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Consumption taxes in the internet world.

Article Excerpt
Abstract

The evolution of e-commerce raises serious issues concerning the current and future viability of consumption taxes. The dimensions of e-commerce (product, process, and agent) are shown to significantly impact the characteristics of taxes. The key issue addressed is whether the sales and use tax or the VAT is better positioned to evolve and handle the consequences of e-commerce. The conclusion deduced is that the United States with the sales and use tax is further ahead in addressing the problems but that the European Union with the VAT is likely to solve the problems first due to uniformity and cooperation. (JEL H2)

Introduction

The development of the World Wide Web in 1990 created a rapidly expanding nontraditional market. E-commerce is a continuation of the market evolution from agriculture to manufacturing to services to the information age. The Internet increases firms' market reach and helps create a truly global marketplace. Increased cross-border transactions are inevitable. Benefits include increased consumer choices and lower prices through increased sales and economies of scale. However, the digitization of commerce affects the administration of consumption taxes that are primarily designed to deal with traditional transactions.

The most significant consumption taxes axe the value added tax (VAT) and the sales and use tax (sales tax). The VAT is used in 118 of 180 nations, while the sales tax is a major source of state and local revenue in the United States. Consumption-based taxes are a growing percentage of worldwide tax revenue accounting for 17.8 percent of revenue in OECD countries and 7.9 percent in the U.S. in 1995 [OECD, Consumption Tax Trends, 1999, p. 16]. The reliance varies widely as Japan receives 5.3 percent of its revenue from consumption taxes compared to Iceland's 32.9 percent. The U.S. federal government effectively receives none, while states average 32.9 percent of state revenue from consumption taxes, ranging from to over 57.4 percent [Federation of Tax Administrators, 1998 Sales Tax Collection by Source].

Can existing consumption tax codes be adapted to deal with e-commerce? Some researchers have predicted the end of the sales tax [Ault and Laband, 2000] or presented options for replacing the sales tax with a VAT [Keen and Smith, 2000; McLure 1999]. Others have argued that the existing sales and use tax system can be modified to handle e-commerce [Fox and Murray, 1997; Hellerstein, 1997; Fox, Luna and Murray, 2002]. The increased volume of cross-border transactions raises concern about lost VAT revenue [Tagliabue, 2000]. The OECD is studying this issue with goals of fostering trade, preserving tax base integrity, and taxing consumption as close to the consumer as possible.

Is the VAT or sales tax better positioned to evolve successfully with e-commerce and the globalizing market place? In theory, there should be no winner since taxes based on final value should equal the accumulated taxes on the successive value added. Therefore, any differences in e-commerce impact are due to the actual application of these two taxes.

Dimensions of E-Commerce

E-commerce significantly affects the mobility of the product, the consumer, and the producer, making tax base definitions problematic. The effects of e-commerce on taxes specifically, and on commerce in general, can be analyzed using the dimensions of a market transaction, product, process, and agent [Choi et al., 1997].

Traditional market transactions are physical on each of the three dimensions. An example is a consumer who buys an automobile by physically driving to a number of car dealers to compare price, make, and model. This is the physical process. Upon finding the car, she wants the car dealer--a physical agent--to physically deliver the car for customer pick-up. The search process takes place in physical space, the car dealer is in a specific physical location to which the customer goes, and the product is physical.

Digitization of the product makes e-commerce revolutionary because it allows the product's location to be dissociated from the customer's. These transactions are categorized as pure e-commerce. An example is the consumer who searches for, buys, and downloads software over the Internet from a company--the agent--that exists solely in cyberspace. Egghead.com is such a company selling software and computer games over the Internet for downloading, but with no physical retail outlets. Electronic brokerage firms...

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