The Power of Independent Thinking


Stay Connected
Get the latest updates straight to your inbox.


No Go from the NGA

Led by Utah Gov. Michael Leavitt, a vocal opponent of proposals to make permanent a three-year moratorium on new Internet taxes that expires next year, the National Governors’ Association (NGA) unveiled a new initiative, "State Strategies for the New Economy," at the start of its winter meeting in Washington, D.C. The NGA’s initiative responds to challenges posed by new electronic technologies that threaten to erode the traditional boundaries defining state and local political jurisdictions. "States can fight the changes and die, accept them and survive, or lead and prosper," Leavitt said.

That mindset, that it is the prosperity of states and not that of their citizens that should be of paramount concern, was evident in February’s "Telecommunications Tax Policies: Implications for the Digital Age," the first in a series of papers to be issued under the auspices of the NGA’s Task Force on the New Economy. Expressing concerns about the discriminatory impact on local merchants and the tax revenue that is "lost" when consumers make purchases online, the report proposes several reforms designed to make it easier for states to collect sales taxes on digital transactions. Saying that the states are being cheated by consumers who take advantage of the opportunity to avoid paying taxes on items they purchase from retailers located out of state is the same thing as saying that all of their hard-earned income belongs to the government – and only by government’s sufferance will they be allowed to keep some of it.

In addition to proposing that states work together to simplify their sales tax codes and to designate a "trusted third party" to collect taxes on transactions that cross state borders, the NGA supports a policy of levying sales taxes at the point of origin rather than at the point of consumption. Under current law, a consumer residing in, say, Utah, who buys a book from, located in Seattle, is not required to pay Utah sales tax on his purchase because does not maintain a "substantial physical presence" in that state. (The consumer is obliged to report and pay a "use tax" equal to the sales tax rate applicable in Utah, but because that requirement is difficult to enforce, consumers rarely comply.) The governors want to collect Washington state sales taxes on all the books they sell. Although Utah would still "lose" revenue, some of the loss would presumably be made up by requiring retailers located in Utah to collect Utah sales taxes on sales made to consumers located elsewhere.

Origin-based sales taxation avoids a serious problem with traditional methods of taxation in a borderless virtual economy. There are 30,000 separate state and local tax jurisdictions throughout the United States, each of which levies a different sales tax rate (which may be zero) and applies that rate to a different mix of goods and services. The continuation of consumption-based sales taxation requires that a way be found for e-tailers to cope with myriad state and local tax laws and determine the appropriate tax due from each customer.

But consumption-based taxation conflicts with widely accepted principle of public finance. A consumer located in Utah sees some of the sales taxes he pays on items purchased from local merchants being spent on local roads and schools from which he himself benefits. **In Utah, sales tax doesn’t go to schools—methinks.** But a Utah consumer, required to pay Washington state sales taxes on an item purchased from a retailer located there, receives nothing in return. Neither does he impose any burden on Washington’s public services: the retailer from which he buys already pays local taxes that help maintain the local roads it uses and the local schools its employees’ children attend. Moreover, Utah consumers have no political voice in Washington and therefore have no influence over how high their taxes will be or how prudently the revenue is spent. Somewhat insulated from the taxing and spending propensities of local politicians by having some of their tax burden exported to consumers located in other states, Washington’s citizens, in turn, have less of an incentive to lobby against high local taxes. Facing less political opposition to higher levels of spending and higher taxes to finance it, Washington’s politicians predictably have a freer hand to pursue their own self-interests.

At bottom, proposals to tax Internet commerce are nothing more than thinly veiled attempts to protect inefficient local retailers and local governments from the beneficial forces of competition. Competition among taxing jurisdictions promotes harmony among tax rates by helping hold tax rates down to their cost-effective minimums; the NGA’s proposal would promote harmony by helping artificially to prop tax rates up. There is a silver lining in this cloud, though. If online transactions are taxed at their origin rather than their destination, e-tailers will have incentives to move their operations to low-tax jurisdictions. But moving is costly. It would be far better to preserve the status quo, allowing consumers to continue to decide where to make their purchases rather than rely on the governors to do the right thing.

William F. Shughart II is Research Director and Senior Fellow at the Independent Institute, J. Fish Smith Professor in Public Choice in the Jon M. Huntsman School of Business at Utah State University, and editor of the Independent Institute book, Taxing Choice: The Predatory Politics of Fiscal Discrimination.

From William F. Shughart II
TAXING CHOICE: The Predatory Politics of Fiscal Discrimination
So-called “sin taxes”—the taxing of certain products, like alcohol and tobacco, that are deemed to be “politically incorrect”—have long been a favorite way for politicians to fund programs benefiting special interest groups. But this concept has been applied to such “sinful” products as soft drinks, margarine, telephone calls, airline tickets, and even fishing gear. What is the true record of this selective, often punitive, approach to taxation?