Commentary

Extend the Internet Tax Moratorium

By Aaron Lukas
May 20, 2000
Taxpayers rejoice: on May 10 the House of Representatives overwhelmingly approved a bipartisan bill that would extend the current moratorium on new and discriminatory Internet taxes for another five years. The bad news, however, is that the Senate has been treading water on the matter because of complaints by a few large retailers and state and local government organizations that favor expanding tax collections. “The advocates of increasing the tax burden on the public have prevailed and have had [the vote] removed to another time,” lamented Sen. John McCain (R-Ariz.) at a recent hearing.

Opponents of extending the moratorium claim that it disadvantages traditional retailers and that, as more commerce migrates online, states will lose sales tax revenue and be forced to (gasp!) tighten their belts. Both fears are wildly overstated.

For starters, untaxed e-commerce isn’t destroying main street retailers — it is saving them. A recent National Trust for Historic Preservation survey of emerging trends in historic Main Street commercial districts discovered that downtowns are enjoying an economic renaissance, in no small part because of the Internet. For example, Osborn Drugs in downtown Osborn, Oklahoma, lets customers refill prescriptions and order other items for local delivery through its Web site. A shoe store in downtown Corvallis, Oregon, offers one of the largest selections of Birkenstocks on the Internet, attracting customers from around the world. Kringle Kottage, in downtown Scottsbluff, Nebraska, now sells most of its collectible ornaments and figurines through the auction site eBay.

Retail giants like WalMart — rarely considered a friend of Main Street America — want these mom-and-pop stores to collect sales taxes on all their national sales. They call that “fairness.” WalMart has stores across the country that benefit directly from state-provided services, which is why the company will likely be forced to collect sales taxes on its sales from Walmart.com. Kringle Cottage, by contrast, only receives services from and has representation in the state of Nebraska. Subjecting small Internet businesses to the tender mercies of more than 6,500 (and potentially over 30,000) state and local taxing jurisdictions wouldn’t level the playing field — it would put the mom-and-pops out of business. Moreover, why should a local business in Nebraska be collecting taxes for Texas or Arkansas? That’s called “taxation without representation,” and it’s rightfully unconstitutional.

Like traditional retailers, state treasuries are managing to thrive in the Internet economy. According to a recent Cato study by Steve Moore and Dean Stansel, between 1992 and 1998 state revenues grew at almost twice the rate of inflation plus population growth. If states had restricted increases in spending and tax collection to the rate of inflation and population growth in those years, the state tax burden would be $75.2 billion lower today. Tax receipts in 1999, not to mention the billions states have begun receiving from tobacco litigation settlements, look just as rosy.

If there’s a budget crunch, the culprit is excessive spending, not insufficient revenue. In an era of almost no inflation, state spending grew by 4.5 percent in 1996, 5 percent in 1997 and nearly 6 percent in 1998. Four states actually increased their budgets by 10 percent or more in 1998. Seven states have permitted spending to mushroom by more than 30 percent after adjusting for population growth and inflation.

Those bloated budgets highlight an important fact: no one has a clue how much e-commerce will grow or what impact it will have on sales tax revenues. Twenty years ago state and local politicians were warning that catalog sales would bankrupt state coffers. It never happened. Before rushing to dismantle the federal barriers that protect out-of-state businesses from taxation without representation, Congress should at least be sure the predicted revenue crisis is real. An extension of the Internet tax moratorium would give us time to find out.

An extended moratorium wouldn’t actually prevent state and local governments from unfairly taxing out-of-state businesses. In fact, the House version of the bill includes a nonbinding resolution that contemplates an eventual “centralized, one-stop, multi-state registration system” for collecting taxes on all cross-border sales. Such a system would require the creation of a massive new tax collection bureaucracy that would wield power over both businesses and states. It would compile fairly detailed records on remote purchases and be a massive invasion of consumer privacy. The Senate should reject efforts to include such a provision in its legislation.

Despite those flaws, the moratorium is a step in the right direction, sending a signal to tax-hungry politicians that Congress won’t be changing the rules in their favor anytime soon. That’s a much-needed reality check for state officials who seem to believe that their desire for an infinitely expanding tax base trumps the U.S. Constitution.

Aaron Lukas is an analyst at the Cato Institute’s Center for Trade Policy Studies and is the author of “Tax Bytes: A Primer on the Taxation of Electronic Commerce” (Cato Institute, 1999).