Sunday, April 13, 2014

From the NYT: Lessons for International Tax from Oregon's Role as Sales/Use Tax Haven

Today's NYT has an article entitled "Buyers Find Tax Break on Art: Let it Hang Awhile in Oregon." The artful dodge is accomplished via simple arbitrage between a source, an intermediary, and a residence jurisdiction, so the story gives a nice illustration of a phenomenon we see play out on the international stage every day, only we have generally been taught to associate tax avoidance arbitrage with the likes of GE, Google, Apple, etc. Here is the simple pattern:
  1. The collector lives in state A (the residence state)--in this example, California. 
  2. The collector buys an expensive work of art in state B (the source state), in this case, New York. As the source state, state B could extract a tax purely on the occurrence of the sale, but chooses not to, rather basing its sales tax on place of use. 
  3. State A generally imposes use taxes on items purchased from outside the state and brought into the state (this is to treat external sales the same as internal ones, which would be subject to sales taxes). But there is an exception: if an item is "used" in another state first, it is not subject to the use tax when it finally makes its way to state A.
  4. To avoid the use tax, the collector can't keep the item in state B because then state B's sales tax will apply.
  5. In comes state C, with no sales or use tax, in this case, Oregon. State C is a safe haven. Collector parks the asset in state C long enough to satisfy the residence state's exemption. 
  6. Hey presto, neither sales nor use tax. 
Nothing illegal has occurred, as the NYT is very quick to point out. But it is also clear that this is a story for a reason, and the reason suggested by the headline is this outcome produces unfairness. 

After all, these are rich people dodging around helpless tax states with the help of sophisticated tax planners. This seems worth examining further given the parallels to corporate social responsibility and international tax planning à la Caterpillar as we have seen recently in the news, and in light of the actions of some states to try to curb international tax planning ... and please do not let it escape notice that this list includes Oregon. 

Let's identify a few problems and a few solutions in the overall tax regime created by the conflicting rules in the three independent states as suggested above. The problems seem to be:
  1. residents of state A will likely object that it is not fair for state A to tax sales occurring in the state and not sales occurring outside the state (violates horizontal equity).
  2. some residents of state A will likely object that it is not smart to tax sales occurring in the state and not sales occurring outside the state (people will react accordingly and the sales tax base will disappear). 
  3. on the other hand, some residents of state A will argue it is smart to do this because it means more people will buy nice things and ultimately bring them into the state C, causing other spillover benefits in the long run. (If so we should question why state A has a use tax at all.)
  4. state A cannot control either state B or state C but unless strict capital or other regulatory controls are applied against state A's population, state A's rules necessarily interact with B and C.
  5. residents of state B might object that it is not fair for state B to tax sales only if the assets purchased stay in the state and not if they leave the state (violates horizontal equity)
  6. on the other hand residents of state B will likely view it as smart for state B to tax sales only if the assets purchased stay in the state and not if they leave the state, because then more sales will occur in state B and with those sales come jobs and other spillover benefits.
  7. state C just doesn't tax these things and so would seem to be neutral, acting without fault in the arbitrage.
  8. state C residents likely view this neutrality as smart because the state benefits by facilitating the arbitrage between states A and B, and it can be expected to defend this benefit.
  9. but what is smart for either states B or C or both creates an unqualifiedly unfair situation in state A.
So much for the problems. Are there solutions?  Again the illustration is enlightening.
  1. A, B, and C could get together and demand a federal regulation to stop the arbitrage amongst the states. They could, but they won't (cooperation fails).
  2. State A could threaten states B and C to stop facilitating the arbitrage or else (coercion). But what, exactly, does state A want? Does it want to force state B to tax on the basis of source? Does it want state C to tax as the conduit? Either of those would produce fairness in that the individuals would pay tax somewhere, but in neither case would it be state A collecting the tax. Also, depending on state C's political, economic, and social power relative to state A, the strategy could yield results, or not; certainly if harsh tactics are used, state A will be resented by its neighbors, and for what? No revenue, but a globally fairer system that neither B nor C wanted.
  3. State A could change its own law to repeal the first use rule, which would eliminate the benefit of the arbitrage. No more icing on the cake per the collector routing through Oregon. (when people say tax planning is icing on the cake as the person did in this article, I picture a tiny cake with a tower of icing. So much icing that by the time you eat it all, there isn't any room for cake. But I digress.)
Now does it not seem that state A has the most power to fix the situation if it chooses to change its own law to nullify the arbitrage? Is this not what Oregon and other states are doing vis à vis the foreign earnings of state-registered companies?

This is what I am talking about when I say that tax avoidance is as much a supply side as a demand side problem. We can blame states B and C all day long for facilitating tax avoidance. But State A often holds the power to solve the problem itself. If state A does not do that, then we should be looking at why state A does not do that rather than why state B or state C stand by and allow or encourage and benefit from the arbitrage. Are democratic decisions being made to ignore the fairness problem in order to achieve a solution some people in state A consider to be smart, and if they are doing so, who are those people who think this is smart and have the people in state A who do not think it is so smart been allowed access to lawmaking in the same manner and capacity of those who do think it is smart?

Note that in this case there is no discussion about the problem of information asymmetry--that is, we are not looking at state B or C hiding the fact of the sale from state A. That is a different problem which state A might not be able to solve on its own (actually I believe it could but that is another story). But in terms of legal tax avoidance, I think this story is a wonderful illustration of the argument I often make, for example here and here, about who we should be looking to when facilitating legal tax avoidance becomes the central defining characteristic of a tax regime created by the interaction of multiple jurisdictions.

Thanks, New York Times, for inadvertently covering international tax policy in a fun story with pictures and even a graphic.


  1. I think one explanation in this case is in the US consumption taxes are a very tricky political and constitutional matter. I would say in terms of state B generally exports to non residents are exempt from consumption tax under most modern principles although the exports generally need to be commercial in nature. If you go to the CRA's website(if it's back up finally) they have some fairly lengthy documentation on what is a "commercial" export from Canada.

    I will add that Ontario and Quebec once had retail sales taxes similar in nature to that of California's and both provinces abandoned them in favor of VAT's(in Ontario's case administered by CRA, in Quebec RQ administers the GST). I think in the more recent case of Ontario concerns that the traditional sales tax base was being eroded by technology and increased trade were very real and that is why the province opted for administration by CRA something in the past that was seen as an erosion of provincial autonomy.

  2. One thing I liked that the NY Times article mentioned is New Hampshire role in this tax scheme. Personally though notwithstanding the fine art museum at Dartmouth I always find the tax free NH State Liquor Stores located right on New Hampshire's interstate highways to be the most interesting element of the state. I should have asked before my last trip to Montreal if you wanted me to pick anything up but I probably wouldn't have been a good as the first thing they ask at the border is whether you have any alcohol with you.