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ndonesia is moving forward with its plan to impose import duties on digital products next year. As reported in this newspaper, the duties will be imposed despite the World Trade Organization’s (WTO) e-commerce moratorium that member countries would not impose customs duties on electronic transmissions.

The government believes imposing the duties will “create a level playing field between online and offline sellers and increase fiscal revenues.” If it succeeds in implementing its plan, Indonesia would become the only country to violate the WTO moratorium and risk being sued by other countries. Apart from that, we must figure out who will actually be picking up the tab.

Duties are taxes imposed on buyers for every unit of goods purchased, regardless of whether the goods are physical goods or services, analog or digital. Whether it is Italian wine or Hungarian software, duties are a penalty that is almost never borne by sellers/suppliers alone.

Let us suppose that, without duties, the demand for Italian wine in Indonesia is US$7 a bottle for 1,000 bottles a year. When the government imposes a duty of, say, $2 per bottle, the demand for the wine will fall. Let us imagine that the new equilibrium sets demand at 800 bottles a year at $6.50 a bottle, because decreased demand tends to bring down the price. Buyers now pay $6.50 + $2 = $8.50 per bottle, while suppliers receive $6.50. This means that the burden on buyers is $1.50, calculated by subtracting the old equilibrium ($7) from the new price ($8.50). On the other hand, the burden on suppliers is $7 - $6.5 = $0.50. In this example, the higher share of the duty falls on the consumer’s shoulders.

There is a way to ascertain whether a duty will affect consumers or suppliers more. In economics jargon, we can state that one who pays a duty (or a tax in general) is not that who ultimately pays the physical amount of money. Rather, this is determined by the relative elasticity of demand and supply. Elasticity measures how the quantities demanded (or supplied) are responsive (sensitive) to price changes.

A demand for a commodity is considered elastic if the reaction to its price change is sensitive. Elasticity varies depending on the relative ease in finding substitutes for that particular good. Goods that evoke a certain degree of addiction (like cigarettes) present a less elastic demand.

If demand is more elastic than supply (as demand tends to be more sensitive to price changes than supply does), consumers pay less of the tax than sellers. Conversely, if supply is more elastic than demand, suppliers pay less of the tax than buyers do.

Thus, elasticity offers a way for consumers to cope with the tax burden. When it is easy to stop consuming a particular good because of the ubiquity of substitutes, we would prefer, to a certain extent, to switch our consumption habits instead of paying a higher price. On the contrary, if for some reason we are loyal to a commodity, we would rather pay a higher price than stop consuming the good or switch to another good.

Yet, in support of free trade, it has to be mentioned that duties, as with any other tax, always results in deadweight loss. Overall, the imposition of duties curtails trade gains. It can even obliterate occasions of exchange altogether. Part of the trade benefit for the consumer and supplier can be literally swallowed up by tax revenues; the other part of the trade benefit simply cannot happen. The higher the elasticity of demand or supply, the bigger the deadweight loss.

The law of supply and demand demonstrates that imposition of duties reduces the actual volume of international trade. Imposing duties reduces trade benefits that would otherwise be enjoyed by consumers and suppliers both. The more sensitive supply and demand is to price changes, the greater the general loss.

Any government considering the imposition of duties on digital goods needs to rethink who will actually pick up the tab in the name of tax revenues or of creating a level playing field. It needs to consider whether the means it opts for will reach the desired end. In any case, one thing is clear: the imposition of duties will be shouldered by real people.

Ignoring the fundamental laws of economics will incur risks far greater than simply being sued by other WTO members. A government that does so risks punishing its own citizens (consumers and importers) as well as foreign citizens (suppliers), and losing international business altogether.
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Carmelo Ferlito is senior fellow at the Institute for Democracy and Economic Affairs (IDEAS) in Kuala Lumpur; Sukasah Syahdan teaches at Prasetiya Mulya Business School in Jakarta.