Tuesday, 2 September 2003

World Wide Web of Taxes

Fearful that overtaxed consumers might want to escape the value-added tax, the European Union concocted a plan to impose VAT on software, videos, computer games and music downloaded via the Internet from non-EU companies. This raises the possibility that U.S. companies selling goods to EU customers will be forced to collect taxes on behalf of European collectors. The EU claims that this extra-territorial tax scheme is necessary to create a so-called level playing field. But this plan is just another attempt by the Union to prevent tax competition and will only lead to higher prices and higher taxes.

In other words, EU politicians want to tax-and-spend without ever suffering any consequences for their irresponsible behavior. Ironically, these same politicians accuse non-EU nations of “poaching” their taxpayers. This is a reprehensible attitude for two reasons. First, it assumes that citizens are tax slaves, perpetually bound by the tax laws of their home government regardless of where they, work, save, shop, or invest. Second, it completely reverses the causality. European consumers are only interested in shopping in other nations because the EU has required all member nations to harmonize their value-added taxes at a rate of at least 15 percent. It is the creation of this high-tax requirement — not “poaching” by more responsible governments — that has caused cross-border shopping to become more attractive.

Interestingly, the scheme to impose EU taxes on non-Union companies is even contrary to standard EU practice. European companies traditionally have added a VAT to the services and products they sell online. A Dutch company would collect the Dutch tax on any online products it sold, for instance, regardless of where the customer lived. Similarly, companies outside the EU imposed only the taxes required by their national governments — and they certainly did not have to collect an EU value-added tax when they were selling goods to EU customers because the point of sale was not in the EU. (EU governments technically oblige consumers to remit a “use” tax on remote purchases, but these levies are so unpopular that they are seldom enforced.)

Under the new proposal, the EU wants to shift the point of taxation to where the good is consumed and not where it is sold. It means that U.S. companies selling to an EU customer would have to collect the tax and remit it to EU governments. Also, in an effort to create a discriminatory preference for exports, EU companies selling to U.S. customers would not collect taxes anymore.

It is not really hard to imagine why the Union would want to do such a thing. Thanks to the Internet, highly taxed Europeans can purchase tax-free goods from non-EU nations. With the cost of shipping in constant decline, buying goods from non-EU online sellers is often a no-brainer for bargain-hunters.

And in fact, the number of EU customers buying from non-EU companies over the Internet has increased drastically. According to eMarleter — an online research firm — while the United States will have 168 million Internet users next year among which 75 percent are online buyers, Europe will have 221 million people online, 86 percent of them being shoppers. Also, in July 2003, Amazon.com reported its international sales are growing faster than its North American sales, thanks mostly to Europe’s “big three” Internet markets: Germany, France and the U.K. Amazon.com also reports that the three countries accounted for 70 percent of e-commerce in Europe in 2002.

The EU hopes to steal a bunch of golden eggs without killing the goose. The size of the market is now big enough that the new tax probably won’t kill it completely and the EU can expect loads of money pouring into its coffers from foreign companies. Also, the revenue lost from ending the taxation of non-European customers buying online from EU companies is expected to be quite small since far fewer foreigners buy from EU companies. At the end of the day, the political cost of the measure is almost zero. Non-EU companies do not vote in Europe, and the new tax revenue can be used to buy additional support from people who do.

For non-EU firms though, it is quite a different story. Non-European businesses have three ways to go about complying with this new rule. First, they can register their business and set up their headquarters in one EU country. They would then have to pay that country’s tax rate. That is the option chosen by AOL, which will move its European headquarters to the EU’s lowest VAT rate country, Luxembourg. This option is complicated and costly but according to an AOL spokeswoman, “it certainly beats the alternative.”

The second option is for companies not to set up a physical presence in Europe but pay the tax rate for the country where the customer lives — ranging from 15 percent in Luxembourg to 25 percent in Sweden. This option of course is extremely complicated because it requires companies to collect extensive information about each customer and to comply with many tax jurisdictions. European companies, by contrast, only charge the tax rate of the country where they are located. That’s the option Amazon.com opted for after it realized how much the new regulation would affect its auctions, plus marketplace and zshop operations where third party new and used items are sold. The Washington State-based company said it plans to charge VAT on the commission but stresses that it will increase its cost drastically.

The third option is for non-EU companies to ignore the new regulation. This option sounds quite appealing especially if compared to the cost of each of its alternatives. However, the cost of noncompliance could be really steep since the EU says it will force companies to pay back taxes and plus fines of 100 to 200 percent, among other penalties. Still it is hard to imagine how Brussels could enforce this rule for smaller companies with no EU presence — or whether in most cases it would be worth the trouble.

E-commerce companies in the United States are worried about the EU’s initiative. If Europe succeeds in requiring them to collect VAT, it might open a Pandora’s box for Internet taxation in the U.S. — or, more specifically, it might lead to requirements that interstate vendors collect sales tax. It’s a genuine fear. More than 30 U.S. state governments are now forming a tax cartel that would allow them to start taxing income earned outside of their state borders just like the EU is trying to do at the international level. And this is where the EU’s scheme becomes clear. All the relentless criticism of the supposed unfairness of the existing regime is just a disguise for a proposal that will make government bigger and more expensive. This project is really about creating more sources of revenue for the EU by allowing governments to tax income earned outside of their national borders. The European Union has a grim history of trying to force its bad tax policy on non-EU nations — with the Savings Tax Directive being the most notable example.

If the EU’s pro-tax forces manage to enforce this new regulation, the French government would be able to collect taxes from the Washington State-based Amazon.com. Never mind, of course, that the company being taxed has no voice in decisions made by the French government and that the company does not benefit from the public services France provides with those tax dollars (not that many French taxpayers do, either).

Under the cover of creating a “level playing field,” EU governments are trying to tax income earned by non-European businesses. In doing so, they are posing a huge threat to taxpayers and economic prosperity. Instead of forcing high-tax European governments to lower their rates — the problem that is causing much of the out-of-Europe online shopping — this project would allow governments to impose reporting and remittance obligations on non-European entities. This clearly violates basic concepts such as “no taxation without representation” and “national sovereignty.”

Taxpayers would be the big losers because under this system, no matter where they shop and how they choose to shop, they would face the same rate as if they were shopping in their own country. And because this would undermine fiscal competition between countries, such a proposal would give European politicians much more leeway to increase taxes – even though that is the mentality that caused the problem in the first place.

Countries, as sovereign entities, should have control over their tax policy. Companies with no physical presence in Europe should not be forced to collect taxes for the European Union. Forcing non-EU companies to collect a tax on behalf of European governments is not the solution for Europe’s economic problems. In addition, it is hard to think of a single good economic reason the non-EU companies should participate. European taxpayers would be the big losers of this game and freedom and economic growth would be permanently damaged.

Veronique de Rugy

This article first appeared on www.techcentralstation.be