Will Retail Still Rule?

How the Internet tax war plays out will have a major role in determining future economic development strategies.
October 2000
William Fulton
By William Fulton  |  Columnist
William is a Governing columnist, director of the Kinder Institute for Urban Research at Rice University and former mayor of Ventura, Calif.

In the very first column I ever wrote in this space, I described the "mall wars" that had broken out between the California town I live in and the neighboring towns along the local freeway. My point was that in America--with our wonderfully decentralized governmental system-- economic development is an "every jurisdiction for itself" proposition.

But there was another point hidden beneath the description of the endless legal and political skirmishes along the freeway, and it was this: Here in the West, where property taxes are frowned on and income taxes are merely tolerated, the sales tax has achieved an almost mythic status among government officials. It may be regressive and unfair, but it's painless. Taxpayers "pay at the pump" and forget about it; in many cases, local voters perceive it as a tax levied mostly on somebody else. Some cities rely on the sales tax for 70 percent or more of their local revenue. Whole states rely on the sales tax to operate.

And in an environment where job growth can sometimes be taken for granted, "economic development" really means enhancement of the sales- tax base. The local economic development director often functions as little more than the minister of retail sales, serving as the emissary to major chain retailers. These folks broker deals to bring the retailers to the nearest freeway interchange--deals that sometimes require them to give away land and urban renewal money and provide necessary infrastructure services to large retail companies, all with an eye on a retail-oriented economic development strategy.

That's one of the reasons local governments are scared of the impact that Internet sales will have on their tax base. It's not just that they fear losing their revenue base because of online retailing. It's because many of them will have to rethink their entire economic development strategy and, perhaps, simply "write off" huge investments they have made based on the assumption that bricks-and-mortar retailing will continue to dominate the economy. And so how the Internet tax war plays out will have a major role in determining future economic development strategies--especially for local governments in the South and West, where sales taxes are critically important.

For now, the federal ban on Internet sales taxes remains in place. In the future, there appear to be two choices: Give the federal government control over collecting and distributing the tax revenue, or feed the byzantine system of state and local tax policies into a giant computer and let the software designers figure it out. Either way, state governments and local officials are likely to have less direct control over their own tax policies. In this way, the future is likely to look a lot like the recent history of California under Proposition 13, where the state determines how the property tax is distributed and local governments spend a lot of their time lobbying state officials to tweak the allocation formula to their advantage.

There may be a silver lining to this dark cloud, and it has to do, ironically, with the very placelessness of the Internet economy.

From the beginning of commerce, market towns have always been more prosperous than the hinterlands around them, simply because of the many spinoff effects of being the location where transactions occur. This has always bred smugness in market towns and hostility in the hinterlands--especially when the resulting tax revenue has worked to the advantage of the market town, which has more revenue to provide public services.

Retail-oriented economic development strategies are simply a modern version of this same rivalry. Ministers of retail sales don't care where the customers or the products come from. All they care about is creating the physical location where transactions take place, because that is the only financial incentive a sales-tax system gives to a government entity. The result, unfortunately, has often been an economic development strategy that focuses on retailing but cares little about jobs in core industries, housing for workers and the other necessary underlying components for retail commerce.

However, in the world of the Internet, the market town ceases to exist. Buyers and sellers don't require a physical location in order to engage in a transaction. And that fact alters the whole question of who should benefit from the tax revenue generated by retailing. Since no town serves as the host of the transaction, the resulting revenue will have to reward towns that host the buyers and sellers. We already see this in the Internet tax wars: States often can levy taxes on e- retailers whose headquarters are located inside their boundaries.

In other words, the Internet may mean that towns will be rewarded with sales-tax revenue for creating housing where buyers live and sites where companies are actually located, rather than subsidizing shopping centers. And that would likely lead to a much more balanced and constructive economic development strategy in sales-tax-oriented areas. The only losers would be the ministers of retail sales, who would become expendable. But maybe that's one job we can do without.