Avoiding a Net Tax Cartel Catastrophe

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Legislation to extend the Internet tax moratorium was introducedrecently by Sen. George Allen (R-VA) and Rep. Chris Cox (R-CA).Their taxpayer-friendly bills have gotten some welcome attentionrecently, but unfortunately, it may already be too late to overcomethe momentum of competing pro-Net tax legislation sponsored by Sen.Byron Dorgan (D-ND) and Rep. Ernest Istook (R-OK).

The Dorgan-Istook legislation, S. 512 and H.R. 1410respectively, enjoys bipartisan support in both chambers ofCongress. Like Allen-Cox, these bills would extend the current banon multiple or discriminatory Internet taxes. But the similaritiesend there. Dorgan-Istook would also authorize the creation of astate-run tax cartel to collect sales taxes on cross-bordercommerce, electronic and otherwise. More than half the states haveexpressed interest in taking part in a multi-state sales taxregime.

Although the Constitution makes it clear that state governmentsare generally prohibited from taxing or regulating interstatecommerce, Congress can override this restriction and sanction suchanti-competitive arrangements. This is what the Dorgan-Istook billdoes. And while current Supreme Court precedents maintain thatstates cannot require remote interstate vendors (mail order,catalog, or Internet) to collect sales taxes unless those vendorshave a physical presence within the taxing jurisdiction, Congresscan override this sensible prohibition on "taxation withoutrepresentation," as well. Again, the Dorgan-Istook bill doesso.

If Congress allows state and local governments to launch such aEuropean Union-style tax collection system, federal lawmakers willbe putting their imprimatur on a de facto national sales tax oninterstate commerce. The only upside: The current tax bias againstbrick-and-mortar retailers would be ended. Unfortunately, thisleveling of the playing field would come by placing more businessesunder government's yoke.

Many Americans will be shocked to learn that the Net tax battlemay turn out this badly. How has the tide turned? First, opponentsof Internet taxation mistakenly placed too much faith in amoratorium that didn't do what everyone thought it did: prohibitstates from taxing out-of-state sales. Thus, while the Allen-Coxapproach of extending the current Net-tax moratorium isn't a badidea, it's important to understand that it wouldn't permanentlyprevent the Dorgan-Istook cartel idea from going forward.

The second reason the Net tax debate has turned sour is thatopponents of new tax authority haven't had a unified alternative.The issue was oversimplified to reduce the cause to a "Don't Taxthe Net" bumper-sticker slogan. As a result, the anti-tax forcesstuttered when faced with the charge that a "tax-free" Internetamounted to little more than an unfair high-tech industrialpolicy.

A final mistake was made in framing this issue as one ofgranting special tax status to the Internet-offering a high-techtwist on the old "infant industry" argument. This spawned analliance of state officials and large brick-and-mortar merchants,both of whom fought to extend America's archaic sales tax system tothe Internet. Many politicians want to tax Internet sales becauseit's a cash cow for them. And many retailers back the tax becauseit will curb their competition. Large retailers saw an opportunityto strangle their smaller competitors with a burdensome taxcode-and they want to do it in the name of fairness. Theseretailers talk about "justice for Main Street" and a "level playingfield" to argue that Internet vendors should be forced to collecttaxes on out-of-state sales. Instead, those retailers could haveused their lobbying muscle to fight for serious reform of the salestax, rather than using it as a club to beat up competitors.

In hindsight, the anti-tax forces should have (a) favoredreplacing sales taxes with a better type of consumption tax, and(b) highlighted the benefits of interstate tax competition and theanti-competitive aspects of extending state tax authority overremote sales. Everyone knows that sales taxes are problematic in adigital age. So why apply an outdated, inefficient and increasinglyunworkable tax system to the Internet? One alternative would be a"savings exempt income tax," where taxpayers exempt all savingsfrom their taxable income, resulting in uniform taxation of theconsumption base.

But the trump card of those who oppose new Internet taxauthority for states should have been tax competition. Most peopledon't realize it, but nothing is stopping states from "leveling theplaying field" on sales taxes. Each state has the legal authorityto tax all transactions that originate within its borders (i.e., an"origin-based" tax). But no state chooses to tax sales thatin-state businesses make to out-of-state buyers. In other words,states purposefully exempt their exports from sales taxes.

So why don't states treat all merchants the same by having themcollect the local sales tax regardless of where the buyer lives?When you walk into Wal-Mart, checkout clerks don't ask you whereyou live; they collect the taxes due where the store is located. Wecould treat Internet sellers that way. But states fear that a fewlow- and no-tax rogue states might lure businesses away.Politicians call that a "race to the bottom." But it's really justhealthy tax competition.

The politician's answer to this problem is to have Washingtonstep in and sanction a multi-state tax cartel. The current effortis called the "Streamlined Sales Tax Project," or SSTP. As OPECraises your oil prices by undercutting competition among oilproducers, an Internet tax cartel will remove the pressure onstates to keep taxes low for fear of losing businesses. By closingthe escape hatch from the taxman, the SSTP will allow states toraise taxes and increase spending.

For those who support limited government, the best hope on thisfront may now be that Congress will fail to address the issue. Ifthat happens, sales taxes will continue to be controlled by theSupreme Court precedent that forces states to compete to keep theirtax rates reasonable. While inaction may not be ideal, it's a lotbetter than the alternative.