To Tax or Not to Tax E-Commerce?

The Internet will simplify a lot of things in life, but don’t count on the country’s unwieldy tax system being one of them.

When California passed a law last month banning any new taxes on Internet services, it raised the volume on a debate about whether tax policies should promote businesses on the information superhighway or preserve those on Main Street.

Many lawmakers and industry experts are predicting the growth in online business will lead to mass confusion among the country’s 30,000 tax jurisdictions.

“It is a very complex issue,” said Utah Gov. Michael Leavitt, who heads the National Governors Assn.’s task force on Internet development. “If we don’t solve it today, businesses that operate on Main Street will start to have serious trouble.”

It is not hard to understand why California was so willing to forgo potential tax revenue on one of its most successful industries. Internet companies in and around Silicon Valley are generating jobs and a level of affluence that have done a lot to erase the memory of the last recession.

“We certainly have more at stake here. We have the largest computer industry in the country,” a spokesman for Gov. Pete Wilson said after Wilson signed a three-year moratorium on sales tax and other state levies on Internet activities.

Although the federal government is leaning toward a policy like California’s that would block new online taxes for at least two years, individual states are lining up on opposite sides of the issue.

Nine states already tax Internet services, as do some local governments. California was the sixth state to pass a law limiting online taxation, arguing that the Internet is a source of economic growth that should not be inhibited.

In the borderless world of cyberspace, these conflicting tax laws pose some tricky problems. And many lawmakers say the policies being drafted today do not even begin to address the economic complexities of Internet commerce.

State governments, which have complained for years about the tax revenue lost in catalog sales, say the Internet could multiply those losses many times. At best, they fear, this will give an unfair advantage to Internet merchants. At worst, it would advance the so-called “digital divide” between the technology haves and have-nots, by imposing more taxes on the have-nots who do their shopping in stores.

For example, when Leavitt recently ordered a book from online retailer Amazon.com Inc., he was not charged a tax. Because online retailers now abide by the same tax laws as mail-order catalogs, they tax sales only in states where they have a physical presence. The same book purchased in Leavitt’s local book store would be taxed.

“That doesn’t make any sense at all,” Leavitt said. “Sales taxes are not a tax on businesses, they are a tax on people who purchase.”

The National Governors Assn. estimates state governments now lose $3 billion to $4 billion a year on mail-order sales to out-of-state merchants. “We think the Internet has the ability to increase that dramatically,” said Jennifer Mello, a policy analyst with the governors association.

Jupiter Communications projects total online shopping revenue, excluding cars and real estate, will top $37 billion in the United States by 2002, up from $5.8 billion this year. “There are significant dollars at stake, and I think the states are going to kind of be forced to come to an agreement as to a new tax policy,” said Jupiter analyst Ken Cassar.

Moreover, new uses for the Internet threaten to further cloud the issue.

Internet telephony is a growing technology in which phone calls can be transmitted over the same lines that deliver Web access. Should that business be allowed to operate without taxing consumers while regular phone companies cannot?

Many of those who work for Internet businesses argue it is not the government’s place to protect older industries that are threatened by emerging technologies.

“The Internet is clearly going to hurt a variety of channels, including brick-and-mortar retailers,” said Jerry Kaplan, president of online auction house Onsale Inc. in Menlo Park, Calif. “The less efficient operators are going to lose and the more efficient will win.”

“We could have enacted laws to protect blacksmiths when the automobile came into effect, but I think in retrospect everyone would agree that would be counterproductive.”

Others argue the tax-free policies, even if they last for just two or three years, are giving online businesses an unfair advantage.

“If the Internet is going to grow, it ought to be because of the advantages in the way it delivers goods, not in the way it is taxed,” Leavitt said.