Tax Bytes: A Primer on the Taxation of Electronic Commerce

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Electronic commerce conducted over the Internet has explodedover the past several years. In 1998 online shopping revenues inthe United States alone totaled approximately $13 billion, and theyare projected to reach $108 billion by 2003--nearly a tenfoldincrease. Such potentially astonishing growth has many governmentsworried that they are not adequately prepared to tax this flood ofnew commerce.

State and local governments in the United States have sensiblybegun to examine how electronic commerce will affect their taxsystems. Contrary to the claims of those governments, however, thecurrent federal rules do not exempt electronic commerce fromtaxation; they simply prohibit certain means of collection. Thefederal government should continue to prohibit states from imposingtax collection duties on out-of-state businesses by establishing auniform national jurisdictional standard for taxing electroniccommerce based on the substantial physical presence test. Such astandard would reaffirm traditional principles of tax fairness,preserve rate competition among states, and avoid years ofcontentious litigation.

If current state tax systems disadvantage local retailers,states already have it within their power to address the problem.Although reform may be difficult, states are in no immediate dangerof going broke, nor do they lack alternatives to the current systemof sales and use taxes. The role of the federal government shouldbe to ensure that states do not unfairly export their taxcollection burden, thereby impeding interstate commerce.

At the international level, the United States has a special roleto play in designing online tax policy. With more computers thanthe rest of the world combined, America is unquestionably the homeof the Internet. It is therefore natural that other countries lookto Washington for leadership on the taxation of electroniccommerce. Thus, it is vital that the United States stand up forimportant principles such as tax competition by rejecting proposalsto draft American businesses as tax collectors for foreigngovernments. In addition, the United States should aggressivelypursue an Internet free-trade agreement in the World TradeOrganization.

Aaron Lukas

Aaron Lukas is an analyst at the Cato Institute�s Center for Trade Policy Studies.