Should Internet sales be taxed?

Taxes have an important impact on many economic decisions. If two sellers are offering the same product at the same price and same delivery terms, basic economics says that the buyer will purchase the product from the seller whose sales tax rate is lowest. This is why people sometimes drive across a state line to buy something in an adjoining state offering lower taxes. For many years, out of state catalog sales had no sales tax, thereby creating a 5% to 8% discount in many states. Similarly, American citizens purchasing products while in Europe could often obtain substantial VAT (value added tax) rebates by merely signing a form saying they were American citizens making the purchase for use in the United States.

Electronic commerce through the Internet has raised the same domestic and international issues. Through 1998, there was no state or local tax on products purchased through the Internet from companies based in other states. Local governments were quite concerned with this because they realized that purchasers would be less likely to shop at local stores on Main Street if the state sales tax is bypassed because the online merchant is headquartered in another state. Furthermore, with the ability to do business from a Web site virtually anywhere in the world, many companies might be tempted to set up subsidiaries or other trading operations in low tax, off-shore locations, thereby eliminating state and local sales taxes altogether.

Responding to this threat to tax revenues, local governments called for action and asked that purchases through the Internet be taxed just like local purchases on Main Street. Congressional representatives from districts in which the computer industry is a key employer disagreed. Their opposing argument stated that since the Internet was clearly becoming a crucial component of commerce in the 21st century, its development should be encouraged through actions such as continuing the no-tax policy.

Even assuming a consensus emerged favoring Internet taxation, the method for identifying taxable transactions, imposing taxes, and receiving payment was unclear. For example, assume that a Panama-based company sets up an Internet site in Israel that sells to customers in Brazil a product assembled in Mexico from components manufactured in China, Canada, and the United States. Who would determine which country would have direct authority for determining the tax rate and collecting the tax?

Questions:

1. Identify a product that might be purchased either from a local merchant or from an Internet merchant. Explain factors that might make it easier or harder for the Internet merchant to offer the product at a lower total price, including taxes.

2. Identify some of the issues each of the five WCA perspectives highlights in this situation. (Among other things, for example, the performance perspective highlights issues about how well taxes are being collected.)

3. Assume that all purchases from Internet merchants would be taxed. Describe a possible process for determining the applicable tax and for collecting it.

Sources:

"Senate Votes Down Internet Sales Tax," Electronic Buyers News, Oct. 12, 1998.
http://www.techweb.com/se/directlink.cgi?EBN19981012S0090

"Amazon.com Accuses Barnes & Noble of Tax Avoidance," Brian McWilliams, PC World NewsRadio, August 22, 1997
http://www2.pcworld.com/pcwtoday/article/0,1510,5230,00.html

"The Great Internet Tax Drain" by Nathan Newman
http://www.techreview.com/articles/mj96/newman.html

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