Information Economy

Created: 1999-12-13
Last Modified: 1999-12-13
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Governor James Gilmore and his Advisory Commission on Electronic Commerce are coming to town later this week.

The way that Gilmore has been conducting the debate about internet taxation annoys me. He hides what seem to me to be the crucial issues. His proposals seem to me to be crafted for public-relations gain. He seems not to encourage but rather to discourage serious thought about what should be done on hard issues...


How Not to Not-Tax the Internet

J. Bradford DeLong and Ann Marie Marciarille
December 13, 1999
705 words

James Gilmore's Advisory Commission on Electronic Commerce comes to San Francisco this week. It brings Gilmore's proposal that there be no internet taxes whatsoever: "Congress should prohibit all sales and use taxes on business-to-consumer internet transactions."

At first glance, Gilmore's proposal seems completely bonkers. If we call up Round Table Pizza on the telephone to order two medium pizzas (one pepperoni, one mushroom) we will owe about two dollars in tax. In the world that Gilmore wants to create, if we (on some future date after it has been upgraded) click on http://www.roundtablepizza.com to order two medium pizzas, they will come tax-free. The two dollars off would be welcome: the kids could use them play an extra four video games. But no purpose is served by giving us a reason to avoid the simple phone connection (requiring two people and two phones) and instead use a much more complicated internet connection (requiring two people, one cable modem, one intranet, at least four computers, and a programmer).

At second glance, Gilmore's proposal still seems... unwise. The most fundamental principle of taxation is that taxes are badly designed if they give people strong incentives to change the way they organize their lives. The purpose of the tax system is to raise money: it is not to make it more profitable to build shopping malls than factories (as Reagan did back in 1981), and it is not to make it cheaper to buy goods over the internet than in a store. If internet-based commerce does turn out to be a more efficient way of delivering the goods people want, then it will flourish without a tax exemption. If internet-based commerce doesn't turn out to be more efficient, it will be a bad thing to encourage its growth beyond its natural limits by giving it a special tax break.

Now there are two reasons that Gilmore might be proposing his internet tax prohibition. One reason is that a prohibition of internet taxes will surely lead to the decline or elimination of many other sales taxes. Businesses restructure themselves to make as many as possible of their transactions with consumers "internet transactions." Governor Gilmore is a Republican who believes that state governments are too large and spend too much money. Sales taxes make up roughly half of the revenue of all state governments. A world with reduced sales taxes would be a world with smaller state governments that do less.

We think that this is a bad reason to be for blanket internet tax exemptions. Voters can and should decide how big their government should be. The size of the government should not be decided by stealth, as a result of policy proposals that are ostensibly aimed at other goals than the overall size of the government.

A second reason is that if internet taxes are not prohibited, it may well be that a lot of internet commerce will be strangled by red tape. Different taxing jurisdictions could pile on inconsistent and incompatible taxes that small businesses, especially, would find it difficult to comply with. As leading website design guru and tool builder Philip Greenspun wrote in Phil and Alex's Guide to Web Publishing (http://photo.net/wtr/thebook/): "there are about 7000 taxing jurisdictions in the United States 17000 different tax rates.... Most states will ...distribute the appropriate amounts periodically to local governments. Still... we will be hiring a big staff of people to sit in front of a forms CD-ROM from http://www.salestax.com or a more automated software package from http://www.corptax.com, http://www.taxware.com, or http://www.vertexinc.com.... The cost of... sales tax compliance... may wipe out many years of profit..."

We think that this is a good reason to worry about internet taxes. Any taxes imposed on internet business-to-consumer transactions need to be simple--so simple that businesses like http://www.virginiadiner.com can deal with them without breaking any sweat.

But surely we are smart enough in this country to figure out how to handle internet taxation without either (a) violating the fundamental principle that taxes should not distort the economy away from its most efficient pattern, or (b) tangling businesses in red tape. In fact, isn't that what the Advisory Commission on Electronic Commerce is supposed to do?


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Do you have a perspective to offer? Please contribute it. If the web does change the world, it will do so only by increasing the bandwidth of communication--by automatically combining the intelligent thoughts of many people. Eric Raymond has claimed that as far as writing software is concerned, "with enough eyeballs, all bugs are shallow." It may be true for the rest of human endeavor as well...


Seth,

I think you are missing something. People ordering pizza's from your virtual pizzeria, will pay the same sales tax as if they walked in and ordered a pie over the counter. Unless the person ordering online lives in another state, and your e-business has no presence or "nexus" within that state. Getting drivers to deliver pizza's across great distances may be another problem however.

Contributed by Ralph Angelotti (rangelot@hotmail.com) on January 15, 2001


So if I run a pizza parlor, I can just install a LAN within my store to connect the front desk with my Web server, and set up a computer with a Web browser at the front desk. Then anyone who shows up at the parlor can order a pizza through the browser, enter a credit-card number, and -- voila! -- since it was ordered over the Internet, there's no sales tax. (Why should an Internet order be treated any differently if the user just happens to be in the same building as the Web server at the time the order is taken?)

Or am I missing something?

Contributed by Seth Gordon (sgordon@kenan.com) on December 15, 1999.


Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
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