Tax Incidence of VAT Enforcement Reform for Foreign Services and Small Businesses in Two-sided Markets

Yukihiro Nishimura ()
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Yukihiro Nishimura: Osaka University and CESifo

No 25-06, Discussion Papers in Economics and Business from Osaka University, Graduate School of Economics

Abstract: Value-added tax (VAT) has two major problems in its enforcement: taxing foreign vendors which do not have a business entity in the destination country, and taxing small and medium-sized enterprises (SMEs) with small tax bases. As a solution of these problems, some countries attempt to utilize online platform, to let the platformer pay the foreign firms’ and SMEs’ VAT according to the sales each firm made (platform tax for the destination principle and formalization of informal sector). In the monopolistic market where the platformer determines the fees for the network entry and the commission fee of the platform services, standard-good’s price, we show that taxing foreign developers increases the tax burden laid on the standard good, and we show that the increased tax burden is born 100% by the domestic standard-good’s consumers. We also investigate whether or not the prevention of tax leaks by platform taxes improves the vendors’ entry and tax revenue of the destination country. The effect of the tax reform on home developers crucially depends on the responsiveness of the developers’ entry to the number of network users, which is decreasing in the VAT rate. The derived formula of marginal value of public funds suggests that, due to the simultaneity of price and quantity, more fully fledged structural analysis may be necessary. Additionally, we show that the VAT serves as a Pigouvian tax to ease congestion externalities, and our results are robust with platform competition. In the context of formalization of SMEs, the strength of network externalities matters to see if the existing formal sector receives windfall gains or losses.

Keywords: Digital economy; Platform; Network externality (search for similar items in EconPapers)
JEL-codes: F23 H26 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2025-07
New Economics Papers: this item is included in nep-acc, nep-pbe and nep-sbm
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Persistent link: https://EconPapers.repec.org/RePEc:osk:wpaper:2506

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