’s country.This shift was expected

to reduce tax competition and increase tax revenues for large European countries. However,enforcing a destination-

based tax entails compliance costs with accounting checks and controls that could prove complicated. In practice, all

European countries have set a threshold for the amount of sales that makes a seller subject to the commodity tax in

the destination country, and small sellers are thus subject to the origin-based tax. For instance, online sellers must

comply with French VAT if their sales in France amount to more than 33,000 euros per year whereas Germany has set

its threshold at 100,000 euros per year.Therefore, in practice, both principles of taxation are applied.

This paper addresses the impacts of online sales on tax competition between countries and consequently on tax

coordination, and compares origin-based taxation and destination-based taxation. Although economic literature on

fiscal competition is substantial, papers on fiscal competition and e-commerce are scarce.

The question of whether goods should be taxedaccording to the origin or the destination principle has been fiercely

debated in the literature. The preference for the destination principle is based on allocative efficiency considerations

because a destination-based tax is neutral regarding relative prices. In an open economy with no cross-border trade,

at the margin and under specific conditions such as competitive marketsand flexible wages, the two principles are the-

oretically equivalent (Lockwood, 1993; Lockwood, de Meza, & Myles, 1995). The preference for the origin principle is

based mainly on its facility to dispense with border controls inside economic unions, for example,within Europe. Cross-

border shopping effectively results in taxes being levied at origin, because the destination principle is undermined by

traveling customers and requires substantial resources for tax enforcement. Fiscal competition with taxes on sales is

studied in Kanbur and Keen’s well-known model (1993); a clear, generalversion of this model is provided by Nielsen

(2001).There are extensive studies examining the variations in this first framework—thorough reviews of the literature

can be found in Lockwood (2001), Keen and Konrad (2012),Leal, Lopez-Laborda, and Rodriguo (2010), and Baskaran

and Lopes da Fonseca(2013).

There is also a growing body of work on tax havens. Slemrod and Wilson (2009) show that tax havensare inefficient

because they lead countries to use resources and lower taxesto limit tax evasion, which reduces tax revenues, while on

the contrary,Johannesen (2010) shows that tax havens may be beneficial and increase tax revenues if the equilibrium

is asymmetric: tax havens make it less profitable to compete for mobile capital, leading small countries to increase

their taxes.

Some theoretical papers (Bruce, Fox, & Murray, 2003; Fox & Murray, 1997; Goolsbee & Zittrain, 1999) study the

optimal taxation of e-commerce and examine the compliance cost of a sales tax on the Internet. Keen (2002), for

instance, suggests that all transactions for which collecting and controlling taxes exceedsthe amount of income tax

should be exemptedfrom the sales tax. In practice, taxing e-commerce raises the question of detecting exchanges and

their traceability. The literatureon e-commerce is mainly empirical. It focuses on price elasticities of online shopping

and shows that consumers use Internet shopping to avoid sales taxes: in an early study,Goolsbee (2000) established

that e-commerce would fall dramatically if sales taxes were to be enforced on the Internet. Goolsbee, Lovenheim,and

Slemrod (2010) examine cigarette sales and show an increasing sensitivity to taxes with the spread of Internet use

during the period they studied. Einav, Knoepfle, Levin, and Sundaresan (2014) estimate that a 1% increase in sales

taxes raises online purchases by 2% and decreases online purchases from home-state retailers by 3%–4%. A few

specific studies focus on leakages on the Internet: Alm and Melnik (2010) study transactions on eBay and show that

sellers’ compliance with the sales tax is low in general, but somewhat higher for established sellers. Alm and Melnik

(2012) study cross-border shopping on eBay USA and estimate that out-of-state purchases amount to 94% of the

volume of transactions.

The only paper that specifically addresses the impact of e-commerce on tax competition is by Agrawal(2016) exam-

ining local tax competition between different towns in different states and estimating the asymmetric effect of broad-

band penetration depending on whether a town is located in a high- or low-tax state. This econometric article shows