The complexities of claiming back internet tax

The not so-subtle authoritarian reign of Hungary’s Viktor Orbán happened upon its first major hurdle in October when tens of thousands of protestors gathered to cry foul against plans to introduce an internet tax. Born of a quarter-million-member-strong Facebook page and a more general sense of discontent concerning the way in which policymakers were out to capitalise on profits made online, the plan to tax internet use was met with a resounding chorus of disapproval in both Hungary and abroad. Some pelted the headquarters of the governing Fidesz party with used computer parts, while others carried banners bearing slogans opposed to the government’s infringement on personal freedoms and its increasingly authoritarian streak.

The government’s original intentions were to take 62 cents for every gigabyte of data consumed, and, though officials maintained the tax would be imposed on internet providers only and not consumers, many were of the opinion that the costs would find their way back to household users. In a country where one in three are at risk of poverty or social exclusion and the average net-adjusted disposable income per capita is almost $10,000 short of the OECD average, the everyday Hungarian citizen could ill afford to foot the bill.

The digital part of the economy is probably the main thing keeping Europe out of recession right now

The Prime Minister countered – rather limply – that the policy would recoup taxes lost as a result of consumers migrating online, though criticisms continued to mount regardless, as EU sources joined hands with protestors in opposing the proposal. Ryan Heath, spokesperson for the outgoing European Commission Vice President for Digital Agenda Neelie Kroes, condemned the plan, calling it a “terrible idea” in a strongly worded statement. “It’s part of a pattern and has to be seen as part of that pattern of actions which have limited freedom or sought to take rents without achieving a wider economic or social interest”, said Heath.

“Hungary is below the EU’s average in virtually every single digital indicator. The digital part of the economy is probably the main thing… keeping Europe out of recession right now. So taxing that, in a country that is already below the average on digital indicators, is a particularly bad idea.”

Unsurprisingly, less than a week on from its first mention, Orbán finally bowed to public pressure and agreed to drop the proposal. Taking to the radio on October 31, over two weeks before the proposal was due to be voted on, Orbán admitted: “The internet tax cannot be introduced in its current form.”

This all serves to illustrate the way in which taxes on the internet are received by the masses, who generally see a tax of this kind as a thinly veiled attempt to infringe on their civil liberties and God-given right to surf the net as they please. “The internet should not be taxed any more than any other product you buy at a store”, says Scott Drenkard, Economist and Manager of State Projects for the Tax Foundation. “I have many concerns about taxes on internet provision limiting access to information. The internet has given us more access to a wide breadth of knowledge and opinions, faster than ever before. Multiple or discriminatory taxes on its provision are bad tax policy, they are illiberal, and they put a penalty on the quintessentially human process of communicating with each other.”

Granted, the case in point is an extreme one, and proposals to impose a tax on data use (otherwise called a ‘bit tax’) are few and far between, but Hungary exemplifies the lengths some governments are willing to go to recoup tax revenue lost to the online economy. The larger question of whether – and, if so, how – the internet should be taxed, has yet to be answered. Despite steps taken to level the playing field between physical and online stores, an agreeable solution is yet to present itself.

Conquering the unconquerable
The birth of e-commerce and the onward march of internet-dwelling giants has brought with it pressures typically reserved for corporate behemoths of the bricks-and-mortar variety. Tax policy being what it is, internet entities, of which Amazon is perhaps the most notable example, have long been exempt from the liabilities placed on their physical counterparts. As such, many states have welcomed the prospect of an online income tax, safe in the knowledge it could well bolster their finances.

To fuel the fire, some sources have made it their mission to quantify what losses e-commerce has inflicted on the economy. In a 2009 University of Tennessee report entitled State and Local Government Sales Tax Revenue Losses from Electronic Commerce, technologies and digital processes were said to have had a profound effect on US state and local finances. In the six-year lead-up to 2012, the report’s authors estimated, national, state and local sales tax losses as a result of e-commerce would amount to $52bn: another report, The Impact of the Internet Sales Tax Disparity on Massachusetts Tax Revenues, Sales and Jobs, put the country’s losses at three times that amount. “States cannot compel internet and other remote sellers that do not have a physical presence in the state – such as large national online retailers or mail order houses – to collect the tax”, said the report. “As a result, billions of dollars of sales tax revenues are lost, and bricks-and-mortar stores are put at an unfair competitive disadvantage.”

Not that much
Public pressure on companies such as Amazon and Google has heightened in recent years, with reports emerging that a growing number of internet-based enterprises have been employing creative ways of escaping liabilities. In answer to the concerns, a series of key reforms, backed by OECD states at the mid-point of 2013, marked the beginning of a concerted worldwide effort to eliminate the advantages afforded to online businesses ahead of bricks and mortar. However, it would appear these stop short of recouping lost taxes in their entirety.

For one, the introduction of the affiliate nexus legislation (often called ‘the Amazon Tax’) requires that out-of-state retailers collect and remit taxes that had previously escaped the state’s attention. The legislation has, in a handful of states, redefined what constitutes a taxable presence, and, whereas companies were previously subject to income tax only if they had a physical presence in the state, the range of taxable activities has now been expanded to include online sales.

True, the legislation marks a landmark change in the US taxation system, but it seems its proponents have been too quick to celebrate the policy’s success. Navigant Economics Managing Director and Principal Jeff Eisenach, for one, estimates the online sales tax’s recoverable potential is only $3.9bn – a mere third of the University of Tennessee estimate and leagues apart from Massachusetts’. Here it becomes clear that either the studies have miscalculated the amount lost to out-of-state businesses, or else the policy is not the all-encompassing measure so many assume it to be.

Simple isn’t easy
Those who insist online retailers are still harbouring billions in taxable gains have highlighted a tendency on the part of their opponents to look past SMEs and focus solely on larger corporations. However, as things stand, the internet income tax, employed principally by those in the US, remains the most effective means of levelling the playing field between online and bricks-and-mortar businesses – despite its many shortcomings.

“Requiring internet retailers to collect sales taxes for every product they sell across the United States would mean that they would be forced to comply with 10,000 different sales tax jurisdictions – this is not a level playing field, because physical businesses online have to comply with one”, says Drenkard. “However, if the federal government would insist on more sizeable simplification measures, allowing states to collect sales taxes on online purchases could be more reasonable.”

Clearly, for as long as out-of-state enterprises are required to comply with this patchwork tax system, the money owed will continue to slip through the net, if not for lack of reporting then through sheer confusion. Without a simplified policy on taxing internet sales, systematic inefficiencies will remain and states will continue to lose out on the finances they are due.

Concrete steps were taken to address the issue in 2013 with the Marketplace Fairness Act (MFA): a law that, if passed, will allow states to collect taxes on remote sales, on the condition that they simplify their tax code. The Senate voted in favour of the bill in May of that year, but it is still pending in the House Judiciary Committee almost two years on. The issue now is not whether the bill will be enacted but how policymakers could conceivably unify a byzantine system once the MFA is put in place.

In the meantime, those concerned about losing precious state finances to out-of-state enterprises have begun to flirt with alternatives. While measures such as the hybrid origin-sourcing and consumer private reporting solutions allay some concerns, each comes with its own set of problems.

No matter what the solution, the problem remains the same, not just in the US but in all the world. Tax systems are far too different state-to-state, country-to-country and continent-to-continent to introduce an all-encompassing internet sales tax. For as long as the world’s governments tackle issues born of the internet one nation at a time, they will only ever come up short. We operate within a global economy, made up of many states and many more laws, and trying to tackle the internet – a community that knows no boundaries and answers to no one – is a thankless task.