The End of the Sales Tax?

Commentary by Pete du Pont

The commission studying Internet taxation has been hearing two starkly different scenarios of our future with e-commerce. On the one hand, the word is that taxing Internet commerce will kill the goose just as it begins to lay golden eggs. On the other hand, there are predictions that state and local government revenue bases will dry up unless Internet sales are subject to the same taxes that apply to traditional bricks-and-mortar businesses.

But the real question we need to confront is whether the sales tax makes economic sense in an Internet world. Abolishing the sales tax is a radical proposition, but governments will have to face the prospect sooner or later, whether they like it or not. Two important developments are rapidly altering not only commerce but also the basic assumption upon which the sales tax rests.

First, obviously, is the Internet. Not only can people order goods over the Internet and have them delivered to their homes, but also increasingly they can have the product actually delivered through the Internet itself - software, music and airline tickets, for example. It is simply impossible to tax goods that can be downloaded from the Internet. Even if some sort of national sales tax could be implemented that encompassed all domestic sellers, sales would simply shift off shore.

A more serious threat to the future base of the sales tax is the increasing shift of our economy from goods toward services. Efforts to tax Internet purchases of services are not viable; most states don't even try to tax services.

What is frightening many governors are the projections of vast Internet sales in the future. If one assumes that Internet sales replace conventional sales dollar-for-dollar, then the conclusion must be that state sales tax revenues will collapse unless Internet sales are taxed.

But I don't believe that is what is happening or is likely to happen in the near future. First, state tax revenues are growing rapidly - much faster than inflation. A quart of milk needed for dinner is not going to be bought over the Internet. Neither are paper towels, newspapers or detergents. Phone calls will still be made and taxed. Many state excise taxes - on gasoline or liquor, for example - will remain viable. Low cost discounters - Wal-mart and Costco - will remain; so will high-end, full service retailers like Nordstrom.

Second, most everything else sold on the Internet would be free of state sales taxes anyway. The fastest growing segment of Internet commerce is business-to-business sales, which are always free of state sales taxes. The next largest categories are stock sales and airline tickets, both of which are also tax-exempt under current law in every state.

Finally, much Internet commerce is either inherently untaxable or comes at the expense of mail order sales rather than local sales. There is simply no constitutional way for a state to tax businesses without a nexus in that state. So for many states, revenue is being lost from one source they cannot tax to another source they also cannot tax. Thus the losses may be illusory.

So the sales tax will linger for some time, but the Internet and the knowledge economy are accelerating economic changes that make the long-term future of the sales tax bleak. So instead of trying to patch together something with difficult constitutional challenges that run counter to changes in technology and consumer purchasing habits, why not embrace the future and simply get rid of the sales tax altogether?

There is no need to do so immediately, and there are some things that can be done to cushion the impact. For example, states can privatize and contract out services, reducing state costs. They can shift toward fee-based, rather than tax-based, government services. And they can use the Internet to lower the cost of delivering government services and to expand quality and access. Registering cars, paying taxes, purchasing supplies - all can be accomplished on the Internet and lower state costs.

In the end, there is no single alternative. Some states may simply find it better to get whatever revenue the sales tax generates, rather than pursue any of the alternatives. That is fine, but there is no global fix that is going to keep the sales tax from eroding more and more as time goes by. Abolishing it altogether over time may ultimately be the only viable solution to dealing with Internet commerce.

 

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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.