Introduction
Many policymakers, journalists, and oth-ers view the debate over Internet taxation infairly narrow terms. They believe the debate isreally about whether or not federal, state, orlocal legislators should “tax the Net.”Consequently, the war of words has focusedon competing bumper-sticker slogans suchas “Don’t Tax the Net” and “Level the TaxPlaying Field.”Framing the debate in this manner grossly underestimates the complexity and impor-tance of the issue. For instance, the don’t-tax-the-net side chooses to ignore the fact that theInternet is not really a “tax-free zone.” Although states cannot force remote vendorsof interstate commerce to collect and remitsales taxes, states have a corresponding “usetax” that requires consumers in their jurisdic-tion to remit the tax owed on out-of-state pur-chases. However, those levies are difficult toenforce. In other words, the absence of use taxcollection is what makes the Internet (e.g.,mail order and catalog sales) appear to be taxfree. Anti-tax activists ought to ask themselveswhether this is really the best way to achievelower tax rates and smaller government. It ispossible that states simply offset tax losses onremote sales by raising taxes on other classesof goods or vendors. Finally, there are legiti-mate tax fairness issues at stake. All otherthings being equal, similar goods and servicesshould be taxed in similar ways.The arguments offered by those peoplewho would like to extend the sales tax toInternet purchases seldom prove valid. Inparticular, the level-playing-field argument—the notion that interstate vendors have a sig-nificant tax advantage over Main Street ven-dors—does not hold water. Indeed, to theextent that there is a genuine level-playing-field problem with regard to the sales tax, it isoften one of the states’ own making, becausethe current system is riddled with exemp-tions and special rules. Attempts to blame the rise of the Internetfor a decline in the sales tax base or state andlocal revenues are completely without merit.Internet business represents a minusculeportion of aggregate retail activity in theUnited States and can hardly be fingered asthe culprit for recent state and local govern-ment budget shortfalls. In fact, according tothe U.S. Department of Commerce, e-com-merce activity accounted for just 1.3 percentof all aggregate retail sales in 2002.
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Regardless, as policymakers debate thiscontentious issue, three themes or principlesshould guide the discussion.
Federalism: A Two-Sided Coin
Although state and local governmentsmust lead reform efforts, Congress has animportant role to play. Although the sales taxis a state and local system, efforts to imposecollection responsibilities on out-of-state vendors automatically warrants some degreeof federal oversight by Congress. Because thedebate is infused with endless talk of protect-ing federalism and states’ rights, it is impor-tant to understand what is meant by thoseterms. Many state and local officials and taxadministrators seem to believe that states’rights means that state and local govern-ments should be free to impose any type of tax or regulatory regime on commercialactivities, even if interstate activities areinvolved. Such an argument shows a misun-derstanding of the federal system that theFounding Fathers set forth in the U.S.Constitution.Federalism is a two-sided coin: one side isstates’ rights and the other is interstate com-merce. The vast majority of tasks undertakenby the federal government since the New Deal have been an unjustifiable usurpationof the powers that the Constitution grantedto the states or the citizenry. But theConstitution was also an explicit rejection of the Articles of Confederation: the disadvan-tages of untrammeled states’ rights weretrade disputes, protectionism, and interfer-ence with the flow of interstate commerce.Consequently, the Founders granted Con-gress the authority to take steps to regulatecommerce among the states—that is, to keep
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Federalism is atwo-sided coin:one side is states’rights and theother is interstatecommerce.
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