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March 23, 2000

E-Commerce: A Taxing Issue

By

Internet retailers are breathing a sigh of relief, at least for now. The congressionally appointed Advisory Commission on Electronic Commerce (ACEC) has called for extending the current moratorium on electronic taxes. But only a simple majority voted that way, not the "supermajority" needed to forward a recommendation to Congress, emboldening e-tax advocates willing to slam the brakes on the economy's fastest-growing sector.

Some commission members had embraced a scheme first proposed by the National Governors' Association (NGA) that would allow state and local governments to impose taxes on Internet vendors with no physical presence in the taxing jurisdiction. To collect these taxes, the governors' plan envisions computerized tax-software systems, private-sector tax collectors called "Trusted Third Parties," "geo-code" tracking systems for individual consumers, and multi-state taxing bodies to administer what would be the equivalent of national sales tax.

If this sounds needlessly complex and frighteningly intrusive, it is. In fact, it would represent the very sort of "taxation without representation" our nation's founders believed unjust enough to warrant a revolution. It could also cripple America's "Information Age" economy by stifling the Internet entrepreneurs who are fueling record levels of economic growth.

Why would any public official endorse a tax system of dubious constitutionality that poses such a clear and present danger to the current economic expansion? Simple: for the money. State and local officials are flocking to an NGA-style plan to pump even more tax dollars into their already overstuffed coffers.

"Money is just pouring in over the transom," says California Gov. Gray Davis. But rather than return record tax surpluses to the people, many governors and mayors are arguing that they need still more revenue to continue providing vital public services. Dallas Mayor Ron Kirk, for example, has joked that citizens who enjoy the tax-free "virtual" world of the Internet should not be surprised if they dial 911 and find that a "virtual" firefighter or cop shows up at their house.

To be fair, e-commerce eventually could erode the sales-tax revenue that cities and states have traditionally relied on. But a failure to raise enough revenue from the bricks-and-mortar merchants based in their jurisdictions is no reason to let mayors and governors slap sales taxes on Internet companies based elsewhere.

The NGA proposal is, in short, a shakedown. The governors want to grab revenue from Internet companies located hundreds or even thousands of miles away, much as police in certain communities set speed traps to raise ticket revenue from out-of-town motorists. Never mind that the companies being taxed would enjoy no democratic representation in the jurisdiction doing the taxing. Who can be bothered with such old-fashioned concerns when money's at stake?

As a practical matter, collecting e-taxes would be a logistical nightmare. Internet merchants resemble mail-order and catalog companies, which send merchandise across the country but are taxed only in the jurisdiction where they reside. There's a good reason for this: The United States contains more than 6,000 taxing jurisdictions. It's folly to argue that a catalog company or Internet merchant should be required to pay taxes to every one of them.

Then there's the legal hurdle. The Supreme Court has restricted state and local efforts to levy taxes on firms without a physical presence in the community. Taxes on Internet sales could be ruled unconstitutional as well.

Not that the Internet should remain completely tax-free, although that is my preference. The solution is to let mayors and governors impose taxes on those Internet companies located within their jurisdictions, just as they are now permitted to do with mail-order and catalog companies. Internet vendors would be taxed on an equal footing with bricks-and-mortar merchants - at the "origin of sale." So, if you purchased a book from Amazon.com, whose principle place of business is Seattle, the sales-tax rate for the city of Seattle and the state of Washington would apply, just as if you walked into a traditional store in Seattle and purchased a book while visiting the city.

Internet users who fear burdensome taxes under an origin-based system need not fear. Such a system would provide a check on excessive taxation by encouraging vigorous interstate tax competition, since companies could "shop around" for more hospitable tax locales if their current jurisdictions became over-zealous tax collectors.

And that, more than anything else, explains why pro-tax members of the Advisory Commission on Electronic Commerce opposed an origin-based system - and why advocates of the free market ought to support it.

Adam D. Thierer is a former Walker Fellow in Economic Policy at The Heritage Foundation, a Washington-based public policy research institute.

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