Killing Uncle Sam The taxman meets his match online

Hal Plotkin, Special to SF Gate
Tuesday, July 20, 1999

URL: http://www.sfgate.com/cgi-bin/article.cgi?file=/technology/archive/1999/07/20/taxes.dtl

Many say the Internet is the biggest thing to hit humanity since the splitting of the atom. Unfortunately, that analogy may be painfully on target. Like the early days of atomic power when most people only saw its promise, the most damaging fallout from this new technology may not have surfaced yet.

To be sure, fallout from the Internet won’t be as lethal as nuclear waste. But one thing is clear: we are in for some very big changes.

Once it hits full throttle, the Internet will knock the financial pins out from under the government. Those pins, which government relies on to support public services, are corporate taxes, personal income taxes, property taxes, and sales taxes.

As the Internet matures, collecting taxes from any of these sources will become increasingly difficult. While some libertarians and extremists on both the right and left will cheer Uncle Sam’s demise, most Americans probably aren’t ready to kiss him goodbye just yet.

But providing public services means finding a way to pay for them. And the traditional spigots are about to be closed off by the Internet.

Take corporate taxes, for starters. Thanks to the online revolution, corporations are increasingly able to locate their operations and workforces wherever taxes are lowest. Even low tax states like Nevada can’t compete with places like Barbados, where most international companies pay just 1% in corporate taxes.

Barbados is where one of the world’s fastest growing new high-tech companies, PRT Group, Inc., now does most of its business. PRT is a custom-software-engineering firm founded just five years ago by 29-year old Doug Mellinger. Last year, it had sales of more than $120 million, making it one of the fastest growing companies in its industry.

Barbados isn’t alone. In fact, helping investors and corporations find tax havens is now an industry in itself. There are dozens of locations around the world where local jurisdictions are so hungry for business they’re willing to virtually forgo the collection of corporate taxes. Instead, these places depend on the employees of such companies to pump up their economies by spending their wages in local shops and businesses.

We can expect an acceleration in the number of companies moving operations to low-tax locales in the years ahead. Companies will make the move not because they are unpatriotic, but because they have no choice. If you are in a business and someone else is making the same product or selling the same service cheaper than you, because their expenses are lower, you either do the same thing or you go out of business.

OK, so if the government decides to eliminate corporate taxes to compete with places like the Caribbean or Belize, it can make up lost revenues by increasing other taxes, right? Say, for example, by increasing personal income taxes? Wrong.

That won’t work because many of the same countries that have low corporate tax rates also frequently have very low or negligible personal income tax rates, particularly for income earned by foreigners. More and more, that’s how these countries compete for jobs.

As the competition between them intensifies, the most desperate of these countries will undoubtedly lower personal income tax rates even further. They can get away with it because they don’t need the tax revenue.

Unlike most large developed countries, these upstart nations typically don’t have a big menu of public sector services to support. Things we take for granted here, everything from (mostly) honest police to CT scanners, are not all that common in places that don’t have the tax base to pay for them.

Well, if the Internet is making it easier and easier to locate businesses and workforces outside the reach of U.S. government corporate and income tax collectors, the government can make up those losses by increasing property taxes, right?

Same deal there: it’s a non-starter. If the government increases property taxes beyond a certain level, property owners rebel or, if that fails, they vote with their feet and move. There are plenty of places where the climate is just as nice, even nicer, than California (let alone New York, New Jersey, or Illinois).

The whole history of humanity is largely a history of mass migration. Nearly all our parents, or our grandparents, came from somewhere else. Our children, or our grandchildren, might also decide it makes sense to move on.

All we have to do is look at California’s Proposition 13, which touched off similar property tax revolts elsewhere, to be reminded that most people won’t tolerate constantly escalating taxes on property they already own.

That leaves sales taxes.

But the Internet is rapidly undermining that escape valve as well. Right now, sales taxes are collected by vendors who turn over the money they collect to the government. But that scheme will fall apart when U.S. consumers make more, or even most, purchases online from vendors located outside the U.S.

What happens when WalMart, needing to compete with those foreign vendors, moves its fulfillment center offshore and starts shipping our online orders of soap and shampoo to us? Ditto with big ticket purchases like cars or even prefab houses? How can the U.S. government collect sales taxes from companies who don’t owe it any allegiance? In essence, online shopping could turn the whole world into a duty-free zone.

One way out might be a return to protectionism, slapping high taxes and duties on imported goods. But protectionism has fallen out of vogue in recent years. The common wisdom today says the trading blocks created by protectionism increase international tensions which, in turn, precipitate even worse problems. Anyone remember World War I and World War II?

The only other way the government might deal with the Internet draining its finances is to intrude even further into our lives. If the government can’t rely on corporate, income, property, or sales taxes there is only one way I can see that it could still obtain the revenue it craves.

The government might decide to create an entirely new form of sales tax which is payable to the taxman not by vendors but by consumers. The records would have to be kept on purchasers rather than sellers since many of the sellers undoubtedly will be located outside the jurisdiction of the U.S. You might call this new form of sales tax a “purchase tax.”

To make a purchase tax work the government would have to eliminate cash, which is hard to trace. In it’s place, consumers might be forced to carry personal identity debit cards which track each and every purchase. If you think the current system of taxation epitomized by the IRS is intrusive, just wait until the government starts compiling records on every magazine you buy, every condom you purchase, and every movie you see.

In the world B.I. (Before Internet) such a system of taxation would be unthinkable. But in the world that is coming, it may be the only alternative government has left. As Sherlock Holmes famously observed, when you eliminate all other possible answers the one you have left is the solution.

There are, of course, a few things we purchase, and a few businesses, that can’t easily be moved offshore. But it’s very unlikely we’ll be able to support our entire public sector by taxing the few remaining domestically-produced goods, like hamburgers and massages. If the government tries, the prices of those items would skyrocket so fast we’d no doubt create a black market that would make prohibition seem like a cake walk. “Pssst. Wanna buy a cheeseburger?”

The Internet’s power to crush our government won’t be felt immediately. And it won’t be felt all at once. True to form, though, Uncle Sam is reacting like the frog placed in a pot of water on a stove. By now, the trends are clear and, probably, already irreversible. I hate to be a party pooper. But maybe it’s time we start thinking about what comes next?

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