Taxing the Net.

To tax or not to tax, that is the question politicians and America's business leaders are pondering in relation to electronic commerce.

The interlocutors include congressional leaders: Rep. Christopher Cox (R-CA) and Sen. Ron Wyden (D-OR), whose 1998 internet Tax Freedom Act put a hold on new internet taxes for three years. Presidential hopeful Sen. John McCain (R-AZ) wants to make the moratorium permanent. Sen. Ernest Hollings (D-SC) wants to override Cox's act and institute a national sales tax on Internet and catalog sales. Governors, mayors, and representatives of other local governments are eager to get a cut of consumer sales over the Internet, or e-tail, which Forrester Research Inc. pegs at $20 billion in 1999 and expects will increase to $184 billion in 2003. And the business community--with chairmen, CEOs, and presidents of such firms as AT&T, Gateway inc., and America Online leading the charge--is playing a prominent role through associations and ad-hoc alliances and in official capacities on the Advisory Commission on Electronic Commerce, which will advise Congress on the issue.

Sales tax revenue currently accounts for 32 percent of the average state's budget and state and local politicians are worried about the tax-free status of e-tailing. They've fought this fight before, and lost, when they attempted to tax the sales of mail-order catalogs, now a $50 billion-a-year business. States can impose a "use tax" on their citizens who send away for goods, whether by snail or e-mail. But, except for products like cars that states register, it's next to impossible to collect these fees.

The National Governors Association is seeking a "21st century sales tax," essentially a national sales tax, where companies would collect sales tax on every purchase and remit it to the state where the purchaser resides. Commission watchers expect it to either recommend tax simplification, along the NGA lines, or no taxes at all. The biggest surprise so far, however, has been how amenable business leaders have been to the idea of taxing the net. Said leading Web-retailer America Value Chairman Craig Winn in a recent Washington Post interview: "The strong view is that education is dependent on sales tax, and for us to deprive education would be a terrible thing to do. So I think the smart move is to have a national sales tax on Internet commerce and direct mail and telephone sales."

Business' main concern seems to be that the taxes be uniform and easily remitted. The Computer Systems Policy Project, composed of chief executives of such companies at Hewlett Packard, Silicon Graphics, Cisco Systems, Dell Computer, IBM, and Intel, is particularly concerned that e-tailers are free from tax collecting responsibilities. This is no small concern, given that there are nearly 7,000 taxing jurisdictions in the U.S. One study pegs the cost of collecting $1 of taxes from the Internet at $.87, compared with $0.7 at the traditional retail level.

Yet it would be nice if CEOs stood steadfast against taxing the new medium in the name of consumers, rather than just easing the burden on the collectors. The governors' pleas--that state and local government need the money and that it's only fair to tax e-tailers like traditional retailers, lest the latter be put at a competitive disadvantage--are seductive. But each of these arguments withers under scrutiny.

State and local governments are awash in funds. Between 1992 and 1998, state revenues grew at nearly twice the rate of inflation, according to the Cato Institute, a Washington DC-based think tank. The American Legislative Exchange Council, whose members are state legislators, recently declared states to be in the best financial health in over a decade. Furthermore, the untaxed Internet generates some of these revenues. E-tailers and retailers are not locked in a zero sum duel. The Internet expands markets. OfficeMax CEO Michael Feuer told CE in 1998 that "about 25 percent of our site visitors actually make a purchase at our stores."

As for fairness, nothing in our tax system is fair by any objective standard. Some states don't tax goods considered essentials--such as food and clothing. Some have no sales tax. Others choose not to tax income. That consumers can avoid taxes by crossing an electronic border is no different than citizens of Washington State who cross into Oregon to shop tax free or Maryland residents who shop in Delaware. Such choice expands freedom and disciplines government. Competition is good for consumers--whether it be competition among corporations or among governments, however distasteful it is to those forced to compete.

CEOs should keep this in mind as they bargain with politicians.

Sally C. Pipes is president of the Pacific Research Institute for Public Policy, a San Francisco-based think tank that analyzes national economic and social problems and proposes free-market solutions.