Weekly SSRN Tax Article Review And Roundup: Scharff Reviews Satterthwaite's Smallness And The VAT

This week, Erin Scharff (Arizona State) reviews a new article by Emily Ann Satterthwaite (Toronto), On the Threshold: Smallness and the Value-Added Tax, 9 Colum. J. Tax L. ___ (2018):

Emily Satterthwaite’s latest article explores the ways tax law should reflect the needs (and especially the relatively high-compliance costs) of small businesses. Her focus is on Value-Added Taxes (VATs) and, in particular, on the VAT exemption threshold.  

Though there is widespread expert agreement that VATs should exempt small firms, there is significant variation in the VAT thresholds, particularly among developing countries. Further, exemption thresholds are often set much lower than what VAT experts have recommended for optimal efficiency. Satterthwaite’s article argues that this expert recommendation not only advances efficiency goals, but would also improve distributional equity.

Satterthwaite does yeomen’s work in making her argument accessible, particularly to U.S. readers who might be less familiar with the way VATs operate, and the first part of her article is an excellent and highly accessible introduction to VATs and its relative advantages over cascading turnover taxes and retail sales taxes. 

In the second part of her argument, where she directs more expert readings to begin, Satterthwaite describes the leading economic model for setting VAT thresholds.  This model, developed by Michael Keen and Jack Mintz, evaluates the tradeoff between the burden administration and compliance costs when small businesses are included in the VAT, and the loss of revenue when they are excluded.  The model also considers the ways exemption thresholds distort business decisions by encouraging businesses to remain artificially small and thus below the exemption threshold.  Under the Keen and Mintz model, small increases in the threshold have four efficiency implications:  (1) loss of revenue from firms now exempt from the VAT; (2) an increase in VAT revenue as these firms are unable to claim VAT credits; (3) lower administrative costs; and (4) an increase in revenue as a result of productivity gains from firms now able to expand without fearing crossing the new, lower VAT threshold.  Using their model and data from Canada’s VAT, Keen and Mintz suggest that for a VAT levied at 15%, a government should exempt businesses with receipts of less than $101,500 (in 2002 U.S. dollars). 

Satterthwaite then documents the growing empirical support for this model and the relative paucity of publically available estimates of optimal VAT thresholds for different jurisdictions.  Satterthwaite, however, manages to pull a variety of data together to make a compelling case that in many countries VAT thresholds are likely set inefficiently low and considers a number of explanations for why this is the case.

Satterthwaite then builds her argument that higher exemption thresholds improve equity in the VAT.  Satterthwaite’s vertical equity analysis focuses not on the equity of the VAT itself, but rather than equity of VAT compliance costs.  Satterthwaite’s review of the empirical literature on VAT compliance costs suggests extensive evidence of firm-size regressivity, and she makes a compelling case that at the firm-level, low thresholds are regressive.  Further, she notes evidence that smaller firms are more likely to be associated with lower-income entrepreneurs and serve lower-income customers; reducing such firms’ VAT compliance costs may increase the progressivity of the VAT beyond these firm-level implications.

Satterthwaite also argues that higher thresholds may improve competitive fairness among similar situated firms.  Satterthwaite first argues that the higher thresholds may minimize the number of similar firms that end up on either side of the threshold.  As she notes, while the majority of VAT revenues are raised by large-firm sales, in most economies, the majority of businesses remain small.  As a result, the lower the threshold, the more businesses are likely to be within the band affected by the discontinuity.  Second, Satterthwaite suggests that the availability of optional VAT registration further reduces horizontal equity concerns because it allows small firms with relatively low compliance costs to opt-into the system. 

As a U.S. reader of Satterthwaite’s paper, I found Satterthwaite’s argument interesting beyond its VAT design implications.  Like the VAT, other types of business taxes tend to place disproportionate compliance costs on small business, as Satterthwaite acknowledges in passing.  Satterthwaite’s paper suggests we should pay more attention to these compliance costs.  For example, if, as many predict, the Supreme Court will take the opportunity in South Dakota v. Wayfair, Inc. to overturn Quill (and full disclosure, I’ve signed several amicus briefs urging the Court to do that), states will need to determine what threshold of sales should establish nexus.  Of course, exempting small businesses from retail sales entails forgoing significantly greater government revenue, but that doesn’t mean there aren’t real tradeoffs that states will need to consider.  (South Dakota’s law, for example, requires tax collection by retailers with more than $100,000 of sales into South Dakota or more than 200 transactions with in-state consumers.)          

Here’s the rest of this week’s SSRN Tax Roundup:

Roundup:

• Erez Aloni (UBC), The Marital Wealth Gap, Washington Law Review, Vol. 93, 2018.
• Emily Cauble (DePaul University), Tax Law's Loss Obsession, Utah Law Review, Forthcoming.
• Scott Dyreng (Duke), Jeffrey L. Hoopes (UNC – Chapel Hill), Patrick Langetieg (IRS) & Jaron H. Wilde (University of Iowa), Strategic Subsidiary Disclosure, Working Paper Series.
• Alexander Fedan (University of Sydney), Application of Neuro-Evolution Machine Learning in Policy Making – Application in International Taxation, Working Paper Series.
• Daniel Jacob Hemel (University of Chicago), The Living Anti-Injunction Act, 104 Virginia Law Review Online 74 (2018).
• Anna Mortimore (Griffith University), What Now for Environmental Sustainability? Government Fails to Link the Australian Car FBT Concession to Vehicle Emissions, Australian Tax Forum, 26(3), 541–583.<.li>
• Anna Mortimore (Griffith University) & Lisa Marriott (Victoria University of Wellington), Emissions, Road Transport, Regulations and Tax Incentives in Australia and New Zealand, Journal of the Australasian Tax Teachers Association, 12(1), 23–52.
• Joel S. Newman (Wake Forest University), Conspicuous Philanthropy: A Response, American University Law Review Forum, Vol. 67, No. 1, 2018.
• James R. Repetti (Boston College), The Impact of the 2017 Act's Tax Rate Changes on Choice of Entity, 21 Fla. Tax Review Issue 2 Spring 2018.
• Emily Satterthwaite (University of Toronto), On the Threshold: Smallness and the Value-Added Tax, Columbia Journal of Tax Law, Forthcoming.
• Clint Wallace (University of South Carolina), Congressional Control of Tax Rulemaking, Tax Law Review, Forthcoming.