May 26, 1998


by Andy Oram
American Reporter Correspondent

CAMBRIDGE, MASS.—Sometimes I fantasize about being an economist—a position most economists wouldn’t wish on their worst enemies. But the discipline can be very useful when trying to determine the effects of Internet tax proposals now circulating in Congress and the World Trade Organization. Indeed, given the swirl of ideological rhetoric that surrounds taxation issues, at least a stab of intellectual rigor is necessary to understand the true benefits and costs.

The House Commerce Committee approved a bill on May 14 that would put a three-year freeze on certain types of Internet taxes; a similar bill has been introduced into the Senate. Governors and mayors are worried that revenues will evaporate as more commerce moves to the Internet. (A recent report by the eMarketer service firm predicts that Web sales will rise from 7.4 billion dollars this year to 294 billion dollars in the year 2002.)

But the only taxes restricted by the Congressional bills are those directly affecting the use of electronic networks: for instance, a surcharge on dialing into America Online. The bills don’t touch at all on purchases over the Internet.

While the heightened concern over Internet taxes resembles the “modem tax” hysteria that circulated on bulletin boards and the Internet for many years, local governments do have reason to worry. The Internet provides a new channel for mail orders, which are rarely taxed. Furthermore, anti-tax zealots pounce on the Internet controversy with open claws, hoping to score ideological blows and perhaps to slice traditional sources of government revenue on the grounds of parity.

The public must beware here of ideology that serves convenience. Debate over Internet taxation brings out swarms of business folk who decry “government intervention in free markets” and “stifling regulation.” But nearly every one goes on to ask for legal backing where it helps their revenues, such as judicial recognition of digital signatures and heavy-handed copyright enforcement.

The industry spokespersons probably see no contradiction in their positions, drawing a distinction between contractual arrangements and regulation. But to me they both represent policies consciously adopted by government. The general public should take a cue and learn when to ask for regulation that’s in the public interest.

The Clinton Administration has gone much farther than Congress when dealing with the World Trade Organization. After months of lobbying by Americans, the WTO announced on May 20 that it would support tax-free transmissions of goods over the Internet for at least a year. Part of a comprehensive deregulation agreement signed on May 15 by Japan and the U.S. included a similar moratorium.

Even these tax bans are limited to information that can potentially be transmitted online, like movies, online books, journals, music, and software. The food, clothing, and durable goods that we all ship traditionally can still be taxed.

Suppose sales over the Internet were indeed exempted from taxes—what would the effects be? A non-profit organization called the Center on Budget and Policy Priorities—which can probably play economist better than I—predicted in a May 12 news report that the affluent will benefit and the poor will suffer. Since affluent consumers have more access to the Internet and more knowledge about how to use it, they’ll make purchases without paying taxes. The burden of funding government will shift to the have-nots.

But wait! That’s not the end of the story for local governments. Now I get to wield the dismal science. If low-income residents are making all their old-fashioned Second-Wave purchases through local retail stores, won’t their communities maintain their current government revenues? It’s the communities with lots of affluent Internet-surfing consumers that will see a decline in public funding.

To make policy we must be willing to make predictions. These are always risky, and require one to think in technical terms, economic terms, and legal terms all at once. None of us have been trained in all the relevant disciplines, so we must be willing to listen to each other’s speculations.

Richard Shaffer, who used to write for The Wall Street Journal, testified in House Commerce Committee hearings on April 30 that, “If electronic commerce, does, in fact, live up to its promise, it will bring new jobs and greater personal and corporate income tax revenue to the states and cities where it thrives. Other states and cities, however, will lose the sales tax revenue that pays for schools, and roads, and police, unless local governments across the country can agree on a simple, fair way to tax goods and services ordered or delivered on the Internet.”

This thoughtful statement does not specify which communities will be winners and losers. Currently, mail order firms tend to find low-income rural communities with low rents, low taxes, and low standards of living. But that doesn’t mean the Internet will accentuate the trend.

To understand why, we must consider another widely-predicted trend: the push caused by information technology to consumer-driven, just-in-time manufacturing. According to some analysts, you will someday find yourself able to design the car you want right down to the number of dials on the dashboard. Your specifications will be zapped to assembly lines where workers put together a car with your name (perhaps literally) on it.

If the factory fills the order, taxes may be collected there—in a high-wage, unionized, urban community—rather than at mail-order houses of the past. The future depends on a multiplicity of choices made by businesses and governments, of course—and regulation may be part of the picture.

Taxation will probably end up a tiny revenue stream in the Niagara of Internet commerce. What scares many governments is the digital networks’ potential for money laundering and the evasion of both taxes and regulation.

I do not doubt that the Internet will facilitate such evasion, but the rich and powerful seem to be doing pretty well without it. Just look at the revelations trickling out of donations to the major political parties from national and international sources.

Drug money is another example where international finance is already quite propitious for criminals. On May 19 it was reported that U.S. law enforcement arrested 180 people involved in drug money, including bankers at 12 of the 19 largest Mexican banks.

While the federal officials congratulate themselves over their confiscation of a piddling 150 million dollars, the April 1998 issue of Current History reports that Mexico’s drug revenues in 1994 were 30 billion dollars. Even that’s dwarfed by money laundering in East Asia, estimated at 500 to 750 billion dollars a year.

So I can’t see how the Internet can improve on the old-boy network and financial transfer system already in place, so far as criminal transactions go. Internet transactions and digital cash, though, could help ordinary citizens make cheaper purchases and protect their privacy while they’re at it.

And while I don’t expect my economic predictions to win me the big Norwegian jackpot, I hope I’ve shown that the public can make choices. It’s part of government’s role to make regulations that ensure the technological boon is fairly shared.

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