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November 3, 1999

Internet Taxes Could Crash the System

By

If Supreme Court Chief Justice John Marshall was right 180 years ago when he observed that "the power to tax involves the power to destroy," then the 19 members of the federal Advisory Commission on Electronic Commerce should ask themselves today: Will taxing the Internet kill this revolutionary medium in the cradle?

Regrettably, some members of the commission, appointed by Congress last year to study the feasibility of taxing electronic commerce, appear unconcerned with such questions. Egged on by governors and mayors, they are pushing proposals to start taxing the Internet as soon as a congressionally imposed three-year moratorium on "e-taxes" expires in October 2001. Indeed, they seem to be working under the assumption that the need to tax the Internet is a foregone conclusion.

Why would any public official want to impose taxes on a largely unfettered medium that has ignited a surge in entrepreneurial activity? The answer, of course, is money. While most Americans view the Internet as a technological passport offering countless ways to get information and exchange products and services, state and local officials (including some who sit on the commission) consider it a threat to their traditional tax base, which they say will erode if "e-commerce" isn't taxed.

This is ironic, since the explosive growth of electronic commerce has been accompanied by a dramatic increase in state and local tax revenue. A recent analysis by budget experts Dean Stansel and Stephen Moore of the Washington-based Cato Institute reveals that state tax collections grew at almost twice the rate of inflation between 1992 and 1998, forcing them to conclude that "today, almost without exception, state governments are awash in tax revenues." Investor's Business Daily notes that state revenues grew 227 percent and local revenues grew 193 percent between 1980 and 1995. And a report by Michael Flynn of the American Legislative Exchange Council finds states "in their best financial health in over a decade," with a $74 billion revenue windfall flowing into their coffers over the past four years.

Pro-tax commission members are unmoved, even though Congress appointed the commission to study "the effects of taxation, including the absence of taxation," on the Internet. House Majority Leader Richard Armey, R-Texas, and 35 other lawmakers reminded them of this in a Sept. 14 letter, saying the commission should bear in mind that "only Congress can authorize one state to compel sellers in another state to collect Internet taxes. This idea is not a popular one in Congress or among the American people. You should know that there are many Members that will oppose any new taxes on the Internet."

Commission members are so concerned with figuring out how to tax the Internet, rather than whether it should be taxed, that they are ignoring the wide gulf separating their views from those held by the lawmakers who appointed them. Indeed, some members of Congress, such as Sens. John McCain, R-Ariz., and Bob Smith, I-N.H., have already introduced legislation that would make the Internet tax moratorium permanent. Unless commission members adhere more closely to their original mandate, they may find their work disregarded entirely.

Which would be a shame, because the commission could serve a useful purpose by examining the larger questions the federal government must consider if it wants to encourage the growth of the Internet economy. For example, how can Internet taxes be reconciled with the ban on interstate taxation established by the Constitution and past Supreme Court decisions? And shouldn't the ability to tax a company be reserved for that state and locality where the company resides? And finally, if the proposed Internet tax threatens e-commerce, shouldn't lawmakers consider the harm existing taxes inflict on the broader telecommunications industry?

In avoiding such questions, the commission has maneuvered itself to the left of even the unabashedly pro-tax Clinton administration, which has proposed a global free-trade zone for Internet commerce. The administration recently lent its support to a congressional resolution introduced by Rep. Christopher Cox, R-Calif., and Sen. Ron Wyden, D-Ore., that urges U.S. trade officials to lobby for a permanent global ban on Internet taxes during a World Trade Organization meeting in November.

Sometime before its report is due next April, the commission needs to recall one of the central tenets of economics: The more you tax something, the less you get of it. Unless their intention is to discourage on-line commercial activity, commission members should hit the "delete" key on any proposals to tax the Internet.

Adam D. Thierer is the Walker fellow in economic policy at The Heritage Foundation (www.heritage.org), a Washington-based public policy research institute.

Distributed nationally by Knight-Ridder Tribune News Service

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