Is Tax-Free Shopping Doomed?

Why Not Tax the Net?

Proponents of Internet taxation argue the Net is the same as any other sales channel and shouldn't be exempt from sales taxes. In fact, we do pay sales taxes on some Internet purchases. Laws originally created to cover catalog sales allow states to require businesses to collect sales taxes if the businesses have a sufficient physical presence ("nexus") in a state.

Not surprisingly, many Internet businesses go to great lengths to avoid nexus status in states that have high sales taxes. That is one reason Amazon.com keeps many of its warehouses in Nevada (sales tax as low as 6.5 percent) instead of California (up to 8.5 percent), where more of its customers reside. It's also why some brick-and-mortar franchises like Barnes and Noble created separate companies to do business online. Otherwise, having stores in virtually every state, Barnes and Noble would have had to pay sales taxes on all its online transactions.

Some argue that not taxing Internet sales exacerbates the digital divide. Because wealthier Americans make more purchases online, does forgoing any online sales tax benefit those who don't need the break? This won't be the case much longer, argues economics professor Alan Auerbach from the University of California at Berkeley. If wealthy Americans are already online, where's the growth market? The middle and lower economic classes, Auerbach answers; so imposing taxes now would eventually affect everyone.

But sales taxes are often the most significant source of income for state and local governments. We all rely on local services, and we'll suffer if regional governments can't meet their budgets, say proponents of Internet sales taxes, such as Republican Governor Michael Leavitt of Utah, who serves on the electronic commerce committee.

Leave the Net Alone

Advocates of a continued ban on Internet sales taxes are at least as vocal. They include most of the presidential candidates as well as Virginia's Republican Governor Jim Gilmore, who heads the U.S. Advisory Commission on Electronic Commerce. Some opponents of Internet taxes favor maintaining the status quo for a few more years; others would make the ban permanent.

Those urging a complete and permanent ban argue that government regulation will stunt the Internet market's growth and hamper innovations that have caused e-commerce to blossom.

Governor Gilmore and presidential candidate Senator John McCain (R-Arizona), both opponents of Net taxes, argue that state and local governments suffer no significant revenue loss as a result of online sales. According to a staff representative, Gilmore also believes that Internet commerce bolsters other areas of the economy, enlarging state and local governments' take from such existing revenue sources as income and property taxes and even stimulating local economies so that offline sales tax revenues grow. And Gilmore expects such trade-offs to continue, offsetting future sales tax losses.

Economist Shane Greenstein of Northwestern University's Kellogg Business School, however, considers Gilmore's view shortsighted. Tax-free online sales will eventually cut into state revenues, he says. Recent research by fellow economist Austan Goolsbee of the University of Chicago supports Greenstein's view.