Beware the Internet Tax Hackers

Beware the Internet Tax Hackers

December 31, 1999

Tax-hungry Grinches aren’t happy that you pay no taxes when Christmas shopping on the Internet.

The nation’s governors and state and local officials, led by the National Governor’s Association, are making a high-profile, passionate case for collecting sales taxes on the Internet. Internet taxes were temporarily banned by 1998’s Internet Tax Freedom Act. The Advisory Commission on Electronic Commerce (ACEC), appointed by that same Act, must decide whether to make that ban permanent, and will make a final recommendation to Congress in April 2000.

What’s at stake in the e-commerce taxation debate? Well, if you’re an e-commerce entrepreneur, your Web venture is in danger of being hacked–not by some enterprising teenager, but by politicians you didn’t elect. Your site may be corrupted, not by nefarious computer code, but by tax code. Your customers will pay more.

At the ACEC meetings, state and local government officials argued they seek to impose taxes on the Internet merely to "level the playing field" between Main Street businesses that pay taxes and untaxed Internet firms. They also claim the need to forestall a hem-horaging of state tax revenues as customers make purchases online.

Main Street businesses who may legitimately fear competition from untaxed Internet firms should realize that the tax hackers coddling them do not genuinely represent their interests. If tax-seekers win, such firms may find themselves bound to Main Street forever, at a time when the Internet increasingly puts the world at their doorstep. Many of today’s "bricks and mortar" Main Street firms have the opportunity to become the "clicks and mortar" innovators of tomorrow. And even if their aspirations aren’t quite so lofty, many Main Street stores already boast a Web page, while others are embracing online auctions or erecting low-cost virtual storefronts through innovations such as Amazon’s z-Shops and Yahoo! Shops. Still others are outsourcing their entire online presence through services like Iconomy’s "turnkey" online storefront, which handles customer service, billing, and shipping. With Iconomy, the merchant merely supplies the goods and a Website. These innovations are just the beginning of new avenues opening up for aspiring Main Streeters.

State and local government officials seeking to tax the Internet threaten such developments, while shamelessly exaggerating their revenue plight. Not only are state tax revenues growing in this age of surplus, but most online sales today are business-to-business sales, which pay no sales tax anyway. Also, financial and travel services–very popular on the Internet–are not subject to sales tax at all. Even as the world moves online, an unfettered Internet means the creation of new businesses and jobs and the increase in income taxes that accompany them.

There is a more fundamental objection to the tax hackers’ scheme: extending taxation to remote jurisdictions as they hope to do is fundamentally unjust. Governments only have the right to tax citizens within their particular jurisdiction. There must be no taxation without representation.

In keeping with that principle, the e-Freedom coalition released a proposal in November, which will be presented formally at the ACEC meeting this week. This proposal seeks to ensure no state collect taxes from firms that have no substantial physical presence within their borders.

In contrast, the advocates of e-commerce taxation openly ask for Congress to require remote sellers without a physical presence to collect taxes on their behalf–all the while readily admitting there are 7,400 taxing jurisdictions which must be accommodated. Small businesses could not possibly deal with such complexity. The ACEC should do its best to ensure that states never put up such onerous barriers to interstate commerce.

Despite their claims to the contrary, the tax hackers’ schemes would be incredibly complex. They will, nonetheless, claim that computer software is available that would makes it easy for businesspersons to collect taxes from their customers. This claim is clearly untrue and laughable: overburdened small businesspersons are busy enough pouring all their energies into their enterprises. Besides, trying to cope with software like Quicken or TurboTax merely to satisfy the IRS is difficult enough. But again, even if such dream software were available, taxation without representation is fundamentally unjust.

Moreover, e-commerce is new and uncharted territory, with relationships still evolving. Who will be liable for taxes: the consumer, the merchant, the consumer’s ISP, or the merchant’s Web host? How about the warehouse that stores goods in the pipeline? Adding to the complexity, all of these potentially liable parties may reside in separate states–or even separate nations. The Internet is global, after all. The new kinds of business associations that are continually emerging, such as the merchant affiliations, auctions, and virtual storefronts, make it impossible to know what it is we’re trying to tax. Everything about online commerce is in a state of flux.

Entrepreneurs devising business innovations to figure out how to make money and serve customers on the Internet are constantly groping, trying to make unpredictable online ventures work. They often don’t, or are before their time: remember "push" technology? To now approach Internet entrepreneurs with myriad tax schemes, to try to force them to contort to accommodate thousands of tax jurisdictions is preposterous and out of bounds.

Furthermore, one of the most important needs on the Internet today is the development of privacy tools to protect customers. By collecting information on every sale, invasive Internet taxation schemes will harm emerging privacy innovations like anonymous digital money and encryption. Internet taxation threatens the very existence of such necessary tools.

State and local politicians claim to seek a "simple and fair" uniform tax, a scheme whose ultimate unadmitted end is a national sales tax. Such a plan, of course, would be simple only from the perspective of the tax collectors, not from that of buyers and sellers on the Web. A simple tax is a simply raised tax, and thus not desirable. Irrational tax policies are common. Policymakers must ensure that there always exist competing tax jurisdictions, not uniformity in taxation across the states. Entrepreneurial flexibility in moving capital to escape the taxman provides a constraint on government overreach, and it is important to preserve that mechanism. A uniform system makes it simple only for multiple states to stake claims and propose new taxes. It can never make life simple for consumers.

Main Street businesses still tempted to embrace Internet tax schemes should realize one final thing. If new taxes are applied to the Internet via software, it is almost a certainty that such taxes will work their way down to Main Street business as well. Those with faith may believe it would replace existing sales taxes; those more wary may reasonably suspect the tax would be added to what exists.

Perhaps the biggest threat to the Internet today is tax fiends who seek to jettison the principle of no taxation without representation. The Advisory Commission on Electronic Commerce should stop tax hacking before it starts.

Fred L. Smith, Jr., is the president of the Competitive Enterprise Institute in Washington, DC.