Should Internet Sales Be Taxed? - Advisory Committee on Electronic Commerce

USA Today (Society for the Advancement of Education), Jan, 2001 by Aaron Lukas

"A speculative revenue crisis doesn't justify giving new taxing authority to states to treat all businesses badly in the name of fairness."

SERVING on a Congressional advisory commission is a bit like being a mother-in-law--you get to criticize everyone, but no one has to listen to you. Life on the 19-member U.S. Federal Advisory Commission on Electronic Commerce (ACEC) is no exception.

The ACEC was created by Congress as part of the 1998 Internet Tax Freedom Act and was charged with studying international, Federal, state, and local tax issues pertaining to the Internet. By law, the commission needs a two-thirds majority vote to approve any recommendation. The ACEC will issue its final report in the spring of 2001, but the real purpose of the commission has already been served. It provided members of Congress and the major party presidential candidates with an excuse not to take a position on Internet taxes right now. Ultimately, it won't really matter what the report says, since Congress is notorious for ignoring its own advisors.

For the sake of argument, though, what will the commission recommend? The smart money is on either "nothing" or "everything." To be sure, there are some areas of agreement among the commission's members. They already had voted to endorse the Clinton Administration's policy of keeping the Internet a global free-trade zone, and informal polls have shown supermajority support for a recommendation that Congress repeal the three percent Federal excise tax on telecommunications services. That's where the harmony ends, however. On the most contentious Internet tax issue--the application of sales and use taxes to cross-border sales--the ACEC is split into three distinct factions: those who want no e-commerce to be taxed, those who want all e-commerce to be taxed, and those who want some e-commerce to be taxed.

The anti-taxers, represented most prominently by the ACEC chairman, Gov. James Gilmore of Virginia, want Congress to ban permanently the collection of sales and use taxes on all online commerce, local or remote. Several bills to this effect have already been introduced in Congress, including legislation by Rep. John Kasich (R.-Ohio), Sen. John McCain (R.-Ariz.), and Sen. Bob Smith (Ind.-N.H.). State and local officials warn that this approach will deplete their tax coffers and lead to the downfall of Western civilization. (I exaggerate only slightly.)

The pro-tax faction is led by Gov. Michael Leavitt of Utah and Mayor Ron Kirk of Dallas. They back a plan by the National Governors' Association that would create a centralized "trusted third party" collection system for sales taxes that would be utilized by all online sellers. In theory, the system would place zero collection burden on businesses and protect them from multiple audits by various state and local tax authorities. Once in place, this system would collect taxes on all remote sales at the rate charged in the buyer's home state. In the middle is a plan crafted by ACEC commissioner Dean Andal of California's State Board of Equalization. The Andal proposal essentially would codify and clarify the status quo by recommending that Congress establish a uniform national jurisdictional standard for taxing e-commerce based on the substantial physical presence test. Under this system, Internet business could be compelled to collect sales or use taxes only in those cases where they have a "significant connection" to the taxing state. Legislation along these lines will soon be introduced by Sen. Judd Gregg (R.-N.H.).

The upshot of these incompatible proposals is likely to be a final report that either makes no recommendation on sales taxes or else details all three options. Either way, the report won't lend much help to members of Congress--assuming they decide to tackle this issue at all.

Sales taxes are excise taxes (i.e., those that are based on the amount of business done) imposed on retail transactions. Sales taxes are generally levied by a state or locality on sales of tangible property and specified services that occur within the relevant jurisdiction. Purchases made by businesses--either for resale or as inputs to production--are (in theory, if not always in practice) exempt from sales taxes in order to avoid double taxation.

Sales taxes are charged to sellers, who then pass those taxes on to consumers. Although consumers are the ultimate taxpayers, there are real economic costs borne by businesses that collect sales taxes. First, there are the administrative costs of registering with multiple state and local agencies, collecting taxes, and remitting the funds (a cost that is higher for remote than for local sellers). Second, businesses may not always be able to pass on the entire amount of the tax to consumers. For example, if Amazon.com is required to collect an average tax of five percent, it may decide to lower its prices slightly to maintain sales volumes. Even if it holds prices steady, it will sell fewer books at the after-tax price, thus suffering a loss of sales revenue.