States Do Nicely Without Web Tax

by Aaron Lukas

Aaron Lukas is an analyst with the Cato Institute's Center for Trade Policy Studies and autor of the Policy Analysis, "Tax Bytes: A Primer on the Taxation of Electronic Commerce."

February 21, 2001

A mere year ago, state and local politicians were whining about the impending collapse of the sales tax under an avalanche of untaxed Internet shopping. The tax-free Web, they warned, soon would bury brick-and-mortar stores and drain public coffers.

Today, however, it's Internet retailers, not the tax collectors, who are fighting for survival. In fact, state tax revenues grew at a record pace last year: personal-income-tax revenues surged 12.4%, sales-tax revenues rose 7.3%, and corporate-income-tax revenues went up 4%. While some states recently have begun to feel a pinch from the slowing U.S. economy, they can't blame Internet shopping for their budgetary woes.

The king of Chicken Little scenarios was probably the e-Fairness Coalition, a pro-tax group backed by multistate retailers. In 1998, the coalition predicted that, "If online and mail-order retailers are not required to collect sales taxes, state and local governments stand to lose more than $20 billion in (tax) revenues by 2003," jeopardizing basic services such as law enforcement.

But as the dot-com corpses pile higher, such panicky predictions seem at best premature. Despite absorbing one of the most intense gluts of investment capital in retailing history, huge numbers of online merchants are in critical condition.

A core reason for the dot-com meltdown is that most Internet retailers miscalculated the average person's attitude toward shopping. As it turns out, people enjoy going to stores that offer hands-on experiences, immediate satisfaction and no shipping charges. For many, shopping is a pleasurable social experience that can't be duplicated online. Thus, Internet sales won't destroy "real" retailers, just as catalog sales haven't.

Online sales inch up

Indeed, as the Commerce Department reported Friday, online sales barely hit 1% of total retail spending in the fourth quarter of 2000. Reuters called that "heady new heights," but a piddling 1% isn't "heady" compared to the National Governors Association's prediction three years ago that Internet sales would total about 10% of retail sales by next year. Theoretically possible, I guess -- but I'm not holding my breath.

Any sales-tax drain from Internet sales is likely to be relatively inconsequential for the foreseeable future. But that hasn't fazed tax-hungry politicians. To get around Supreme Court rulings that limit their authority to force companies outside their borders to collect taxes, creative pols are pushing a "voluntary" tax cartel, in which states essentially will agree to collect each other's taxes.

Like previous multistate tax schemes, the current "Streamlined Sales Tax Project" pushed by state legislators and governors runs afoul of the Constitution -- specifically, this clause: "No state shall, without the consent of Congress, enter into any agreement or compact with another state." The clause's purpose is to prevent states from grabbing powers that rightly belong to the federal government -- which is exactly what they're trying to do in this case.

Keep your hands off

But competition, not the Constitution, may ultimately thwart the Internet taxers. If I were a state legislator, for example, I wouldn't be pleased with out-of-state politicians taxing sales made by firms in my state. "Nobody taxes my state's businesses," I would say in an extraordinarily stirring speech, "except this state's duly elected representatives -- and that's me."

Then I would draft a bill, called "The Local Business Protection Act," which would instruct state-revenue officials to reject the sales-tax claims of other states and to eschew participation in any multistate collection agreement. I would also make sure that Internet and mail-order retailers knew what a great place my state was to do business and how instrumental I was in making it that way.

That's just what I would do -- hint, hint.

This article appeared in USAToday.