Time to Stop Subsidizing Internet Giants

The sales tax exemption for Internet retailers is a preference that made sense once, but does not any more.

By + More
Amazon.com worker David Brendoff, left, moves boxes with merchandise for shipment Tuesday, Dec. 13, 2005, at the Amazon.com fulfillment center in Fernley, Nevada. With the holidays just around the corner, many shoppers are relying on online sites like Amazon.com to complete their shopping. This facility, over 800,000 sq. ft., or roughly 13 football fields, is capable of handling hundreds of thousands of orders per day.

David Brodwin is a cofounder and board member of American Sustainable Business Council. Follow him on Twitter at @davidbrodwin.

Next week, the Senate is likely to approve the Marketplace Fairness Act, a long-overdue reform which levels the playing field between Internet marketers and brick-and-mortar stores. The bill would fundamentally change how sales taxes are collected.

Currently, sales tax is only paid when the buyer lives in the same state where the business is located. Since most Internet sales cross state lines, most internet sales go untaxed. The bill would change that, requiring Internet retailers to collect sales tax based on the sales tax rate where the purchaser lives and works.

The lack of sales tax on most Internet purchases penalizes small businesses, turning many of them into little more than showrooms where customers conduct research but do not buy. When these small businesses fail due to lost sales, jobs vanish.

States, meanwhile, lose tax revenues they need to pay for police, fire, schools and other essential services. The loss to state budgets and local economies has become substantial. For example, Virginia loses about $251 million per year. Losses in a large state with a high sales tax (like California) approach $2 billion per year.

Bipartisan Calls for Reform

Calls for reform have grown and become bipartisan, even among legislators who usually condemn anything with the faintest whiff of a tax increase. As the New York Times reported, Republican representatives have heard the calls for relief from small business owners in their districts, and they are defying the powerful anti-tax crusaders such as Grover Norquist and his organization, Americans for Tax Reform.

[See a collection of political cartoons on Congress.]

It's easy to dismiss this issue as simply another case of two different sectors of the economy squabbling for competitive advantage. Brick-and-mortar retailers oppose Internet retailers. States with a sales tax oppose states without one. But a larger principle is at stake here.

The debate over sales tax is really about when we should subsidize or protect a new and emerging industry and when we should not. And although this particular case pits local stores against Internet marketers, and states that have a sales tax against states that don't, the same principle applies to competition between the U.S. and other nations.

Building Competitive Advantage in Emerging Industries

The larger principle at stake is what economists call the "infant industries argument." When a new, disruptive, strategically important technology or business practice comes on the scene, it is in the national interest to nurture it, subsidize it and protect it at first. The nation that captures leadership in a new, fast-growing industry can capture much of the wealth that flows from it. This was the situation the U.S. faced starting in the mid-1990's as the potential for electronic commerce was emerging.

[See a collection of political cartoons on the economy.]

But there's a second important part to the infant industries argument: Once the new industry is no longer in its infancy, all subsidies and other protections should be stopped, and all companies in that industry should compete on their own merits.

Both parts are important. If a nation doesn't take steps to support an emerging industry, it is unlikely to win the race for leadership. It will lose the opportunity for enormous private wealth creation that comes when new, high growth companies go public. But if a nation doesn't withdraw subsidies and other protections when it should, enormous national wealth is siphoned off to subsidize companies that can't compete on their own. This burdens the taxpayers and disrupts the flow of capital to new and better opportunities.

The U.S. has a long and generally successful history of nurturing industries that turned out to be important. Many industries where U.S. companies enjoy leadership have benefited from subsidies and other protections. For example, pharmaceutical companies benefit from research paid for by more than $20 billion in research grants through the National Institutes of Health, a government body. Boeing owes its strong position in commercial airplane manufacturing to deep and long lasting support from the Department of Defense. Crucial microprocessor technology from Intel and others has also been subsidized heavily by military spending.

[Read the U.S. News Debate: Should the Senate Have Passed an Online Sales Tax?]

It's Easier to Add Support than Withdraw It

Unfortunately, we are far better at putting protections in place than at phasing them out. The U.S. adopted a patchwork of agricultural supports to prop up family farms in the depression. But now, 70 years after the last dust storm rolled across the prairie, only 1 percent of the U.S. population works on a farm. Yet, we still pay more than $15 billion each year to subsidize crops, primarily corn and cotton.

Other industries continue to receive protection long after they need it: The U.S. provides considerable direct and indirect support for the oil industry. We subsidize banking with bailout guarantees that are paid for by taxpayers.

The sales tax exemption for Internet marketers is just the latest example of a preference that made sense once, but does not make sense today. At the dawn of electronic commerce, it made sense to exempt Internet retailers from collecting sales tax, to help U.S.-based companies become world leaders in Internet technology and business models.

This prudent decision helped Amazon, eBay and others to flourish here. But now, online merchants dominate many product categories. They no longer merit special protection. It's time to undo that special privilege and let Internet retailers compete with local retail on an even and unsubsidized basis.

  • Read Keith Hall: How Bad Is the Long-Term Unemployment Problem?
  • Read Chad Stone: The Relationship Between Debt and Economic Growth
  • Check out U.S. News Weekly, now available on iPad