February 2, 2000

States should not be authorized to collect taxes from out-of-state Internet businesses
Congress must not allow a phony revenue crisis justify new taxes

Congress should reject calls for it to authorize states to collect taxes from out-of-state Internet businesses, urged Aaron Lukas, an analyst with the Cato Institute's Center for Trade Policy, in testimony today before the Senate Budget Committee.

The increase in online commerce has led many state and local officials to call for Internet taxation. In the United States alone, approximately 39 million people made a purchase online last year-more than double the number of Internet shoppers in 1998-and sales may reach $50 billion this year. "Such astonishing growth has many state and local governments worried that they are not adequately prepared to tax this flood of new commerce," noted Lukas.

Contrary to the claims by state and local governments, current federal rules do not exempt electronic commerce from taxation; they simply prohibit certain means of collection, Lukas said. He stressed the importance of tax fairness. "The federal government should continue to prohibit states from imposing tax collection duties on out-of-state businesses by establishing a uniform national jurisdictional standard for taxing e-commerce based on the substantial physical presence test. Such a standard would reaffirm traditional principles of tax fairness, preserve rate competition among states and avoid years of contentious litigation."

Lukas reminded the lawmakers of advantages that the Internet can offer to consumers. "The current standard promotes tax competition among the states. Electronic commerce gives everyone the opportunity to live on a virtual border-to take advantage of the fact that no state, although it is free to do so, currently taxes its exports or voluntarily collects use taxes for other states. Like a real border, the Internet can be a potent safety valve that guards against excessive taxation. E-commerce allows consumers who have found it difficult to travel out of state-the poor, the elderly and the infirm-to take advantage of tax competition for the first time," Lukas explained.

Safeguarding Internet Tax Fairness

"Tax Bytes: A Primer on the Taxation of Electronic Commerce"