September 2003
The New World of E-Commerce Taxation
Cross border sales, through the Internet or other channels, are currently taxed based on their point of destination, not the country or state from which they originated. At a September 5 event, Michael S. Greve, the John G. Searle Scholar at AEI, presented a paper proposing that the current system be reformed in order to tax cross border sales on the basis of their origin and not their destination. Daniel Shaviro of New York University School of Law and Peter R. Merrill of PricewaterhouseCoopers commented on his paper.
Michael S. Greve
AEI
Cross border sales can be taxed either on the basis of their destination or their origin. The current e-commerce situation poses many problems for the international and national consumption tax system, which is based primarily on the principle of destination-based taxation. Instead of extending the already broken, destination-based sales tax system to e-commerce, we should implement a system that taxes cross border sales at their origin, not their destination.
Destination-based taxation is terribly complex, burdensome, and inefficient. In addition, the system gives Internet sales the opportunity to escape taxation, resulting in the depravation of government revenue and an unfair competitive advantage for Internet retailers. Under the destination-based system, it is practically impossible to collect consumption taxes from purchasers. This forces the burden upon the seller, resulting in extravagant compliance costs. In an e-commerce context, destination-based taxation lends itself to theoretical as well as practical problems.
Origin-based taxation offers three main advantages over destination-based taxation. First, origin-based taxation enhances competition. Second, a destination-based taxation system reaches across borders, requiring intergovernmental agreement. Finally, origin-based taxation deals most properly with the issues concerning multi-jurisdictional Internet regulation, such as data protection and privacy.
In reforming the structure of the sales tax, one should pick a system that minimizes transaction and efficiency costs. The destination-based system has too many flaws with regard to the demands of e-commerce. An origin-based tax is superior to a destination-based tax in terms of economic efficiency and operation of political institutions.
Daniel Shaviro
New York University School of Law
The significance of compliance complexities and the difficulty of reducing them through voluntary harmonization are well documented in this paper. An analysis of the difference between the destination-based and origin-based system with respect to the retail sales tax (RST) is appropriate in understanding the ramifications of these systems.
The destination-based system taxes local consumption as defined by an individual’s residence, whereas the origin-based system taxes consumption based on the location of a store within a given jurisdiction. Implementing an origin-based system would diminish the government’s ability to consider distributional objectives in allocating the cost of providing public goods and transfers. Origin-based RSTs become inconsistent with the use of tax to pursue distributional objectives with regard to residents.
The paper’s concerns of administrative and compliance costs, undue cartelization in pursuit of bad objectives, and the undue projection of power to foreign jurisdictions are relevant, but locational neutrality should not be considered the only offsetting factor. Tiebout factors, involving the limited transactions cost of moving to another city, limit the government’s ability to tax their resident’s production and consumption, but locational neutrality can also be affected by a government’s ability to provide public goods and services.
Peter R. Merrill
PricewaterhouseCoopers
The first step in analyzing this paper would be to define the problem. As I see it, the difficulty lies in collecting destination-based sales taxes on intangible goods and services sold by remote sellers to nonbusiness customers. The situations arising from the sales to business customers and the sale of tangible goods are easily explained through the intricacies of destination-based taxation.
Mail order has existed since the 1890s with the Internet recently providing alternative communication channels, replacing mail, telephone, and facsimile. The small portion of the e-commerce market controlled by business to consumer (B2C) sales (10 percent–15 percent) leads me to conclude that the inability of the current destination-based tax system to collect taxes on these transactions is in no way of a severity warranting the implementation of an origin-based system.
Origin-based sales taxes require more inter-governmental cooperation than destination-based taxation. With regard to intermediate goods, an origin-based system would require agreement among all states and countries with a stake in the tax revenue. Such an arrangement could lead to the double-taxation of certain items.
Relatively minor complications introduced by e-commerce technology have been used by many to justify radical change in both indirect and direct tax systems. The destination-based tax system can be modernized through the use of increased technology, including harmonized productive and service definitions, digital certificates, and certified software systems for e-commerce. The very few success stories of origin-based taxation lead me to believe that modernizing the current sales tax system is the most practical solution.
AEI intern Christopher Slimm prepared this summary.
