Kemp — Real Tax Reform First: Don’t Tackle Net Taxation until We Overhaul the System


More than 100 million American adults now use the Internet, up from 65 million in mid-1998 and 84 million at the end of 1998.  According to a University of Texas study, Internet-economy revenues are expected to reach $1.2 trillion by 2002, rivaling health care as the nation’s largest industrial sector.  Between 25 and 33 percent of America’s economic growth in the 1990s has been due to the information-technology sector. 


But the effects of this new economic infrastructure extend far beyond mere commerce. The Internet is an agent of revolutionary change in the way people worldwide communicate and interact with each other, socially, politically, and culturally, as well as economically.  A free and unfettered Internet will hasten the day when democratic capitalism comes to people who today are struggling against privation, dictatorship, and oppression. Consequently, any policies—state, local, federal, or international—that inhibit or retard the development and operation of the Internet should be held to a heavy burden of proof before being adopted.  Three issues stand out in discussion of Internet taxation:


Tax Reform.  In 1996, the National Commission on Tax Reform and Economic Growth (TRC) found that the current federal tax code is plagued by three principal defects: It is economically destructive, impossibly complex, and overly intrusive.  The TRC also found the Internal Revenue Code to be outrageously expensive and manifestly unfair, and recommended that it be repealed in its entirety and replaced with a new, simplified tax system for the 21st century. Efforts to design a new 50-state sales tax system without considering such major changes in the context of comprehensive tax reform are short-sighted and counterproductive.


State Revenue Issues.  Even as e-commerce metrics explode, state governments continue to enjoy annual sales tax revenue growth, with total revenue growth of close to 6 percent.  Further calculations suggest that state and local surpluses as a percentage of state and local revenue will continue to outpace federal surpluses as a percentage of federal revenue.  The empirical evidence is quite clear that far from being a zero-sum drain on government coffers, cyberspace has been an overall boon to the economy and to state, local, and federal treasuries.


National Governors’ Association (NGA) Plan.  Based on at least two Supreme Court cases (Virginia v. Tennessee, 1893, and U.S. Steel Corp. v. Multistate Tax Compact, 1978), there appears to be a tolorable argument  against an interstate compact or agreement like the NGA proposal to make uniform state and local sales tax policies.  These cases establish that a compact may not “tend to increase the political powers of the contracting states or to encroach upon the just supremacy of the United States” without the consent of Congress.  A strong argument can be made that the NGA proposal violates both of these tests, and as it does not seek Congressional approval may very well be unconstitutional.  Attempting to rebut the argument that the NGA scheme fails the Multistate Tax Compact application of the Virginia v. Tennessee tests, state and local officials may be tempted to argue that by ceding each state’s individual taxing authority to a supra-state authority, and by drastically curtailing each state’s control over its own tax system, the Governors’ scheme actually results in a serious diminution of each state’s political power, not an enhancement of it.  Consequently, the scheme would satisfy the Court’s requirement of not “increasing the political powers of the contracting states.”


This argument, however, to the extent that it shields the NGA plan from a clause-three (Compact Clause) challenge under Article I, Section 10, ironically could expose the plan to a challenge under clause one (Confederation Clause) of that same Section.  It is up to the Congress, not a confederation or alliance of the states, to decide whether we need a uniform national sales tax.  Congress should refrain from upsetting the well-established constitutional law with respect to remote sales. And it should exercise its powers under the Constitution to prevent the states from colluding, such as is proposed in the NGA plan, to circumvent this body of settled jurisprudence.


There is much we still don’t know about the Internet and our dynamic new economy, but of three things we can be certain: (1) the Internet, even in its infant stage, is a major driving force in the economies of America and the world; (2) the current federal tax code is a confusing and corrupting burden on our economy; and (3) certain factions are seeking to impose a new national framework of Internet taxation that many believe contains the same flaws as the current federal code and that may be unconstitutional as well.


When we consider all the opportunities and unknown benefits of the Internet economy; the likely prospect that real tax reform is just around the corner; and the fact that the leading “pro-Internet tax” alternative is deeply flawed, it is apparent to us that setting out today to achieve a unified, interstate sales tax system is highly premature.  No interstate Internet sales tax regime should be considered until we as a nation take action on the issue central to any discussion of taxation in the 21st century: comprehensive tax reform.


Jack Kemp is a distinguished fellow at CEI and co-director of Empower America.