Commentary

A Dot-Comical Tax Debate

By Aaron Lukas
This essay originally appeared in USA Today.
Last year, politicians were whining about the impending collapse of the sales tax under an avalanche of untaxed Internet shopping. From toys to groceries, the tax-free Web supposedly would bury bricks-and-mortar stores and drain public coffers. “Ten years from now, the typical person will be all wired,” warned Dallas Mayor Ron Kirk. “He’ll have his high-speed Internet link, buying everything online.”

Today it’s the Internet retailers, not the tax collectors, who are fighting for survival. In fact, state tax revenues grew at a record pace last year: personal income tax revenues surged 12.4 percent, sales-tax revenues rose 7.3 percent, and corporate income-tax revenues went up 4 percent. While some states have very recently begun to feel a pinch from the slowing U.S. economy, it’s a decade of runaway spending, not runaway Internet shopping, that’s responsible for their budgetary woes.

The king of chicken-little scenarios was probably the e-Fairness Coalition, a pro-tax group backed by multi-state retailers like Wal Mart. In 1998, the Coalition predicted that, “If online and mail order retailers are not required to collect sales taxes, state and local governments stand to lose more than $20 billion in revenues by 2003.” [Of course, $20 billion is a ridiculously high figure—more than a quarter of total projected online sales for that year by some estimates.]

Basic services like law enforcement, the Coalition claims, will be “jeopardized” by those uncollected taxes. Presumably that’s because the billions of dollars of pork spent on things like freeway off-ramps for Wal Marts is untouchable.

But as the dot-com corpses pile higher, such panicky predictions seem at best premature. Despite absorbing one of the most intense gluts of investment capital in retailing history, a huge number of online merchants are in critical condition. There’s even a dot-com where participants place bets on which e-biz will go belly up next.

Struggling Internet retailers are seeking new money to keep the doors open, but investors aren’t biting. “Of the companies that need cash,” says Goldman Sachs analyst Anthony Noto, “less than a handful will be able to raise it.” Other experts predict that only one in 20 companies will survive.

The reason for the dot-com meltdown is that most Internet retailers miscalculated the average person’s attitude toward shopping. As it turns out, people enjoy going to stores that offer a hands-on experience, immediate satisfaction and no shipping charges. Shopping is for many people a pleasurable social experience that can’t be duplicated online. Thus, Internet sales won’t destroy “real” retailers, just as catalog sales haven’t.

When the Commerce Department said recently that Internet sales had cracked 1 percent of total retail sales for the first time during the fourth quarter of 2000, a Reuters’ headline crowed, “U.S. online purchases hit heady new heights.” But a piddling 1 percent isn’t exactly “heady” compared to predictions by the National Governors’ Association just three years ago that Internet sales would hit $300 billion, or about 10 percent of retail sales, by next year. Theoretically possible, I guess, but I won’t hold my breath.

What this means is that any sales tax drain will be relatively inconsequential for the foreseeable future. But that inconvenient fact hasn’t fazed tax-hungry politicians. To get around Supreme Court rulings that limit their authority to force companies outside their borders to collect taxes, creative pols are moving ahead with a “voluntary” tax cartel in which states will essentially agree to collect each other’s taxes.

Like previous multi-state tax schemes, the current “Streamlined Sales Tax Project” runs afoul of the U.S. Constitution; specifically, the compacts clause, which says, “No state shall, without the consent of Congress, enter into any agreement or compact with another state.” The purpose of that clause is to prevent states from taking unto themselves sovereign powers that rightly belong to the federal government, which is exactly what they’re trying to do in this case.

But it may be competition, not the Constitution, that ultimately thwarts the Internet taxers. If I were a state legislator, for example, I wouldn’t be pleased with out-of-state politicians taxing sales made by companies in my state. “Nobody taxes my state’s businesses,” I would say in an extraordinarily stirring speech, “except the duly elected representatives of this state—and that’s me.”

Then I would draft a bill called, “The Local Business Protection Act,” which would instruct state revenue officials to reject the sales tax claims of other states and to eschew participation in any multi-state collection agreement. I would also make sure that Internet and mail order retailers knew what a great place my state was to do business, and how instrumental I was in making it that way.

That’s just what I would do—hint hint.

Aaron Lukas is an analyst at the Cato Institute’s Center for Trade Policy Studies and author of “Tax Bytes: A Primer on the Taxation of Electronic Commerce.”