Annotated bibliography

Theoretical and Empirical Macroeconomic Effects of Corporate Taxation

FAIRCHILD, F. (1921). The Case Against the Sales Tax. The Bulletin of the National Tax Association, 6(9), 270-275. 

This paper offers a theoretical overview of the impact of a sales tax. The sales tax can essentially be paid by either the consumer by being passed through by increased prices, or by the producer, where it eats into business profits. Typically, when an increase in sales tax is introduced, we expect that firms will pay the tax and gradually pass the tax off to the consumer. So first and foremost, the sales tax is a consumption tax and therefore an added business cost. 

On the business side, the tax acts as a cost to the business, who in lieu of raising prices in order to remain competitive, will eat the cost of the tax. This is particularly harmful to “weaker competitors”, those “on the margin” who may be forced out of business by the increased cost of the tax. Secondarily, the cost of the tax is eventually shifted to the consumer by sellers raising prices. This also acts as a business cost, as goods become more expensive, producers' ability to sell their products decreases as consumers are priced out of the marketplace and the tax then becomes a cost of foregone business. This is especially true as all goods become more expensive, consumer choices become more constricted on what they may spend their income on. This provides the theoretical background around how an increased sales tax can be harmful, however, its implementation nuances and resulting implications on firm behavior are analyzed in other empirical papers discussed below. 

Djankov, Simeon, Tim Ganser, Caralee McLiesh, Rita Ramalho and Andrei Shleifer. (2010). The Effect of Corporate Taxes on Investment and Entrepreneurship. American Economic Journal: Macroeconomics, 2(3), 31–64.

In a cross sectional study of 85 countries, the authors utilized survey data collected by Price WaterhouseCooper that quantifies the tax liabilities of the “same” standardized firm in 85 different countries to measure the impact of increased corporate taxes on domestic investment, foreign direct investment, and entrepreneurial activity. The measures of entrepreneurial activity used in this study were the number of business establishments and the rate of new business registration. The study found that a 10-percentage point increase in the effective corporate income tax rate reduces the investment rate by 2.2 percentage points (average investment rate is 21.5 percent) and FDI rate by 2.3 percentage points (average FDI rate is 3.36 percent).

The effects of taxes on our measures of entrepreneurship are large and statistically significant. A 10 percentage point increase in the first-year effective corporate tax rate reduces business density, measured as the number of registered limited liability corporations per 100 members of the working-age population, by 1.9 firms per 100 people (average is 5), and the average rate of new business registrations by 1.4 percentage points (average is 8).

Romer, Christina D., and David H. Romer. (2010). The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks. American Economic Review: 100(3), 763-801.

This paper investigates the impact of legislated tax changes on economic activity and output. The study shows that tax changes have very large, statistically significant, and robust effects on economic output. Specifically, the paper estimated that an exogenous tax increase of one percent of GDP lowers real GDP by almost three percent. Several robustness checks for the most part point to a slightly smaller decline, but one that is still typically over 2.5 percent. 

Hibbs, Douglas A., and Violeta Piculescu. (2010). Tax Toleration and Tax Compliance: How Government Affects the Propensity of Firms to Enter the Unofficial Economy. American Journal of Political Science, 54(1), 18–33.

Authors create a theoretical model concerning the determinants of firms’ tax toleration and tax compliance and then tests the model’s predictions empirically based on interview data obtained from managers of 3,686 enterprises distributed over 55 countries by the World Bank’s World Business Environment Surveys. The central implication of theoretical and empirical results in this article is that big migrations out of legal production into the underground economy occur when large numbers of firms perceive taxes as not “worth paying.” Tax toleration is driven by firm-specific appraisals of the availability, quality, and usefulness of government services supporting official activities. Firms without much intrinsic need of government institutional services will likely always be tempted to produce unofficially and evade taxation unless tax rates are negligible. Such firms are likely to be small (and in many cases single-person operations). In conclusion, modest tax rates are particularly important to small and medium-size enterprises, which contribute to economic growth and employment but do not add significantly to tax revenue.

Rockefeller Institute of Government & The Pew Charitable Trusts. (2018). Are Sin Taxes Healthy for State Budgets? Taxes on vices are tempting but unreliable source of revenue.

This report discusses the viability of sin taxes as a source of revenue for local and state governments. Taxes on tobacco, alcohol, gambling, and more recently e-cigarettes and marijuana, are appealing to policymakers as a potential source of revenue. However, states should be cautious about relying on sin taxes as longer-term fixes to budget woes because of their volatility in the near-term and their unlikeliness to be sustained in the long-term due to how the products are taxed, changes in demand, and casino competition.

Case Studies of Tax Policy in Indian Country

North Dakota State Legislature. (2019). Tribal Taxation Issues Committee.

A report prepared by the North Dakota Tribal Taxation Issues Committee discusses previous tax sharing agreements for cigarette and tobacco excise tax, motor vehicle fuel and special fuel tax agreements, oil and gas tax agreements, and sales and use tax collection agreements. For example, under cigarette and tobacco excise tax agreement, the tribe levies a cigarette and tobacco excise tax on all licensed wholesalers and distributors operating on the reservation. The tax rates are identical to the state tax rates. The Tax Department serves as an agent of the tribe in collecting the tax, then shares a pre-determined percentage of the tax revenue back to the tribe. In this particular instance, 87 percent of the tax, less a 1 percent administrative fee, is returned to the tribe. Thirteen percent, plus the 1 percent administrative fee, is deposited in the general fund. See here for additional examples for Tribal-State Tax Agreements. The implication for the Navajo Nation is that it could seek to enter similar agreements with border states. This way, it both removes the threat of dual taxation and places the cost of tax collection and enforcement on state entities.

National Congress of American Indians. (n.d.). Current Tax Needs in Indian Country.

Navajo Nation lacks the typical tax base of states or other localities. The Navajo Nation is unable to impose a property tax on trust lands, and imposing an income tax on reservation residents is largely infeasible. Therefore, a significant amount of tribal tax revenue is generated through sales taxes on any product sold within their territorial jurisdiction. In some cases, a tribal tax has to compete with applicable state taxes resulting in double taxation. However, in other cases, the state tax may be preempted, particularly if the incidence of the tax would fall directly on the tribe or a tribal member for a transaction occurring in Indian Country. 

In lieu of agreements discussed above, the implication for the Navajo Nation Tax Commission is that tax compliance would likely be higher if there were clearer rules that exempted requirements for state taxes.

Thompson, Heather. (2015). Doing Business with Native American Tribal Corporations: Some Competitive Advantages. Greenberg Traurig.

In an expanding global economy, investors are looking for competitive advantages and more advantageous business environments. In this article, the author lists comparative advantages that can make Indian tribes and their wholly-owned corporations very attractive for potential business partnerships and investment. In a section that discusses state and federal tax exemptions advantages, the author lists 1) no state or federal income tax; 2) no state sales tax; 3) no state property tax; and 4) no state property improvement taxes. 

While these may be true, Navajo Nation has several of their own versions of these taxes that would negate the tax advantages discussed in this paper. Namely, Navajo Nation does issue its own business activity tax, which acts as a corporate income tax, its own sales tax, and a Possessory Interest Tax (PIT) on land. It is important to note that the Navajo Nation can maintain its competitive advantage by creating rates lower than other state or federal taxes.

National Congress of American Indians. (2017). Addressing the Harms of Dual Taxation in Indian Country Through Modernizing the Indian Trader Regulations.

Dual taxation, the imposition of both state and tribal taxes on the same transaction, has caused significant harm to tribal governments. If they impose a tribal government tax, then the resulting dual taxation drives business away. Or, tribes collect no taxes and suffer inadequate roads, schools, police, courts and health care. Additionally, reservation economies are funneling millions of tax dollars into treasuries of state and local governments who spend the funds outside of Indian country in border towns.

This resolution argues for a number of federal reforms that will lessen the burden of dual taxation and improve tribal sovereignty by amending federal Indian Trader Regulations. These include amending the federal licensing of Indian traders to defer to tribal regulation, consenting to tribal courts for dispute resolution, tax sourcing of retail sales, and tribal-state agreements. 

Smart Tax Administration

International Tax Dialogue. (2007). Taxation of Small and Medium Enterprises. Background paper for the International Tax Dialogue Conference, Buenos Aires.

This paper reviews best practices and their supporting evidence for tax administration design and treatment of small- and medium-sized enterprises, particularly in economies like Navajo that have high levels of micro-firms, informality, and where enforcement costs are resultantly high across the tax base. There is considerable evidence that the costs of compliance, relative to firm size, are greater for smaller firms. This has been widely documented for higher income countries, for example in one study cited by this paper conducted the the European Commission indicated that compliance costs for the VAT and corporate tax are around 0.02 percent of turnover for larger enterprises, but 2.6 percent for small businesses. Evidence for lower income countries, which are likely to be more relevant to the Navajo context in terms of tax administration, points to similar conclusions. These findings are no surprise, of course, since compliance is likely to involve significant fixed costs. On the side of the tax authorities too, fixed costs in some aspects of administration—the time required for collection enforcement is largely independent of the amount due, for instance—mean that taxing smaller enterprises is relatively more costly.

Smaller enterprises may thus find paying taxes especially burdensome, while the tax authorities are likely to find it especially unrewarding to collect it from them. All this points to relatively low levels of both compliance and enforcement for smaller enterprises— consistent indeed with the focus on larger taxpayers that, as noted above, has been so marked in recent years. Viewed more positively, it points to potential mutual gains, to taxpayer and tax authorities, from the development of simple schemes for taxing small businesses.

Typical distributions of tax revenue by firm size for economies similar to Navajo Nation in that there is a large amounts of micro and small sized businesses, show that micro, small and medium-size enterprises make up more than 90% of taxpayers but contribute only 25–35% of tax revenue.  Imposing high tax costs on businesses of this size might not add much to government tax revenue, but it might cause businesses to move to the informal sector or, even worse, cease operations.

Bird, Richard. (2010). Smart Tax Administration. Economic Premise (World Bank), 36, 1–5.

In many transition economies in the 1990s, the failure to improve tax administration when new tax systems were introduced resulted in the uneven imposition of taxes, widespread tax evasion and lower-than-expected tax revenue. The author discusses the importance of an effective tax administration and lays out high level strategies to help encourage businesses to become formally registered, thereby expanding the tax base and increasing tax revenues. 

Pontus Braunerhjelm, and Johan E. Eklund. (2014). Taxes, Tax Administrative Burdens and New Firm Formation. KYKLOS, 67(February), 1–11.

This paper examines the tax administrative burden and its effect on new firm formation. The authors use World Bank data of tax administration burden and a measure of new firm formation in 118 countries over 6 years to understand the burden that the complexity of tax policy imposes on new firms. The research found that a 10% reduction in the tax administrative burden—as measured by the number of tax payments per year and the time required to pay taxes—led to a 3% increase in annual business entry rates. This shows that an important determinant of firm entry is the ease of paying taxes, regardless of the corporate tax rate. 

Dabla-Norris, Era & Misch, Florian & Cleary, Duncan & Khwaja, Munawer. (2017). Tax Administration and Firm Performance: New Data and Evidence for Emerging Market and Developing Economies. IMF Working Papers.

This paper examines how the quality of tax administration affects firm performance for a large sample of firms in emerging market and developing economies. Using a dataset of an index of tax administration quality and World Bank Enterprise Surveys, the authors show that better tax administration attenuates the productivity gap of small and young firms relative to larger and older firms, a result that is robust to controlling for other aspects of tax policy and of economic governance, alternative definitions of small and young firms, and measures of the quality of tax administration. From a policy perspective, this study provides evidence that tax entities can reap growth and productivity dividends from improvements in tax administration that lower compliance costs faced by firms.

Benefits of Electronic Filings

Kochanova, A., Hasnain, Z., & Larson, B. (2016, April). Does E-Government Improve Government Capacity? Evidence from Tax Administration and Public Procurement. World Bank Group: Policy Research Working Paper 7657.

In this working paper, Kochanova et al. analyzes whether e-filing of taxes improves the capacity of governments to raise and spend resources through the lowering of tax compliance costs. The authors rely on several World Bank databases to construct a dataset of variables related to management information systems for public finance and tax administration and tax compliance costs at both the firm and country levels. The research finds that the adoption of e-filing reduces tax compliance costs as measured by the number of tax payments, the time required to prepare and pay taxes, the probability of being visited by tax officials, the number of visits by tax officials, and the perception of tax administration as an obstacle to firms’ operation and growth. The most compelling evidence from this study is that the transition to e-filing lowers tax compliance costs for both governments and for firms. 

For the purposes of this literature review, we are most interested in the evidence that supports savings at the government level. Transactional e-filing systems that do not feature e-payment functionality do not significantly reduce tax compliance costs in the short or medium run, but the effects gradually increase, and become statistically significant only in the long run, after five years. In contrast, the implementation of transactional e-filing systems with e-payment functionality significantly reduces tax compliance costs, and the effects are almost immediate and become stronger in subsequent years. The results suggest that only the adoption of the more advanced e-filing system that includes an e-payment option significantly reduces tax compliance costs.

International Finance Corporation. (2018). Improved Tax Administration Can Increase Private Investment and Boost Economic Development in Tajikistan. International Finance Corporation, Washington, DC.

The government of Tajikistan has made tax reform a major priority for the country as it seeks to achieve its development goals. In 2013, Tajikistan launched the Tax Administration Reform Project and, as a result, the country built a more efficient, transparent and service-oriented tax system. The modernization of IT infrastructure and the introduction of a unified tax management system increased efficiency and reduced physical interactions between tax officials and taxpayers. Following the improvement of taxpayer services, a taxpayer in Tajikistan spent 28 days in 2016 complying with all tax-related regulations, compared with 37 days in 2012. As a result, the number of active firms and individual taxpayers filing taxes has doubled and revenue collections have risen strongly. 

Nasr, Joanna. (2013). Implementing electronic tax filing and payments in Malaysia. World Bank.

This case study discusses the implementation of an electronic tax filing system in Malaysia and the resulting outcomes. Seeking the benefits of electronic tax systems and reflecting the government’s vision of leveraging online technology, Malaysia’s Inland Revenue Board (IRB) launched its electronic system for taxes in 2004. IRB aimed to increase revenue collection by improving taxpayer services. The goal was to cut time and cost and to allow taxpayers to comply with tax obligations more easily, enabling IRB to maintain a good reputation with taxpayers even as it widened its tax base. With the new system, taxpayers can complete forms and provide needed payment details online instead of sending them by mail or taking them to a tax office. Between 2006 and 2011 the share of individuals and companies filing electronically increased from 5% to 34%. Over the same period, tax collections increased from 14.5% of GDP to 15.3%. By 2007, far more small and medium-size companies were filing electronically, further reducing time to comply with corporate income and labor taxes obligations from 166 hours in 2006 to 145 in 2007. 

Discussion of Regression

Davis, A. (2018). Options for a Less Regressive Sales Tax in 2018. Institute on Taxation and Economic Policy.

Sales taxes are one of the most important revenue sources for state and local governments; however, they are also among the most unfair taxes, falling more heavily on low- and middle-income households. State and local sales taxes are inherently regressive, requiring a higher contribution as a share of income from low- and middle-income taxpayers than the wealthy, because lower-income families have no choice but to spend more of their income on items subject to the tax. According to Consumer Expenditure Survey data, ITEP estimates that low-income families typically spend three-quarters of their income on sales-taxable items, while middle-income families spend about half, and upper-income families spend roughly one sixth of their income.

This policy brief discusses two approaches for a less regressive sales tax to make sales taxes more equitable while preserving an important source of funding for public services. The first of which broad-based exemptions by eliminating sales tax on particular retail items, particularly targeted to exclude items that make up an especially large share of low- and moderate-income households’ budgets such as groceries, prescription drugs, and residential utilities. While exemptions have the potential to make sales tax regimes less regressive, they have several disadvantages such as they narrow the tax base, are poorly targeted, and can be complicated to implement. A second approach is targeted tax credits that provide a flat dollar amount for each member of a family and are available only to taxpayers with income below a certain threshold. These are widely thought to be superior in that they ameliorate many of the concerns previously discussed about exemption. However, sales tax credits do have some disadvantages; the main drawback is the added administrative responsibility on taxpayers. Eligible taxpayers who do not know about the credit, or who do not have to file an income tax form, may miss out on the chance to claim the credit.