TechKnowledge No. 59

European Politicians Want to Tax U.S Companies

Fearful that overtaxed consumers might want to escape the value-added tax (VAT), the European Union concocted a plan to impose the VAT on software, videos, computer games and music downloaded via the Internet from non-EU companies. Since July 1, 2003, U.S. firms selling goods to EU customers have been theoretically required to collect taxes on behalf of EU tax collectors. The EU claims that this extra-territorial tax scheme is necessary to create a level playing field. But this plan is just another attempt by the Union to prevent tax competition and will only lead to higher prices and higher taxes.

EU politicians want to tax and spend without suffering any consequences for their irresponsible behavior. Ironically, these same politicians accuse non-EU nations of “poaching” their taxpayers. That is a reprehensible attitude for two reasons. First, it assumes that citizens are tax slaves, perpetually bound by the tax laws of their home government regardless of where they work, save, shop, or invest. Second, it completely reverses causality. European consumers are interested in shopping in other nations because the EU has required all member nations to harmonize their value-added taxes at a rate of at least 15 percent. It is that high tax requirement-not “poaching” by more responsible governments-that makes cross-border shopping attractive.

Interestingly, the scheme to impose EU taxes on non-EU companies is even contrary to standard EU practices. European companies traditionally add a VAT to the services and products they sell online. A Dutch company collects the Dutch tax on any online products it sells, regardless of where the customer lives. Similarly, companies outside the EU only impose the taxes required by their national governments- and they certainly do not have to collect an EU value-added tax when they are selling goods to EU customers because the point of sale in not in the EU. But now, the EU wants to shift the point of taxation from where the good is sold to where it is consumed. A U.S. company selling to an EU customer would have to collect the tax and remit it to the EU government. Also, in an effort to create a discriminatory preference for exports, EU companies selling to U.S. customers would not collect taxes anymore.

The EU’s motives are not hard to spot. Thanks to the Internet, highly-taxed Europeans can purchase tax-free goods from low-tax nations. With the cost of shipping in constant decline, buying goods from non-EU online sellers is often a no-brainer. Accordingly, the number of EU customers buying from non-EU companies over the Internet has constantly increased. A study by Emarketer reveals that in 2004 the United States will have 168 million Internet users among whom 75 percent will be online buyers, while Europe will have 221 million people online, 86 percent of whom will be shoppers. In July 2003, Amazon reported that its international sales are growing faster than its North American sales, thanks mostly to Europe’s “big three” Internet markets-Germany, France, and the UK. Amazon also reports that those three countries accounted for 70 percent of the e-commerce in Europe in 2002.

The EU hopes to steal the golden eggs without killing the goose. Today, the size of the market is big enough that the new tax probably won’t kill it completely and the EU expects loads of tax money at the expense of non-EU companies. Also, the revenue lost from ending the taxation of non-European customers buying online from EU companies would be quite small since fewer foreigners buy from EU companies. Then, the political cost of the measure is almost zero-non-EU companies do not vote in Europe-while the new tax revenue could be huge.

For non-EU firms, it is a different story. Non-European businesses have three options. First, they can register their business and set up their headquarters in one EU country. They would then pay that country’s tax rate. That is the option chosen by America Online, which will move its European headquarters to EU’s lowest VAT rate country, Luxembourg. This option is complicated and costly but according to an AOL spokeswoman, “it certainly beats the alternative.”

The second option is for non-EU companies to pay the tax rate for the country where the customer lives-ranging from 15 percent in Luxembourg to 25 percent in Sweden. This option is complicated because it requires companies to collect information about each customer and to comply with many tax jurisdictions. European companies, by contrast, only charge the tax rate of the country where they are located. That’s the option Amazon.com opted for after it realized how much the new regulation would affect its operations where third-party new and used items are sold. By charging VAT on each of its commissions, Amazon will see its cost increase significantly.

Finally, non-EU companies can ignore the new regulation. In theory, the cost of noncompliance could be steep since the EU threatens to force “cheaters” to pay back taxes and added fines up to 200 percent of the back taxes, among other penalties. Yet, nothing is said about how the EU could enforce this rule for smaller non-EU companies with no EU presence.

This is where the scheme becomes clear. It’s all about creating more sources of revenue for the EU by allowing governments to tax income earned outside of their national borders. Under this plan, the French government would be able to collect taxes from the U.S-based Amazon.com or other e-commerce vendors. The companies being taxed have no voice in the tax-and-spending decisions made by the French government. Nor do they benefit from the public services France provides with those tax dollars.

E-commerce companies in the U.S. are also worried about the EU’s initiative because it might lend support to efforts by state and local governments in the U.S. to apply a similar tax scheme to interstate e-commerce vendors. This fear is legitimate since over 30 state governors in the U.S. are banding together to create a tax cartel that would allow them to start taxing income earned outside of their state borders. Some lawmakers even introduced a bill that would grant congressional approval to this dangerous practice in America. In the name of the “level playing field,” EU governments and state governments in the U.S. are just trying to companies outside their jurisdictions. Also, the extension of such tax collection obligations to cross-boarder sales represents a huge threat to taxpayers and economic prosperity. Instead of forcing high tax governments to lower their rates, these efforts would allow them to impose reporting and remittance obligations on entities outside their boundaries, which clearly violates the basic concepts of “no taxation without representation” and sovereignty.

Under such schemes, taxpayers would be the big losers because no matter where they shop and how they choose to shop, they would face the same rate as if they were shopping in their own jurisdiction. And because that would undermine fiscal competition among countries and states, such proposals would give politicians more leeway to increase taxes. Countries and states, as sovereign entities, should have control over their tax policy. Companies with no physical presence in Europe should not be forced to collect taxes for the European Union. And the same logic should govern tax policy within the U.S. If either of these plans goes through, tax competition, freedom, and economic growth will be permanently damaged.

Veronique de Rugy (vderugy [at] cato [dot] org) is a policy analyst at the Cato Institute in Washington, D.C. To subscribe, or see a list of all previous TechKnowledge articles, visit www.cato.org/tech/tk-index.html.