National Policy Analysis Logo

 #278  

 February 2000




Internet Tax Could Doom Web's Freebies

by David Ridenour

 

Freebies that many Internet surfers now take for granted could be eliminated or scaled back if advocates of Internet sales taxes get their way.

Over the past several years, some of the nation's governors and big-city mayors have been pushing hard for new taxes on the Internet. Sales over the Internet are currently treated as ordinary mail order sales, which are exempt from most sales taxes, much to the displeasure of these politicians.

Under a 1992 Supreme Court decision, Quill v. North Dakota, mail order businesses do not have to collect sales taxes from customers living in states where the business has no "physical presence," such as a retail store or office. As virtual retail stores without a "physical presence" in most states, Internet-based businesses are thus also exempt from most state and local sales taxes.

The Internet, which many regard as a key engine for future economic expansion, is already significantly taxed as it is. Notes Americans for Tax Reform's Grover Norquist, "The building blocks of the Internet - phone lines, cable, all telecommunications - are already one of the most heavily taxed parts of the American economy." Indeed, in addition to a federal excise tax, state and local excise taxes average 14.1 percent and are as high as 28.6 percent in Texas and 24.5 percent in Florida.

Some state and local officials apparently don't believe this is enough. The reason? Private studies estimate that Internet sales doubled from 1998 to 1999, growing from $10 billion to $20 billion. State and county governments are no doubt eager to get their hands on a piece of this business by assessing taxes. They want to do so despite the fact that state taxes already represent nine percent of Gross Domestic Product.

Critics of the Internet sales tax proposal argue that these taxes threaten to kill a key economic engine of the future, the Internet. A June 1999 study by Professor Austen Goolsbee of the University of Chicago Business School backs this up. Goolsbee's study found that taxation of electronic commerce would reduce Internet sales by 24 percent or more.

Just imagine what this could mean for the stock market. Millions of investors have paid inflated prices for shares of as yet unprofitable Internet companies on the assumption that profits are on the way. A 24 percent drop in Internet sales could kill many of these enterprises.

And this is only the tip of the iceberg. Many of the free services that many of us take advantage of on the Internet could disappear or be significantly scaled back if sales taxes are imposed. Much of the free stuff we get on the Internet is offered for the explicit purpose of increasing traffic for web pages to make them attractive to advertisers. Fewer Internet sales would mean fewer advertising dollars devoted to the Internet, and many of these free services could disappear.

A good case in point are Internet search engines that make the Internet such a useful research tool. Companies such as Yahoo! and Lycos provide these services - which can be quite expensive to maintain - only because they make money on the advertising. A dip in e-commerce could make a big difference for these firms' bottom lines. Yahoo! only began showing a profit two years ago - and then just eleven cents a share - while Lycos has yet to show a profit. Last year, Lycos lost 60 cents per share and its executives are no doubt hoping continued Internet growth will reverse their fortunes.

OnLineNow is another good example of a free service made possible by advertising. Launched in 1997 from a rental shed in Idaho, OnLineNow offers a quick, easy and completely free way for people to find business information on the web. Called by some a "global yellow pages," visitors to OnLineNow's web page can get the business contact information they need in seconds simply by entering a business category and city or country on the OnLineNow web page. The web page receives over one million hits per day. This valuable service could be in jeopardy, however, if sales on the Internet slow due to the imposition of sales taxes.

But that's not all that's at risk. A good corporate citizen, OnLineNow has donated a million dollars worth of Internet advertising to Kid 4 Tomorrow, a charity founded by former NFL stars L. Rayfield Wright, Andy Livingston and Earl Edwards that offers assistance to "at-risk" students. Among other things, the organization provides drug and alcohol prevention training and peer leadership programs.

This and other philanthropy by Internet-based business could be at risk if the Internet's growth is stymied by taxes.

Some advice to state and local politicians: Keep the economic engine of tomorrow going. Keep the Internet free for all to use.

Keep your hands off the Internet.

# # #

David Ridenour is vice president of The National Center for Public Policy Research. Comments may be sent to [email protected]




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