Note: there is a closed question that is similar (https://money.stackexchange.com/questions/126677/paying-taxes-revenue-vs-taxes-profit) but the response offers a perspective that I would like to challenge and understand.

Companies pay taxes on gross income (revenue - cost of sold goods) while individuals pay directly on revenue.

Several sources I could read (including the answer to the question I mentioned) mention fairness between companies and the fact that they "spend to make money" and not "consume" as in the case of an individual (why would one be better than the other?)

Not being an economist, I still do not understand why the difference in treatment.

If taxes were paid on revenue, wouldn't the money flow stabilize somewhere else? (prices would go up, and so would salaries in order for people to afford the new prices).

One of the advantages I imagine would be that countries that have lower taxation would not be artificially used as a consolidation center to show a "zero (or small) gross income" (and therefore low or zero taxes) in other countries.

To be clear: I am not trying to be the Robin Hood of economics, I am trying to understand whether there are fundamental reasons why the market would not stabilize elsewhere.

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    $\begingroup$ If taxes were paid on revenue then companies have to consolidate or die. The computer company buys hard drives from the hard drive company which buys metal sheets from the metal smelting company which buys metal ore from the mines? Well, that means they pay tax four times! But the company which owns the mines and the refinery and the hard drive factory and the computer store only pays tax once. So you're giving money to companies to incentivize them to become as big as possible. $\endgroup$ – user253751 Sep 14 '20 at 14:25
  • $\begingroup$ @user253751: thank you, this is a very interesting point I did not think about at all (on eof probably many others) $\endgroup$ – WoJ Sep 14 '20 at 14:27
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    $\begingroup$ @BrianRomanchuk but VAT system by its definition includes deductions for VAT payed on materials and so on. Only the final goods and services are really having any net positive tax impact under VAT and it will be on net for many firms 0 and economically assuming away all real world imperfection the same firms that would pay positive VAT would be the same firms that pay any sales tax. It really only collects information at stages but not the tax itself. Furthermore, even if you would want to just look at things pro forma, income tax is also not applied to all incomes as many people are in zero $\endgroup$ – 1muflon1 Sep 14 '20 at 19:13
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    $\begingroup$ @BrianRomanchuk tax bracket and some forms of income are excluded altogether yet that does not mean income tax not applied universally ceases to be income tax and by the same virtue even if you want to put economics aside and just look at the paper trail sales tax would still be revenue tax even if it generates smaller amount of paper trial. $\endgroup$ – 1muflon1 Sep 14 '20 at 19:14
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    $\begingroup$ In addition firms that do not hit certain turnover thresholds are in many VAT countries not required to register for VAT at all. So for those companies VAT won’t be zero but simply won’t apply. Again using your semantics then this would mean that your original analogy won’t apply $\endgroup$ – 1muflon1 Sep 14 '20 at 20:00

If taxes were paid on revenue, wouldn't the money flow stabilize somewhere else? (prices would go up, and so would salaries in order for people to afford the new prices).

This sentence is unclear. If you mean to ask whether market would eventually reach some stable equilibrium the answer would be yes.

However, this is a bit of a moot point. There actually already are taxes on revenue as pointed in comments. VAT and sales taxes are de facto taxes on company's revenue even if they might not be de jure taxes on company revenue. This is because company's revenue is defined as price times quantity sold $R=pq$ so any tax that is levied on price company charges is de facto a revenue tax.

I make a purposeful distinction between de facto and de jure tax because in most tax codes you will see written that firms collect VAT/sales tax from consumers on behalf of the government. So de jure these taxes are applied to consumers, however from economic perspective it does not matter if VAT or sales tax is de jure levied on consumers or producers as tax burden is always allocated by the market (see Mankiw Principles of Economics).

The intuition why they are equivalent can be seen in the pictures below I taken from the Mankiw's book. The intuition is that whether tax is levied on consumers or suppliers (firms) it will have the same effect on new market equilibrium price and quantity supplied. enter image description here enter image description here

So de facto VAT and sales taxes are also revenue taxes. Also since tax burden is split by the market it does not really matter from distributional/welfare perspective if government puts this tax de jure on businesses, so there is no opportunity here to do any redistribution just by changing the de jure designated payer of a tax. This does not mean the burden of the tax is distributed equally or that even there might not be cases where only one side of the market bears the burden. The point is that the burden is determined by the market not government.

In practice the designation of who pays might have political significance. That is an economically equivalent tax on producers might be more palatable to voters to the same tax on consumers but that does not matter for economic analysis.

Furthermore, an important caveat is that sometimes it might be more practical to tax one party because they might have for example lower administrative burden. This is why VAT and sales tax are both collected by companies so in fact they pay the tax even though de jure these are taxes on consumers and de facto the tax burden is always split between consumers and producers depending on parameters of supply and demand regardless of designated payer stipulated in law.

  • $\begingroup$ The difference between a revenue tax and VAT is that VAT is refunded on the materials that go into the product. So each dollar of the product's price is taxed once, not once per company. $\endgroup$ – user253751 Sep 14 '20 at 17:05
  • $\begingroup$ @user253751 but precisely you can only deduct the VAT from materials and other inputs in order to avoid double taxation, but not cost of those inputs only VAT that you previously paid over those costs. This is why in the end sales tax and VAT are economically equivalent. But that tidbit aside yes it is a revenue tax because the tax is levied on revenue firm earns minus tax paid for COGS not just minus the COGS in which case it would be gross profit tax. Or to be more specific it is revenue tax from perspective of final goods and services. $\endgroup$ – 1muflon1 Sep 14 '20 at 17:22
  • $\begingroup$ You pay the tax on (revenue minus COGS). Equivalently: You pay (tax on revenue) minus (tax on COGS). You do not pay: tax on (revenue minus (tax on COGS)) $\endgroup$ – user253751 Sep 15 '20 at 11:17
  • $\begingroup$ @user253751 but this is simply not correct generally speaking. VAT is applied to revenue not gross profit. You can look at any accounting book, see for example this accounting for dummies as example dummies.com/business/accounting/how-to-calculate-vat-2 $\endgroup$ – 1muflon1 Sep 15 '20 at 11:25
  • $\begingroup$ For example, if there is 10 percent VAT firm buys materials for 10e +1e VAT and then sells the product for 100e the VAT on that 100e sale will be 10e not 9e sure company gets eventually 1e refund for the VAT payed in the first step but the VAT is applied to revenue not gross profit and then you deduct the VAT payed on materials. Company cannot deduct COGS that include also wages for assembly workers from VAT. Also if company produces everything in house there is not even that deduction there. $\endgroup$ – 1muflon1 Sep 15 '20 at 11:34

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