Wednesday, June 22, 2005

Internet taxes

Issues concerning taxation and the Internet have become rather complicated, especially in the United States where there are tensions between the individual states and the Federal authorities. The Internet Tax Freedom Act of 1998 imposed a three year moratorium on new Internet taxes – some states that already had taxes in place were allowed to maintain them – and established the Advisory Commission on Electronic Commerce, which eventually reported in April 2000. [Advisory Commission on Electronic Commerce]

The Chair of the ACEC, Virginia Governor James Gilmore III, a strong proponent of an outright ban on Internet taxes, was unable to get the two-thirds support that he needed so the recommendations were limited to
(i) An extension of the moratorium until the end of October 2003
(ii) The end of taxation on Internet access (subscription fees)
(iii) The end of a tax on telephone services (since some Interent access was via telephone lines) – this recommendation was not approved by Congress.

The moratorium has since been extended on several occasions and the Streamlined Sales Tax Project (SSTP) was also launched in July 2003. When at least 10 states accounting for 20% of the population agree to the imposition of a sales tax on Internet transactions then it will take effect across all states. Several companies (e.g. WalMart and Toys-R-Us) have voluntarily introduced online sales tax collection systems but others have steadfastly stuck to the position that if they don’t have a physical presence in a state with an online sales tax they won’t collect it.

In the European Union things are a little clearer. In May 2002 the EU agreed new rules for an online sales tax (VAT). Overseas suppliers were required to register for tax purposes in one of the member countires and to levy the tax at the local rate. This directive came into force in July 2003.

The main arguments in favour of an online sales tax are (i) without it there is not a level playing field – online merchants have a competitive advantage over offline stores and this creates distortionary effects (ii) the individual state budgets are thereby affected since they depend to a large extent on local sales tax revenues. The argument usually deployed by those in favour of a tax ban is that e-commerce is still in its (relative) infancy and applying the tax would inhibit its growth. A similar argument is also used against the imposition of a tax on Internet access. (It would also make it harder to close the "Digital Divide" because it would raise the cost of Internet access.)

For more details on this see my Economics of the Internet lecture notes at

A new issue has recently been added to the debate – what some have called the “iPod tax”. Some people have argued that not only should physical goods that are ordered over the Internet but delivered to people's homes offline (for example by mail) be subject to sales tax, but so should information goods that are delivered via the Internet (electronic entertainment - music and film downloads etc.) Last month the Wisconsin Joint Finance Committee considered a proposal for just such a tax, but turned it down on the grounds that it would place at a disadvantage companies trying to operate this kind of business from within the state.
[See “Finance Committee rejects extra tax on Internet buys”, By Katy Williams, Wisconsin Technology Network 25th May 2005]

In another development a California state appeals court decided that Borders Inc. must collect online sales taxes within the state because their offline stores and their online stores are all part of the same company – their operations are “co-mingled”. [See “Click and Pay a Little More: The Days of Tax-Free Online Shopping May Be Over”, By Bob Tedeschi, New York Times, June 20, 2005.]

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