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Capitol Comment 252 – No Internet Tax: Why Internet Sales Taxes Aren’t Necessary

Ten years ago, discount retailers like Wal-Mart were redefining the face of the American retail industry. Today, online retailers like are again redefining not only the ways that businesses interact with their customers, but also how they interact with each other. Two years ago, Congress passed a three-year moratorium on new Internet taxes to help the fledgling market grow. In the interim, the battle to create an Internet tax plan has begun.

The best way to protect small businesses and our strong economic outlook is to allow E-commerce to establish itself free from the greedy hands of government regulators and tax collectors.

The rapid growth of the Internet and E-commerce has eclipsed that of any previous human invention. Estimates that were once seen as naively optimistic are now often considered too conservative. A recent Forrester Research report estimates that online advertising will reach $33 billion worldwide by 2004,1 more than double their previous estimate of $15 billion for 2003.2 In 1998, the same firm also estimated that online business will be worth $1.3 trillion by 2003, representing over 9 percent of U.S. business sales.3 It is now likely that this figure is too low as well. But such numbers do not mean anything without a precise definition of what constitutes E-commerce.

The uncertainty about E-commerce projections indicates that the common definition for E-commerce is too broad for a meaningful economic discussion. Broad definitions may be useful to define a new and growing market sector like E-commerce. However, when discussing taxation and states’ lost revenue projections the difference between $1 billion and $1 trillion will have a huge impact on the outcome of those discussions.

The E-commerce figures being tossed about include different types of transactions, and not every E-commerce sale represents a loss in sales tax revenue. E-commerce is a term used to describe three types of sales that utilize the Internet: (1) sales between businesses, (2) sales between individuals, and (3) retail sales between businesses and individuals. Of the three types of transactions, only retail sales are subject to taxation outside of cyberspace. Taxing sales between businesses or individuals could result in double or triple taxation of a single item or activity.

Eliminate sales not taxed outside of cyberspace, and current retail E-commerce estimates range from $7 billion to $51 billion annually. Even these numbers are too high for the tax debate because the estimates include everything from purchases influenced by the Internet to purchases actually made over the Internet. If a sale is not actually completed online, it is already subject to the same taxes and regulations as a normal sale. For example, a consumer who compares different products and/or collects quotes from various dealers online, but completes the final transaction in person still pays applicable state and local taxes, yet the sale is often still considered an E-commerce transaction. In many cases, even if the deal is completed online, it is still subject to the same taxes and regulations as traditional transactions. However, for the purposes of the E-commerce tax debate, we can still consider sales completed online.

The discrepancy between the perception and reality of lost tax revenue suggests we take a closer look at the fiscal health of our states. There are many officials who believe the sales tax revenue lost to E-commerce is a serious threat to their state’s fiscal well being. In fact, the National Association of Counties, along with the U.S. Conference of Mayors, has filed a lawsuit to prevent meetings of the Advisory Commission on Electronic Commerce, created by Congress to recommend future Internet tax policies. Such drastic measures must mean there is a lot a stake, yet “the accounting firm of Ernst & Young estimates that nationwide lost tax revenue will only be about $170 million – not quite one-tenth of 1 percent of state and local government sales and use tax collections.”4 As with all statistics in the E-commerce debate, it is important to examine the implications behind the numbers.

Most states are looking for ways to get rid of the sales tax revenues they’ve already collected. According to a recent report by the National Conference of State Legislatures (NCSL), states had a $5.5 billion surplus for 1999, and “this is the third straight year that most states have faced decisions on how to allocate these excess revenues.”5 In fact, 21 states have chosen to lower their existing sales tax collections by a total of $1.6 billion. This decision represents a $1.6 billion net loss in sales tax revenues, roughly 1000 percent more than the E-commerce losses the NCPA projected. Many of the politicians pushing hardest for a tax on Internet sales suggest that while they may not need the money just yet, they might need it sometime down the road. If politicians are really concerned about a source of revenue for the future, it makes more sense to give E-commerce the opportunity to grow, rather than drowning it in a sea of regulation and taxation.

Politicians need to exercise caution to avoid suffocating this new sector of the economy. On the heels of three years of budget surpluses, the latest effort to impose new taxes on Internet transactions seems out of place at best. As most states look for new ways to spend or return their excess revenues, there is little evidence suggesting that adding another $170 million to their overstuffed coffers would provide tangible benefits. On the other hand, with hundreds of small businesses entering and/or servicing the E-commerce industry every day, there is a strong argument that a new Internet tax could cripple existing companies and discourage potential entrepreneurs. The best way to protect small businesses and our strong economic outlook is to allow E-commerce to establish itself free from the greedy hands of government regulators and tax collectors.

1Forrester Research press release, “Online Advertising To Reach $33 Billion Worldwide By 2004 ,” August 12, 1999.

2Forrester Research press release, “Forrester: Worldwide Spending For On-Line Advertising Will Reach $15 Billion By 2003,” August 19, 1998.

3Forrester Research press release, “U.S. On-Line Business Trade Will Soar to $1.3 Trillion By 2003, According to Forrester Research,” December 17, 1998.

4NCPA Policy Digest, August 20, 1999, referencing Pete du Pont, “Tax Sales on the Internet?” The Washington Times, August 20, 1999.

5National Association of State Legislatures, “State Budget and Tax Actions 1999: Preliminary Report.”