Consumption Taxes and Corporate Tax Planning - Evidence from European Service Firms

Abstract

Consumption taxes are a primary source of tax revenue and, against the common intuition, firms might bear the respective tax burden. However, it is largely unknown how firms respond to consumption taxes. We examine whether service firms in Europe respond to consumption taxes and whether managing sales as the respective tax base is interrelated with subsequent income tax-motivated profit shifting. We exploit corporate affiliate-level panel data and a unique setting in Europe over the period 2007-2015 with 72 staggered and plausibly exogenous consumption and corporate income tax rate changes. We find that firms, on average, exhibit a negative valueadded tax-rate semi-elasticity of reported sales of around 0.5. Consistent with theory and incentives from the European value-added tax system, the effect is stronger for firms with greater discretion over the jurisdiction of value-added tax liability (firms in the digital service sector) and firms facing greater demand elasticity. We then show that the extent and the channels of profit shifting depend on firms' responsiveness to consumption taxes consistent with managing sales in response to consumption taxes placing a constraint on manipulating transfer prices for intra-group trade. Our study thereby provides novel insights for the design of multidimensional tax systems.

Taxation in the Digital Economy – Recent Policy Developments and the Question of Value Creation

“…Olbert and Werner (2018) find only limited evidence of a stronger tax sensitivity of pre-tax earnings for digital firms in the European service sector. 9 For a detailed review of the 2015 final report, seeOlbert and Spengel (2017).10 For a condensed summary, see EY (2018).…”

“…In a recent working paper, Olbert and Werner (2018) find that digital firms in the service sector significantly decrease (increase) reported sales in the country of their incorporation in response to VAT rate increases (cuts) between 2007 and 2015. Assuming the location of a multinational group's subsidiaries (firms) is fixed and independent of VAT changes, this evidence is consistent with firms channeling sales of digital services and goods through locations with lower VAT rates.…”

“…the OECD claims that many member states have successfully addressed these challenges by implementing the destination principle for B2B services (chapters 3.2 and 3.4 of the revised OECD International VAT/GST Guidelines (OECD 2017a)) and for B2C services (accompanied by a simplified registration system) as evidenced by increasing VAT revenues (OECD 2018b). 5 Rising consumption tax revenues, however, might also be a consequence of the general economic conditions or improved enforcement in non-digital sectors (CASE and IHS 2017) and we lack evidence whether (digital) consumption taxes affect corporate decisions of (digital) firms (Jacob, Michaely, and Müller 2018;Olbert and Werner 2018).…”

“…In its strategy on the Digital Single Market the European Commission has acknowledged that a consumption tax system with low compliance costs and no discrimination based on the location of vendors or consumers is indispensable to avoid economic distortions in the digital economy (European Commission 2016a). Indeed, Hoopes, Thornock, and Williams (2016) show that circumventing sales taxes in the US provides a competitive advantage of e-commerce sellers and the evidence in Olbert and Werner (2018) highlights that digital firms are particularly sensitive to VAT rates (holding other macroeconomic factors constant). Consumption taxes or more general forms of destination-based taxes are typically justified by the existence of a market's demand side (Devereux and Vella 2017;Schoen 2018).…”

Negative Interest Rates and Corporate Tax Behavior in Banks

“…Individual banks may alter their 13 business model through reduced risk provisioning , charging higher fees on other products (Turk, 2016), or increasing risk (Heider et al, 2019). Using value-added tax (VAT) changes, Olbert and Werner (2019) find that firms adjust their output as a response to changes in consumption taxes. Following the introduction of bank levies on bank liabilities, Bremus et al…”