Does e-commerce ease or intensify tax competition? Destination principle versus origin principle

International Tax and Public Finance https://doi.org/10.1007/s10797-023-09796-8 Does e‑commerce ease or intensify tax competition? Destination principle versus origin principle Hiroshi Aiura1 · Hikaru Ogawa2 Accepted: 28 August 2023 © The Author(s) 2023 Abstract This study examines the relationship between e-commerce development and the intensity of commodity tax competition under two tax principles for goods purchased online: the destination principle and the origin principle. The main findings are as follows: Given that origin-based tax is applied to purchases made in brick-andmortar stores, (i) tax competition under destination-based taxation on e-commerce is more intense than tax competition under origin-based taxation; and (ii) the expansion of the online market intensifies destination-based tax competition while easing origin-based tax competition. The main factor leading to the results is that replacing the choice of “where to purchase” goods, consumers will have a new choice of “how to purchase” when online purchasing becomes available, and destination-based taxation distorts the latter choice, while origin-based taxation is neutral. Keywords Tax competition · E-commerce · Tax principles JEL Classification H21 · H71 · H87 1 Introduction The development of e-commerce and the associated change in the role of consumption taxes have recently led theoretical researchers to study e-commerce taxation (Bacache-Beauvallet, 2018; Agrawal and Wildasin, 2020). Underlying this is the policy concern that failing to design an adequate tax system for expanding * Hikaru Ogawa Hiroshi Aiura 1 Faculty of Economics, Nanzan University, 18 Yamazato‑cho, Showa‑ku, Nagoya 466‑8673, Japan 2 Graduate School of Economics and Graduate School of Public Policy, University of Tokyo, 7‑3‑1 Hongo Bunkyo‑ku, Tokyo 113‑0033, Japan 13 Vol.:(0123456789) H. Aiura, H. Ogawa e-commerce will create significant tax revenue losses, as e-commerce could trigger increased tax competition and more channels for tax avoidance.1 Specifically, the ability to purchase goods and services via the Internet allows consumers to choose the region from which to purchase, not only from neighboring regions but also from more distant regions and, therefore, from a greater number of regions. This would accelerate the interregional commodity tax competition for cross-border consumption. Our study intends to present one view of this new field of research, which searches for an appropriate way to tax e-commerce transactions. Specifically, our study provides one possible answer to the question of whether the imposition of taxes on e-commerce should be based on origin or destination principles. In the case of taxation based on the former, tax is levied on transactions of goods and services at the supplier’s location, and in the case of the latter, it is levied on the recipient of goods or services. VAT in the EU has experienced both of these tax principles. It was crafted about three decades ago, when e-commerce was almost non-existent, with the aim of arriving at a definitive VAT system based on the origin principle, but it has now shifted toward destination principle taxation. The result derived in this study is that taxing e-commerce under the origin principle rather than the destination principle will be superior from the standpoint of a revenue-maximizing government if, as we still observe in a number of cases, origin-based taxes are applied to the purchase of goods in brick-and-mortar stores. Many classic studies on cross-border shopping that do not address e-commerce have analyzed the choice between origin and destination principles. There is a general consensus that the destination principle of taxation is superior to the origin principle of taxation when assuming a competitive market (Keen and Lahiri, 1998, p.325). Economists have recognized the importance of enforcing a destination-based tax to avoid inter-regional competition that lowers tax rates (Lockwood et al., 1994a, p.5; Agrawal and Fox, 2017, p.917). In the case of origin-based taxation, a region with a lower tax rate has an advantage in terms of the tax burden on mobile firms and consumers, leading to a race for lower taxes. However, in the case of destination-based taxation, even if tax rates differ among regions, the tax burden on them is the same regardless of where the production and consumption activities take place; thus, competition for lower taxes is avoided and efficiency is not impaired. Subsequent studies broadened the scope of analysis to include imperfectly competitive markets with factors such as trade costs, spillovers, and unemployment. Some studies have confirmed that the superiority of the destination principle holds true, whereas others have indicated the possibility of a counterview (Lockwood et al., 1995; Lockwood, 2001; Haufler and Pflüger, 2004; Haufler et al., 2005; 1 There have been numerous estimates of the magnitude of tax revenue lost due to the growth of e-commerce. In the early stages, Bruce and Fox (2000) and Bruce et al. (2009) found that as of 1999, the US had lost $7 billion in annual state and local tax revenue due to e-commerce, and by 2012, that amount is estimated to increase to about $11.4 billion to $12.7 billion. In the most recent, Beem and Bruce (2021) showed that an increase in online firms could affect (and might slightly increase) tax revenues by changing the number of firms with sales tax liability. 13 Does e‑commerce ease or intensify tax competition? Destination… Hashimzade et al., 2011; Antoniou et al., 2019, 2022; Agrawal and Mardan, 2019).2 The contribution of our study in this context is to present a model that includes e-commerce, which was not included in the analysis of any of the various types of models mentioned above; however, such an analysis will inevitably be complicated by the addition of new purchase options to these models in which consumers only purchase goods in brick-and-mortar stores. To present our main findings with analytical solutions, we focus on the symmetric equilibrium in the majority of studies. The findings when asymmetry is included are presented in the Discussion section. The most closely related theoretical study to our own, encompassing both e-commerce and taxation, pertains to Agrawal and Wildasin (2020). They extend commodity tax competition models with a specific focus on online purchases, subjecting them to destination-based taxation, whereas goods procured from brick-and-mortar stores are taxed in accordance with the principle of origin. Presenting a tractable model in which the number of Internet users is endogenously determined, they reveal that as the cost of online purchasing decreases and e-commerce expands, the tax rate decreases in the core region where special goods available for online purchases are produced. By contrast, the tax rate in the peripheral region increases, leading to a reduction in tax differentials.3 Two empirical studies corrobo (...truncated)