Is Tax-Free Shopping Doomed?

SAN FRANCISCO (02/15/2000) - I ran up plenty of bills shopping online this holiday season; being spared the sales tax was a blessing. That said, I don't want to lose speedy response times from my local fire and police departments, reasonably prompt repaving of my local roads (this century, please), and other community services.

Unrelated issues? No. Increased online spending by consumers has left state and local governments fearing that a significant drop in a major source of revenue--local sales taxes--will prevent them from providing the services we all expect. And many government agencies are clamoring to end the ban on interstate Internet sales taxes that we've enjoyed for the past few years.

Taxing the Net will literally take an act of Congress. A 1992 U.S. Supreme Court ruling held that states can't tax out-of-state purchases. The 1998 Internet Taxation Freedom Act put a three-year moratorium on Internet access taxes (but not sales taxes). And it created an advisory committee to study electronic commerce and recommend action on various issues, including online sales taxes; this committee is scheduled to give its final report on April 21.

A Piece of the Internet Pie

Web surfers in the United States spent about $20 billion on cyberpurchases last year, according to Forrester Research; it's more than double the figure for 1998. Projections vary, but nobody doubts that online spending will continue to grow--and state and local governments want a piece of the fiscal action.

Some states aren't waiting for Congress to act. Michigan and North Carolina residents will get a surprise on their 1999 state income tax forms: a line asking them to calculate what they spent online and then to pay local sales tax on that amount. Florida and other states are mulling similar action.

These states are merely enforcing existing use laws that let them recoup sales tax revenue lost to out-of-state purchases. Most states have such laws; the new twist is charging consumers directly. Usually, businesses pay the fee because the states consider collecting from buyers too much trouble. Cybersales, however, are a tempting enough target to prompt some states to change their approach.

Have you kept all your online receipts? Probably not (or you might have deleted them accidentally). That's one reason this approach won't work very well and why ultimately Congress may have to intervene to get money to the states.

Why Not Tax the Net?

Proponents of Internet taxation argue the Net is the same as any other sales channel and shouldn't be exempt from sales taxes. In fact, we do pay sales taxes on some Internet purchases. Laws originally created to cover catalog sales allow states to require businesses to collect sales taxes if the businesses have a sufficient physical presence ("nexus") in a state.

Not surprisingly, many Internet businesses go to great lengths to avoid nexus status in states where sales taxes are high. That's one reason Amazon.com keeps many of its warehouses in Nevada (sales tax as low as 6.5 percent), instead of California (up to 8.5 percent) where more of its customers reside. It's also why some brick-and-mortar franchises like Barnes and Noble created separate companies to do business online. Otherwise, having stores in virtually every state, Barnes and Noble would have had to pay sales taxes on all its online transactions.

Some argue that not taxing Internet sales exacerbates the digital divide.

Because wealthier Americans make more purchases online, does forgoing any online sales tax benefit those who don't need the break? This won't be the case much longer, argues economics professor Alan Auerbach from the University of California at Berkeley. If wealthy Americans are already online, where's the growth market? The middle and lower economic classes, Auerbach answers; so imposing taxes now would eventually affect everyone.

But sales taxes are often the most significant source of income for state and local governments. We all rely on local services, and we'll suffer if regional governments can't meet their budgets, say proponents of Internet sales taxes, such as Republican Governor Michael Leavitt of Utah, who serves on the electronic commerce committee.

Leave the Net Alone

Advocates of a continued ban on Internet sales taxes are at least as vocal.

They include most of the presidential candidates as well as Virginia's Republican Governor Jim Gilmore, who heads the U.S. Advisory Commission on Electronic Commerce. Some opponents of Internet taxes favor maintaining the status quo for a few more years; others would make the ban permanent.

Those urging a complete and permanent ban argue that government regulation will stunt the Internet market's growth and hamper innovations that have caused e-commerce to blossom.

Governor Gilmore and presidential candidate Senator John McCain (R-Arizona), both opponents of Net taxes, argue that state and local governments suffer no significant revenue loss as a result of online sales. According to a staff representative, Gilmore also believes that Internet commerce bolsters other areas of the economy, enlarging state and local governments' take from such existing revenue sources as income and property taxes and even stimulating local economies so that offline sales tax revenues grow. And Gilmore expects such trade-offs to continue, offsetting future sales tax losses.

Economist Shane Greenstein of Northwestern University's Kellogg Business School, however, considers Gilmore's view shortsighted. Tax-free online sales will eventually cut into state revenues, he says. Recent research by fellow economist Austan Goolsbee of the University of Chicago supports Greenstein's view.

Leave the Net Alone--For Now

Economists Auerbach, Greenstein, and Goolsbee agree that a permanent ban is not the answer, and given the revenue potential from Internet transactions, it is politically unlikely. They and (recently) the Committee on Internet Taxation suggest maintaining the status quo for a few more years.

After all, they don't want to dampen growth of the Internet and of the overall economy, which benefits from tech businesses. Online sales figures may look big, but they represent only about 1 percent of overall retail sales and probably won't grow beyond 2 percent before 2004, Goolsbee says. Imposing Internet sales taxes now, before cybershopping has become widely and firmly established, could cause online sales to drop by as much as 24 percent, according to one of Goolsbee's studies.

Furthermore, sales taxes already don't apply to the bulk of online and offline buying--namely, to services, ranging from financial transactions to dry cleaning. Forrester reports and Goolsbee's research both support this conclusion, and they note that the nation's strongest economic growth is occurring in the service sector. Taxing services would require a complete overhaul of the tax system. That's not on the table--yet.

Maintaining the status quo may give policy makers a chance to examine the issue in greater depth and consider whether sales taxes are the best way to give state and local governments a cut of online sales.

One plan suggests introducing a simplified sales tax at the federal level that would impose a single sales tax rate across the country, instead of making businesses deal with 7000-plus tax rates in different states and communities.

Another proposal, supported by Utah's Governor Leavitt and the National Governors Association, would create a set of databases like those used in processing credit card orders, so all businesses could easily calculate the appropriate sales taxes for any order. Regional governments have plenty of incentive to build such databases. But either plan would take time to implement.

Net Result

The problem isn't simple, and it will only get more complicated as the economy grows increasingly global. The electronic commerce committee is deeply divided over specific proposals and will likely recommend a simple three- to five-year extension of the current moratorium--which means the taxation issue will be left for Congress to resolve or defer without any clear long-term recommendation. The candidate we vote into the White House this year will also significantly influence the course of Internet taxation.

Citizen cybershoppers can stall for only so long: As online sales grow, states will clamor for their fair share. Now is a pivotal time, before we reach a crisis. Consumers probably have one or two more "free" shopping seasons left on the Net. But as the saying goes, there are only two things in life we can count on: death and taxes (even online).

• Bookmark this page
• Share this article
  •  
  • facebook
  • slashdot
  • digg
  • Reddit
  • stumbleupon
  • linkedin
  • twitter
• Got more on this story? Email Computerworld
• Follow Computerworld on twitter

• Share
  Share this article

  •  google+
  • facebookfacebook
  • slashdotslashdot
  • diggdigg
  • RedditReddit
  • stumbleuponstumbleupon
  • linkedinlinkedin
  • twittertwitter
• print
• email
• Bookmark