Commentary

Is America Losing Its High-Tech Edge

By Aaron Lukas
October 23, 2000
The United States has been the undisputed world leader in the development and deployment of e-commerce technologies. Lately, however, Americans have been wringing their hands over the fact that so many Europeans own Internet-capable cell phones. An endless succession of articles has declared that the European Union’s single standards regime for wireless services has given it an enormous “lead” over the United States. Even many Americans seem inclined to believe The Economist magazine’s grim prognosis that their country is “falling badly behind in the race to go wireless.” If wireless e-commerce is indeed the wave of the future, could it be that the days of U.S. high-tech dominance are numbered?

My advice to anxious Americans is to relax. Europeans may be laboriously tapping out messages to each other on microscopic keypads, but so what? Cell phones won’t be driving the digital economy any time soon. For one thing, wireless personal digital assistants and laptops offer vastly superior Internet access, and both are more common on this side of the Atlantic. But more important, European policymakers are busy pursuing a bone-headed agenda that will ensure U.S. high-tech mastery for years to come. Consider just a few recent examples.

One of Europe’s chief concerns is the application of the value-added tax (VAT) to digital products and services. The VAT—which can add up to 25 percent to the cost of a product—is usually charged at the point of entry on “tangible” products shipped from the United States. But since products such as software and music can be delivered directly over the Internet, there aren’t any packages for European Union tax collectors to inspect at the border. Thus, when French president Jacques Chirac (who earlier this year had to ask what a mouse was) downloads a game called, say, “Jerry Lewis’s Championship Boxing,” he’s responsible for paying the VAT himself. But because there’s no practical way to track Chirac’s purchase, the odds of his paying the tax voluntarily are essentially zero.

To fix this, the European Commission proposed in June that U.S. companies be required to collect a VAT on all sales of digital products to Europe. If this beggar-thy-neighbor tax proposal becomes law, all U.S. businesses will, in theory at least, have to register with the tax agency of at least one EU member country, ascertain the location and taxable status of each and every customer, transmit payments electronically to the relevant tax authority, and submit to audits and “due diligence examinations” to make sure no one is cheating. In return for acting as Europe’s tax collectors, American businesses would receive half-price coupons for EuroDisney (just kidding, they won’t get anything).

Naturally, U.S. policymakers aren’t thrilled about this plan. Under the current rules, European consumers have an incentive to shop VAT-free from U.S. companies, which also makes the United States an attractive market for e-commerce investors. European companies rightly complain about that disparity, but too bad: let Europe solve its own tax problems. If political leaders there weren’t reflexively opposed to tax cuts, they could simply exempt digital products and services from the VAT.

Enforcement will be difficult without Washington’s help, but Europe’s tax collectors are determined to try. U.S. businesses with a branch office in Europe, for example, could probably be forced to comply—at least until they close their local offices. Another option being considered is “blacking out” the Web sites of companies that refuse to register for VAT collection. But consider that, despite having highly centralized systems of Internet service provision, authoritarian governments (such as China) have been unable to control access to dissident Web sites. The Internet is simply too massive and decentralized to police effectively. Thus, the ultimate result will be wasted government resources and a permanent tax disadvantage for European businesses.

For the past couple of years, EU and U.S. negotiators have been feuding over Europe’s data protection directive, which empowers regulators to halt the flow of personal information to countries they judge lack adequate data protection arrangements. The law is intended to “protect” European consumers from zealous marketers but could also limit the ability of companies to efficiently target products and services to European consumers.

The European Commission took things a step further last month when it signaled its intention to regulate “cookies” and “spam”. If approved by the Council of Ministers, the new rules would forbid companies from sending unsolicited commercial e-mail (spam) unless a consumer specifically requests it. Although spam can be annoying, it can also be a useful low-cost marketing tool, allowing small businesses to connect with otherwise unreachable customers. Most people simply won’t be willing to make the extra effort that opting in requires. At best the spam ban would be superfluous, since rapidly improving filtering software already allows customers to make their own choices about what types of e-mail they want to receive.

But if regulating spam will hurt only some European e-businesses, restricting cookies will handicap them all. Cookies are digital tags that are saved to an Internet user’s computer. Among other uses, these tiny files are used to keep track of online shopping carts and record how many times a user sees a certain advertisement. They also help Web sites identify when a regular visitor has returned, so that the visitor need not re-enter his identification information every time or see the same ads repeatedly. No cookies equals less convenience; less convenience equals fewer customers.

European online advertisers would be devastated by a cookie ban. “If we didn ’t use cookies, it would horribly affect the way we collect data,” says Greg Turzynski, managing partner at Optimedia, a division of Publicis SA of France. “We want to know who is looking at what on the Web.” So do their clients: if European companies are forbidden from collecting such data, U.S. ad firms—which operate beyond the reach of EU regulators—will end up being the only ones with their hands in the virtual cookie jar.

While European privacy laws impose draconian restrictions on the private sector, governments can get away with nearly anything. Consider the new Regulation of Investigatory Powers bill working its way through Parliament in Britain. If it becomes law—which is likely—the British government could require anyone communicating via the Internet to hand over the keys to decoding their e-mails and other encrypted data. In addition, Internet service providers could be forced to install hardware (at their own expense) designed to monitor the traffic that crosses their system and report suspicious messages to MI5, the British security service. Unlike in the United States, authorities in Britain would not need to obtain a warrant signed by a judge.

Aside from the obvious privacy concerns, this law will be bad for business. As House of Lords member David Howell has observed, “Many British citizens happen to have Internet service providers, along with domain hosts and encryption security services, in the United States and elsewhere. Obviously many more will move their providers offshore if they want to avoid official intrusion.”

Mr. Howell’s point is well taken. Europe’s ongoing attempts to tax and regulate the Internet are good news for U.S. businesses. In isolation, these policy initiatives might not appear to seriously handicap European e-commerce. Taken together, however, they will provide a powerful incentive for entrepreneurs and investors to set up shop outside of Europe. All the cell phones in the world won’t save Europeans from their apparent fondness for intrusive government.

The United States is well positioned to take advantage of Europe’s policy blunders; we just have to make sure our public officials don’t make the same mistakes themselves. Given the slew of new Internet-related bills working their way through Congress, however, they certainly seem determined to try.

Aaron Lukas is an analyst at the Cato Institute’s Center for Trade Policy Studies and author ofTax Bytes: A Primer On the Taxation of Electronic Commerce.