Consumption taxes are a primary source of tax revenue in many jurisdictions. While consumers nominally
are the taxable entity, firms might actually bear the respective tax burden. We examine whether
service firms in Europe strategically report sales in order to avoid consumption taxes. We then test if
managing sales in response to consumption taxes affects income tax-motivated profit shifting. We
exploit firm-level panel data and a unique setting in Europe in 2007-2015 with 65 staggered and plausibly
exogenous consumption and corporate income tax rate changes. We find that service firms, on
average, report 0.5 percent less in sales if consumption taxes increase by one percentage point. Consistent
with theory and incentives, the effect is stronger for firms with greater discretion over where to
pay value-added taxes and firms facing greater demand elasticity. We then show that the extent and
the channels of profit shifting depend on firms’ responsiveness to consumption taxes. This result suggests
that consumption taxes place a constraint on corporate income tax planning.
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