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Remarks by Fred Smith to the Advisory Commission on Electronic Commerce Panel on International Taxes, Tariffs & Duties Assoc

Regulatory Comments and Testimony

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Remarks by Fred Smith to the Advisory Commission on Electronic Commerce Panel on International Taxes, Tariffs & Duties Assoc

San Francisco, California

This Commission has heard repeatedly that the Internet is one of the most promising developments in the world economy -- this is true and indeed understated. Electronic commerce, by eliminating space and time has the potential to drastically reduce transaction costs, that is, the costs incurred in bringing buyer and seller into agreement. By advancing trade, expanding individual privacy, disciplining irresponsible governmental action and offering more protection to basic human rights, this technology offers great hope to all mankind. That hope is perhaps greatest for the citizenry of the developing world because informational technologies do not require the massive capital investments necessary for earlier technological advances. And the anonymity offered by this technology offers special hope to those pariah groups throughout the world who are today most threatened by loss of civil and economic liberties.

Some, however, focus on the downside of e-commerce; they note that it may -- by expanding the range of choices open to more consumers -- increase the difficulty of collecting sales and use taxes. On those grounds, they would abandon America’s traditional policy of No Taxation Without Representation. I think this is wrong and so argue in my comments.

This panel is to discuss the specific issues related to the international aspects of that question. I find the issues raised by this increased tax threat similar at both the domestic and international level -- merely that the world has even more to lose if we take the wrong path in this matter.

Relative to the world, U.S. markets are consumer-friendly Walmarts are rarely blocked from entering closed local markets; hours of service and prices are left to the buyer and seller. Few Americans view "discounting" as unfair, nor are we opposed to convenience stores operating at "convenient" hours. Firms are free in America to compare themselves with competitors -- to lure business away from higher priced or lower quality suppliers.

Today, in much of the world, such pro-consumer policies are illegal. But the globalization competitive forces created by the Internet are making it increasingly difficult to maintain these anti-competitive policies. The Internet leaps over national boundaries allowing firms anywhere to reach consumer everywhere. For the first time a small business, a family business, run by only one or two people, has access to the entire world. The Washington Post mentions a $10,000 per month orchid retailer in Bangkok. "Ads in flower magazines were costly; the Internet is cheap." Today, anyone anywhere can open a global store! Not surprisingly, the protected economies of Europe are upset over this and would love to see this new technology constrained by taxes and regulation.

In a prime example of how regulation of commerce helps competitors rather than customers, Lands’ End’s policy of unlimited returns on merchandise was challenged in Germany. The German Supreme Court agreed that the policy constituted "unfair competition" -- many companies, the court ruled, would find it difficult to provide such guarantees. But, of course, the purpose of an economy is not to protect Main Street companies but rather to protect consumers. Politicians find it attractive to defend powerful local economic interests -- the costs are born by trapped consumers.

Such policies are unfair -- especially to those consumer who lack the mobility to travel elsewhere to purchase goods and services. The Internet brings the world to everyone’s front door – if the governments do not erect barriers. The Internet forces governments to be more accountable to their citizenry – it provides consumers greater power against special economic interests. . Federal Express which transports tons of electronically ordered goods to foreign nations has spoken out against moves to block such trade. "If they put of barriers to stop it, they’re going to pay the price in their economy," said Frederick W. Smith of FDX Corp., the parent of Federal Express, in the Washington Post.

The Internet is a truly democratizing technology. Or that is it may be. Internet tariffs and taxes would threaten the advantages the Internet offers for Trade, Privacy and (a value too often ignored) Human Rights. Knowledge about the wealth and holdings of minorities should not be made available to dictators or to oppressive governments. Certainly, the U.S. should not become a tax collector for such groups.

Taxation Without Representation Is Wrong

The fundamental principle involved in disallowing Internet taxation is recognition that there should be no taxation without representation. The e-Freedom coalition proposal issued today (http://www.e-freedom.org) seeks to ensure that no state collect taxes from firms that have no substantial physical presence within their borders. The advocates of e-commerce taxation readily admit there are 7,400 taxing jurisdictions and openly ask for Congress to "require remote sellers without a physical presence to collect" taxes. Constitutional government requires that elected officials face those whom they burden with taxes or regulation.

Moreover, the role of taxes is to support those functions carried out by that jurisdiction. To tax remote firms is to lay claims on activities far less likely to obtain any benefit from the taxing jurisdiction. Moreover, since these parties will not be able to hold the politician accountable, it is far less likely that the burdens created will be offset by the benefits achieved. Public choice research suggests we move very carefully before weakening any further the restraints which have, to date, kept Leviathan minimally in check.

Taxing "Frontier" Sectors is Foolish:

In thinking through the issues considered by this Advisory Commission, I recalled the opening scene from the great Kurosawa movie, The Seven Samurai. In that scene, a bandit gang rides to a hillside and looks down on a small village; one bandit urges that they ride down immediately to rob, rape and pillage; but he is restrained by the leader, who argues for patience. The rice is not yet ripe, he notes, wait till the harvest and then we’ll attack.

Certainly, the governments of the world should display at least this level of restraint. The world of electronic commerce is the most dynamic sector of the world’s economy. In scope and scale, this field is changing daily. Structural changes in the way the industry is structured, information is formatted and transmitted, the way in which exchanges are created and financed, the way in which individuals ensure that an exchange will go forward, that their privacy will be protected. All these and a myriad number of other key features of this emerging industry are in flux.

Any effort to assert political control -- whether by regulation or taxation -- over such rapidly changing activities is fraught with difficulty. And while one might conceive that some small group of brilliant individuals might be able to design a system that would achieve reasonable and equitable taxation of these activities, it is highly unlikely that such individuals would seek employment as civil servants in the tax bureaucracy. To seek to impose the rigidities of a tax system on this most dynamic part of the world economy is foolish. Where should taxes be levied, how would we monitor compliance, what record keeping would be required, how would sales links be followed, how would double billing be avoided, which link in a complex exchange would be tax-liable – all these and myriad other questions suggest that restraint is wise in these areas.

Whatever the wisdom of eventually imposing taxes on electronic commerce, it is clear that we should wait till this sector matures and stabilizes. To do otherwise is to build implementation castles in the sand. Applying yesterday’s tax policies to today’s growth industries can only endanger the hopes of a better tomorrow.

Don’t Blame the Internet

Main street businesses that may be inclined to embrace internet taxes out of fear of the Internet should reconsider. But the pressures facing Main Street businesses are not primarily tax issues. As one ad running on cnn.com puts it, "The problem isn’t losing your customers to an e-business. It’s losing them to someone else’s e-business." Today’s "bricks and mortar" Main Street firms may be the "clicks and mortar" innovators of tomorrow. Many main street stores are already online, many are embracing online auctions, and new innovations like Amazon’s zShops and Iconomy’s storefront’s, all of which show promise for aspiring Main Streeters. Firms have always had problems in high-tax and high-regulatory environments -- but that has encouraged (to some degree) these governments to rethink their policies. If we weaken the political accountability of state and local officials, we run the risk of even more burdensome tax and regulatory policies.

State and local officials and foreign bodies claim to seek to impose taxes to prevent what they call "discriminatory" tax treatment. But "discrimination" is really caused by the states’ excessive taxation of their residents. States concerned about ending discrimination by reviewing their own tax policies.

Business-to-business commerce is the largest component of Internet commerce now. And it is becoming more important for smaller business to get on the bandwagon. Even if Main Street businesses don’t set up e-commerce, they will be using it to stock their own shelves -- and to stock them creatively.

Privacy Is Hurt By E-Commerce Taxation

One of the most important needs for e-commerce to flourish is the development of privacy tools. Invasive taxation will harm emerging privacy innovations like anonymous digital money and encryption. Such private protections are all too likely to be viewed as "weakening" the state’s ability to collect taxes.

Traditionally, taxes on remote sales entail large and invasive monitoring, enforcement and collection costs. As a result, most states have sought to collect such taxes only when the costs of doing were reasonable. Normally, taxes will be collected on sales outlets in the state or on larger items such as cars or boats. They will also seek bi-lateral tax "treaties" with neighboring jurisdictions on occasion, acting as tax collectors for other jurisdictions.

Ideas that these problems disappear because of software of because of an illusory "Trusted Third Party" are foolish. Indeed, the more serious problems with extending taxes to electronic commerce are already foreshadowed by the experiences of using financial transaction data as a way to "improve" law enforcement. Consider, the U.S. "money laundering" laws -- these laws essential presume that all Americans engaging in large dollar transactions are guilty until proven innocent. This perverts all normal notions of justice. Moreover, as electronic commerce becomes more sophisticated, such "large" denomination transactions can be electronically divided into numerous small transactions. Such "problems" led to FDIC efforts (under the proposed Know Your Customer rule) to extend their presumption of guilt to all depositors. As most of you know, that proposal created a firestorm of protest and resulted in the regulation being withdrawn.

This experience is highly relevant to proposals to tax the Internet. Such tax proposals would pose severe threats to the evolving privacy protections (encryption and digital money) now becoming available. While the Internet is a liberating force; Internet taxation threatens to create a 1984 Big Brother regime instead. Consider as one example how one European government has sought to tax one early form of electronic commerce -- television. The UK system of "licensing fees" to support the BBC is enforced by TV inspectors going around with electronic monitoring devices to see whether viewers might be evading the tax. Does America want this type of regime?

Moreover, government efforts to use private parties to act as tax collectors is likely to chill private voluntary information sharing activities. There are great consumer benefits in arrangements whereby I provide a firm greater information in exchange for lower prices. Those gains are threatened if the government sees such informational accounts as ways of collecting taxes.

Civil Rights, Civil Liberties

Many countries’ governments are not friendly to all or some of their citizens. One of the great potentials of the Internet is that it provides new protections to oppressed minorities around the world. The ability to bypass official channels via the Internet increases their ability to engage in economic exchange on an anonymous basis. Race, creed and political ideology -- all are invisible over the Internet, expanding the range of economic opportunities available to such groups. Moreover, that same Internet allows them to transfer and shelter their economic earnings. Internet taxation policies -- especially if enacted at the global level -- would strip away these privacy protections, making it all too easy for oppressive or populist governments to seize or tax away their savings. The Internet cannot eliminate hatreds and prejudices -- it cannot do what years of religious efforts have yet failed to do -- but it can make the situation somewhat better. It can’t ensure Good Neighbors but by granting the individual greater anonymity it can make it less likely that Bad Neighbors will do you harm. That anonymity will be far harder to achieve in a world that sees such privacy provisions as threatening tax revenues. And with private data, only a supoena away from public hands, the risks that this might occur in an Internet taxed world are strong.

Does Government Need More Tax Revenue?

The proposed new taxes on electronic (or even remote sales) commerce would almost certainly not be offset by tax reductions elsewhere. Thus, these would be new burdens on the citizenry. With the United States and most state governments experiencing massive tax over-payments already, there is certainly no urgency or rationale in considering tax increases at this time. Moreover, the Internet by reducing the costs of monitoring and tracking activities makes it possible to address many tasks now performed by government -- the burden of property protection, fire prevention, education, environmental improvement -- all may well be addressed to a greater degree privately in the New Economy.

Bad Tax Policy is Good Tax Policy; Good Tax Policy is Bad Tax Policy (And the only good tax is an Old Tax)

The French minister Colbert once stated that the goal of the politician is to pluck the feathers from the goose in such a way that the goose barely squeaks. And, this is one of the major problems of the proposed Internet tax -- it makes it too easy to increase taxes. In my early work on highway, pollution and other excise taxes, an older analyst suggested that I be careful of accepting uncritically the virtues of "efficient" taxation, that is taxes that minimized the dead weight losses of revenue collection. His point was that such "painless" taxes (those that minimally affected choice) would be raised far too easily by politicians -- increasing the overall burden and, therefore, drain on society. In contrast, a tax that was costly to collect and readily avoided would rarely be raised, reducing the threat to economic growth. Internet taxes are bad taxes on both grounds -- and they are also new taxes.

The broader point here is that "harmonization" of tax policy is not necessarily good policy. Competition is useful in the marketplace, but it is perhaps even more valuable in the political world. Irrational and counter-productive taxing policies are not uncommon -- the flexibility in moving capital and economic activities around the globe offered by the Internet make it possible to sharpen those disciplining influences. There has always been great value in encouraging more responsible political action and this has become even more critical in a global economy.

There is no virtue in a simple, uniform tax. A simple tax is a simply raised tax. Therefore, we need to ensure that there always exist competing tax jurisdictions. Entrepreneurial flexibility in moving capital to escape the taxman provides a constraint on government overreach. A uniform system makes it simple only to raise taxes. It does not make life simpler for consumers.

Are Taxes Even Appropriate for an Informational Resource?

To these concerns must be added the high costs of enforcement and the even higher risks of evasion unavoidable in seeking to translate the rules applied to a world of physical entities to the virtual world of the internet. Indeed, taxation of the Internet raises many of the same concerns expressed in taxing intellectual property more generally. Informational resources are not subject to the same scarcity concerns that affect real goods -- a flick of a toggle and data can be distributed to thousands of individuals around the world. As the late Ithiel de sola Poole noted, Information wants to be free, and that fact makes it possible to envision a much faster rate of growth in the developing world than was possible in a world limited by the scarcity, the rivalry, inevitable in a world of physical resources. Should we weaken the hopes of the peoples of the developing world by raising the costs of such resources artificially by taxation?

Summary Thoughts:

Neither Europe nor the United States needs additional tax revenues at this time. In both societies, tax revenues are already excessive, government is already far larger than that justified. In large part, that is because modern government has found many ways to reduce its accountability. To allow states to force private parties to whom they are not accountable at the ballot box to collect taxes for them, would be to abandon a basic principle of good government -- No Taxation Without Representation. Moreover, the Internet itself is still in an embryonic state -- to impose static laws on this dynamic sector can only reduce the gains possible from this innovation. If governments are concerned about the "tax avoidance" made possible by this technology and by other forms of remote sales, then they should re-consider their overall tax systems. There are far less invasive ways of resolving the concerns expressed by some proponents of such a tax without the distortions discussed here.

But for the moment, this Commission should strongly recommend that we extend indefinitely the moratorium on Internet taxes.

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