Article: Private interests Intervene in Tax Loophole for Cigarettes

It's been long known that websites like yessmoke.ch have offered extremely low cost cigarettes worldwide. They can do so by undermining tax law- the way it works is that you purchase two packs of cigarettes off yessmoke for, say, 40 cents a pack. Added to that is 2.00 or so in shipping and handling charges. They send the product 2 packs at a time to avoid postal office scrutiny, and although they follow the law in printing the fact that cigarettes are in the package and should be taxed, they make this statement in what appears to be Swiss-German (evidently not many postal service people speak Swiss-German).

So the package comes through, and the product is never taxed. What to do about it? Well, such business has aroused the ire of the government, but the postal service is too understaffed and overworked already to take on the responsibility of scanning every cigarette pack sized package that comes through. This week, however, Phillip Morris has stepped in, agreeing not to supply illegal internet vendors with their product. It is the latest in moves to curb illegal cigarette distribution, including limitations by credit card companies in March that crippled many online vendors, and actions by private companies (for example Phillip Morris' successful attacks on yessmoke.ch which have essentially destroyed the company's main avenue of business).

The importance of this goes beyond cigarettes... its at the heart of one of the largest issues on the internet: who will be the force behind regulating commerce. On one hand, you have those that want to raise taxes on the internet to close the loophole that many online enterprises employ. On the other, some argue that such taxation would create further problems. Gary Becker argued in May on the Becker-Posner blog,

I oppose taxation of the internet not because it is an “infant industry” that needs artificial stimulation to grow, nor because sales taxes of a few per cent alone would destroy this industry. Rather, my reluctance to interfere with the dynamics of the growth of the internet largely explains my opposition to taxation of transactions and other activities on the internet. I fear that the additional regulation of the internet that would inevitably accompany efforts to enforce taxation of transactions by either American states or the federal government would have a negative effect on internet growth in the United States.

Any significant sales tax on internet transactions would induce sellers and buyers to find ways to evade paying the tax. That includes setting up offices outside the United States, perhaps while shipping from places within the country, false invoicing, and still other methods from creative minds intent on evasion. All taxes induce avoidance and evasive actions, but internet transactions are particularly difficult to police, as seen, for example, from the proliferation of internet pornography. Hence attempts to collect taxes is likely to lead to substantial regulations that would slow down the so-far remarkable rate of innovation on the internet.

However, I can't agree that the slippery slope argument justifies a policy of non-taxation. As Becker points out, "ALL taxes induce avoidance and evasive action"- and the idea that transactions are particularly difficult to police isn't a political objection, its a pragmatic one. In other words..if internet taxation were easier to regulate, would that then make it justified? Perhaps what's needed then is a model of enforcement that is not likely to lead to the "substantial regulations" that Becker worries about.

I'd like to take a second and look at the other side of this equation: what happens if there is no model of enforcement. Then you have what amounts to private enforcement, on the part of big companies like Phillip Morris, and individuals bringing lawsuits against internet vendors. Is this sort of hodge-podge of enforcement preferable to attempting to create a workable model?

Off the top of my head, here's one possible model of net tax regulation which combines the flexibility of private companies with the structural power of government. Pass some sort of legislation that requires credit card companies to obey with state a fed tax laws. In other words, if a company doesn't sign some sort of documentation that notes they follow tax guidelines, then they can't work with the companies that provide secure credit card transactions, such as Verisign. This creates a burden on those that don't tax. If a consumer wants to purchase gray market products, they do so with the risks of unsecure transactions. It wouldn't destroy the gray/black market online, but it would curb it.