Satterthwaite: Smallness And The Value-Added Tax

Emily Satterthwaite (Toronto), On the Threshold: Smallness and the Value-Added Tax, 9 Colum. J. Tax L. ___ (2018):

Three-quarters of the world’s population live in a country in which a value-added tax (VAT) is collected on sales of goods and services. The registration threshold determines which businesses — typically as measured by their annual revenues — remain exempt from the obligation to register for and collect VAT on their sales. Among VAT economists, there is broad consensus that setting thresholds higher rather than lower (such that more rather than fewer businesses are exempt) increases the economic efficiency of a VAT. Despite these high stakes and the longstanding expert consensus in favor of high thresholds, real-world thresholds vary widely and skew low, even within OECD and European countries. This article leverages the insights of the economic model to address an issue that lies outside of it but is central to lawyers and policymakers: distributional equity.

Numerous studies show that smaller businesses’ costs of complying with the VAT are disproportionately higher than larger businesses. To the extent that lower-income entrepreneurs internalize those costs or pass them on to lower-income consumers, there is a vertical equity rationale for raising thresholds. Moreover, where there are more small firms than large firms, setting thresholds higher rather than lower while offering exempt firms an election to voluntarily register for VAT can minimize the (horizontal) unfairness of drawing an arbitrary bright line between taxable and non-taxable firms. Under these conditions, higher registration thresholds can improve the equity and the efficiency of a VAT.