Commentary

Business Sells Out on Internet Taxes

By Aaron Lukas
February 22, 2000
The federal Advisory Commission on Electronic Commerce (ACEC) was recently offered a “compromise” on Internet sales taxes by representatives of six companies that serve on the commission: Charles Schwab, America Online, MCI Worldcom, AT&T, Time Warner and Gateway. Their ill-advised plan would pave the way for one of the largest expansions of state taxing power in U.S. history.

On the plus side, the deal calls for Congress to enact legislation extending the moratorium on “new” Internet taxes for five years, scraping the 3 percent federal telecommunications excise tax and banning taxes on Internet access. In a meaningless gesture, the plan also calls for a ban on state sales tax on such products as recorded music and books — something Congress clearly has no authority to do. On the downside, the proposal appears to endorse the efforts of states to develop a centralized sales tax collection system for out-of-state sales.

Telecommunications providers, Internet service providers, publishers and large multistate retailers would reap practically all the benefits from that deal. Interestingly, all the companies pushing the plan fit into one of those categories. Smaller retailers and consumers would get nothing but headaches and new taxes. Shareholders take note.

The companies that drafted the proposal may be tech savvy, but they’re shockingly naïve when it comes to politics. Their plan is a compromise only if “compromise” means conceding important principles in exchange for empty promises. Their one substantive policy request is for repeal of the federal excise tax on telecommunications. But Congress could care less what the ACEC says with respect to federal taxes. In any event, the commission would likely have recommended repeal even without this devil’s bargain.

State and local officials, on the other hand, will be getting the only thing that really matters to them: a recommendation to phase out the federal “nexus” standard that currently protects wholly out-of-state retailers from serving as tax collectors. The politicians realize that at the end of the day the only thing Congress and the public will remember about the ACEC is that it voted to tax electronic commerce. All side deals will be long forgotten.

The closer one looks, the worse the deal gets. The “simplified” tax collection system that those businesses are helping to bring about is neither simple nor fair. It would force tax collection by remote businesses that don’t benefit from state services. Even worse, it would create a massive new tax collection authority that would wield power over both businesses and states. The system would also compile fairly detailed consumer purchase records on remote sales, a move that would destroy the primary advantage of sales taxes: anonymity.

The states’ plan envisions a “trusted third party” collection system for sales taxes. In other words, tax collection and auditing duties would be farmed out to private firms that would receive a cut of the taxes they collect. If you think a government-run IRS is bad, wait until you see one that works on commission.

In theory, the system would be voluntary, would place “zero” collection burden on businesses and would somehow protect them from multiple audits by state and local tax authorities. But without federal nexus protection, the system won’t be voluntary for long. In fact, according to the National Governors’ Association, it would eventually be used to collect taxes on all remote sales, including those in traditional brick-and-mortar establishments. No longer would shoppers be able to drive to neighboring states to take advantage of lower tax rates.

The burden placed on retailers by that monstrously complex simplification scheme wouldn’t be zero, as even a cursory analysis shows.

In 1998 there were $1.6 trillion in retail sales of nondurable goods. That means things like cars, furniture and electronics aren’t included in that total. Assume that the average purchase was $50. That gives us a total of 32 billion retail transactions — an absurdly conservative estimate.

Now suppose that the states’ sales tax plan had been in effect for all retailers in 1998. It’s not difficult to imagine adding 15 seconds on to each transaction: the clerk must ask (at a minimum) the customer’s ZIP code and type it into the register, and we must allow for a slight delay while the information is transmitted. Leaving aside the cost of actually building and running the system, conducting audits and so on, what would be the cost to businesses in lost productivity?

Using our 32 billion transactions estimate for 1998, employees would spend approximately 133 million hours just collecting and inputting information. At $6.50 an hour, that would cost businesses roughly $867 million dollars annually in wasted employee time. The total would be even higher if durable goods were included. That’s not the tax money that’s being collected, that’s a loss that does absolutely nothing to benefit the U.S. economy. $875 million might not sound like much, but consider this: the best estimates put “lost” 1998 sales tax revenue due to untaxed e-commerce at around $270 million. Are state and local officials really looking to simplify sales tax collection, or are they more concerned with circumventing constraints on future tax increases?

The ACEC’s business proposal — in the name of fairness — would give states the authority to treat all retailers badly. The companies who drafted it should go back to the drawing board.

Aaron Lukas is an analyst at the Cato Institute’s Center for Trade Policy Studies and has served on the ACEC’s panel of experts. He is the author of “Tax Bytes: A Primer on the Taxation of Electronic Commerce” (Trade Policy Analysis No. 9, 1999).