ARTICLE

Don't Tax the Internet

Federal, State, and Local Governments Have Lost No Revenues to Expanding E-Commerce

JUNE 01, 2000 by LAWRENCE W. REED

On a recent visit to the Roman ruins at Volubulis, Morocco, I noticed a magnificent stone arch the city’s officials erected nearly 2,000 years ago. Etched in stone and still eminently readable were Latin words thanking Emperor Caracalla for two things: protecting the city from invaders and exempting the citizens from taxation. Please excuse the ancient redundancy.

Caracalla was not generally known for his kindnesses. Indeed, he brutalized and persecuted many citizens of the Roman Empire. But that tax policy is the perfect answer to a burning question in America today: Should states and localities tax the Internet? What Caracalla did for Volubulis, our politicians ought to do for the Web. They should leave it alone. (Unfortunately, later Roman emperors did tax Volubulis and that’s one reason why it’s in ruins).

Sales over the Internet are fast capturing the attention of tax-hungry politicians, but collecting sales taxes on Internet purchases poses logistical, as well as constitutional, problems. If 7,500 jurisdictions with sales taxes were to apply their own tax collection regimes to the Internet, America would experience tax pandemonium. To prevent chaos and allow for time to think about the issue, Congress in 1998 passed the Internet Tax Freedom Act, which instituted a national three-year moratorium on any taxes directed at electronic commerce.

State and local officials aren’t upset because they’re losing revenue. They’re upset because they’re missing out on a new source of revenue. South Dakota Governor William Janklow startled an audience when he declared that unless steps are taken to immediately tax online purchases, he may “disrupt interstate commerce” by sending out state highway patrol officers to pull over “little brown trucks,” inspecting packages for those originating out of state, and then “following the packages” to their destination to force his residents to pay the state’s sales tax.

The Internet taxation debate has produced tough questions that must be answered if this promising new sphere of enterprise is to grow unmolested by government. Here are a few of those questions, with some suggested answers.

Has the growth of tax-free Internet sales hurt government revenues?

State governments are awash in tax revenues, with a total surplus this year of $36 billion. Investor’s Business Daily notes that state revenues grew 227 percent and local revenues grew 193 percent between 1980 and 1995.

Raymond J. Keating, chief economist for the Small Business Survival Committee, pointed out in testimony last year that “federal, state and local governments have lost no revenues to expanding e-commerce, but have gained revenues due to economic growth driven in part by information technologies.”

Instead of always worrying about whether government is getting enough of other people’s money, we ought to be concerned about whether people are able to keep enough of what they earn to continue saving, investing, and baking a bigger economic pie for everyone.

Is it “unfair” for sales over the Internet to be tax-free while more traditional sales are taxed?

No. In fact, it would be blatantly unfair to tax out-of-state vendors that do business in a state over the Internet. Taxes are supposed to pay for services that governments provide, such as police protection. As Adam Thierer of the Heritage Foundation has pointed out, “out-of-state vendors of electronic commerce, though subjected to the same tax burdens that Main Street vendors must bear, would receive none of the benefits for the taxes they paid to state and local governments where they did not reside. This amounts to a form of taxation without representation.”

Would imposing new taxes on the Internet do serious damage to the ability of this new form of commerce to thrive?

A recent study by economists Austan Goolsbee of the University of Chicago and Jonathan Zittrain of Harvard University estimates that applying sales taxes to electronic commerce would reduce the number of online buyers by 25 percent and total spending on Internet transactions by more than 30 percent. The study suggests that these sales would not be replaced by ordinary retail sales, since the Internet is probably a net trade creator, generating business that would not otherwise have occurred.

Does the growth of online shopping pose a threat to traditional bricks-and-mortar retailers?

The most pertinent answer to that question is yet another question: Do catalog sales pose such a threat?

Like Internet sales, catalog sales involve greater convenience for the shopper. They’ve been a reality in America for decades. Yet catalog sales haven’t devastated traditional retailers. Why? Because both catalog sales and e-commerce have—and always will have—a decisive disadvantage in relation to traditional retail sales: the inability of the consumer to examine the goods. And, of course, there’s no need to charge for shipping.

The latest figures available bear out this counsel of common sense. E-commerce—while thriving—still only constitutes a tiny fraction—less than one percent—of all retail sales. E-commerce poses no danger of large income losses for traditional retailers. Indeed, the Web offers new sales opportunities for every business. Because setting up and maintaining a Web page is inexpensive, this is especially true for small firms.

Does tax-free Internet shopping disproportionately hurt the poor?

No, quite the contrary. And applying taxes to the Internet would certainly not help the poor at all.

The pro-tax argument goes like this: Since low-income individuals are the least likely to have Internet access, they are the least able to shop online. The poor will end up paying the lion’s share of sales taxes as wealthier citizens escape through untaxed Internet purchases.

“The Internet is especially valuable to inner-city residents” notes Aaron Lukas of the Cato Institute. “Lower-income urban shoppers can go online to find goods and services not available in their own neighborhoods, which often aren’t served by traditional stores.” A recent study conducted by PricewaterhouseCoopers and the Initiative for a Competitive Inner City concludes that “inner-city residents with access to computers and the Internet use the Web as often as, and sometimes more frequently than, does the general U.S. population.”

Moreover, computer ownership and Internet access among low income people are growing at rates so rapid that some observers are predicting that every man, woman, and child in America will be connected to the Internet before this decade is out.

The Internet represents a new world of enterprise, easily accessible to buyers and sellers alike. Rather than looking for ways to swipe some chunk of it, politicians should see it as a means to a better life for everyone.