Internet Sales Tax Is a Bad But Necessary Idea

We seem to be stuck with high sales taxes, and Congress needs to level the playing field.

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Robert Hahn is director of economics and professor at the Smith School, University of Oxford. Peter Passell is a senior fellow at the Milken Institute and editor of The Milken Institute Review. They co-founded, a web portal on economic regulation.

The Financial Times recently published commentary by Jacob Weisberg deploring's use of political and financial muscle to avoid collecting sales taxes on out-of-state purchases. Amazon, he notes, only recently relented because the company sees greater advantage in positioning warehouses closer to customers. 

Wall Street Journal writer Gordon Crovitz responded with a column entitled, "9,646 Tax Burdens on the Internet," in which he argued that the crazy quilt of state and local tax rules would be unmanageable for Internet retailers – especially smaller ones. Crovitz offers the example of a 1,400-word Wisconsin regulation differentiating taxable ice cream cakes from ones that are exempt by virtue of contents.  

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

Who's right? Neither and both. Forgive our pedantry here, but it's important to get back to economic basics in judging the merits of Internet sales taxes. Here, we offer three criteria.

  1. Economic efficiency: Virtually all taxes drive a wedge between buyers and sellers, implying that they reduce the total size of the economic pie. Equally important, the revenues from some are spent in ways that offset the inefficiency. So in the case of taxing Internet sales, much depends on how much market choices are distorted and how the receipts are used. Plainly, there is no single answer for every product sold and every locality.
  2. Equity: Taxes yield winners and losers. Weisberg is correct that bricks-and-mortar firms are big losers now. But like all good economists, we think that what happens to consumers matters more. And like many, we care whether the poor pay more or less taxes per dollar earned than the rich. Suffice it to note that if the affluent shop more on the Internet – which seems to be the case -- the net effect of failing to collect sales taxes from them is very regressive.
  3. Simplicity: Crovitz is right that sales taxes are exceptionally complicated by virtue of both product exemptions and decentralization of jurisdictions. But complexity, in itself, is hardly a reason for favoring one seller over another. In any event, the complexity issue is a bit overblown since there is more than one software package that automates the process.
  4. So how does the Internet tax bill stack up by these criteria?

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

    Start with the fact that sales taxes are, in general, lousy ways to raise revenue because they are inefficient and regressive. Yet, sadly, state legislatures seem determined to shift their tax regimes toward sales taxes in an apparent effort to attract businesses that are unaffected by local sales levies.

    That said, it's hard to defend the Internet exemption that drives customers away from local merchants – especially in the case of big-ticket items like consumer electronics. A decade ago, one could plausibly defend the exemption on the grounds that Internet merchants needed extra help in convincing consumers to try purchases at a distance. Today, the convenience of Internet stores and the ease of comparison shopping have erased that issue. By the same token, the red tape in following the tax rules of thousands of individual localities has been cut by computerization.

    In the best of possible worlds, states and localities would reduce or eliminate their use of sales taxes, rendering the argument moot. In this world, we seem to be stuck with high sales taxes, and Congress needs to level the playing field.

    • Read Nita Ghei: Internet Sales Tax Stifles Small Business Competition
    • Read Chad Stone: The Relationship Between Debt and Economic Growth, Part II
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