Virginia Governor James Gilmore, chair of the Advisory Commission on Electronic Commerce, hoped that the group would act quickly to make permanent a three-year moratorium on new Internet taxes enacted by Congress in 1998. But faced with an administration policy statement objecting to any move that would ban the collection of sales taxes on online purchases, a letter signed by 49 economists contending that Internet taxes are necessary to restore "neutrality" to the sales tax code, and the testimony of mayors and other public officials lamenting the billions in revenue state and local governments stand to lose if the tax moratorium is extended, the commission adjourned its recent meeting in San Francisco without reaching agreement. Given the strength of pro-tax forces being mobilized, it is doubtful that the two-thirds majority required for the commission to make a recommendation preserving the Internet tax haven can ever be achieved.
The fact that new taxes are being pushed at a time when the economy is booming, sales tax receipts have swollen, and most state government budgets are awash in black ink undercuts most of what passes for serious analysis of Internet tax policy. Indeed, the palpable absence of a budgetary justification for taxing electronic commerce suggests that the current moratorium was enacted, not on the basis of a principled opposition to such taxes, but rather because the tax writers in Congress have not yet figured out how to structure and administer e-taxes so as to maximize the Internet tax take or found a politically acceptable way for the federal government to share in the Internet tax loot.
Of course, the pro-tax forces contend that closing the Internet tax loophole would not impose a new tax but simply eliminate existing distortions in the sales tax code, that is, ensure that the tax laws do not favor one segment of the retail trade over another. Consumers buying products online currently enjoy the same immunity from state and local sales taxes the U.S. Supreme Court has carved out for mail-order catalog sales. The Court ruled earlier this decade that requiring retailers located in one state to collect sales taxes from consumers in another unconstitutionally burdens interstate commerce. Hence, sales taxes are due on mail-order and Internet purchases only if the retailer has a "physical presence" in the customers state of residence. Although buyers in every state with a sales tax are obliged to report and pay "use" taxes on items purchased elsewhere, that requirement is rarely enforced.
As a result, local retailers who must collect appropriate sales taxes are supposedly placed at an unfair competitive advantage relative to Internet and mail-order retailers, and including such purchases in the tax code would merely restore a level retail playing field. But the economists who support taxing the Internet in order to eliminate perceived distortions are living in a fiscal fantasyland. Except insofar as "reform" generates more revenue, government has no interest in designing a neutral tax code, nor in broadening the tax base so that tax rates can be lowered. Rather, the flesh-and-blood politicians who function in a world light years distant from the policy prescriptions of public finance textbooks are motivated by more narrowly self-interested objectives.
Fiscal federalism is a stubborn constitutional barrier to the parochial politics of taxing and spending. As is the case in ordinary markets, competition between the nations 30,000 separate state and local tax jurisdictions helps hold tax rates down to their cost-effective minimum. If one jurisdiction imposes a sales tax rate that is too high compared with the quantity and quality of public services those taxes help finance, its tax base will tend to shrink as businesses and consumers relocate to other jurisdictions having lower taxes, better roads and schools, or both. 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.
Local "brick and mortar" retailers that are placed at a competitive disadvantage by high local sales taxes do not have to stand idly by. They can get business lost to catalog sales or to the Internet back by providing services consumers value and are willing to pay for or by lowering their prices so that, inclusive of sales tax, the prices they charge are equal to or less than those charged by out-of-state retailers, which normally add hefty shipping and handling charges to their customers orders. That is how competition is supposed to work. When the playing field is instead leveled 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 and taxpayers become more vulnerable to exploitation by big government.