TCS Daily


Forget Trying to Design a Good Internet Tax

By James K. Glassman - May 8, 2000 12:00 AM

I have good news and bad news about Internet sales taxes. The good news is that Congress is largely ignoring the worst idea to emerge from this debate. That was a plan from the National Governors Association to allow state and local governments to collect sales taxes from out-of-state web merchants. Hitting online consumers with new taxes while simultaneously forcing Amazon.com to assess liability for each of its millions of consumers based on where they're located within America's thousands of taxing jurisdictions is an obvious loser. Most D.C. pols have now recognized it as such.

The bad news is that, in the misguided belief that the Internet economy is somehow getting a free ride from taxes (instead of enjoying the Constitutional freedom of interstate commerce), Congress is now looking for a "good" way to tax online sales. The latest effort comes from Senators Judd Gregg (R-NH) and Herbert Kohl (D-WI). Their new bill, known as the New Economy Tax Simplification Act, or S. 2401, gives you a clue to their problem right in its title. As we all know, it would be nice if taxes could be simple, but what we really want is for taxes to be low, or better yet, not to exist at all.

The Gregg-Kohl bill says that state and local governments can tax Internet sales if merchants have a "substantial physical presence" in their jurisdictions. So the state of Washington could tax all the sales made through Amazon.com, because the company is based in Seattle. The idea is to tax sales at the point of origin - Amazon's headquarters - instead of the point of delivery - the consumer. This is certainly preferable to the governors' plan, because it would create a healthy competition among states to offer market-friendly tax policies. The states with the lowest tax rates would encourage businesses to locate inside their borders. Meanwhile, high-tax states would be punished by the loss of such businesses. But an even better idea is to abolish sales taxes.

Of course Internet sales taxes would be bad for the new economy. Of course they would slow the growth of e-commerce. Of course they will hurt online consumers. But what's lost in this fight over online taxes is that sales taxes of all kinds are bad for consumers. In fact, until this Internet squabble began, sales taxes had been thoroughly discredited as an unfair burden that hits the poor harder than any other government program.

A sales tax is a kind of consumption tax, and it's true that we should always tax consumption instead of savings. But an easier, fairer way to institute a consumption tax would be to take annual income and deduct annual savings and investments, then apply the tax rate (both federal and state) to what's left: consumption.

For several years, Rep. Billy Tauzin (R-LA) has been trying to pass a national sales tax to replace the income tax. The idea has gone nowhere, for lots of good reasons. For one, the European version of this idea, the Value Added Tax, or VAT, has proven to be a nightmare of bureaucratic complexity.

Whenever there are new taxes on retail sales, lots of people try to figure out how to avoid them by buying at wholesale or purchasing the goods in another jurisdiction. Then the government has to add new regulations to close the escape hatches, and new requirements on business to help the government collect the money.

On the Net, it would take about five minutes for websites offshore to begin selling tax-free goods to US consumers and about another five minutes after that for a web entrepreneur to create a system for people to gather in cyberspace and buy as wholesalers. Then a new round of regulation would begin and the vicious cycle would begin anew. (If you want to get really depressed, imagine the Internet being regulated by a taxation system developed in France.)

The biggest reason to oppose sales taxes is that they demand the highest percentage of income from the people who make the least. Sales taxes are the exact reverse of income taxes - the less you make, the higher your tax rate. If Bill Gates and a factory worker both want to have a Miller Lite at the end of a long day, they both must pay the same amount of tax. Even though Bill's income is many times that of the factory worker, and his net worth is perhaps a million times as large, the worker gets hit with just as high a tax bill.

Repeal all sales taxes. They're unfair, they hurt consumers and they'll hurt our economy if they're expanded to include cyberspace. Don't believe these politicians who say that you won't have fire and police departments without sales taxes. Only 16% of local government revenues come from sales taxes. At the state level, several governments impose no sales taxes at all and 45 states receive most of their revenue from other sources.

And there's no doubt that revenue from those other sources is booming. Many states are running record surpluses, even as they cut taxes. Reports Merrill Matthews, Jr. of the Institute for Policy Innovation, "According to the National Conference of State Legislatures, based on responses provided by 44 states, 24 states have cut personal income taxes recently, 14 states have cut corporate and business taxes, and 21 states have reduced sales and use taxes." We can do without sales taxes. And we should.
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