SYNOPSIS: There's no good reason not to tax the Internet.
CAMBRIDGE, Mass. -- Last week's attacks on the Internet are an exciting subject, about which I have nothing to say. But they did make me think about a less exciting but still important subject: a tax on the Internet. (Apologies to Groucho Marx.) You see, Internet taxation is one of John McCain's signature issues, second only to campaign finance reform. And it so happens that his position is wrong.
Right now, if you buy a book at your local bookstore, you probably pay sales tax. If you order it from Amazon.com, you don't. This unequal treatment is largely due to administrative issues: state and local governments haven't yet figured out how to collect taxes on catalog shopping, let alone e-commerce. But there is also a legal impediment: the Internet Tax Freedom Act of 1998, of which John McCain was a chief sponsor, imposed a three-year moratorium on Internet taxes. And Mr. McCain is the only presidential contender promising to make that moratorium permanent.
Why is this a bad idea? A basic principle of taxation is that different ways of doing the same thing should face more or less the same tax rates. Suppose that there are two bridges connecting the suburban community of Sprawlville to Anytown U.S.A. And suppose that the bridge authority needs to levy tolls to pay for maintenance, interest on its bonds, etc. Should it collect tolls on only one bridge? No. Not only is this unfair to those who have to use that bridge, but it leads to wasted time and money, because some people will take a longer route to work in order to use the toll-free bridge. If revenue must be raised, charging the same toll on both bridges minimizes the associated distortion of incentives.
The same principle applies to any tax. If I really prefer roaming the aisles of a physical bookstore to browsing the Web, but I nonetheless decide to order from Amazon to avoid paying sales tax, my decision has been distorted. So why exempt the Internet from the taxes imposed on the material world?
Mr. McCain likes to talk about consumer savings, exulting in the taxes cybershoppers saved this past Christmas. But those savings (which, like tolls saved by drivers who go out of their way to avoid them, are partly offset by hidden costs) are also lost revenue. The only way to regard them as a net benefit is to suppose both that the loss in revenue will force governments to spend less rather than tax other things more and that the spending forgone is of no value. It is, in short, the slash-taxes-to-starve-the-bureaucrats theory -- which is precisely the theory Mr. McCain rightly derides in his critique of George W. Bush's tax plan.
Mr. McCain also argues that the Internet deserves special treatment because it is nifty -- it's an "engine of growth," cyberspace is the new frontier ("President Jefferson did not send a revenue agent to ride herd on Lewis and Clark") and all that. And of course e-business does claim to be special -- but that's what they all say. When I buy from Amazon instead of my local bookstore, should I feel proud because I am helping settle the electronic frontier or guilty because I am undermining an institution that I will miss when it is gone? Anyway, conservatives are supposed to be against the idea of "picking winners," a.k.a. industrial policy -- that is, having the government second-guess the market, according some sectors special treatment because it thinks that they are more equal than others.
Mr. McCain is not alone in his position. Right-wing think tanks like the Heritage Foundation have blithely brushed aside the normal principles of taxation and their usual opposition to industrial policy -- not to mention their usual solicitude for states' rights! -- when it comes to the Internet. I have always assumed, however, that this is basically a fund-raising ploy. Opposing Internet taxes panders both to crude anti-tax conservatives -- who don't really want to live without a government but can't bring themselves to admit that any tax is necessary -- and to the new money of the cyberelite, which like any elite thinks that it deserves special treatment.
I'd like to think that Mr. McCain isn't engaged in that kind of pandering. So let's hope he's just confused.
Originally published in The New York Times, 2.13.00