To Tax or Not to Tax: is that the question

July 15 2006 at 9:50pm was the first public tweet. Jack Dorsey, founder of Twitter wrote: "just setting up my twttr.” Today there are more than 200 million tweets per day. As the world celebrates the fifth anniversary of the latest evolution in communications the conflict between the digital world and its physical counterpart is growing. Amazon, the world’s largest online retailer (triple its nearest competitor), and the State of California are poised to go to battle over the state’s newest law requiring online companies to charge and collect state sales taxes. Previously only companies with physical locations in the state were required to charge sales tax. Amazon and others are refusing and there are legal battles as well as PR fights underway in California and elsewhere.

Business owners and legislators in the 12 states that have tried similar efforts argue that online retailers are at a competitive advantage because they don’t have to charge the tax. Consumers by law are supposed to pay the use tax regardless of whether the retailer charges them. (How many of us do?) In California the sales tax rate for the past 2 years was nearly 10%. So if you buy a product for $100 at the store you have to pay $110 whereas ordering the same item on your computer you would pay $100. (For most sites consumers have to pay shipping and handling so any price advantage in total seems to be negligible and having to charge tax on top of that might way become a competitive disadvantage.)

Online retailers argue that since 1922 the law has been clear: sales taxes are to be charged by companies that have a physical presence in the state. When online commerce was in its infancy in the late 1990’s Congress passed several laws (and have subsequently reaffirmed them) that continued the legal precedent of nearly a century.

The internet is the fastest growing, most successful economic innovation in human history. From 1994 to 2011 – seventeen short years – the consumer commercial Internet went from zero to 2.095 billion users (30% of the world population.)

Revenues are significant. E-commerce in 2009 for retail sales was up 4% to $145 billion, part of total online spending of $3.371 trillion.

Sales taxes fund a variety of programs and services – from education to public safety. The idea has always been that if a business resides inside of a particular city, county and state then it’s likely that it and its customers will use and need community services. The merchant collects the tax and pays it to the state on behalf of the consumer is a pass-through proposition where the business has to incur accounting and reporting costs. That cost of business is the result of that company deciding to have a physical presence in that community.

What about those companies who choose not to have a physical presence in that community? Why should they incur costs and increase the price of their product if they’re not going to benefit from the services that the community provides?

The better question is which taxes are effective. Governments have been imposing, collecting and spending tax money since early Egyptian times.  While it would be easy (and naive) to demand that there be no taxes whatsoever, the more productive issue is looking at some of the different types of taxes – sales, personal, corporate, etc.

Most people support corporate taxes because they don’t directly pay them. Consumers pay those taxes indirectly as that cost is passed through in the cost of goods and services. There is much talk these days about closing tax incentives (“loopholes”). Incentives are created as a way of legislating behavior towards a particular result.

When the U.S. government wanted ethanol to become a competitor to oil as a way to reduce reliance on OPEC, launch a new U.S. industry and support farmers --- companies who invested in the development of ethanol were rewarded for this risk by getting tax breaks. The government felt that the potential loss of tax income would be far outweighed by the emergence of a new industry. It didn’t quite work out that way. Take the ethanol example – a well meaning idea with poor results – and multiply it by thousands of other programs and you have a picture of the U.S. corporate tax code. A mess riddled with programs for every conceivable industry. It’s these incentives that result in GE not paying any taxes last year despite record profit.

51% of Americans do not pay personal income taxes. 30% get money back from the IRS without having paid any tax through a variety of programs that largely target and benefit the poor. The top 20% of wage earners pay 68.9% of all taxes.

Sales taxes are generally considered the most regressive. People with limited means wind up paying more in sales taxes as a percentage of their overall income than people who have more money. 45 states have them and there is no national sales tax.

The fact that taxes are used to drive political policy is the problem. The tax code is used not to raise revenue to pay for services, but rather to engineer a society - whether at the individual or the corporate level. After a century of tinkering it’s unwieldy and unfair.

To tax or not to tax isn’t the question, is how to tax. Sounds like a great tweet.