Internet Starts Shattering Low-Performance Public Policy Paradigm

Commentary, Disruption, Frontier Centre

The proper relationship between governments and the burgeoning Internet has so far eluded precise definition. Birthed by the U.S. Defense Department, the Web has exploded into a cantankerous adolescence beyond the traditional scope of public control.

Should governments try to oversee it as rigorously as they do other parts of the economy? Can they? At the heart of the challenge is their inability to collect taxes on Internet commerce.

Jeffrey Owens, head of fiscal affairs at the Organization for Economic Co-operation and Development, recently pointed out the obvious: people who sell goods or services on the Web may be impossible to identify or locate. How can authorities regulate electronic activity that is securely encrypted in a server somewhere on a tropical atoll? How can they gather information when the Internet's direct links between buyers and sellers cut them out of the loop? "Tax authorities cannot remain passive in the face of such developments," Owens frets.

Canadian finance ministers worry that their governments will lose a big chunk of tax revenue, and a federal-provincial working group is pondering the imminent erosion of sales-tax income. The phenomenal growth of Internet commerce — a study presented to the World Economic Forum predicts a 56% annual growth rate and a $3 trillion market by 2003 — lends urgency to their task.

The OECD claims this shrinkage is already under way. Tax systems could be so badly damaged that governments might find themselves "unable to meet the legitimate demands of their citizens for public services." European governments complain that, to keep pace, they have to tax fixed assets like labour and natural resources at higher rates because mobile factors like capital are increasingly difficult to capture.

The solution? Bewildered theorists have hatched a variety of schemes to tap into e-commerce incomes, including unitary international levies and the omnivorous Tobin tax on all electronic transactions. These either fail to pass the test of collectability or require a level of transborder co-operation impossible to imagine.

Since such taxes are becoming impossible to collect fairly, or at all, others have suggested dropping sales levies altogether. Various think tanks have recommended that governments in the U.S. raise revenue by other means in order to level the playing field for offline merchants.

Economist Murray Weidenbaum suggests that we eliminate income tax altogether and replace it with a flat charge on consumption. To calculate the tax base, you simply deduct savings from income. The amount left equals the value of resources you have consumed. Multiply that by some low flat rate and, voilà, you have created a revenue stream for government.

This tax, called the Universal Saving Allowance tax, would end the rigmarole involved in tracking each individual transaction and applying different rates to different products and services. The tax base remains intact while eliminating the collection bureaucracy and virtually all the paperwork of our archaic, transactions-based system.

Canada has more to lose on the tax side because our public sector is proportionately much larger than the Americans'. The latest OECD figures show government spending in Canada at 40.9% of the economy in 2000; well above the 30% level that many economists believe works best to maximize general living standards. The government sector in the U.S., at 29.9% of the economy, is almost 40% smaller than ours.

Combine rising health and pension bills from an aging population with tax rates and methods that are not sustainable in a hyper-competitive, open economy, and the writing appears on the wall. The low performance monopolies that now dominate our public sector — schools, health care and municipal services – will collapse sooner than we think. They will be replaced by efficient, consumer-oriented systems that improve services while generating big savings.

The sale of government assets like Crown corporations is now standard public policy around the world. Only a few die-hards still believe politicians and bureaucrats can effectively manage business assets and large organizations in general. They get away with it because systems that measure performance remain primitive in our public sector. Moreover, these organizations benefit from hidden subsidies which make their products look like a better deal than they are. Selling these assets would virtually eliminate provincial debts in Manitoba, Saskatchewan and B.C., reducing interest payments by billions annually. And it would prepare us for the impending loss of revenue.

Inertia and politics may slow down these inevitable developments, but the technology revolution (particularly the death of distance) will eventually shatter government's low-performance paradigm. It will shrink the state's core business down to what it does best — setting the overall policy framework. Governments will fund services but not deliver them, from revenues raised through intelligent, growth-maximizing taxation.

Perhaps we're worrying too soon. A Dallas-based think tank, the National Center for Policy Analysis, downplays the magnitude of Internet sales. It suggests that they will not grow exponentially, and that they now amount to a little over one half of one percent of retail sales. There is a practical limit to what people will buy online, especially when shipping costs eat up savings from avoiding sales taxes. The folks at think 15% of the total is the upper limit on Internet sales.

"Hands Off the Internet," goes the hymn of those who want to keep it tax-free. But as the Web grows, governments will have no choice. They may somehow find a way to tax it. But don't bet on it. They will definitely learn to deliver public services for a lot less money.