A Dot‐​Comical Tax Debate

This essay originally appeared in USA Today.

Last year, politicians were whining about the impending collapse of thesales tax under an avalanche of untaxed Internet shopping. From toys togroceries, the tax-free Web supposedly would bury bricks-and-mortar storesand drain public coffers. "Ten years from now, the typical person will beall wired," warned Dallas Mayor Ron Kirk. "He'll have his high-speedInternet link, buying everything online."

Today it's the Internet retailers, not the tax collectors, who are fightingfor survival. In fact, state tax revenues grew at a record pace last year:personal income tax revenues surged 12.4 percent, sales-tax revenues rose7.3 percent, and corporate income-tax revenues went up 4 percent. While somestates 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, theCoalition predicted that, "If online and mail order retailers are notrequired to collect sales taxes, state and local governments stand to losemore than $20 billion in revenues by 2003." [Of course, $20 billion is aridiculously high figure—more than a quarter of total projected online salesfor that year by some estimates.]

Basic services like law enforcement, the Coalition claims, will be"jeopardized" by those uncollected taxes. Presumably that's because thebillions of dollars of pork spent on things like freeway off-ramps for WalMarts is untouchable.

But as the dot-com corpses pile higher, such panicky predictions seem atbest premature. Despite absorbing one of the most intense gluts ofinvestment capital in retailing history, a huge number of online merchantsare in critical condition. There's even a dot-com where participants placebets 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 GoldmanSachs 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 retailersmiscalculated the average person's attitude toward shopping. As it turnsout, people enjoy going to stores that offer a hands-on experience,immediate satisfaction and no shipping charges. Shopping is for many peoplea 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 1percent of total retail sales for the first time during the fourth quarterof 2000, a Reuters' headline crowed, "U.S. online purchases hit heady newheights." But a piddling 1 percent isn't exactly "heady" compared topredictions by the National Governors' Association just three years ago thatInternet 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 relativelyinconsequential for the foreseeable future. But that inconvenient fact hasn't fazed tax-hungry politicians. To get around Supreme Court rulings thatlimit their authority to force companies outside their borders to collecttaxes, creative pols are moving ahead with a "voluntary" tax cartel in whichstates will essentially agree to collect each other's taxes.

Like previous multi-state tax schemes, the current "Streamlined Sales TaxProject" runs afoul of the U.S. Constitution; specifically, the compactsclause, which says, "No state shall, without the consent of Congress, enterinto any agreement or compact with another state." The purpose of thatclause is to prevent states from taking unto themselves sovereign powersthat rightly belong to the federal government, which is exactly what they'retrying to do in this case.

But it may be competition, not the Constitution, that ultimately thwarts theInternet taxers. If I were a state legislator, for example, I wouldn't bepleased with out-of-state politicians taxing sales made by companies in mystate. "Nobody taxes my state's businesses," I would say in anextraordinarily stirring speech, "except the duly elected representatives ofthis state—and that's me."

Then I would draft a bill called, "The Local Business Protection Act," whichwould instruct state revenue officials to reject the sales tax claims ofother states and to eschew participation in any multi-state collectionagreement. I would also make sure that Internet and mail order retailersknew what a great place my state was to do business, and how instrumental Iwas in making it that way.

That's just what I would do--hint hint.

Aaron Lukas

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."