On-Line Commerce Flusters Tax Officials

P> It's the problem everyone seems to be dancing around: Once commerce goes on-line, the tax man will have to follow.

For decades, the government has fought tax evasion and money-laundering by criminals by asking the banks and the Federal Reserve to record financial transactions and to report cash deposits of more than $10,000.

Tax officials "have reason to be concerned," said Mike Nelson, a technology advisor in the White House's Office of Science and Technology Policy. "As soon as taxes start going out the door," on-line tax evasion will become an issue for government officials to deal with, he predicted.

The combination of on-line commerce, data-scrambling technology, electronic cash and international communications could allow tax-free buying and selling of goods and services via the Internet. Electronic cash is a particular worry for government officials, partly because it might be exchanged without leaving an auditable tax trail.

Every percent of missing tax revenue costs the Treasury Department more than $10 billion.

Treasury Secretary Robert Rubin has assembled a panel of officials to study tax-related developments. So far, however, no one has found a solution.

On-line tax evasion "is a significant issue, particularly if there are inadequate audit trails," said Larry Gilbert, general counsel for CyberCash Inc., Reston, Va., that is developing an electronic cash network. CyberCash computers will record any deposits greater than $3,000 in electronic cash, he said. "It [will] be a very large challenge to master."

But David Chaum, founder and president of DigiCash Inc., based in the Netherlands, dismissed concerns about tax evasion. Banks will be able to track the movement of digital cash, and people ultimately will want to buy things from legitimate companies, he said.

"We lose more money today" when people use untraceable cash purchases to hide their taxable income, Chaum said.

John Gilmore, a California-based encryption expert, said companies could not avoid paying taxes without falsifying their internal accounts, which could be checked once tax officials suspect tax evasion. "To pull the wool over the government's eyes, it would have to pull the wool over the shareholders' eyes," he said.

Sales taxes imposed by states may also be hit hard by on-line commerce, said Kent Johnson, national partner for sales and transaction services in KPMG Peat Marwick LLP, an international accounting firm. Consumers in one state could avoid an 8 percent local sales tax by buying a new computer from a tax-free state via the Internet, he said.

In 1995, roughly $200 million in goods and services were sold via on-line services. Industry officials expect sales volume to quickly grow to billions of dollars per year.

If states try to crack down on such interstate on-line purchases, consumers and companies might respond by buying products from overseas sellers using the Internet, electronic cash and overseas banks.

"There could be nothing [states] could do about it, absent an international treaty," said Gilbert.

Federal and state officials have just begun to grapple with the tax-related issues of on-line commerce, but they acknowledge that they can't keep pace with the rapid developments in on-line commerce technology.