Industry Comment: Is An Internet Tax In Our Future?

The events of Sept. 11 wiped quite a few media stories of little significance from our collective consciousness. It has been awhile since any reporter breathlessly told us on the evening news how Congressman Gary Condit had spent his day. Also, to the media's credit, O.J. Simpson was able to be the subject of yet another trial, this one about his purported road rage, without taking up front-page headlines across the nation's newspapers. However, we have equally ignored a few proceedings that ultimately may be important in our daily lives. One of these was the expiration of the ban on Internet sales taxes.

The U.S. Congress quietly decided, a few weekends ago, to let the ban on taxing Internet sales expire. While the House of Representatives passed a modified two-year extension of the moratorium, the Senate did not concur. As a result, states are free to do what they will with respect to taxing Internet commerce.

The original moratorium, passed in 1998, prohibited direct taxes on Internet access and special taxes on the sale of goods or services across the Internet. It's interesting to see how we arrived at such a law in the first place.

Under existing statute, each of us who buy on the Web has an obligation to send our state or local government a "use tax" equal to our sales tax. However, there's a big loophole in the ability to collect this money. It's up to each of us to remit it, essentially on the honor system.

As the result of a Supreme Court decision, a business cannot be required to collect this tax for a state in which the business does not have a physical presence. To keep states from becoming inventive about how to touch these funds, Congress decided three years ago to allow a breathing space for E-commerce to grow and for the issues involved to be identified and resolved.

For states, the potential money involved is enormous, with an estimated leakage of more than $25 billion. Sales taxes exist in 45 states and the District of Columbia. Since even in the most jaded of legislative bodies, a billion here and a billion there adds up to real money, it's unlikely that the status quo will remain in place a long time without the protection of a congressional law. The only question is, who will be first to tap this huge source of funds?

The pressure to require collection of sales tax on E-commerce can only increase. With the downturn of the economy, each of our states is seeing its revenue decreasing. Unfortunately, weak economic times are when more money is required for things such as unemployment claims and support for needy people.

Local merchants, who in general have never seen a tax they like, can be counted on to support this one. From their perspective, Internet retailers have the same advantage as telephone catalog outfits; they can offer the buyer a lower effective price because they don't charge sales tax. The savings involved can easily be enough to cost a local store a customer. If you buy a stereo or a computer that costs $1,000 over the Web, the sales tax savings more than cancels out any shipping charge.

The states have been working together to come up with a uniform policy of taxation to eliminate the hodgepodge of local ordinances. They were counting on Congress to provide them with enough time to resolve the multiplicity of issues involved. Now, each state is free to do as it pleases with respect to E-retailers, although there's no reason to expect that enforcement will be any easier than in the past.

What makes sense? It's foolish to believe that the Internet will escape taxation. As the scope of E-commerce continues to increase, the potential revenue to the states becomes more tempting. With the specter of increased taxation, prudent businesspeople will evaluate capital investments and expansions with an eye to what the taxing authorities will do.

It's human nature, however, when faced with uncertainty, to put off spending decisions. In this time of weakened capital investments, that hesitation may well engender a deeper economic slump. No one wants to make the wrong bet when the economy is as unforgiving as it is today.

It's up to the various states and Congress to work together to arrive at an equitable solution to Internet taxation. If we cannot have an additional period of tax abeyance for Internet commerce, then let us at least come up with a rational and fair process to tax E-retailing. One hopes that in doing so, the people deciding how to resolve the issues involved do not kill the proverbial (in this case) Internet golden goose.

There has to be a rational solution to this problem, but I'm not sure what it is. How do you think the sales-tax issue should be resolved? Tell me your ideas in my discussion forum.

Robert M. Rubin is CEO of Valley Management Consultants, a firm specializing in E-business and information technology strategy, organizational design, and evaluation. Before joining VMC, he was senior VP and CIO for Elf Atochem North America, a $2 billion diversified chemical company. The recipient of multiple industry awards, he is a contributing editor to InformationWeek and a member of its advisory board.