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Abstract
This paper examines the size and composition of the sales and use tax gap in
Minnesota. The first segment of this thesis estimates the gap primarily attributed to
business-to-consumer sales using data on remote sales collected by the U.S. Census
Bureau. Business-to-consumer sales are primarily sales to individuals, while business-tobusiness
sales are primarily sales to firms. We find…The second segment of the paper
examines unremitted sales and use tax, primarily attributed to business-to-business sales,
using data from audits conducted by the Minnesota Department of Revenue. It is
important to note that while e-commerce does play a significant role in the
underreporting of use tax, the sales tax gap is largely comprised of noncompliance
unrelated to e-commerce. While capturing lost tax revenue to e-commerce will
significantly decrease the size of the use tax gap, a sales tax gap will persist.
We find that, after controlling for audit selection, the estimated sales tax gap to be
between $263 million to $1,039 million dollars each year. The use tax gap is somewhere
between $261.3 million dollars and $400.3 million dollars. We also find that find larger
firms are more likely to be audited, but that they are more likely to yield a no-change
assessment, indicating that compliance increases as firm size increases. However, the size
of audit assessments increase as tax liability increases, which likely explains why audit
rates increase as firm size increases. We also find that firms with out of state addresses
are less likely to be audited but are more likely to be noncompliant. Finally, from our
analysis of the predicted magnitude of noncompliance, we can conclude that, after
controlling for firm size and audit selection, the industries most likely to yield high use
tax audit assessments are firms in the Mining and Utilities and Finance & Insurance
industries. Firms most likely to yield high sales tax audit assessments are firms in the
Information industry. Finally, we examine ways Minnesota may implement new tax
policy to mitigate further erosion of the sales tax base.