Should access to information on the Internet be taxed? Should e-commerce be taxed? If so, then how? Before taxing the Internet, policymakers need to take a close look at the impact taxes would have on the new e.conomy.

Growth of the New e.conomy

64.2 million adult Americans go online each month to obtain information or make purchases. Although business-to-consumer Internet sales are currently only about 2 percent of the $2.7 trillion retail industry, that figure is expected to grow to 6 percent by 2003. Business-to-business e-commerce is expected to grow to $1.3 trillion by 2003.

• 17 million households shopped online by the end of 1999, spending an average of $1,167 per household.
• By 2004, that number is expected to grow to 49 million households spending an average of $3,738 each.

According to the Center for Research in Electronic Commerce, the Internet economy created $301.4 billion in 1998 and was responsible for 1.2 million jobs. About a third of that amount, $102 billion, was a direct result of Internet commerce.

Can States Tax the Internet?

Issues surrounding taxing the Internet are the same ones that have plagued catalogue sales – estimated at an annual $57 billion - for years. In Quill Corp. v. North Dakota, the U.S. Supreme Court ruled in 1992 that the Commerce Clause bars states from requiring an out-of-state mail-order company to collect taxes on sales made to customers inside the state unless the company has a substantial presence (referred to as “nexus”) within the state. Thus, the states’ authority to collect taxes stops at their borders.

Internet Tax Options

An option supported by the National Governor’s Association (NGA) would require online vendors to collect sales taxes based on the residence of the purchaser, not the vendor. This approach would use existing state and local tax structures, but is currently prohibited by the Commerce Clause. It would also create an administrative nightmare. Not only will vendors need to know where to ship the item, they will need to know which of the 7,500 taxing jurisdictions the customer lives in so they know how much tax to charge.

One seldom-discussed solution would require online vendors to impose the sales tax appropriate for its place of business, rather than the residence of the purchaser. In this case the nexus applies to the seller rather than the buyer, just as when a customer travels to another state and purchases something from a retail outlet. The vendor doesn’t ask or care whether the buyer is from another state or not.

Internet Tax Proposals

Hollings’ proposal has minimal privacy problems because the buyer’s residence is irrelevant; however, it would represent a new and unprecedented federal incursion into state activities. The money also comes with strings attached, as it must be used on education.

While the NGA’s desire to simplify the sales tax system is laudable, there may be an underlying motive to eliminate competition. Uniform sales taxes would give companies no incentive to look to another state for lower taxes or less restrictive regulations.

Because Congress is looking to the commission for recommendations, its findings will likely have a significant impact on the Internet tax debate. It is scheduled to release its report and recommendations to Congress in April 2000. So far, the draft report specifically states that “At this time, it does not appear that there is any compelling reason to impose taxes exclusively targeted at electronic commerce,” and that “Governments should keep tax burdens on American consumers and businesses as low as possible.”

Arguments for and Against Taxing the Internet

It is not necessarily true that if online sales increase, state revenues will decrease. State sales tax receipts have continued to increase during the 1990s, even with the growth of Internet sales. How?

1. Many Internet purchases – for example, prescription drugs - would not be taxed if bought in-state anyway.
2. States have various ways of collecting some of the taxes for out-of-state mail order and online purchases.
3. Because online consumers are just as subject to impulse buying as those shopping retail, there is not a direct trade-off between online purchases and lost retail sales.
4. Online sales have a “multiplier effect.” For example, online sales are helping to keep inflation down and so spurring economic activity in retail stores. Economists Ethan S. Harris and Joseph T. Abate of Lehman Brothers found that Internet prices average 13 percent lower than retail stores even with the shipping costs.

The problem with the fairness argument is that it only wants to go one way – increasing taxes. If fairness were really the issue, retailers would be indifferent as to whether state and local governments imposed an equal sales tax rate on e-tailers, eliminated sales taxes on retail stores, or somehow split the difference.

As for government officials, it is clear that their real concern is increased revenue. If it is unfair to tax retail sales and not online sales, then fairness proponents should oppose all schemes that give tax breaks to one business and not another.

The Economic Impact of Taxing the Internet

Should the Internet Be Taxed?

According to the National Conference of State Legislatures, based on responses provided by 44 states: “Conservative revenue forecasting and prudent fiscal management have left states in their best financial condition in decades. . . .Thirty-two of the reporting states ended FY 1999 with a balance exceeding 5 percent . . . Seventeen of these states ended with balances exceeding 10 percent.”

And with regard to tax cuts, the NCSL says, “State legislatures in 1999 lowered taxes for the fifth consecutive year, approving a net reduction of:”

Were states struggling for revenue, the NGA’s concerns about the loss of public services might make sense. But what reason is there to create a new tax while states are trying to cut and eliminate already existing taxes?

There Are No Fair Taxes.

Politicians are increasingly pushing sweetheart deals by giving one business a tax break and not its competitor. Clinton’s $350 billion tax cut package provides targeted tax cuts to a wide range of individuals, families, businesses, organizations and special interests. If associations like the NGA really wanted tax fairness, they would be supporting a flat income tax and the elimination of all other taxes and tax breaks. They are doing just the opposite.

So the states don’t need the additional revenue and there is no fair tax. That being the case, there is no justification for taxing Internet access or sales.