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Who pays sales taxes? Evidence from French VAT reforms, 1987–1999
Journal of Public Economics 91 (2007) 1219 – 1229 www.elsevier.com/locate/econbase
Who pays sales taxes? Evidence from French VAT reforms, 1987–1999 Clément Carbonnier PSE (CNRS-EHESS-ENPC-ENS), Campus Jourdan, 48 Bd Jourdan 75014, Paris, France Received 13 September 2005; received in revised form 6 December 2006; accepted 6 December 2006 Available online 25 January 2007
Abstract The point of this paper is to provide visual evidence of tax shifting and to measure empirically the distribution of the sales tax burden between consumers and producers. For that purpose, two French reforms are studied. These reforms entail steep decreases of the VAT rate. September 1st 1987, the VAT rate on car sales went down from the luxury-rate of 33.33% to the full-rate of 18.6%. September 1st 1999, the VAT rate on housing repair services went down from the full-rate of 20.6% to the reduced-rate of 5.5%. The consumer share of the sales tax burden is 57% in the new car sales market and 77% in the housing repair services market. © 2006 Elsevier B.V. All rights reserved. JEL classification: D43; H22; H32 Keywords: Commodity taxation; Tax burden; Tax incidence; Oligopoly
1. Introduction The present paper studies the economic impact of sales tax reforms, and attempts to provide visual evidence of tax shifting and to measure the distribution of the sales tax burden between consumers and producers. Sales taxation is heavily used all around the world, through different kinds of tax. In Europe, a VAT system is applied and those taxes make up a large part of fiscal revenue. For an example, the 2006 French budget forecasted VAT would represent 48.8% of the French total fiscal revenue. Indeed, sales taxes are quite easy to collect. Moreover, it is generally assumed that they do not generate distortions, as they are paid only by consumers. However, the sales tax burden is not paid by consumers only but is shared between consumers and producers, and may be different for different goods. E-mail address: [email protected]. 0047-2727/$ - see front matter © 2006 Elsevier B.V. All rights reserved. doi:10.1016/j.jpubeco.2006.12.004
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The point of this paper is to point out this fact, through visual evidence first, then through econometrical estimates. Therefore, we use price data around the time of two French VAT reforms. The consumer share is found to be 77% in the housing repair service market, and 57% in the new car market. Usual indirect taxation recommendations do not take tax shifting into account. The question of the consumer share of the tax burden may have political implications, as it may affect the optimal sales tax schedule. For an example, the values of VAT shifting on prices should have an impact on the European debate about reducing VAT rates for labor intensive services. However, little is known about the actual indirect tax share borne by the consumer. A number of theoretical papers have studied the question of sales tax shifting on prices. Katz and Rosen (1985) studied a closed Cournot oligopoly. Stern (1987), Besley (1989) considered the free-entrance impact, based on the conjectural variation model developed by Seade (1980). Delipalla and Keen (1992) compared consumer shares of specific or ad valorem sales taxes. They found that the consumer share is higher in the case of specific sales taxes. These papers all pointed out the influence of imperfect competition on tax shifting on price. In essence, the consumer share may be higher than 100% under imperfect competition. From an empirical point of view, Besley and Rosen (1999) tested tax shifting through a number of local sales tax variations in the United States. They found very few markets with a consumer share of the sales tax burden significantly different from 100%. The few goods whose tax shifting on prices is found significantly different from 100% are sold through the retail industry. Taxes on these goods are over-shifted, which means that the consumer share is higher than 100%. Furthermore, there exists a literature on excise tax incidence on prices. Concerning tobacco, most studies estimate only demand elasticity. However, Barnet et al. (1995) estimated a general equilibrium model, with tax shifting on prices. They found that consumer share is equal to 102% for federal excise taxes and 90% for state excise taxes. Delipalla and O'Donnell (2001) tested the theoretical results of Delipalla and Keen (1992) in the case of the European tobacco market. They confirmed that consumer share of specific taxes is higher than consumer share of ad valorem taxes. Young and Bielinska-Kwapsisz (2002) studied the alcohol market with Washington D.C. price data. They found that excise taxes on alcoholic beverages are over-shifted on prices. These papers studied small tax rate variations. Therefore, price shifting cannot be discerned in figures, and these studies cannot measure precisely the values of the consumer share. The present paper study large sales tax rate variations. The rest of the paper is organized as follows. Section 2 presents the data. The empirical work uses price data at the time of two reforms that induced ample VAT rate variations. September 1st 1987, the French VAT rate on car sales went down from the luxury-rate of 33.33% to the full-rate of 18.6%. September 1st 1999, the French VAT rate on housing repair services went down from the full-rate of 20.6% to the reduced-rate of 5.5%. Section 3 presents the visual evidence and the results of estimates. The consumer share is 77% in the housing repair service market and 57% in the new car market. Section 4 concludes on the distribution of the sales tax burden between consumers and producers, and its implication as a matter of optimal taxation. The point is that optimal tax rate should take into account tax shifts on prices. 2. Data The point of this paper is mainly empirical; it is to estimate precisely sales tax shifting on prices. For that purpose, two tax reforms are studied. It is necessary to study tax rate variations large
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Table 1 Concentration in the car and the housing repair sectors Firm classes (by employee nb.)
Housing repair services
New car sales
Number of firms
Proportion of employees
Number of firms
Proportion of employees
0 1 to 2 3 to 5 6 to 9 10 to 19 20 to 49 50 to 99 100 to 199 200 to 249 250 to 499 500 to 999 1000 to 1999 2000 to 4999 5000 and more Overall Concentration
124 347 65 649 35 107 18 116 11 021 4804 663 221 34 44 17 12 10 0 260 045 0.02%
47.82% 25.25% 13.50% 6.97% 4.24% 1.85% 0.25% 0.08% 0.01% 0.02% 0.01% 0.00% 0.00% 0.00% 100%
74 34 18 20 14 18 8 5 2 7 2 2 6 3 213 8.96%
34.74% 15.96% 8.45% 9.39% 6.57% 8.45% 3.76% 2.35% 0.94% 3.29% 0.94% 0.94% 2.82% 1.41% 100%
Note: The concentration parameter is calculated as an Herfindahl–Hirschman index, taking the number of employees as proxy of the size of the firms. As data do not give the exact number of employees in each firm, the number of employees used for a firm is the lower limit of the segment it belongs to. Source: French data base SIRENE.
enough to get precise estimates of the consumer share. There have been few large tax rate changes, and the only reforms that can be studied are those changing the sales tax category of one kind of good.1 There have been two such reforms. September 1st 1987, the VAT rate on new car sales went down from the luxury-rate of 33.33% to the full-rate of 18.6%. September 1st 1999, the VAT rate on housing repair services went down from the full-rate of 20.6% to the reduced-rate of 5.5%. The two markets studied in this article differ markedly, and therefore the two estimates should be very different from one another. The new car market is a closed oligopoly and the housing repair market is close to perfect competition. Obviously, there are very few new car producers. There exist high fixed costs to enter the new car producing market. Between 1992 and 2002 the mean ratio of fixed capital on value added for the car industry was 455%, which is indeed very high. On the other hand, the 1999 reform applied to housing repair services. Fixed costs to enter this market are low. For the most part, housing repair service firms are very small, often with only a few employees. The mean ratio of fixed capital on value added for personal and domestic services between 1992 and 2002 was 32%, which indeed is low. Table 1 gives the number of firms by size for each of these two economic sectors. In this table, there is also a concentration parameter. It is calculated as a Herfindahl–Hirschman index with the number of employees as proxy for the firm size.
1 Some minor reforms occurred; they are studied in Carbonnier (2005). These reforms do not provide a large enough variation to estimate precisely the consumer share values. However, it is possible to point out short-run asymmetrical effects in tax shifting.
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The Concentration index is found equal to 0.02% for the housing repair service industry and 8.96% for the new car sales industry. This confirms the assumption that the new car sales industry is quite an oligopoly and housing repair service industry is close to perfect competition. In order to study these reforms, I use price index time series IPC, built by INSEE, the French statistics agency. IPC, Indice des Prix la consommation, is a price index built with a classification close to the international reference COICOP, with more details. There are 12 divisions, 86 groups and 161 classes. It is calculated each month. It includes more than 1000 different goods and 161 classes of goods. The prices are checked all along the month in 27 000 selling points of 106 cities with more than 2000 inhabitants. IPC is an annually chain-linking Laspeyres index. Each one of the collected prices is checked each month and the weights of the different collected prices are the same for two consecutive months.2 However, it remains that the time series are a little smoothed. The reason is the collection duration. All the prices in the sample are checked each month, but they are checked at a different time in the month. This induces heteroscedasticity on data. Let us suppose that an exogenous shock occurs March the 15th. Among the prices used to build an index for March, some are checked after the 15th– and they take the shock in account for the March index– while some are checked before the 15th– and they take the shock in account for the April index. Therefore, the regression residuals for March and April are correlated. To correct this heteroscedasticity, I use the White method– equivalent to the Newey–West method with no lag– to estimate the standard errors. The new car sales index and the housing repair service index are used to measure the consumer share of sales tax burden. Furthermore, the general index is used in order to implement a double difference regression. At that point, I construct a new index that is the index for all goods except the one studied, using for that purpose the weight coefficients of the class indexes in the general index building. In order to control the regressions, production costs are also used. The proxies of production costs are the price index of rents on the one hand and of energy on the other hand. Fig. 1A and B show the general price index and the new car price index around the time of the 1987 reform— Fig. 1B shows these prices very close to the time of the reform while Fig. 1A shows longer time series. Fig. 2A and B show the general price index and the housing repair service price index around the time of the 1999 reform— Fig. 2B shows these prices very close to the time of the reform while Fig. 2A shows longer time series. In Fig. 1B, the 1987 VAT shifting in new car prices appears clearly. It has been positive. The new car price volatility seems quite high, and some price falls occur sometimes. However, the price fall at the time of the reform is really bigger than the others. At the same time the overall price index seems not to have undergone shocks. The 1999 VAT shifting was also strictly positive. Fig. 2B shows that the 1999 VAT rate decrease shifted strongly on housing repair service prices. The housing repair price index underwent very small fluctuations, except at the time of the reform, when it fell. At the same time the overall price index seems to remain quite linear. 3. Tax shifting measures The point of the present section is to estimate precisely consumer shares. Consumer share is the share of the tax burden paid by the consumers. This consumer share is noted s and also represents the tax shifting on prices. 2
Weight modifications may occur, mainly at the beginning of a year, but there have been no weight changes at the time of the reforms studied in this article.
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Fig. 1. A: Car prices around September 1987 tax reform, long time series. B: Car prices around September 1987 tax reform, short time series Notes: September 1st 1987, the VAT tax rate on new car sales went down from the luxury-rate of 33.33% to the full-rate of 18.6%. The continuous curve is the INSEE price index– base 100: 1980– for new cars. The discontinuous curve is the INSEE price index– base 100: 1980– for everything except new cars.
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Fig. 2. A: Housing repair service prices around September 1999 tax reform, long time series. B: Housing repair service prices around September 1999 tax reform, short time series. Notes: September 1st 1999, the VAT tax rate on housing repair services went down from the full-rate of 20.6% to the reduced-rate of 5.5%. The continuous curve is the INSEE price index– base 100: 1998– for housing repair services. The discontinuous curve is the INSEE price index– base 100: 1998– for everything except housing repair services.
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The tax analyzed here is VAT. It is an ad valorem sales tax applied on the before tax price. The p sp before tax price is 1þs where p is the sale price. The amount of the tax is then 1þs . After a VAT rate dp variation, the consumer price variation is , and the producer price variation– the before tax price ds dp d variation– is ds , that is equal to ds ð1 þ sÞ−p . Consumer share is then given by Eq. (1). 2 p 1þs
ð1 þ sÞ
0
1 ð1 þ sÞ dp @ 1þs A: s¼ p ds 1 þ s ð1þsÞ dp p
ð1Þ
ds
This equation is complex, but the parameter s in this equation is the output of the function dp + + 1þs f : xix 1þsx when x ¼ ð1þsÞ p ds is the input. The function f is bijective from R to R . It is strictly ð1þsÞ dp increasing with respect to x, with only two fixed points 0 and 1. Therefore, if x ¼ p ds is inferior to 100%, so is the consumer share s. Furthermore, if x1 for good 1 is higher than x2 for good 2, the consumer share s1 for good 1 is higher than the consumer share s2 for good 2. The rest of this section dp studies the influence of market properties on the proxy x ¼ ð1þsÞ p ds of the consumer share. Under perfect competition, this proxy is given by Eq. (2). x¼
o : d þ o
ð2Þ
p AD Where o ¼ Op AO Ap is the supply elasticity and d ¼ − D Ap is the demand elasticity. Eq. (2) shows that consumer share under perfect competition is always inferior to 100%. It is increasing with respect to supply elasticity and it is decreasing with respect to demand elasticity. Under imperfect competition, over-shifting may happen. Tax over-shifting on prices corresponds to consumer shares superior to 100%. In this case, the selling price increase is higher than the tax increase. Fully-shifted taxes induce price increases equal to the amount of the tax increase, and then consumer shares equal to 100%. The usual case is consumer shares inferior to 100%; taxes are then under-shifted on prices. Preliminary estimates may be made, according to Fig. 1A to B. Not taking the inflation trend into account, Fig. 1B indicates that there has been a 3.7% car price fall in the four months following the 1987 reform (the new car sales price index is 1738 for August 1987 and 1674 for December 1987). Moreover, there has been 4.2% inflation of new car sales prices during the year preceding the reform. Then, there has been a 5.3% car price fall adjusted for inflation in four months. The VAT rate decreased from 33.33% to 18.6%, which represents an 11% decrease. A preliminary estimate of tax shifting on new car prices is thus 48%. The same thing may be done for the 1999 reform. Not taking the inflation trend into account, Fig. 2B indicates that there has been a 8.4% housing repair service price fall in the four months following the 1999 reform (the housing repair service price index is 1017 for August 1999 and 932 for December 1999). Moreover, there has been 1.5% inflation of new repair service prices during the year preceding the reform. Then, there has been an 8.8% repair service price fall adjusted for inflation in four months. The VAT rate decreased from 20.6% to 5.5%, which represents an 11% decrease. A preliminary estimate of tax shifting on housing repair service prices is thus 80%. Furthermore, sharper estimates are found through regressions. The parameter that has to be estimated is the parameter s defined by Eq. (1) in Section 2. Therefore, the proxy x of this
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parameter is first estimated. Using operator Δt, defined by Eq. (3), double difference regressions are implemented following Eq. (4). Dt ðX Þ ¼
Xt −Xt−1 Xt−1
Dt ðpdependant Þ ¼
4 X
ð3Þ
ai Dtþ1−i ð1 þ sÞ þ bDt ðpoverall Þ þ
X
gi Dt ðpcontroli Þ þ t :
ð4Þ
i
i¼1
Where poverall is the general price index, and the controls are the rent index and the energy price index. Moreover, the spreading out of the price collections all along each month causes heteroscedasticity on data. Therefore, I adjust the regression estimates using the White method for computing standard errors. The sum of the αi estimates is equal to the proxy x. According to Eq. (1), this regression gives the consumer share estimate as presented by Eq. (5). ! ! ! 4 4 X X 1þs Consumer share ¼ f ai ¼ ai : ð5Þ P 1 þ s 4i¼1 ai i¼1 i¼1 These regressions are implemented for both the new car market around 1987 and the housing repair service market around 1999. Price data used in these regressions are the monthly prices for the three years around the reforms. The results of these estimations are presented in Table 2. The consumers pay almost all the sales taxes on housing repair services: 77% of these taxes. They paid a lower share of sales taxes on new cars, only 57%. It also means that car producers pay more than 40% of VAT on car sales. These results are very precise, as Figs. 1B and 2B already Table 2 Consumer share estimates OLS
Number of observations R2 VAT rate shifting during the 1st month (α1) VAT rate shifting during the 2nd month (α2) VAT rate shifting during the 3rd month (α3) VAT rate shifting during the 4th month (α4) Consumer share+
White method
(1) House repair
(2) Car sales
(3) House repair
(4) Car sales
36 99% 0.169⁎⁎⁎ (0.009) 0.472⁎⁎⁎ (0.009) 0.072⁎⁎⁎ (0.009) 0.024⁎⁎⁎ (0.009) 77%⁎⁎⁎ (2%)
36 67% 0.173⁎⁎⁎ (0.043) 0.272⁎⁎⁎ (0.045) 0.025 (0.044) 0.032 (0.044) 57%⁎⁎⁎ (6%)
36 99% 0.169⁎⁎⁎ (0.002) 0.472⁎⁎⁎ (0.002) 0.072⁎⁎⁎ (0.002) 0.024⁎⁎⁎ (0.002) 77%⁎⁎⁎ (0.4%)
36 67% 0.173⁎⁎⁎ (0.008) 0.272⁎⁎⁎ (0.024) 0.025⁎⁎ (0.010) 0.032⁎⁎⁎ (0.009) 57%⁎⁎⁎ (2.9%)
⁎⁎⁎: Significant at 1%, ⁎⁎: significant at 5%, ⁎: significant at 10%. Standard errors in parentheses. +: Calculated as the sum of the coefficients until the last significant, according to Eq. (5). Note: This table presents the results of the regressions of housing repair service prices in the one hand and of new car sale prices in the other hand, on VAT rate changes. Columns (1) and (2) present the result of the regressions with a standard OLS method. Columns (3) and (4) present the result of the regressions with the White method for estimate the standard errors.
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Fig. 3. Price reaction simulations. Notes: The curves are the prices– base 100 before the reforms– as they appear out of the regressions. Error bars indicate the 99% confidence intervals. The discontinuous curve– “consumer share = 100%”– shows the prices that would occur if the consumer share was 100%.
indicated. In addition, tax rate variations explain the main part of price variations. Indeed, R2 are very high: 99% for housing repair services and 67% for new car sales. Furthermore, these results are very significant (1% significant). Standard errors are very small and then consumer share estimates are very sharp. The values themselves– and not only their signs— are significant. Because of the small standard errors, the difference between the two consumer share estimates is also significant. The difference between consumer share in the housing repair service market and consumer share in the new car sales market is 25%. The standard error of this difference is lower than 2.9%. Thus, the difference between the two consumer shares is 1% significantly positive. This difference is illustrated in Fig. 3. This figure presents price reactions of new car sales and housing repair services, as predicted by the regressions. The error bars indicate the 99% confidence intervals as estimated by the regressions. The 99% confidence intervals do not cross. Hence, this figure illustrates that tax shifting on housing repair service prices is very significantly higher than tax shifting on new car sales. The regressions demonstrate another result: tax shifting on prices is very fast. For both goods, taxes shifted almost entirely during the first two months following the reforms. The ratio between tax shifting during the first two months and tax shifting during the two following months is 7.8 for the 1987 reform on new car sales and 6.7 for the 1999 reform on housing repair services. Tax shifting occurred very quickly, but far from instantly. In spite of price checking delays, and because the reforms took place the first day of the month, all the prices used to build the indexes
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for the first month following the reforms take the new VAT rate into account. Hence, the regression results indicate that more than one month is needed for sales taxes to shift on prices. 4. Conclusions Analyzing huge VAT variations, this study provides sharp consumer shares estimates for two very different markets. The estimations find for both markets that taxes are under-shifted on prices, as in Delipalla and O'Donnell (2001). Moreover, the consumer share in the housing repair service market– a close to perfect competitive market– is very significantly higher than the consumer share in the car market– a quite closed oligopoly with very few firms competing. These empirical results are consistent with theoretical results. Under perfect competition hypotheses, more fixed capital implies less supply elasticity, which leads to a lower tax shifting on prices. Furthermore, competition arguments may also explain these results. Tax shifting in closed oligopolies may be higher or lower than 100% depending on the position of the second demand elasticity with respect to 1 (e.g.: Katz and Rosen, 1985; Stern, 1987; Besley, 1989). These results are found using a Cournot oligopoly model with conjectural variations. Two important hypotheses are settled. First, the tax studied is a specific sales tax. Delipalla and Keen (1992) demonstrate that ad valorem sales taxes shift less on prices than specific sales taxes do. The second hypothesis is a constant marginal cost of production, which would induce a 100% shifting under perfect competition. If implementing the same model with non-constant marginal costs of production and with specification of an ad valorem sales tax (e.g.: Carbonnier, 2006), tax shifting in oligopoly is found lower than tax shifting in perfect competition market if the second elasticity of demand is positive.3 This last hypothesis is usually true concerning non-addictive goods, but may be false in the short-run after small price decreases (e.g.: Carbonnier, 2005). This result is quite intuitive: because prices are close to marginal costs in perfect competition market, firms cannot pay a large sales tax share. On the opposite, oligopoly firms already capture a consumer surplus portion without sales taxes. Hence, they have to bear a larger sales tax burden share. This gives another cause for the new car sales tax shifting being lower than the repair service tax shifting. The tax shifting differences between different goods may have political implications as to fiscal decisions. For an example, it should influence the decision to choose which kind of goods has to be taxed at full-rate or at reduced-rate. The tax-payer identity is different in different markets. The consumers are about the only payers when tax shifting on prices is close to 100%. The producers are about the only payers when tax shifting on prices is close to 0%. The outcome of our study is that consumers pay three quarters of the sales taxes on repair services. They pay only half the sales taxes on the new car sales, the other half being paid by the producers. If the goal of a fiscal policy is to maximize consumer utility, there should be implemented a differentiated sales tax schedule. The higher rates should be applied on goods whose demand elasticity is low and tax shifting on prices is low. In perfect competition market, tax shifting is decreasing with respect to the demand elasticity. Therefore, the real cause of differentiated tax rates should be supply and demand elasticities under perfect competition, and the competition level.
3
The comparison is between different competition properties, but with the same demand elasticity and production cost curves.
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Under perfect competition, supply elasticity is higher– which implies a lower tax shifting and a higher optimal tax rate– for faster increasing marginal production costs. Higher tax rates in this case may prevent production at too high marginal production costs. Concerning the competition matter, firms in low competition markets pay a larger share of sales taxes than firms in competitive markets. Therefore, higher sales tax rates for low competition market goods may be a means for governments to capture an oligopoly rent portion. Acknowledgement I thank the editor and referees for helpful comments. I am grateful to Thomas Piketty for his help and his comments. I am grateful to Michel Pierssens. References Barnet, P., Keeler, T., Hu, T.-W., 1995. Oligopoly structure and the incidence of cigarette excise taxes. Journal of Public Economics 57, 457–470. Besley, T., 1989. Commodity taxation and imperfect competition, a note on the effects of entry. Journal of Public Economics 40, 359–367. Besley, T., Rosen, H., 1999. Sales taxes and prices: an empirical analysis. National Tax Journal 52, 157–178. Carbonnier, C., 2005. Is Tax shifting asymmetric ? Evidence from French Reforms, 1995–2000. PSE Working Paper. wp2005-34. Carbonnier, C., 2006. Who pays commodity tax? Evidence from French Reforms, 1987–1999. PSE Working Paper. wp2006-13. Delipalla, S., Keen, M., 1992. The comparison between ad valorem and specific taxation under imperfect competition. Journal of Public Economics 49, 351–367. Delipalla, S., O'Donnell, O., 2001. Estimating tax incidence, market power and market conduct: the European cigarette industry. International Journal of Industrial Organization 19, 885–908. Katz, M., Rosen, H., 1985. Tax analysis in an oligopoly model. Public Finance Quarterly 13, 3–19. Seade, J., 1980. On the effects of entry. Economtrica 48, 479–490. Stern, N., 1987. The effects of taxation price control and government contracts in oligopoly and monopolistic competition. Journal of Public Economics 32, 133–158. Young, D., Bielinska-Kwapsisz, A., 2002. Alcohol taxes and beverage prices. National Tax Journal 55, 57–74.
Who pays sales taxes? Evidence from French VAT reforms, 1987–1999 Clément Carbonnier PSE (CNRS-EHESS-ENPC-ENS), Campus Jourdan, 48 Bd Jourdan 75014, Paris, France Received 13 September 2005; received in revised form 6 December 2006; accepted 6 December 2006 Available online 25 January 2007
Abstract The point of this paper is to provide visual evidence of tax shifting and to measure empirically the distribution of the sales tax burden between consumers and producers. For that purpose, two French reforms are studied. These reforms entail steep decreases of the VAT rate. September 1st 1987, the VAT rate on car sales went down from the luxury-rate of 33.33% to the full-rate of 18.6%. September 1st 1999, the VAT rate on housing repair services went down from the full-rate of 20.6% to the reduced-rate of 5.5%. The consumer share of the sales tax burden is 57% in the new car sales market and 77% in the housing repair services market. © 2006 Elsevier B.V. All rights reserved. JEL classification: D43; H22; H32 Keywords: Commodity taxation; Tax burden; Tax incidence; Oligopoly
1. Introduction The present paper studies the economic impact of sales tax reforms, and attempts to provide visual evidence of tax shifting and to measure the distribution of the sales tax burden between consumers and producers. Sales taxation is heavily used all around the world, through different kinds of tax. In Europe, a VAT system is applied and those taxes make up a large part of fiscal revenue. For an example, the 2006 French budget forecasted VAT would represent 48.8% of the French total fiscal revenue. Indeed, sales taxes are quite easy to collect. Moreover, it is generally assumed that they do not generate distortions, as they are paid only by consumers. However, the sales tax burden is not paid by consumers only but is shared between consumers and producers, and may be different for different goods. E-mail address: [email protected]. 0047-2727/$ - see front matter © 2006 Elsevier B.V. All rights reserved. doi:10.1016/j.jpubeco.2006.12.004
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The point of this paper is to point out this fact, through visual evidence first, then through econometrical estimates. Therefore, we use price data around the time of two French VAT reforms. The consumer share is found to be 77% in the housing repair service market, and 57% in the new car market. Usual indirect taxation recommendations do not take tax shifting into account. The question of the consumer share of the tax burden may have political implications, as it may affect the optimal sales tax schedule. For an example, the values of VAT shifting on prices should have an impact on the European debate about reducing VAT rates for labor intensive services. However, little is known about the actual indirect tax share borne by the consumer. A number of theoretical papers have studied the question of sales tax shifting on prices. Katz and Rosen (1985) studied a closed Cournot oligopoly. Stern (1987), Besley (1989) considered the free-entrance impact, based on the conjectural variation model developed by Seade (1980). Delipalla and Keen (1992) compared consumer shares of specific or ad valorem sales taxes. They found that the consumer share is higher in the case of specific sales taxes. These papers all pointed out the influence of imperfect competition on tax shifting on price. In essence, the consumer share may be higher than 100% under imperfect competition. From an empirical point of view, Besley and Rosen (1999) tested tax shifting through a number of local sales tax variations in the United States. They found very few markets with a consumer share of the sales tax burden significantly different from 100%. The few goods whose tax shifting on prices is found significantly different from 100% are sold through the retail industry. Taxes on these goods are over-shifted, which means that the consumer share is higher than 100%. Furthermore, there exists a literature on excise tax incidence on prices. Concerning tobacco, most studies estimate only demand elasticity. However, Barnet et al. (1995) estimated a general equilibrium model, with tax shifting on prices. They found that consumer share is equal to 102% for federal excise taxes and 90% for state excise taxes. Delipalla and O'Donnell (2001) tested the theoretical results of Delipalla and Keen (1992) in the case of the European tobacco market. They confirmed that consumer share of specific taxes is higher than consumer share of ad valorem taxes. Young and Bielinska-Kwapsisz (2002) studied the alcohol market with Washington D.C. price data. They found that excise taxes on alcoholic beverages are over-shifted on prices. These papers studied small tax rate variations. Therefore, price shifting cannot be discerned in figures, and these studies cannot measure precisely the values of the consumer share. The present paper study large sales tax rate variations. The rest of the paper is organized as follows. Section 2 presents the data. The empirical work uses price data at the time of two reforms that induced ample VAT rate variations. September 1st 1987, the French VAT rate on car sales went down from the luxury-rate of 33.33% to the full-rate of 18.6%. September 1st 1999, the French VAT rate on housing repair services went down from the full-rate of 20.6% to the reduced-rate of 5.5%. Section 3 presents the visual evidence and the results of estimates. The consumer share is 77% in the housing repair service market and 57% in the new car market. Section 4 concludes on the distribution of the sales tax burden between consumers and producers, and its implication as a matter of optimal taxation. The point is that optimal tax rate should take into account tax shifts on prices. 2. Data The point of this paper is mainly empirical; it is to estimate precisely sales tax shifting on prices. For that purpose, two tax reforms are studied. It is necessary to study tax rate variations large
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Table 1 Concentration in the car and the housing repair sectors Firm classes (by employee nb.)
Housing repair services
New car sales
Number of firms
Proportion of employees
Number of firms
Proportion of employees
0 1 to 2 3 to 5 6 to 9 10 to 19 20 to 49 50 to 99 100 to 199 200 to 249 250 to 499 500 to 999 1000 to 1999 2000 to 4999 5000 and more Overall Concentration
124 347 65 649 35 107 18 116 11 021 4804 663 221 34 44 17 12 10 0 260 045 0.02%
47.82% 25.25% 13.50% 6.97% 4.24% 1.85% 0.25% 0.08% 0.01% 0.02% 0.01% 0.00% 0.00% 0.00% 100%
74 34 18 20 14 18 8 5 2 7 2 2 6 3 213 8.96%
34.74% 15.96% 8.45% 9.39% 6.57% 8.45% 3.76% 2.35% 0.94% 3.29% 0.94% 0.94% 2.82% 1.41% 100%
Note: The concentration parameter is calculated as an Herfindahl–Hirschman index, taking the number of employees as proxy of the size of the firms. As data do not give the exact number of employees in each firm, the number of employees used for a firm is the lower limit of the segment it belongs to. Source: French data base SIRENE.
enough to get precise estimates of the consumer share. There have been few large tax rate changes, and the only reforms that can be studied are those changing the sales tax category of one kind of good.1 There have been two such reforms. September 1st 1987, the VAT rate on new car sales went down from the luxury-rate of 33.33% to the full-rate of 18.6%. September 1st 1999, the VAT rate on housing repair services went down from the full-rate of 20.6% to the reduced-rate of 5.5%. The two markets studied in this article differ markedly, and therefore the two estimates should be very different from one another. The new car market is a closed oligopoly and the housing repair market is close to perfect competition. Obviously, there are very few new car producers. There exist high fixed costs to enter the new car producing market. Between 1992 and 2002 the mean ratio of fixed capital on value added for the car industry was 455%, which is indeed very high. On the other hand, the 1999 reform applied to housing repair services. Fixed costs to enter this market are low. For the most part, housing repair service firms are very small, often with only a few employees. The mean ratio of fixed capital on value added for personal and domestic services between 1992 and 2002 was 32%, which indeed is low. Table 1 gives the number of firms by size for each of these two economic sectors. In this table, there is also a concentration parameter. It is calculated as a Herfindahl–Hirschman index with the number of employees as proxy for the firm size.
1 Some minor reforms occurred; they are studied in Carbonnier (2005). These reforms do not provide a large enough variation to estimate precisely the consumer share values. However, it is possible to point out short-run asymmetrical effects in tax shifting.
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The Concentration index is found equal to 0.02% for the housing repair service industry and 8.96% for the new car sales industry. This confirms the assumption that the new car sales industry is quite an oligopoly and housing repair service industry is close to perfect competition. In order to study these reforms, I use price index time series IPC, built by INSEE, the French statistics agency. IPC, Indice des Prix la consommation, is a price index built with a classification close to the international reference COICOP, with more details. There are 12 divisions, 86 groups and 161 classes. It is calculated each month. It includes more than 1000 different goods and 161 classes of goods. The prices are checked all along the month in 27 000 selling points of 106 cities with more than 2000 inhabitants. IPC is an annually chain-linking Laspeyres index. Each one of the collected prices is checked each month and the weights of the different collected prices are the same for two consecutive months.2 However, it remains that the time series are a little smoothed. The reason is the collection duration. All the prices in the sample are checked each month, but they are checked at a different time in the month. This induces heteroscedasticity on data. Let us suppose that an exogenous shock occurs March the 15th. Among the prices used to build an index for March, some are checked after the 15th– and they take the shock in account for the March index– while some are checked before the 15th– and they take the shock in account for the April index. Therefore, the regression residuals for March and April are correlated. To correct this heteroscedasticity, I use the White method– equivalent to the Newey–West method with no lag– to estimate the standard errors. The new car sales index and the housing repair service index are used to measure the consumer share of sales tax burden. Furthermore, the general index is used in order to implement a double difference regression. At that point, I construct a new index that is the index for all goods except the one studied, using for that purpose the weight coefficients of the class indexes in the general index building. In order to control the regressions, production costs are also used. The proxies of production costs are the price index of rents on the one hand and of energy on the other hand. Fig. 1A and B show the general price index and the new car price index around the time of the 1987 reform— Fig. 1B shows these prices very close to the time of the reform while Fig. 1A shows longer time series. Fig. 2A and B show the general price index and the housing repair service price index around the time of the 1999 reform— Fig. 2B shows these prices very close to the time of the reform while Fig. 2A shows longer time series. In Fig. 1B, the 1987 VAT shifting in new car prices appears clearly. It has been positive. The new car price volatility seems quite high, and some price falls occur sometimes. However, the price fall at the time of the reform is really bigger than the others. At the same time the overall price index seems not to have undergone shocks. The 1999 VAT shifting was also strictly positive. Fig. 2B shows that the 1999 VAT rate decrease shifted strongly on housing repair service prices. The housing repair price index underwent very small fluctuations, except at the time of the reform, when it fell. At the same time the overall price index seems to remain quite linear. 3. Tax shifting measures The point of the present section is to estimate precisely consumer shares. Consumer share is the share of the tax burden paid by the consumers. This consumer share is noted s and also represents the tax shifting on prices. 2
Weight modifications may occur, mainly at the beginning of a year, but there have been no weight changes at the time of the reforms studied in this article.
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Fig. 1. A: Car prices around September 1987 tax reform, long time series. B: Car prices around September 1987 tax reform, short time series Notes: September 1st 1987, the VAT tax rate on new car sales went down from the luxury-rate of 33.33% to the full-rate of 18.6%. The continuous curve is the INSEE price index– base 100: 1980– for new cars. The discontinuous curve is the INSEE price index– base 100: 1980– for everything except new cars.
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Fig. 2. A: Housing repair service prices around September 1999 tax reform, long time series. B: Housing repair service prices around September 1999 tax reform, short time series. Notes: September 1st 1999, the VAT tax rate on housing repair services went down from the full-rate of 20.6% to the reduced-rate of 5.5%. The continuous curve is the INSEE price index– base 100: 1998– for housing repair services. The discontinuous curve is the INSEE price index– base 100: 1998– for everything except housing repair services.
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The tax analyzed here is VAT. It is an ad valorem sales tax applied on the before tax price. The p sp before tax price is 1þs where p is the sale price. The amount of the tax is then 1þs . After a VAT rate dp variation, the consumer price variation is , and the producer price variation– the before tax price ds dp d variation– is ds , that is equal to ds ð1 þ sÞ−p . Consumer share is then given by Eq. (1). 2 p 1þs
ð1 þ sÞ
0
1 ð1 þ sÞ dp @ 1þs A: s¼ p ds 1 þ s ð1þsÞ dp p
ð1Þ
ds
This equation is complex, but the parameter s in this equation is the output of the function dp + + 1þs f : xix 1þsx when x ¼ ð1þsÞ p ds is the input. The function f is bijective from R to R . It is strictly ð1þsÞ dp increasing with respect to x, with only two fixed points 0 and 1. Therefore, if x ¼ p ds is inferior to 100%, so is the consumer share s. Furthermore, if x1 for good 1 is higher than x2 for good 2, the consumer share s1 for good 1 is higher than the consumer share s2 for good 2. The rest of this section dp studies the influence of market properties on the proxy x ¼ ð1þsÞ p ds of the consumer share. Under perfect competition, this proxy is given by Eq. (2). x¼
o : d þ o
ð2Þ
p AD Where o ¼ Op AO Ap is the supply elasticity and d ¼ − D Ap is the demand elasticity. Eq. (2) shows that consumer share under perfect competition is always inferior to 100%. It is increasing with respect to supply elasticity and it is decreasing with respect to demand elasticity. Under imperfect competition, over-shifting may happen. Tax over-shifting on prices corresponds to consumer shares superior to 100%. In this case, the selling price increase is higher than the tax increase. Fully-shifted taxes induce price increases equal to the amount of the tax increase, and then consumer shares equal to 100%. The usual case is consumer shares inferior to 100%; taxes are then under-shifted on prices. Preliminary estimates may be made, according to Fig. 1A to B. Not taking the inflation trend into account, Fig. 1B indicates that there has been a 3.7% car price fall in the four months following the 1987 reform (the new car sales price index is 1738 for August 1987 and 1674 for December 1987). Moreover, there has been 4.2% inflation of new car sales prices during the year preceding the reform. Then, there has been a 5.3% car price fall adjusted for inflation in four months. The VAT rate decreased from 33.33% to 18.6%, which represents an 11% decrease. A preliminary estimate of tax shifting on new car prices is thus 48%. The same thing may be done for the 1999 reform. Not taking the inflation trend into account, Fig. 2B indicates that there has been a 8.4% housing repair service price fall in the four months following the 1999 reform (the housing repair service price index is 1017 for August 1999 and 932 for December 1999). Moreover, there has been 1.5% inflation of new repair service prices during the year preceding the reform. Then, there has been an 8.8% repair service price fall adjusted for inflation in four months. The VAT rate decreased from 20.6% to 5.5%, which represents an 11% decrease. A preliminary estimate of tax shifting on housing repair service prices is thus 80%. Furthermore, sharper estimates are found through regressions. The parameter that has to be estimated is the parameter s defined by Eq. (1) in Section 2. Therefore, the proxy x of this
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parameter is first estimated. Using operator Δt, defined by Eq. (3), double difference regressions are implemented following Eq. (4). Dt ðX Þ ¼
Xt −Xt−1 Xt−1
Dt ðpdependant Þ ¼
4 X
ð3Þ
ai Dtþ1−i ð1 þ sÞ þ bDt ðpoverall Þ þ
X
gi Dt ðpcontroli Þ þ t :
ð4Þ
i
i¼1
Where poverall is the general price index, and the controls are the rent index and the energy price index. Moreover, the spreading out of the price collections all along each month causes heteroscedasticity on data. Therefore, I adjust the regression estimates using the White method for computing standard errors. The sum of the αi estimates is equal to the proxy x. According to Eq. (1), this regression gives the consumer share estimate as presented by Eq. (5). ! ! ! 4 4 X X 1þs Consumer share ¼ f ai ¼ ai : ð5Þ P 1 þ s 4i¼1 ai i¼1 i¼1 These regressions are implemented for both the new car market around 1987 and the housing repair service market around 1999. Price data used in these regressions are the monthly prices for the three years around the reforms. The results of these estimations are presented in Table 2. The consumers pay almost all the sales taxes on housing repair services: 77% of these taxes. They paid a lower share of sales taxes on new cars, only 57%. It also means that car producers pay more than 40% of VAT on car sales. These results are very precise, as Figs. 1B and 2B already Table 2 Consumer share estimates OLS
Number of observations R2 VAT rate shifting during the 1st month (α1) VAT rate shifting during the 2nd month (α2) VAT rate shifting during the 3rd month (α3) VAT rate shifting during the 4th month (α4) Consumer share+
White method
(1) House repair
(2) Car sales
(3) House repair
(4) Car sales
36 99% 0.169⁎⁎⁎ (0.009) 0.472⁎⁎⁎ (0.009) 0.072⁎⁎⁎ (0.009) 0.024⁎⁎⁎ (0.009) 77%⁎⁎⁎ (2%)
36 67% 0.173⁎⁎⁎ (0.043) 0.272⁎⁎⁎ (0.045) 0.025 (0.044) 0.032 (0.044) 57%⁎⁎⁎ (6%)
36 99% 0.169⁎⁎⁎ (0.002) 0.472⁎⁎⁎ (0.002) 0.072⁎⁎⁎ (0.002) 0.024⁎⁎⁎ (0.002) 77%⁎⁎⁎ (0.4%)
36 67% 0.173⁎⁎⁎ (0.008) 0.272⁎⁎⁎ (0.024) 0.025⁎⁎ (0.010) 0.032⁎⁎⁎ (0.009) 57%⁎⁎⁎ (2.9%)
⁎⁎⁎: Significant at 1%, ⁎⁎: significant at 5%, ⁎: significant at 10%. Standard errors in parentheses. +: Calculated as the sum of the coefficients until the last significant, according to Eq. (5). Note: This table presents the results of the regressions of housing repair service prices in the one hand and of new car sale prices in the other hand, on VAT rate changes. Columns (1) and (2) present the result of the regressions with a standard OLS method. Columns (3) and (4) present the result of the regressions with the White method for estimate the standard errors.
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Fig. 3. Price reaction simulations. Notes: The curves are the prices– base 100 before the reforms– as they appear out of the regressions. Error bars indicate the 99% confidence intervals. The discontinuous curve– “consumer share = 100%”– shows the prices that would occur if the consumer share was 100%.
indicated. In addition, tax rate variations explain the main part of price variations. Indeed, R2 are very high: 99% for housing repair services and 67% for new car sales. Furthermore, these results are very significant (1% significant). Standard errors are very small and then consumer share estimates are very sharp. The values themselves– and not only their signs— are significant. Because of the small standard errors, the difference between the two consumer share estimates is also significant. The difference between consumer share in the housing repair service market and consumer share in the new car sales market is 25%. The standard error of this difference is lower than 2.9%. Thus, the difference between the two consumer shares is 1% significantly positive. This difference is illustrated in Fig. 3. This figure presents price reactions of new car sales and housing repair services, as predicted by the regressions. The error bars indicate the 99% confidence intervals as estimated by the regressions. The 99% confidence intervals do not cross. Hence, this figure illustrates that tax shifting on housing repair service prices is very significantly higher than tax shifting on new car sales. The regressions demonstrate another result: tax shifting on prices is very fast. For both goods, taxes shifted almost entirely during the first two months following the reforms. The ratio between tax shifting during the first two months and tax shifting during the two following months is 7.8 for the 1987 reform on new car sales and 6.7 for the 1999 reform on housing repair services. Tax shifting occurred very quickly, but far from instantly. In spite of price checking delays, and because the reforms took place the first day of the month, all the prices used to build the indexes
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for the first month following the reforms take the new VAT rate into account. Hence, the regression results indicate that more than one month is needed for sales taxes to shift on prices. 4. Conclusions Analyzing huge VAT variations, this study provides sharp consumer shares estimates for two very different markets. The estimations find for both markets that taxes are under-shifted on prices, as in Delipalla and O'Donnell (2001). Moreover, the consumer share in the housing repair service market– a close to perfect competitive market– is very significantly higher than the consumer share in the car market– a quite closed oligopoly with very few firms competing. These empirical results are consistent with theoretical results. Under perfect competition hypotheses, more fixed capital implies less supply elasticity, which leads to a lower tax shifting on prices. Furthermore, competition arguments may also explain these results. Tax shifting in closed oligopolies may be higher or lower than 100% depending on the position of the second demand elasticity with respect to 1 (e.g.: Katz and Rosen, 1985; Stern, 1987; Besley, 1989). These results are found using a Cournot oligopoly model with conjectural variations. Two important hypotheses are settled. First, the tax studied is a specific sales tax. Delipalla and Keen (1992) demonstrate that ad valorem sales taxes shift less on prices than specific sales taxes do. The second hypothesis is a constant marginal cost of production, which would induce a 100% shifting under perfect competition. If implementing the same model with non-constant marginal costs of production and with specification of an ad valorem sales tax (e.g.: Carbonnier, 2006), tax shifting in oligopoly is found lower than tax shifting in perfect competition market if the second elasticity of demand is positive.3 This last hypothesis is usually true concerning non-addictive goods, but may be false in the short-run after small price decreases (e.g.: Carbonnier, 2005). This result is quite intuitive: because prices are close to marginal costs in perfect competition market, firms cannot pay a large sales tax share. On the opposite, oligopoly firms already capture a consumer surplus portion without sales taxes. Hence, they have to bear a larger sales tax burden share. This gives another cause for the new car sales tax shifting being lower than the repair service tax shifting. The tax shifting differences between different goods may have political implications as to fiscal decisions. For an example, it should influence the decision to choose which kind of goods has to be taxed at full-rate or at reduced-rate. The tax-payer identity is different in different markets. The consumers are about the only payers when tax shifting on prices is close to 100%. The producers are about the only payers when tax shifting on prices is close to 0%. The outcome of our study is that consumers pay three quarters of the sales taxes on repair services. They pay only half the sales taxes on the new car sales, the other half being paid by the producers. If the goal of a fiscal policy is to maximize consumer utility, there should be implemented a differentiated sales tax schedule. The higher rates should be applied on goods whose demand elasticity is low and tax shifting on prices is low. In perfect competition market, tax shifting is decreasing with respect to the demand elasticity. Therefore, the real cause of differentiated tax rates should be supply and demand elasticities under perfect competition, and the competition level.
3
The comparison is between different competition properties, but with the same demand elasticity and production cost curves.
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Under perfect competition, supply elasticity is higher– which implies a lower tax shifting and a higher optimal tax rate– for faster increasing marginal production costs. Higher tax rates in this case may prevent production at too high marginal production costs. Concerning the competition matter, firms in low competition markets pay a larger share of sales taxes than firms in competitive markets. Therefore, higher sales tax rates for low competition market goods may be a means for governments to capture an oligopoly rent portion. Acknowledgement I thank the editor and referees for helpful comments. I am grateful to Thomas Piketty for his help and his comments. I am grateful to Michel Pierssens. References Barnet, P., Keeler, T., Hu, T.-W., 1995. Oligopoly structure and the incidence of cigarette excise taxes. Journal of Public Economics 57, 457–470. Besley, T., 1989. Commodity taxation and imperfect competition, a note on the effects of entry. Journal of Public Economics 40, 359–367. Besley, T., Rosen, H., 1999. Sales taxes and prices: an empirical analysis. National Tax Journal 52, 157–178. Carbonnier, C., 2005. Is Tax shifting asymmetric ? Evidence from French Reforms, 1995–2000. PSE Working Paper. wp2005-34. Carbonnier, C., 2006. Who pays commodity tax? Evidence from French Reforms, 1987–1999. PSE Working Paper. wp2006-13. Delipalla, S., Keen, M., 1992. The comparison between ad valorem and specific taxation under imperfect competition. Journal of Public Economics 49, 351–367. Delipalla, S., O'Donnell, O., 2001. Estimating tax incidence, market power and market conduct: the European cigarette industry. International Journal of Industrial Organization 19, 885–908. Katz, M., Rosen, H., 1985. Tax analysis in an oligopoly model. Public Finance Quarterly 13, 3–19. Seade, J., 1980. On the effects of entry. Economtrica 48, 479–490. Stern, N., 1987. The effects of taxation price control and government contracts in oligopoly and monopolistic competition. Journal of Public Economics 32, 133–158. Young, D., Bielinska-Kwapsisz, A., 2002. Alcohol taxes and beverage prices. National Tax Journal 55, 57–74.