European Politicians Want to Tax U.S Companies

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Fearful that overtaxed consumers might want to escape thevalue-added tax (VAT), the European Union concocted aplan to impose the VAT on software, videos, computer games andmusic downloaded via the Internet from non-EU companies. Since July1, 2003, U.S. firms selling goods to EU customers have beentheoretically required to collect taxes on behalf of EU taxcollectors. The EU claims that this extra-territorial tax scheme isnecessary to create a level playing field. But this plan is justanother attempt by the Union to prevent tax competition and willonly lead to higher prices and higher taxes.

EU politicians want to tax and spend without suffering anyconsequences for their irresponsible behavior. Ironically, thesesame politicians accuse non-EU nations of "poaching" theirtaxpayers. That is a reprehensible attitude for two reasons. First,it assumes that citizens are tax slaves, perpetually bound by thetax 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 nationsbecause the EU has required all member nations to harmonize theirvalue-added taxes at a rate of at least 15 percent. It is that hightax requirement-not "poaching" by more responsible governments-thatmakes cross-border shopping attractive.

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

The EU's motives are not hard to spot. Thanks to the Internet,highly-taxed Europeans can purchase tax-free goods from low-taxnations. With the cost of shipping in constant decline, buyinggoods from non-EU online sellers is often a no-brainer.Accordingly, the number of EU customers buying from non-EUcompanies over the Internet has constantly increased. A study byEmarketerreveals that in 2004 the United States will have 168 millionInternet users among whom 75 percent will be online buyers, whileEurope will have 221 million people online, 86 percent of whom willbe shoppers. In July 2003, Amazon reported that its internationalsales are growing faster than its North American sales, thanksmostly to Europe's "big three" Internet markets-Germany, France,and the UK. Amazon also reports that those three countriesaccounted 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 taxprobably won't kill it completely and the EU expects loads of taxmoney at the expense of non-EU companies. Also, the revenue lostfrom ending the taxation of non-European customers buying onlinefrom EU companies would be quite small since fewer foreigners buyfrom EU companies. Then, the political cost of the measure isalmost zero-non-EU companies do not vote in Europe-while the newtax revenue could be huge.

For non-EU firms, it is a different story. Non-Europeanbusinesses have three options. First, they can register theirbusiness and set up their headquarters in one EU country. Theywould then pay that country's tax rate. That is the option chosenby America Online, which will move its European headquarters toEU's lowest VAT rate country, Luxembourg. This option iscomplicated and costly but according to an AOL spokeswoman, "itcertainly beats the alternative."

The second option is for non-EU companies to pay the tax ratefor the country where the customer lives-ranging from 15 percent inLuxembourg to 25 percent in Sweden. This option is complicatedbecause it requires companies to collect information about eachcustomer and to comply with many tax jurisdictions. Europeancompanies, by contrast, only charge the tax rate of the countrywhere they are located. That's the option Amazon.com opted forafter it realized how much the new regulation would affect itsoperations where third-party new and used items are sold. Bycharging VAT on each of its commissions, Amazon will see its costincrease significantly.

Finally, non-EU companies can ignore the new regulation. Intheory, the cost of noncompliance could be steep since the EUthreatens to force "cheaters" to pay back taxes and added fines upto 200 percent of the back taxes, among other penalties. Yet,nothing is said about how the EU could enforce this rule forsmaller non-EU companies with no EU presence.

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

E-commerce companies in the U.S. are also worried about the EU'sinitiative because it might lend support to efforts by state andlocal governments in the U.S. to apply a similar tax scheme tointerstate e-commerce vendors. This fear is legitimate since over30 state governors in the U.S. are banding together to create a taxcartel that would allow them to start taxing income earned outsideof their state borders. Some lawmakers even introduced a bill thatwould grant congressional approval to this dangerous practice inAmerica. In the name of the "level playing field," EU governmentsand state governments in the U.S. are just trying to companiesoutside their jurisdictions. Also, the extension of such taxcollection obligations to cross-boarder sales represents a hugethreat to taxpayers and economic prosperity. Instead of forcinghigh tax governments to lower their rates, these efforts wouldallow them to impose reporting and remittance obligations onentities outside their boundaries, which clearly violates the basicconcepts of "no taxation without representation" andsovereignty.

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