Commentary

Internet Tax: The New OPEC for Politicians

Fearful that they might be missing a chance to collect more taxes, bureaucrats from 31 states recently met in Chicago to create a new system for taxing Internet purchases. They claim they are trying to simplify their respective sales taxes. But state governments actually are banding together to create a tax cartel that would not only lead to higher taxes but also would be a flagrant violation of the Constitution.

Thanks to a Supreme Court decision (Quill vs. North Dakota), states can only collect sales tax on purchases made over the Internet if the retailer has a physical presence in that state. If the vendor lacks such a “nexus,” which is typically the case for Internet stores, a book purchase from a local retailer, for example, ends up being subjected to the applicable state and local sales tax, while the same purchase made by a resident in Virginia through the Internet to a Washington-based company is effectively exempt. Many state governments technically oblige consumers to remit a “use” tax on out-of-state purchases, but these levies are so unpopular that they are seldom enforced.

There also is a federal moratorium that prevents states from coming up with new special and discriminatory taxes for e-commerce, but it will expire at the end of 2003. State tax officials are offering to homogenize their tax jurisdictions to gain permission from Congress to tax all purchases made over the Internet, and in particular to collect taxes from sales from companies located in other states.

The state politicians call this proposal the Streamlined Sales Tax Project. It should be called the “OPEC for politicians.” Amazingly, some of the politicians claim that taxpayers would be better off after the cartel is created. Utah Gov. Mike Leavitt, a key leader in the states’ effort, says, “it will dramatically improve the morass that currently exists.” It is a fact that America’s sales-and-use tax system, with 7,500 state and local taxing jurisdictions across the nation, is complex and cumbersome to businesses. But what really bothers state officials is that the arrangement makes it difficult for “remote” retailers, such as mail order companies and e-commerce companies, to calculate, collect, and remit sales taxes to different states and local government.

And this is where the Streamlined Sales Tax skim becomes clear. Leavitt’s relentless criticism of the unfairness of the existing sales-tax regime is just a veil to mask government’s endless craving for more taxes. This project is really about creating more sources of revenue for the states by allowing them to start taxing income earned outside of the borders of their state. If Leavitt’s pro-tax forces have it their way, going back to our previous example, Virginia would be able to collect taxes from the Washington-based book retailer. Never mind, of course, that the company that is being taxed has no voice in the tax-and-spending decision made by Virginia and that the company never benefits the public services Virginia provides with those tax dollars.

Make no mistake: Under the cover of the SSTP, states and local governments are asking Congress to lift the restriction that forbids them to tax extraterritorial income earned by remote sellers. The extension to sales-and-use taxes to out-of-state sales, no matter how simplified and harmonized, represents a huge threat to taxpayers and economic prosperity. The states involved want to create a tax cartel to allow them to impose taxes on firms that do not have a physical presence in the state, which means those companies would pay taxes to that state but would not consume public services. And that equals taxation without representation. Further, some states, such as California, would have the power to tax consumers who reside in other states, thus infringing on state sovereignty. Taxpayers would be the big losers because the new lack of competition between states would mean the end of any constraint to increase taxes.

It should go without saying that states, as sovereign entities, should have control over their tax policy. Tax harmonization and tax cartel are not the answer to the Internet tax debate. Taxpayers would be the big losers of this sordid game and freedom and economic growth would be permanently damaged. For the sake of American taxpayers the Streamlined Sales Tax Project should be defeated and tax competition should be protected.

Veronique de Rugy is a fiscal policy analyst with the Cato Institute.