Choosing the Lesser of Two Evils

Conservative icon Art Laffer argues that taxing Internet sales is better than taxing income.

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The passage through the U.S. Senate, not once but several times, of legislation that would change the tax treatment of goods sold over the Internet is one of Washington's most hotly debated issues.

Some argue the bill, called the Marketplace Fairness Act, would be a tax increase as it allows for a levy to be assessed on goods that are currently sold tax-free. Others argue that many goods sold in cyberspace are already subject to sales tax – depending on the physical presence of the seller and the shipping address of the buyer – and that what some call "tax avoidance" is actually "tax evasion" since people who pay no tax at the time of sales are supposed to voluntarily remit payment in their home state.

It is a confusing situation with parties on both sides claiming adherence to first principles, either that tax increases should be resisted at every turn or that the loophole creates an inequity in the law that allows taxes to be assessed unequally and, therefore, unfairly.

Into the debate comes Art Laffer, one of the founders of supply-side economics and a highly respected name in his field. Along with his colleague Donna Arduin and Let Freedom Ring, where I am a senior fellow, he has released "Pro-Growth Tax Reform and E-Fairness," an extensive study showing that putting an end to the inequity in the tax treatment given Internet sales can actually be a boon to the total economy.

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

Writing in Thursday's USA Today Laffer explained that:

Because state sales taxes generally have fewer loopholes and lower rates – and therefore have a lesser impact on growth and employment – pro-growth policies should favor sales over income taxes where possible. True reform should include addressing the online sales tax loophole.

A move towards e-fairness would give states an opportunity to use additional online sales tax revenues to lower rates on more burdensome taxes, such as the personal income tax. This would create a more efficient tax system and correct a fundamental distortion of the retail marketplace, where traditional retailers must collect the sales tax and their online competitors don't.

The key, of course, is the idea that cash-strapped states will use any new revenue generated from the change in tax treatment to underwrite cuts in state incomes taxes, a goal Republican Govs. Scott Walker of Wisconsin and John Kasich of Ohio are already working towards.

"Gross state product would increase from 1.2 percent in Alaska to 4.6 percent in Washington State over 10 years," Laffer forecast. "States would see jobs created, anywhere from about 2,000 in Vermont to more than 180,000 in California. Gross domestic product would grow by more than $563 billion, creating 1.5 million jobs nationwide. But in order to capitalize on this opportunity, Congress must first pass legislation allowing states to act," he concludes in the study, which was funded by the Marketplace Fairness Coalition, a business group that backs the legislation.

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

It may very well be that the version of the Marketplace Fairness Act that passed the Democratically-controlled U.S. Senate may have no chance in the anti-tax GOP-led U.S. House. Virginia Rep. Bob Goodlatte, who chairs the House Judiciary Committee, which has jurisdiction over the issue, has said as much. But even Goodlatte acknowledges that there is an inequality in the current system, one that favors online retailers over the community establishments that are the backbone of rural and suburban communities as well as many inner city neighborhoods that needs to be addressed. Using any new revenues generated by the change in tax policy contemplated in the MFA to offset state income tax rates, while politically challenging, would be economically beneficial. The change would, in essence, replace or cut the rate of a "bad tax" that hampers economic growth with one that has a much broader base, is more equitable and would lead to growth in state economies as the Laffer study argues would be the case.

Neither side in the debate, among conservatives at least, wants to see a net tax increase. The idea that taking steps to insure that one tax that now largely goes uncollected starts to generate revenues in order to lower rates on a tax that is far worse, from an economic standpoint, may be one whose time has come.