Don’t Tax Internet Purchases

If Christmas 1999 was notable for the volume of gifts purchased over the Internet, Christmas 2000 could be notable for something else: “e-taxes.”

Congress is hashing out whether to tax Internet purchases. It imposed a three-year moratorium in 1998 to give it time to study the issue. With billions of dollars in tax revenue at stake, the issue is heating up.

In December, the Advisory Commission on Electronic Commerce met to consider making the moratorium permanent. The commission adjourned without reaching agreement.

Consumers buying products online currently enjoy the same immunity from state and local sales taxes as mail-order-catalog customers. The Supreme Court ruled a decade ago that requiring retailers in one state to collect sales taxes from consumers in another unconstitutionally encroaches on interstate commerce.

Supporters of legislation aimed at overturning the Supreme Court’s ruling argue their goal is simply to restore “neutrality” to the sales-tax code. They say the Internet tax haven places local retailers at a competitive disadvantage. And closing the Internet tax loophole would not impose a new tax, they say; it would simply level the playing field. Moreover, state and local governments lose considerable tax revenue when customers purchase items over the Internet from retailers located in other jurisdictions – revenue that is sorely needed to finance schools, roads, and other essential public services.

The opponents of such taxation emphasize that electronic commerce does, in fact, generate substantial revenue for state and local governments from a variety of tax sources, including business and personal income taxes, and that additional tax revenue is hardly needed at a time when the economy is booming and most state government budgets are awash in black ink.

Unquestioned by everyone in this debate are the benefits to taxpayers of the status quo. Competition between the nation’s 30,000 state and local tax jurisdictions helps hold tax rates down to their cost-effective minimum. If one state or city imposes a sales tax rate that is too high in relation to public services those taxes help finance, its tax base will shrink as businesses and consumers move to other jurisdictions with lower taxes and better roads and schools.

But moving is costly. The ability to avoid high local taxes by making purchases over the Internet or through mail-order catalogs supplies an alternative margin of competition that forces governments to be more fiscally responsible.

While local retailers are then at a competitive disadvantage, mail-order businesses and “e-tailers” have a disadvantage of their own in the form of the shipping and handling charges their customers must pay. Local retailers then can recapture business lost to catalog sales or the Internet by providing services that consumers value – and are willing to pay for. Or they can lower their prices so that, even with sales tax, their prices are equal to or less than those charged by Internet retailers with their hefty shipping and handling charges.

That is how competition is supposed to work. When the playing field is leveled, instead, by forcing Internet companies to raise their prices by collecting sales taxes and remitting them to the treasury of the state where the purchaser resides, the competitive market process is short-circuited.

Proposals to tax Internet commerce are thinly veiled attempts to protect inefficient local retailers and local governments from the beneficial forces of competition. It is unwise public policy to correct the “distortive” effects of the Internet tax haven by introducing yet another distortion. This is especially true of sales taxes, which are highly regressive, placing the heaviest tax burden on low-income Americans. Far better to allow the flourishing competition from e-commerce to help mute the distortions created by existing taxes.