Ask people if we should tax the Internet and you get very negative responses. Ask if Internet businesses should get special exemptions from the taxes that competitors pay and the responses are less one-sided and adamant.
Questions of taxation and the Internet, once again in the news, are not as cut-and-dried as they appear at first glance.
Economists generally don’t like ad hoc taxes on specific products — whether they are excise taxes on perfume or Seattle’s recently defeated latte tax. Such taxes are inefficient because the real resources wasted in complying with or avoiding the tax are high compared to the revenue raised.
One exception to the rule would be the motor fuel tax, in which the object is to make drivers pay for the roads they use. Emission taxes, a low-cost way to reduce pollution, would be another exception.
So, economists see the idea of imposing a new excise tax of any sort on Internet activity itself or on Internet-based commerce as a bad one.
Unfairness arises, however, if we already tax similar services. A federal excise tax on telephone calls has existed since the Spanish-American war. The rationale then was the usual one for an excise tax: Telephone calls, like jewelry and perfume, were considered a non-essential luxury largely used by wealthy people who could afford to pay without suffering privation.
Similarly, many municipalities and a few states impose franchise taxes on utilities such as electric, telephone and cable-TV companies. Such taxes ostensibly are fees paid by the lucky businesses for government-granted local monopolies. More practically, they are a way of taxing consumption that is not detected by 99.9 percent of consumers and is thus politically bland.
If we impose excise taxes on traditional telephone service and franchise fees on most utilities, should Internet service providers or Internet-based telephony, a technology that is starting to surge, be exempted?
If we already apply general state sales taxes to services from food preparation to pet grooming, why shouldn’t we apply them to ISPs or server farms? The answer is not clear-cut.
If I must pay sales tax on books purchased at a shop down the street, why should purchases from Amazon be exempt? What special benefit is there to the nation from Internet retailing that merits an implicit 6.5 percent subsidy?
Anti-tax advocates trot out rhetoric on how the Internet is the most dynamic sector in our society and therefore deserves a break. That argument rests on a fallacious assumption that governments are good at picking winners and losers. This is the same mistaken assumption used to justify tax-increment financing and multi-billion-dollar subsidies to attract auto plants.
Yet, the practical objections against taxing ISPs or Internet telephony or subjecting Internet sales to common sales taxes are stronger. Technology and the wide variation between states in sales and franchise taxation make such taxation difficult in practice. If Minnesota or St. Paul subjected such services to franchise or sales taxes and the Dakotas do not, we soon would be connecting to ISPs based in Brookings, S.D.
Collecting state sales taxes on distance retailing was an issue long before the Internet. Catalog mail- and telephone-order businesses posed the same challenges decades ago. But the Internet has upped the ante.
It is unfair to impose taxes on retail sales made in local brick-and-mortar stores and not impose them on sales of identical products made by mail, telephone or the Internet. On the other side of the coin, while programming Amazon’s computers for the sales tax regimes of more than 30 different states might be feasible, the same task could be huge for small startup Internet retailers.
The lesson is that the Internet eventually will force us to rethink many state and local taxes. The excise tax on telephony is an anachronism that Congress should have abolished a long time ago, along with the federal excise tax on the rubber in tires. Agreement among the states on a coordinated, simplified system of taxes for interstate sales would be a big step toward leveling a playing field that is currently unfair to traditional retailers.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.