Should We Tax Sales on the Internet?

Commentary by Pete du Pont
"Technological changes are increasing the mobility of labor and capital around the world. Because of this mobility, governments no longer have a fixed supply of productive resources to tax and regulate. Instead, governments are in active competition with each other."

Economists Richard McKenzie and Dwight Lee wrote those words in 1991, contending that the ability to move wealth rapidly has changed the world, and suggesting that governments that couldn't adapt by reducing the burden of government were going to lose to countries (and here in America, states) that could.

The National Governors Association and a bunch of mayors agree that technology has caused change, but their concerns about adapting seem to be focused on a slightly different objective: how to get tax revenue from the Internet. Thus far they seem not to have considered at all the McKenzie and Lee thesis, which is that in a world of increasing mobility and portability, it may become more and more difficult to find your tax base and to enforce tax collections.

Last year Congress enacted a three-year moratorium on taxing Internet commerce. At the same time it created the Advisory Commission on Electronic Commerce to create a policy for the years after 2001 when the moratorium expires. Already many in the Governors Association are complaining about how the loss of all that e-commerce tax revenue is about to cripple their economies. Ohio, for example, has said it will lose $150 million in tax receipts this year. Yet the accounting firm of Ernst & Young estimates that nationwide losses will only be about $170 million, not quite one-tenth of 1% of state and local government sales and use tax collections. This means the commission and Congress have plenty of time to examine the issue, the Ernst & Young report said.

Nevertheless, when the advisory commission got together in June for the first time, Dallas Mayor Ron Kirk, a member of the commission and chairman of the economic task force of the U.S. Conference of Mayors, complained that the three-year moratorium was a threat to the nation's public education system. Washington Gov. Gary Locke said that not taxing Internet sales threatened to "undermine our efforts to educate the next generation of workers."

Kirk and Utah Gov. Michael Leavitt maintained that the commission needs to find a way to make sure somebody collects the sales tax, no matter where the seller and buyer are located. Their suggestion: the federal government must create a tax on Internet transactions, presumably with the proceeds being divvied up among state and local governments.

As you can imagine, that idea will not go unchallenged, both by those conducting Internet commerce and by policy makers who think it's a bad idea in principle. In the latter category, for example, House Majority Leader Dick Armey (R-Texas) wants the moratorium to be permanent and Rep. Christopher Cox (R-Calif.) wants to be sure that "the tax vultures will [not] descend and start creating new ways to collect money that doesn't presently exist."

Kirk, Leavitt et al. seem to be ignoring the possibility that they may have to come up with something more ingenious than a national sales tax on Internet commerce. State and local governments already have a hard time getting traditional retailers to collect the sales tax on items sent across municipal or state lines. How much more difficult will it be to enforce an Internet sales tax? If a retail business is set up in, say, Mexico or the Caymans, how do you force it to collect a tax on sales to California or North Dakota? Is it practical or cost-effective for government to go after the buyer in California or North Dakota?

Even as arguments raged among the 19 members of the advisory commission, Kirk maintained that he felt a consensus was already emerging that it wouldn't hurt Internet commerce to apply traditional retail sales taxes. Wishful thinking, for the chairman of the commission, Virginia Gov. Jim Gilmore, said he didn't see any evidence of a consensus.

Granted the commission has a difficult task ahead. But the governors and mayors had better realize that the world has indeed changed, and that it will take creative, innovative approaches to deal with Internet commerce. Just saying, "Let's tax it" isn't good enough any more.



The National Center for Policy Analysis is a public policy research institute founded in 1983 and internationally known for its studies on public policy issues. The NCPA is headquartered in Dallas, Texas, with an office in Washington, D.C.