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E -commerce firms pose vexing new challenges to “old economy”
regulators. Virtual merchants’ extreme mobility, remoteness from
customers and ability to deliver some goods digitally rather than physically,
have helped them stay far beyond the reach of most tax and customs authorities.
But the obstacles to taxing and regulating e-commerce are more political
than technical. Information technology firms and tax-averse conservatives
have lobbied hard to keep government hands off of what they claim is an
“infant industry” in need of nurturing. U.S. officials, eager
to curry favor with the hi-tech sector, have responded by promoting a
de-regulated approach to e-commerce at home and abroad.
The U.S. Sales Tax Loophole
In the United States, the Supreme Court has ruled that state and local
governments cannot force retailers to collect sales taxes unless they
have a physical presence, such as a store or warehouse, in their jurisdiction.
The Court has noted, however, that Congress has the power to change the
policy by enacting legislation authorizing states to enter into an interstate
compact to require remote sellers to collect and remit sales tax.
The National Governor’s Association and other state and local government
groups have pressed Congress to do just that. They argue that if the existing
loophole remains open, the shift to on-line purchasing will erode their
revenue base, diminishing their ability to provide adequate health, education
and other services.
Although e-commerce remains a tiny portion of the retail market (about
1 percent), it is growing faster than traditional brick-and-mortar business,
with U.S. e-commerce rising 19.3 percent in 2001, to $32.6 billion in
sales. And the recipients of privileged tax treatment are not just small
start-ups struggling to survive the dot-com bloodbath, but also Amazon.com
and the expanding online divisions of “click-and-mortar” giants
such as Wal-Mart and Barnes & Noble. A September 2001 study by the
Center for Business and Research at the University of Tennessee estimates
that foregone revenues for states and localities could total as much as
$54.8 billion by 2011, forcing them to raise their sales tax rates between
0.83 and 1.73 percent to make up for the loss.
State and local governments have found allies among traditional brick-and-mortar
retailers, who resent the tax-free advantage enjoyed by their online competitors.
A number of traditional retailers, including Ames, Lowe’s and RadioShack
have formed the “e-Fairness Coalition” to lobby for a level
playing field.
The American Booksellers Association, which represents independent bookstores,
is a coalition member. “Our government should not be in the business
of playing favorites,” says the American Booksellers Association's
Chief Operating Officer, Oren Teicher. “Either require all retailers
to collect sales taxes or none of us.”
State governments concede that the current state sales tax system is
a cumbersome patchwork. There are 7,500 tax jurisdictions in the United
States and often they define and tax products differently (with orange
juice defined as a taxable fruit in one state, and a non-taxable beverage
in another). However, 38 states are involved in a project to streamline
the tax system through uniform product definitions and simplified administrative
procedures.
Despite this progress, Congress remains reluctant to allow states to
make sales tax collection by remote sellers mandatory. In October 1998,
the U.S. Congress passed the Internet Tax Freedom Act, a three-year ban
on new Internet taxes, such as taxes on access fees. Although the measure
didn’t ban sales taxes on e-commerce, it didn’t do anything
to address the loophole either, despite demands from the brick and mortar
retailers and state governments.
When the moratorium approached expiration in the fall of 2001, Senator
Byron Dorgan, D-North Dakota, took the lead in demanding that Congress
close the sales tax loophole. Dorgan, a former tax administrator, co-sponsored
a bill supported by state government groups and large retailers that would
allow states and localities that adequately simplify their tax systems
to require online retailers to collect sales taxes. However, Congress
opted to extend the existing moratorium for two more years, leaving the
loophole wide open.
Support for Dorgan’s bill was undercut by a competing proposal offered
by Senator Ron Wyden, D-Oregon, from the hi-tech stronghold of the Northwest.
Wyden’s approach did not explicitly oppose sales tax collection,
but would have imposed much tougher conditions on local governments to
simplify their tax systems before Congress would consider allowing them
to collect sales tax on e-commerce. “State and local governments
have a right to be concerned about where their revenue is coming from,”
Wyden said, “but they should not be able to view the Internet as
a cyber cash cow.”
A formidable coalition of hi-tech industry associations rallied behind
Wyden, including the 500-member Information Technology Association of
America; the more elite Information Technology Industry Council, which
represents about 30 top firms, including Amazon.com, AOL Time Warner and
IBM; and the Business Software Alliance, comprised of Adobe, Apple, Microsoft
and other software developers.
The hi-tech bloc’s strategy of linking tax collection to sales tax
simplification was “pure obfuscation,” says Teicher. “You
can buy software off the shelf that will compute state and local sales
taxes for you. This was all about the raw power of the electronic industry.”
Indeed, these firms’ clout on Capitol Hill has expanded along with
their campaign contributions. According to the Center for Responsive Politics,
computer/Internet firms’ donations jumped more than 700 percent between
the 1992 and 2000 presidential election years, totaling about $40 million
in 2000.
Dorgan faced additional opposition from a group of conservative think
tanks and anti-tax groups that formed the “e-Freedom Coalition”
(a not-so-subtle challenge to the retailers’ “e-Fairness Coalition”).
One member group, Americans for Tax Reform, issued a hostile press release
with the headline: “Dorgan to Internet Users: Drop Dead.” The
coalition’s opposition to e-commerce taxes is a matter of democracy,
says the libertarian Cato Institute’s Aaron Lukas: “When a local
business collects sales taxes, there is a clear link among taxes paid,
services provided and legislative representation. To force a wholly out-of-state
business to collect taxes would be ‘taxation without representation,’
pure and simple.”
Main Street supporters, such as David Morris of the Minneapolis-based
Institute for Local Self-Reliance, reject this perspective out of hand.
Asks Morris, “Why should distant companies which contribute little
to the communities where they do business enjoy a 5 to 8 percent price
advantage over local stores?”
Dorgan plans to push for further progress in streamlining the state sales
tax system and intends to re-introduce his legislation when the current
moratorium expires in November 2003.
The e-Freedom Coalition will continue to oppose any “schemes to
wring more tax money out of remote consumers,” responds Bartlett
Cleland, a coalition spokesperson based at the Institute for Policy Innovation.
The Global “E-Freedom” Agenda
While the tax debate has raged in the United States, both the Clinton
and now the Bush White Houses have busily promoted rules at the international
level that would minimize governments’ ability to tax e-commerce.
Within the World Trade Organization (WTO), U.S. officials have succeeded
in obtaining a moratorium on tariffs on products transmitted electronically
(downloadable software, printed material, videos, music, databases, architectural
drawings, etc.). They are also advocating for a ban on new taxes on e-commerce
in the WTO as well as in the negotiations around the Free Trade Area of
the Americas (FTAA), the Asian Pacific Economic Cooperation and through
bilateral agreements. As part of the FTAA process, the U.S. government
has persuaded other countries to accept the formation of a joint private
sector-government committee on e-commerce that allows Microsoft, AOL,
IBM, Motorola and other hi-tech firms to sit side by side with public
officials to hammer out recommendations for the negotiators.
The U.S. government claims that a de-regulated approach to e-commerce
is particularly important for the economic future of the developing world.
By contrast, the United Nations Conference on Trade and Development (UNCTAD)
has raised strong concerns about the potential impact of the tax-free
approach on the global South. Because of U.S. dominance of this new technology,
most online orders in developing countries are received as U.S. imports.
Although governments technically have the right to impose customs duties
on these imports if they are delivered across the border as physical goods,
most developing countries lack the capacity to screen each individual
package, calculate a duty and collect the revenue. With regard to digitized
products, developing countries are at an even greater disadvantage. The
WTO bans duties on these transactions and developing countries are heavy
net importers of these products.
Customs duties are generally a much more important source of revenue
for Third World nations than for rich countries. According to UNCTAD,
these poorer nations’ losses in uncollected tariffs will amount to
64.5 percent of all countries’ e-commerce customs losses. Seven developing
countries are expected to be among the top 10 losers, including India,
Mexico, Malaysia, Brazil, China, Morocco and Argentina. In some countries
the tariff losses may be as much as 20 percent of import duty revenues.
Moreover, the WTO moratorium means that many countries will lose not only
tariff revenues but also additional duties they collect on imports, such
as customs surcharges and consumption taxes.
A major e-commerce report published by UNCTAD in 2001 concludes that
“the development of efficient tax collection systems for e-commerce
should be a priority for all developing countries.” However, the
study laments the fact that developing countries have not participated
much in discussions around Internet taxation, while the richer nations
have largely ignored their concerns.
The EU Fights Back
The European Union has most strongly resisted tax-free e-commerce, largely
because sales taxes, known as value-added taxes (VAT), account for about
30 percent of member states’ tax receipts. However, despite strong
political support for taxing e-commerce, loopholes remain. Currently,
the VAT (which ranges from 15 to 25 percent, depending on the country)
is supposed to apply to all goods and services, regardless of the mode
of delivery. But e-commerce firms based outside the EU can export material
goods into the EU free of VAT or customs duties if they are worth less
than about $27 (which would include many commonly ordered CDs and books).
Moreover, non-EU firms have been able to export digitized products into
the EU tax-free because such exports were treated as services, which under
EU rules are taxed where they are provided.
In February 2002, EU finance ministers moved to close this service loophole
by requiring non-EU companies that sell online digital products to collect
VAT. The plan is scheduled to go into effect in July 2003, but the U.S.
government appears poised to try to block it. Both the U.S. Treasury Department
and industry groups have attacked the plan as discriminatory because it
would force non-EU providers to apply tax rates depending on the location
of the customer, whereas EU firms would continue to collect taxes based
on the company’s country of establishment. The Europeans’ explanation
is that if non-EU firms were allowed instead to collect taxes based on
the rates of a single EU country, they would surely all opt for Luxembourg,
which has the lowest VAT.
The United States is threatening to take the dispute to the WTO. Deputy
Treasury Secretary Kenneth Dam says, “The United States and each
country of the EU … has obligated itself in international treaties
not to impose measures that discriminate against nationals of the other
signatories. The EU proposal may be contrary to those agreements.”
Spanish Finance Minister Rodrigo Rato, who chaired the finance ministers’
meeting, dismissed the U.S. complaints, telling AFX news service, “We
believe that the new directive is perfectly compatible with the WTO rules.”
In picking this fight with a major trade partner, the U.S. government
is representing the interests of U.S. hi-tech firms. The president of
the Information Technology Association of America, Harris Miller, for
example, has likened the EU plan to a virtual deathblow to U.S. online
service providers’ ability to operate in the EU. Referring to the
time that it would take a U.S. vendor to verify an EU customer’s
location and compute a tax, Miller says, “Anything that slows the
processing of Internet transactions by more than a few seconds will result
in the loss of significant revenue. There is the risk that the EU may
prescribe rules of compliance that, in effect, will close the European
market to U.S.”
Tax Havens — The Final Frontier
Beyond their ability to elude sales taxes, tariffs and customs duties,
the extreme mobility of e-commerce firms offers potential opportunities
for avoiding income taxes as well. As e-commerce tax expert David Hardesty
points out: “A 13-year-old child can, in 10 minutes, move an entire
web site from a server in one country to a server in another. This makes
web sites highly mobile, and enables operators to move sites easily from
unfriendly jurisdictions to ones that are friendly.”
The World Bank and the International Monetary Fund have raised similar
concerns. For example, the Bank’s annual report “Global Economic
Prospects” warned that “electronic commerce will pose difficult
challenges for government regulation of tax and financial systems. ...
Multinationals will find it easier to shift activities to low-tax regimes.
Governments may find it more difficult to impose desired income tax levels
on existing corporations, and competition among developing countries for
investment by multinationals may rise.”
Already, scores of web sites offer assistance in setting up “offshore”
web servers to take advantage of what they label “tax e-fficiency.”
Although the extent of offshore e-commerce is not well-documented, Bermuda
appears to be a major magnet. Long known as a tax haven, Bermuda has also
attracted significant investment in telecommunications infrastructure.
Offshore operations there range from small dot-coms to the international
trading operations of online broker E*Trade. The legal issues of such
operations remain murky, and accountants are relying on this ambiguity
to help U.S. firms keep a few steps ahead of the authorities.
Even with the best efforts of policymakers, e-commerce firms may continue
to elude the world’s regulators for some time to come. And it does
not appear as though U.S. officials will ease up their efforts to block
e-commerce taxation any time soon. At least as long as U.S. firms continue
to dominate the information technology sector, U.S. officials are likely
to work to advance their interests through every possible channel.
Sarah Anderson is director of the Global Economy
Project at the Institute for Policy Studies in Washington, D.C. The Project
is conducting a research project on e-commerce in collaboration with the
International Forum on Globalization.
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