Ohio Doesn’t Need to Tax the Net

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State officials in Ohio have been complaining recently about potential revenue losses from the growth of untaxed Internet shopping. "We figure we're losing over $200 million annually from direct marketing, catalog and Internet sales," says Clare Long, Ohio's deputy tax commissioner. Across the nation, departments like Long's have been fighting for years to force out-of-state mail order companies to collect sales taxes. Now electronic commerce is in the cross hairs. What state officials propose is -- you guessed it -- more taxes.

The officials are worried because an estimated 27 million U.S. households (anumber that's getting bigger every day) now use the Internet regularly. Inthe officials' eyes, that's too many consumers who might make purchaseswithout the government's getting a cut. Buyers are supposed to pay a "usetax" in lieu of a sales tax on all out-of-state purchases, but fewvolunteer.

At first glance, the proposal sounds reasonable: why not tax identical itemsthe same regardless of how they're purchased? From the tax collector'sperspective, that makes sense. But in the real world, there are severalreasons why allowing states to tax out-of-state electronic commerce is badpolicy.

First, there is no immediate danger of large revenue losses for traditionalretailers, and by extension, for state tax authorities. Because they caterto a customer's desire for a hands-on experience, local stores don't chargefor shipping and offer immediate gratification and so will probably alwaysdominate retailing. What's more, shopping is for many people a pleasurablesocial experience that cannot be duplicated online. Thus, Internet saleswon't destroy "real" retailers, just as catalog sales haven't.

National data support that conclusion. In an era of almost no inflation,state budgets grew by 5 percent in fiscal year 1997 and by more than 6percent in fiscal year 1998. The last fiscal year ended with about $21billion more in tax collections than originally anticipated. It appearsthat states will enjoy a sizable revenue windfall this year as well. Ifelectronic commerce is undermining state revenues, it's an undetectabletrend. Electronic commerce certainly hasn't slowed the flood of surplusmoney pouring into Columbus -- expected to be around $400 million this year.

Second, it's not fair to force out-of-state firms to act as tax collectorswhen they don't benefit from state services. When an Ohio business collectssales taxes, there is a clear linkage between the taxes paid, the servicesprovided, and legislative representation. After all, local firms benefitfrom police and fire protection, roads and waste collection and other stateservices, so it is proper that they help cover those costs. And local firmscan make their voice heard directly through lobbying and membership ingroups like the Chamber of Commerce.

Remote sellers, on the other hand, don't enjoy any of those advantages. Ifthe state wants more of the taxpayers' money, it should collect it itselfand not try to push the burden onto out-of-state businesses.

Finally, differentiated tax rates create healthy competition that helps keeplocal rates under control. For example, some residents of Manhattan driveto Delaware to avoid sales taxes -- an option that has undoubtedly curbedthe profligate fiscal habits of New York politicians. Electronic commercesimilarly guards against excessive taxation. When sales tax rates get toohigh, it's important that Ohioans have a shopping alternative.

The idea that government won't find some way to keep the tax dollars flowingis laughable. So let's be honest about what's going on here: allowingstates to tax out-of-state electronic commerce would be the equivalent of atax increase. States would fatten already overflowing coffers without everhaving to bring the issue to a vote at home. That's a dream scenario forstate legislators but a nightmare for taxpayers.

If states are concerned about local retailers, they can effectively addressthe issue by moving tax rates downward. Minnesota policymakers have raisedone such interesting possibility, proposing to eliminate the sales tax oncertain products that are easily acquired online. Specifically targeted areintangible goods that can be downloaded, such as software, music and books.

Sure, limiting states' taxing authority can lead to unequal taxation. Butsuch limitations are a crucial component of American federalism. Absentthose restraints, confiscatory tax rates -- which are the true injustice --would get worse. To improve its business climate Ohio should cut taxes, notscheme to collect more.

Aaron Lukas

Aaron Lukas is a trade policy analyst at the Cato Institute's Center for Trade Policy Studies.