If you think Congress is showing signs of dealing rationally with the nascent online economy by proposing the Internet Tax Freedom Act - a two-year moratorium on state and local Internet-commerce taxes - you're about half right.
Rational? Sure, as far as that goes. It makes sense to keep hungry state tax auditors from strangling ISPs and Web-based retailers in red tape until the industry, the states, and the Feds agree who, what, where, when, and whether to tax in the new realm of online commerce.
It's the "dealing" part of it that's a joke.
Congress and the Clinton administration are spouting the usual free-market rhetoric in supporting ITFA (which will probably pass into law by October). But they're neglecting sticky state-level tax problems that have existed forever, are only growing worse, and are now pitting the online industry against state and city interest groups.
Why won't Congress touch these problems? Because nobody wants to admit that the sacred cow of "devolution" - the decentralization of government from the federal level to states and cities - might be an obstacle to the borderless Web economy. And by taking the quasi-libertarian rhetoric in Washington at face value, the online community may, in the long run, be shooting itself in the foot.
Ever since Reagan began cutting federal subsidies in 1981, sales taxes have zoomed upward nationwide. Some 250 cities added sales tax in 1996; in 1990, only 68 did. According to Jack Ferraioli at Vertex Corp. (which develops automated tax-compliance software), the labyrinth of state tax rates, rules, and exemptions gets more complex every year. This causes a massive administrative burden that's especially hard for small businesses. To make things worse, Ferraioli says, "As the federal money dried up, the states had to get more aggressive" about collecting taxes, even sending auditors across state lines to track down their money.
For 30 years, mail-order companies have avoided state sales taxes by not having a "nexus," or physical presence in a state, but are still making sales to residents. It has created a booming business; buy a computer by mail from Dell, and you don't pay sales taxes unless you live in Texas, Kentucky, or Nevada. (On Dell's invoices, the small print says consumers in other states are responsible for reporting the transactions to their states' tax authority. Needless to say, almost no one does.)
States contend that they are entitled to the money for transactions that cross their borders. But the last time a state took the issue to the Supreme Court, the justices decided that only Congress can come up with a national mail-order sales-tax solution. And whenever Congress has tried to do anything about it, consumer groups and businesses have howled. Now devolution and "no-new-taxes" have created paralysis.
That hungry state-tax bureaucrats try to eat ISPs for breakfast shouldn't surprise anybody in a climate like this.
Mayors and governors were already volubly upset about the Contract with America's unfunded mandates. Now, in their eyes, Congress is rubbing salt in old wounds with the Internet Tax Freedom Act. "We get these additional responsibilities, and at the same time there are growing local and state needs, and we get kicked in the chin" by the ITFA, said Larry Jones, vice president of the US Conference of Mayors. Nobody's against online commerce, he added, but Congress isn't dealing with its potential squeeze on local governments.
Nathan Newman, former co-director of the Center for Community Economic Research at the University of California, Berkeley, predicts a clash between local sales-tax dependence and the Web's globalizing commercial force in his 1995 essay "Proposition 13 Meets the Internet."
"Despite all the rhetoric about decentralization of government," Newman says, "it makes zero sense. In a global information economy, the government that's closest is the government that's appropriate. And it may be the national government is much closer to you for what you need." Newman is blunt about the implications of borderless online commerce: "In reality, new information technologies call for more centralized revenue collection, not less."
Not a pretty picture, is it? Sending tiny encrypted tax packets to some central force with every sale? It's enough to make a libertarian blanch. But there it is. The need for an efficient business environment, no less, may bring it about. Would-be online entrepreneurs may start asking themselves which would be worse - sending money to one lumbering but predictable federal bureaucracy, or to 50 states, many clueless and most voracious.
Don't count on a tax-free Internet in the long run, though. Just walk down to your local main street or mall and explain to the struggling storefront retailer why he should pay sales taxes if an online business doesn't have to. The economy is good right now, but if a downturn came with Internet industry smugly taking advantage of politicians seeking high-tech bucks, political support in mom-and-pop America for a free lunch online could collapse in a week.
Ironically, the Internet Taxation Freedom Act itself shows how Web taxation and regulation issues naturally gravitate to the federal level. Internet industry representatives and the ever-powerful direct-marketing lobby didn't take their concerns to 46 states and several thousand taxing localities to convince them individually of the wisdom of leaving online commerce alone. They went straight to Washington for protection. And they'll get it, in a show of raw federal power. But the regional tax crunch will remain and get worse, as will the broader conflict between local control and the borderless Web.
The states aren't about to synchronize online-commerce policies voluntarily. That's why the Silicon Valley Software Industry Coalition, responding to Clinton's laissez-faire Framework for Global Electronic Commerce, urges the administration to support "nationwide uniform state and local tax laws" that are "easy for businesses of all sizes to comply with." The framework itself says that existing taxes applied to electronic commerce "should be consistent across national and subnational jurisdictions." All this seems to leave the ideal of diffused power, for the Web's sake, pretty much in the dumpster.
Whatever is eventually done about the online-tax mess, it's crucial to keep in mind that the way things are now, with thousands of tax districts and states scheming to get their individual pieces of the pie, it's the small entrepreneurs - those who can't afford dozens of staffers - who are most likely to lose out if states get the power to tax Net commerce. It'll be ironic if the push for decentralized government, the ideal of many netizens, ends up legitimizing their claim to that power.
This article appeared originally in HotWired.
