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 (a number that’s getting bigger every day) now use the Internet regularly. In the officials’ eyes, that’s too many consumers who might make purchases without the government’s getting a cut. Buyers are supposed to pay a “use tax” in lieu of a sales tax on all out‐​of‐​state purchases, but few volunteer.

At first glance, the proposal sounds reasonable: why not tax identical items the same regardless of how they’re purchased? From the tax collector’s perspective, that makes sense. But in the real world, there are several reasons why allowing states to tax out‐​of‐​state electronic commerce is bad policy.

First, there is no immediate danger of large revenue losses for traditional retailers, and by extension, for state tax authorities. Because they cater to a customer’s desire for a hands‐​on experience, local stores don’t charge for shipping and offer immediate gratification and so will probably always dominate retailing. What’s more, shopping is for many people a pleasurable social experience that cannot be duplicated online. Thus, Internet sales won’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 6 percent in fiscal year 1998. The last fiscal year ended with about $21 billion more in tax collections than originally anticipated. It appears that states will enjoy a sizable revenue windfall this year as well. If electronic commerce is undermining state revenues, it’s an undetectable trend. Electronic commerce certainly hasn’t slowed the flood of surplus money 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 collectors when they don’t benefit from state services. When an Ohio business collects sales taxes, there is a clear linkage between the taxes paid, the services provided, and legislative representation. After all, local firms benefit from police and fire protection, roads and waste collection and other state services, so it is proper that they help cover those costs. And local firms can make their voice heard directly through lobbying and membership in groups like the Chamber of Commerce.

Remote sellers, on the other hand, don’t enjoy any of those advantages. If the state wants more of the taxpayers’ money, it should collect it itself and not try to push the burden onto out‐​of‐​state businesses.

Finally, differentiated tax rates create healthy competition that helps keep local rates under control. For example, some residents of Manhattan drive to Delaware to avoid sales taxes — an option that has undoubtedly curbed the profligate fiscal habits of New York politicians. Electronic commerce similarly guards against excessive taxation. When sales tax rates get too high, it’s important that Ohioans have a shopping alternative.

The idea that government won’t find some way to keep the tax dollars flowing is laughable. So let’s be honest about what’s going on here: allowing states to tax out‐​of‐​state electronic commerce would be the equivalent of a tax increase. States would fatten already overflowing coffers without ever having to bring the issue to a vote at home. That’s a dream scenario for state legislators but a nightmare for taxpayers.

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

Sure, limiting states’ taxing authority can lead to unequal taxation. But such limitations are a crucial component of American federalism. Absent those restraints, confiscatory tax rates — which are the true injustice — would get worse. To improve its business climate Ohio should cut taxes, not scheme to collect more.

Aaron Lukas

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