The Internet Tax Solution: Tax Competition, Not Tax Collusion

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A heated debate is once again under way inCongress over the tax treatment of electronic commerceand the Internet Tax Freedom Act of 1997. The ITFA imposed a moratorium on state andlocal taxes on Internet access and banned "multipleor discriminatory" taxes on electronic commerce.That moratorium was intended to last onlythree years but was extended by Congress in 2001for another two years. It will lapse on November 1,2003.

The ITFA has been a remarkably misunderstoodor misinterpreted statute and has very little to dowith what really lies at the heart of this debate--theeffort by state and local governments to collect salesand use taxes on remote vendors in interstate commerce(mail order, catalog, and e-commerce companies).Contrary to press reports and statementsmade by some members of Congress, the ITFAmoratorium does not directly affect the ability ofstates and localities to impose sales and use taxes onpurchases made over the Internet.

What state and local officials are really at warwith is not the ITFA but 30 years of SupremeCourt jurisprudence that has not come down intheir favor. Their ultimate goal is to overturnthose precedents, which held that states couldrequire only firms with a physical presence--or"nexus"--in their jurisdictions to collect taxes ontheir behalf. State and local tax officials haveworked to eliminate or water down these restrictionson their tax reach but thus far have notbeen able to get around them or convinceCongress to authorize the imposition of collectionobligations on interstate vendors.

Although extending the existing ITFA moratoriumand continuing to uphold the SupremeCourt's nexus jurisprudence makes good sense,Congress must also take an affirmative standagainst efforts by state and local governments tocreate a collusive multistate tax compact to taxinterstate sales. Other options exist that stateand local governments can pursue before lookingto impose unconstitutional tax burdens oninterstate commerce. Of course, getting runawaystate spending under control would go a longway toward solving many of their supposedproblems. Merely extending sales tax collectionresponsibilities to electronic commerce--whichconstitutes less than 2 percent of all retail activityin the United States--will not solve the fiscalcrisis that state and local governments have createdthrough their profligate spending habits.