"Tax-free Internet" -- a Seductively Simplistic Slogan

"Tax-free Internet" -- a Seductively Simplistic Slogan

by / February 28, 1999
"Tax-free Internet." It has the ring of a brilliant, forward-thinking public policy. And it should be especially appealing to me, a free-market elected Republican whose recent term as president of the National Association of Counties (NACo) focused on the need for counties to become "digital" and "global."

But "tax-free Internet" is really a simplistic slogan that could have profoundly negative consequences for Main Street businesses, people who depend on state and local government services in their daily lives, and those who pay taxes on income and property.

There are only three significant sources of revenue for state and local governments in the United States -- taxes on sales, income, and property. Forty-five states look to sales taxes for roughly one-third of their revenue. In various ways, these states have decided to minimize taxes on activities they want to encourage, such as earning income, investing and saving, and owning property, and shift taxes to activities they want to discourage, such as consumption. When was the last time anyone argued that Americans save too much and consume too little?

However, as a result of Supreme Court decisions dating back to the 1960s, catalog merchants are exempt from collecting state sales taxes unless they maintain a "presence" such as a retail store within the buyer's state. The Supreme Court interpreted the "Interstate Commerce Clause" of the Constitution as allowing only Congress to tax these "interstate" sales. Catalog merchants have vigorously lobbied Congress to maintain their exemption from collecting sales taxes so they can maintain the 5 percent to 9 percent competitive advantage they enjoy over Main Street businesses. They have worked to defeat legislation that would delegate to states the authority to require them to collect taxes on such transactions.

Why is this so important now?

After decades of exemption from collecting sales tax on interstate transactions, catalog and mail-order sales, on the Internet, reached a billion dollars after just a few years. Some observers predict that electronic commerce transactions will reach $1.5 trillion within five years, and that two-thirds of all retailers plan to sell online by the end of 1999. Electronic commerce and at least the financial and legal consummation of most transactions involving sales of goods and services seem inevitable, because they offer the possibility of a quantum leap forward for consumers: more information, more choice, more convenience. They also reduce costs for merchants, because paperwork is automated and the need to maintain inventories and multiple "storefronts" is reduced.

How did Internet merchants respond to these prospects? Despite overwhelming evidence that Internet merchants were enjoying the most spectacular increases in business in the entire history of human commerce and trade, they wanted something more from the federal government. They insisted that they needed the additional "protection" of being exempted from collecting state and local sales taxes during a six-year moratorium, if not permanently. For two years, Internet merchants intensely lobbied Congress for the same competitive advantage enjoyed by catalog merchants under the guise of a "tax-free Internet."

At one point, the Internet merchants actually claimed that it would be too complicated for them to figure out how to calculate sales-tax rates that vary between states, even though other merchants who sell from both stores and by mail have done so for years!

The powerful Internet merchants almost succeeded in their efforts to establish themselves as an elite class of merchants given special privileges by Congress. Instead, they reluctantly settled for a compromise of a three-year moratorium on new sales taxes and an Advisory Commission on Electronic Commerce to study the issues in depth.

Unfortunately, the credibility of both congressional leaders and the Internet merchants evaporated when Congress quietly stacked the commission with industry representatives (10 from industry compared to six local and state representatives). This defied the very law establishing the commission, which requires that it be composed of an equal number of members from the industry and from state and local governments.

It may turn out that sales of most goods and services over the Internet and other forms of electronic commerce will be impossible to detect, thus making sales taxes on such transactions impossible to collect. This will force states and local governments to abolish most sales taxes to maintain a level playing field for Main Street retailers. It is tempting for many people, especially political conservatives like me, to respond, "So what? State and local governments will just have to cut their spending." But there is little public support to sharply cut the services state and local governments provide for people in their daily lives. "Devolution" will only increase those responsibilities.

Tax policy should be based on more than simplistic slogans such as "tax-free Internet." Americans need time to study the long-term policy implications of collecting or not collecting sales taxes on Internet transactions.

The next step is for congressional leaders to follow the law they passed by appointing fair representation of state and local governments to the Advisory Commission on Electronic Commerce.

Randy Johnson is NACo's immediate past president.

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