TCS Daily

Internet Tax Revolt

By Lawrence Hunter - March 5, 2003 12:00 AM

At the winter meeting of the National Governors Association (NGA) Senator Byron Dorgan, D-ND, urged Congress to pass a sales tax "streamlining" bill this year. He argued that, "The tax is old, it's just not collected," referring to the use taxes due on out-of-state purchases. There's just one little problem with collecting that 'old tax'; it's unconstitutional.

States have been trying for more than three decades to tax people and businesses that are located out-of-state for one simple reason: non-residents can't kick the taxing scoundrels out of office. The issue of taxing remote sales started when states tried to tax catalogue sales, arguing that such "favorable" tax treatment put brick-and-mortar companies at a disadvantage.

The Supreme Court finally settled that dispute in 1992 in Quill Corp. v. North Dakota. That decision barred the state of North Dakota from requiring an out-of-state mail order company to collect taxes on sales made to customers inside the state unless the business had a "substantial presence" within the state. In addition to finding no sufficient taxing "nexus" the Court also found the state tax scheme was too complex for remote sellers and thus created an "undue burden" on inter-state commerce-rendering the taxing scheme unconstitutional and settling the issue, albeit temporarily.

With the advent of the Internet in the mid-1990s and the growth of e-commerce, the states and the NGA found a new hook for their 'old tax' collecting problems and, more importantly, they think they have stumbled upon the proverbial golden goose.

The new electronic medium has created infinite new and creative opportunities for entrepreneurial taxing schemes. By 1998 the debate reached a fever pitch but the fight was temporarily stayed for three years with the passage of the Internet Tax Freedom Act (ITFA). This Act barred post-1998 access taxes on the Internet as well as multiple and discriminatory taxation on e-commerce.

In 2001, when the ITFA was set to expire, the fight to permanently or temporarily extend the moratorium on Internet taxation reached a crescendo as Senators, Byron Dorgan (D-ND) and Mike Enzi (R-WY), held hostage any extension of the Internet tax moratorium unless Congress allowed for some type of national sales tax cartel. In November, almost two months after the original moratorium had expired; the Senate finally passed a clean two-year extension of the Internet tax moratorium. The Senate rejected the Dorgan-Enzi amendment, an amendment that could have led to future collection of state taxes on Internet sales by a 57-43 vote. The Dorgan-Enzi Amendment would have preauthorized a national sales tax compact if a mere 20 states agreed to the "harmonized" sales tax regime. This national sales tax would then be levied collectively by all the states and would only be alterable if individual state legislatures acquired the approval of a ''consensus board'' of non-elected bureaucrats-so much for representative democracy. The latest extension of the ITFA is set to expire in October of this year and another round of the great Internet tax debate will surely ensue.

During the first two rounds of the Internet tax debate the NGA argued the central issue was "fairness." Supporters of Internet tax "harmonization" obfuscated the issues insisting that somehow the moratorium barred taxation of Internet sales leaving brick-and-mortar industry at a disadvantage to commerce conducted electronically; that could not be farther from the truth. As noted above, the Internet tax moratorium only bars access fees and multiple and discriminatory taxation. It's the U.S. Constitution, not the moratorium, that imposes the restrictions on the ability of state and local governments to tax remote sales.

This year, with most states running deficits, the NGA has a new strategy. Instead of talking about "fairness" they are talking about "fiscal responsibility." A recent New York Times article quoted Frank Shafroth of the NGA lamenting "if only states could tax online sales they could plug 30-50 percent of the state budget deficits this year and next." But Shafroth fails to acknowledge that the states could just as easily "plug" budget shortfalls by cutting bloated state budgets.

It's important to remember that throughout the 1990s when the states were "losing" revenue for their failure to tax online sales state budget coffers were overflowing with revenue from the growing economy. State revenues grew on average by more than 48% during the 1990s. So what happened to the money? From '95-'2000 state spending grew even faster approaching 50%. The need to authorize a national tax cartel at the expense of the economic growth, Supreme Court precedent and the Constitution in an effort to balance budgets and eliminate deficits is a red herring.

If the tax harmonizers are serious about fairness then let's talk about how fair it is to increase the tax burden on citizens when their tax burden currently exceeds 40% of all wages and earnings. And, how fair is it to tax individuals and corporations that have no recourse at the ballot box? The fairness issue is not about brick-and-mortar industry versus e-commerce, but rather the age-old issue of taxation without representation. Moreover, should the sales tax cartel, as envisioned by the NGA and advocated by the likes of Senator Dorgan, become law it would directly conflict with our federal system, which not only allows, but encourages, states to innovate and compete within their borders.

As Congress begins anew debating the issue of Internet taxation and contemplates the authorization of an Interstate sales-tax cartel they should keep in mind three principles: 1) be aware of the total tax burden on citizens, not merely new means of taxing non-residents; 2) tax competition between states is not only good, but necessary for economic growth and the health of the national economy; and 3) be Constitutional; the Compact Clause exists to prevent states from creating "quasi-governmental" entities that intrude on the supremacy of the United States.

In that vein, Congress should permanently extend the current Internet tax moratorium on access taxes and multiple and discriminatory taxation of e-commerce, and, more importantly, they should put the kibosh on the NGA's machinations of a national sales tax cartel.

Dr. Lawrence Hunter is the chief economist and Shaun Small is the senior policy analyst at Empower America.

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