VAT Reform via Monopolistic Platformer in Borderless Economy: Price Pass-Though and Efficiency Consequences

The development of online markets has raised ongoing concerns that foreign app service developers are avoiding value-added tax (VAT) in destination countries. To address this issue, some countries have introduced tax reforms that require platforms to pay VAT on behalf of foreign firms based on the sales generated by each firm. This study investigates whether preventing tax leakage through platform taxation improves welfare in the destination country. We first show that taxing foreign firms leads to a reduction in the commission fees charged by the platform to the sellers (developers) which replaces exited foreign developers with domestic ones. However, the increased tax burden also decreases the size of the network user base. Given this trade-off, we demonstrate that whether the domestic welfare increases after the tax reform depends critically on how responsive the sellers’ market entry is to network size. When the tax reform brings welfare gain, it increases with the tax rate and reduces with the initial share of foreign developers. Finally, we show that digitalization mitigates both welfare loss and the platform’s tax avoidance.