===================================================================== Center for Community Economic Development University of Wisconsin-Extension Community Economics Newsletter No. 296 June 2001 ===================================================================== A Newsletter from the Center for Community Economic Development; Community,Natural Resource and Economic Development Programs, and University of Wisconsin-Extension, Cooperative Extension Service ===================================================================== Think Locally, Tax Globally by Simona Fuma Shapiro* Web retailers in the U.S. are largely exempt from collecting state and local sales taxes. In allowing this exemption, Congress agrees to give out-of-state businesses a 5 to 7 percent price advantage over local stores. Proponents of the exemption argue internet based suppliers would stagger under the administrative burden of collecting thousands of different state and local sales taxes; opponents of the exemption argue that the electronic commerce companies don't need help siphoning business away from already struggling downtowns. Unlike the United States, the European Union never considered making the internet a taxfree zone. The difference in approaches can be traced to the treatment of mailorder goods. Mailorder goods present a problem for taxation authorities because a taxing jurisdiction must either collect taxes from a supplier outside its borders (hard to administer) or tax the consumer within its borders as soon as she receives the product (hard to enforce). European countries figured out a way to tax these items. The U.S. exempted them. /1 E.U, and U.S. Views Differ In 1998, E.U. tax authorities voiced their concerns that, "aside from revenue considerations, it would be essential to be able to apply VAT (valueadded tax) to trade over the networks in order to avoid distortion of competition with conventionally traded products." In October of that year, an international conference on the subject of ecommerce was held in Ottawa, Canada. Participants included ministers and high level officials from all 29 OECD (Organization for Economic Cooperation and Development) member countries, as well as participants from 12 nonmember countries, representatives of international business organizations and various trade unions, consumer groups and other nongovernmental organizations. The OECD issued a report on "framework conditions" for the taxation of ecommerce. The first principle cited is that of neutrality: Taxation should seen to be neutral and equitable between forms of electronic commerce and between conventional and electronic forms of commerce. Business decisions should be motivated by economic rather than tax considerations. Taxpayers in similar situations carrying out similar transactions should be subject to similar levels of taxation. This approach is in stark contrast to the Clinton administration's December 1997 policy paper, "A Framework for Global Electronic Commerce," which argued that the internet be tariff-free. Point of Collection All E.U. purchases are subject to a valueadded tax, or VAT, which is similar to U.S. states' sales taxes on retail goods. Each of the 15 E.U. member states has its own VAT rate, ranging from 15-25 percent of the price of the good sold. (In many member states, reduced or even zero rates are applied to "essential" products such as food, fuel and children's clothes and to products of cultural or educational significance, such as books and newspapers.) One difference between VAT and state sales taxes, however, is that VAT is collected at the final destination where consumption occurs (usually the vendor in the consumer's own country), while U.S. states' sales taxes are charged where the product is purchased. Thus, a visitor to a European country can be refunded the VAT he paid on a product purchased in that country if he carries that product with him across the border. In addition, products entering international trade do so free of VAT. However, a foreign tourist visiting Minnesota is not refunded the sales tax on her purchases once she leaves the state. VAT collection becomes logistically more difficult when an individual makes mail-order purchases across European borders. Which country has the right to collect tax on the transaction? Is this practical? If not, can one country collect the tax and remit it to the other ? How can this be accomplished? According to European rules, if I live in E.U. member state A and buy a product from E.U. member state B, it is state A that has the right to charge VAT on my purchase, since VAT is collected at the point of consumption. But because the vendor is the best place for the tax authorities to intercept my purchase, the E.U. nations early on developed a framework whereby the vendor in state B must collect VAT and remit it to state A. Physical Presence vs. Economic Influence Both the U.S. and Europe use a similar test to decide whether a tax can be imposed on remote suppliers. In the United States "nexus" occurs when the seller has a physical presence in the state (e.g. a store or warehouses). In Europe, what corresponds to nexus occurs when a seller has a sufficiently large economic presence that it can affect local enterprises. The threshold for registration for distance sales is set out in European Commission (EQ legislation and is generally 100,000 Euro a year (about $90,000 USD), with some exceptions. Saving Retail in the Digital Age One complaint of those who oppose e-commerce taxation in the United States is that with so many taxing jurisdictions (approximately 7600, each of which has the right to impose its own sales tax rate), collecting and remitting taxes to the appropriate authority would be impracticable. The European entities offer a model of how interstate taxation can be achieved when there is a political will to do so. Indeed, a larger number of taxing jurisdictions makes it that much less likely for a truly small-time operation to achieve nexus in any one of them. Internet vendors of jam and maple syrup will not likely have to register in many Jurisdictions. It is the internet giants like Amazon.com and eBay that would have to remit taxes in those areas where their business was sufficient to establish "nexus." While we have been busy undermining our traditional retail sector, the Europeans have been devising ways to treat theirs fairly. We should learn from them in developing tax policies for the digital age. * Simona Funia Shapiro is a researcher with The New Rules Project of the Institue for Local Self-Reliance. From her article of the same title appearing in The New RULES, Summer 2000. 1/ In 1967 the U.S. Supreme Court (National Bellas Hess Inc. v. Department of Revenue of Illinois) concluded that states cannot compel outofstate mail order firms to collect sales taxes. The court said that state taxation on remote business is justified only where the tax is necessary to make the business bear its fair share of the cost of the government whose protection it enjoys. Thus, it conditioned nexus upon finding that the retailer had a physical presence in the state. In 1998 Congress extended the exemption for mailorder merchants to ecommerce. The 1998 Internet Tax Freedom Act imposed a threeyear moratorium on any new taxes on electronic transactions and created a commission to study this issue. Ron Shaffer Community Development Economist Issued in furtherance of Cooperative Extension work, Acts of May 8, and June 30, 1914, in cooperation with the U.S. Department of Agriculture. Carl O‘Connor, Cooperative Extension, University of Wisconsin-Extension. University of Wisconsin-Extension, U.S. Department of Agriculture and Wisconsin counties cooperating. UW-Extension provides equal opportunities in employment and programming, including Title IX and ADA.