Shopping around

The Internet age has dawned just as tax collectors are getting worried about another aspect of globalisation: tax competition. Both the European Union and the OECD have declared war on “harmful” low-tax policies used by some countries to attract international businesses and capital. The OECD says that tax competition is often a “beggar-thy-neighbour policy” which is already reducing government tax revenues, and will start to be reflected in the data during the next couple of years. The Internet has the potential to increase tax competition, not least by making it much easier for multinationals to shift their activities to low-tax regimes, such as the Caribbean tax heavens, that are physically a long way from their customers, but virtually are only a mouse-click away. Many more companies may be able to emulate Rupert Murdoch’s News Corporation, which has earned huge profits in Britain since 1987 but paid no corporation tax there.

This survey will seek to discover whether all this poses a real threat to tax revenues. Inevitably, this will involve a good deal of speculation. The Internet is still young, and nobody can know how big it will grow. For the taxman, its increasing use raises two main challenges. The first is unique to the Internet. The World Wide Web is an entirely new channel for moving goods and services from producers to customers, and taxing virtual goods and retailers is much more difficult than taxing physical ones. Music can now be downloaded via the Internet, from a retailer located who knows where, without a need for discs or tapes. Other products may similarly dematerialize, making it hard for the taxman to pinpoint them. New Internet taxes, such as the proposed “big tax”, levied on the volume of electronic transmissions, make little sense, and would face huge political opposition from those who want to keep the taxman out of cyberspace – including some American Presidential hopefuls.

Taxpayers, too, may dematerialize. In a famous New Yorker magazine cartoon showing two dogs sitting in front of a computer screen, one tells the other: “On the Internet, nobody knows that you are a dog”. The ability to collect tax is contingent on knowing who is liable to pay it, but taxpayers may become increasingly hard and uncrackable encryption technology are developed.

As almost everybody knows, there are two ways of cutting your tax bill. Tax avoidance is doing what you can within the law. As a great American judge Learned Hand, put it, “There is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich and poor; and all do right, for nobody owes any public duty to pay more than the law demands”. Tax evasion is what happens outside the law. There may be a thin line between the two, but in one sense it is a solid one; as Denis Healey, a former British chancellor, once put it, “The difference between tax avoidance and tax evasion is the thickness of a prison wall”. The Internet is likely to make it easier to break the law.

The second challenge the Internet raises for the taxman in its potential for intensifying tax competition between governments. Tax collection around the world is built on the belief that every nation – state has the right to decide for itself how much tax to collect from the people and businesses within its borders. Governments may be willing to pool their sovereignty by joining international bodies such as the UN, the IMF or the EU, but they cling to their right to set their own taxes. Even in what some see as the nascent EU superstate, member countries refuse to give up their control of direct taxation.