By: Leandra Lederman
On March 22, the Indiana University Maurer School of Law’s Tax Policy Colloquium welcomed Prof. Emily Satterthwaite from the University of Toronto Faculty of Law, who presented “Optional Taxation: Survey Evidence from Ontario Microentrepreneurs.” This interesting new paper is not yet publicly available.
The paper explores Canada’s “small supplier” exemption from value-added tax (VAT) registration. Canada’s exemption allows suppliers with less than CAD $30,000 of sales (turnover) in a year to avoid registering for and complying with the VAT unless they opt in. (This amount is not indexed for inflation, and Emily’s paper explains that this threshold is fairly low.) Although it may seem odd for someone to opt into a tax system, as Emily’s paper explains, some small suppliers have incentives to do so: if they buy supplies subject to VAT, they can offset that against VAT owed, and obtain a refund if VAT paid exceeds VAT due. In addition, some small suppliers may be encouraged by their VAT-registered customers to become part of a formal supply chain, because the VAT those customers pay on inputs is creditable. The downside of registering is the cost of doing so, which includes the requirement to file an annual return regardless of whether VAT is owed.
Emily’s paper explores the possibilities of input-channel and customer-channel supply-chain effects via a survey of 98 small suppliers in Ontario, Canada. In order to obtain variation in input-channel and customer-channel incentives, she selected three types of small suppliers: artisans, farmers, and handy people. The paper explains that farmers sell a zero-rated product (food), meaning that a 0% VAT rate applies to output but input tax credits can be claimed. Farmers thus are likely have a strong input-channel incentive to register for the VAT. Handy people typically provide a labor-intensive, non-zero-rated service with few taxable inputs, and they are likely to have customers who are not VAT-registered businesses. Therefore, in this typical case, handy people should be unlikely to opt in. Artisans, by contrast, are likely to purchase more taxable supplies than handy people. Accordingly, they may have an input-channel incentive to register. However, unlike farmers, artisans’ products are not zero-rated. Unless they sell to VAT-registered customers (e.g., businesses such as boutiques, online marketplaces, etc.), charging VAT may put them at a competitive disadvantage compared to artisans who are not registered for VAT. (These general facts, and the implications from them, are summarized in the chart below.)
|Taxable inputs?||Yes||No (generally)||Yes|
|Sell to VAT-registered businesses?||Maybe||No (generally)||Maybe|
|Implication||Likely to opt in (input channel)||Unlikely to opt in||Depends on customer base|
Emily recruited the study’s artisan and farmer participants at farmer’s markets and via trade associations; she successfully recruited 46 eligible artisans, of whom 9 (20%) had registered for the VAT, and 43 eligible farmers, of whom 29 (67%) had registered. Recruiting handy people proved more difficult; she was only able to recruit 9 of them. Of the handy people, 3 (33.3%) had registered for VAT—a higher percentage than expected. Emily’s paper acknowledges limitations of the survey methodology (selection bias and non-representativeness, particularly with regard to handy people).
The study’s quantitative analysis found a significant correlation between selling a greater portion of output to VAT-registered businesses and registration, consistent with a customer-channel effect. The study did not find such a correlation with respect to the input channel: there was no relationship between the ratio of taxable inputs to sales and the participant’s choice to register. Accordingly, Emily found that, in her dataset, input credits apparently did not provide a sufficient incentive for small suppliers to incur the costs of registration, while customer interests did.
The narrative responses to the qualitative portions of the survey suggested that those who had registered for the VAT had generally found it easy to do so, while, for those who had not registered, a common reason was perceived complexity. This contrast is worth noting, as it suggests a perception of complexity that does not reflect what small suppliers experience when they actually register.
The study provides an engaging exploration of topic that U.S. tax scholars probably don’t often think about very often—what prompts people to opt into an elective tax regime? It is interesting that in Emily’s sample, suppliers were more likely to register when it would likely be preferred by their customers (i.e., when they sold largely to VAT-registered businesses) than when they could capture more direct cash tax benefits through refunds of tax paid on inputs.
Emily’s paper concludes by calling for further empirical studies of small-supplier exemptions, but it also notes that her study does not suggest that the complexity such an exemption adds is particularly troublesome for the small suppliers she studied. And the combination of quantitative and qualitative discussion in this exploratory paper helps it provide an interesting window into how small entrepreneurs of various types interact with a VAT. Thank you again to Emily for a terrific talk and a stimulating discussion!
Maurer’s Tax Policy Colloquium series will continue on April 5, with Prof. Len Burman from Syracuse University and the Urban Institute/Tax Policy Center presenting “The Rising Tide Wage Credit.”