Canada Should Not Follow Europe’s Example In Taxing Online Purchases

Written in collaboration with Diego Menegon, Fellow at the Istituto Bruno Leoni, Italy.

There has been some debate in Canada recently over the issue of sales taxes when making purchases on the Internet from abroad. Right now, when Canadians buy products and services, such as clothes or movie streaming subscriptions, from online vendors located abroad, it is the consumers who are responsible for declaring sales taxes. Very few do so, however, or are even aware that they are supposed to. To remedy this fiscal gap, the Canadian Border Services Agency filters packages, applying taxes and an extra handling fee, but many packages get through untaxed.

Beyond this fiscal gap, Canadian sales taxes, both federal and provincial, give foreign vendors an advantage over Canadian retailers. However, the search for an alternative to current policies should not neglect consumers' interests.

One such alternative policy has been in place since January 1st, 2015 in Europe. Foreign businesses selling goods and services on the Internet are required to charge the sales taxes that are applicable in the country where the buyer is located. This "destination principle" was an important departure from the standard that was applied previously, the so-called "origin principle," where the sales taxes applied were those of the country where the seller was located. The goal of this change was to level the playing field for online retailers in high sales tax countries, who had difficulty competing with retailers in low sales tax countries. But consumers are the ones who bear the cost of this policy through higher prices.

Certain voices in Canada are calling for an application of the destination principle, requiring foreign businesses to collect sales taxes directly. In its 2015-2016 budget, for example, the Quebec government asked Ottawa to increase its efforts in this regard. But Canadian policy shouldn't repeat Europe's mistakes.

First, there's no reason to believe that foreign governments would be particularly cooperative in forcing their retailers to collect and remit Canadian sales taxes, even though the OECD is applying pressure for the signature of international agreements on the matter. The American Internal Revenue Service, for example, has not yet prosecuted any American businesses for failing to comply with European sales tax rules. And indeed, it is not in the interests of the tax authorities in one country to police millions of transactions and devote substantial resources to proceedings for the benefit of tax collectors in another country. We should therefore not expect that foreign governments will play along with our rules.

Even if foreign governments don't play along and these policies aren't being enforced, uncertainty regarding its enforcement can still marginalize foreign small businesses from the European market. Micro-enterprises consisting of a single person need to keep up with the VAT rates of 28 different European countries (with some countries having as many as four different rates), collect the right VAT rate for every order, and file the taxes with the European Union. Despite implementation of a new set of rules to simplify procedures, the European approach proved to be unsatisfactory; the regulatory and compliance burden are still widely recognized as being disproportionate.

If these rules were thoroughly enforced, though, they would amount to a bureaucratic barrier to trade for small businesses through excessive bureaucracy. Such policies threaten the incredible benefits of the Internet revolution to both consumers and businesses by making it so complicated to sell online that eventually, only large firms will be able to afford the red tape.

But it is consumers who would lose the most. Avoiding the payment of sales taxes is obviously attractive to them. Studies have consistently found that foreign electronic retailers sell more where local sales taxes are high.

One of those studies reports that when the prices of online purchases abroad go up due to taxes, the resulting foregone purchases are not all replaced by local purchases. For transactions of more than US$250, only 10 per cent to 56 per cent of the lost sales are replaced by sales at brick-and-mortar stores. This gap is explained by the fact that sales taxes reduce the real incomes of consumers.

We must, therefore, keep in mind that if by some miracle, American retailers accepted to collect the GST and Canadian provincial taxes from their Canadian customers, it is not all of the foregone sales that would be recuperated by Canadian retailers. In up to half of all cases, consumers would simply abandon their planned purchases.

At a time when the fundamentals of the Canadian economy are weak, it is a very bad idea to reduce the real incomes of consumers. Canada should not go the way of Europe with regard to the taxation of online purchases. It should instead remain open for business.

Mathieu Bédard is Economist at the Montreal Economic Institute and the author of "The Dilemma of Taxing Online Purchases." The views reflected in this op-ed are his own.

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