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Safeguarding
Internet Tax Fairness by Aaron
Lukas on 02/02/2000 of Cato Institute Topic: Taxation |
I
"Safeguarding Internet
Tax Fairness"
Testimony
by Aaron Lukas Analyst,
Center for Trade Policy Studies Cato Institute
February 2, 2000
Hearing on Internet Tax Issues Senate Budget Committee First, let me thank the committee for the
leadership it is showing on the Internet tax issue, and also for
allowing me to testify at this morning's
hearing.
Electronic commerce
has exploded over the past several years. In the United States
alone, approximately 39 million people made a purchase online last
year—double the number of 1998 Internet shoppers. Total sales may
reach $50 billion this year.
Such astonishing growth has many state and local governments
worried that they are not adequately prepared to tax this flood of
new commerce. Contrary to the claims of those governments, however,
the current federal rules do not exempt electronic commerce from
taxation; they simply prohibit certain means of collection. The
federal government should continue to prohibit states from imposing
tax collection duties on out-of-state businesses by establishing a
uniform national jurisdictional standard for taxing e-commerce based
on the substantial physical presence test. Such a standard would
reaffirm traditional principles of tax fairness, preserve rate
competition among states, and avoid years of contentious litigation.
But before discussing what
should be done, let me state what should be avoided: Congress should
reject any option that effectively raises taxes—that results in more
money for states and less for taxpayers. In other words, simply
authorizing states to compel use tax collection from out-of-state
businesses should be rejected out of hand.
Under the 1992 Quill Supreme Court
decision, states can't compel sales tax collection by an
out-of-state business unless that business has a significant
connection to the taxing state—a legal concept known as nexus. There
are at least three important reasons to retain and perhaps
strengthen the current nexus standard.
First, there is no hint of a revenue crisis facing
states. The roughly $20 billion in 1999 business-to-consumer online
sales represented less than 0.3% of total consumer spending.
In an era of almost no
inflation, state budgets grew by 5% in FY97 and nearly 6% in FY98.
Over the past four years, state tax collections have exceeded
expectations by about $25 billion. In addition, all states will
split $246 billion over 25 years from the 1998 tobacco settlement.
With revenues pouring in so rapidly, it cannot credibly be argued
that electronic commerce is currently undermining the ability of
states to provide legitimate government
services.
And in-state sales
will continue to be a dependable source of tax revenue. Despite the
growth of Internet shopping, traditional retailers had a fantastic
Christmas in 1999, enjoying a healthy 7.7% increase in sales over
the year before.
Why is that?
Because local stores cater to a customer's desire for a hands-on
experience, offer immediate gratification, and do not charge for
shipping, they will probably always dominate retailing. In addition,
shopping is for many people a pleasurable social experience that
cannot be duplicated online. Thus, Internet sales won't destroy
"real" retailers, just as catalog sales haven't. The human factor
still drives shopping and that will likely always be
true.
The second and most
important reason to limit state taxing authority over remote
transactions, however, is fairness. When a local business collects
sales taxes, there is a clear link among taxes paid, services
provided and legislative representation. Local firms benefit from
police and fire protection, roads, waste collection and other
services, so it's proper that they help cover those costs. Remote
sellers don't enjoy any of those services, and shipping companies
already pay taxes to cover their use of public goods. To force a
wholly out-of-state business to collect taxes would be "taxation
without representation," pure and simple.
It is also important to note that local businesses
are tasked only with collecting taxes for the state where they are
physically located (origin-based taxation), while e-commerce firms
are being asked to collect taxes for every state where their
customers live (destination-based taxation). Ernst &
Young has estimated that while collecting $1 in taxes costs
traditional retailers 7 cents, it could cost Internet retailers as
much as 87 cents. How is that a level playing field? The bottom line
is that only a state where a business is located should have the
right to compel sales tax collection.
Third, the current nexus standard promotes tax
competition among the states. Electronic commerce gives everyone the
opportunity to live on a virtual border—to take advantage of the
fact that no state, although it is free to do so, currently taxes
its exports or voluntarily collects use taxes for other states. Like
a real border, the Internet can be a potent safety valve that guards
against excessive taxation. E-commerce allows consumers who have
found it difficult to travel out of state—the poor, the elderly, and
the infirm—to take advantage of tax competition for the first time.
Remember that nothing
currently prevents a state from instructing e-commerce retailers
within its borders to collect sales taxes on all sales, regardless
of the ultimate destination of the product—exactly as
brick-and-mortar sellers do. State officials are hesitant to do this
because they fear that businesses might decide to locate in other
states with lower taxes. They call that a "race to the bottom," but
it's really just healthy tax competition.
So what, if anything,
should Congress do? Legislation to codify and clarify the
Quill nexus standard would help businesses to know exactly when
they are liable for sales taxes, just as federal law now does for
income taxes. Greater certainty would help to avoid years of
pointless lawsuits. Moreover, a uniform nexus standard would not
adversely impact state efforts to simplify their tax systems or
encourage voluntary collection by businesses.
Ultimately, there should be more equal tax
treatment among all forms of commerce, but that does not mean
abandoning traditional principles of tax fairness. Congress must not
allow a phony revenue crisis to justify quick passage of new taxing
authority for states that would achieve fairness only by treating
all businesses badly.
Thank
you.
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