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The State and Local Stake in a Federal Digital-Commerce Tax

Europe is heading in that direction. If the idea begins to catch on here, states and localities will need to be at the federalism policymaking table to share in the revenues.

The pandemic has rocked the retail sector, decimating the local tax base. Is revenue sharing through federal taxation of a broad spectrum of e-commerce the answer? (Shutterstock)
New taxes are always unpopular. Macroeconomists and policy wonks generally agree that It is counterproductive and unwise to impose new taxes in the middle of a recession, with the possible exception of a fat-cat income surtax that would not materially impact the economy. However, governments at all levels are desperate for new post-COVID-19 revenue sources.

Meanwhile, the stock market and the economic data both reveal a growing "COVID chasm" between leading digital businesses and smaller companies that rely on local storefront sales and services. The global technology giants' shareholders have recently enjoyed new all-time-record highs. Yet most economists expect that when federal pandemic-stimulus aid dries up, small-business bankruptcies will increase. And the pandemic has accelerated America's migration away from shopping malls and Main Street shops.

Local governments, which are the most highly dependent on property-tax revenues, see this erosion of local commerce most vividly. The stomping elephant in the room is Amazon: Its pre-COVID e-commerce sales were at least seven times those of its nearest competitor, Walmart, and its market share has surged during the pandemic.

All of this sets the stage for policymakers in Washington to begin looking at what might have seemed unthinkable just a few months ago: federal taxation of interstate digital commerce, which could have significant revenue implications for state and local governments if they play their cards right.

President Trump might love to see a tax on Amazon alone: He harbors a personal grudge because of its founder's ownership of the editorially unfriendly Washington Post and because of the recent suspension for "hateful conduct" of the president's campaign-rally videos by Twitch, an Amazon-owned streaming service. Putting Oval Office ire aside, however, it's not far-fetched to think that there could be popular and congressional support for a targeted federal tax on the interstate Internet revenues of all of the goliath digital oligopolies, not only Amazon but also companies like Apple, eBay, Facebook, Google, Microsoft, Netflix and Twitter. A federal tax might also apply to the online sales of other giant retailers with big-box storefronts, such as Walmart.

One rationale for such a tax is the same as the argument for the levies on online sales that states already collect: that it would help to level the playing field for smaller home-town competitors. By some estimates, the behemoth online retailers enjoy a 5 to 10 percent price advantage over local vendors. Aside from products, cloud and software services often escape sales taxes, as do online ads. A federal levy on those revenue streams would appeal to antitrust progressives who want to help smaller, local businesses compete.

The point here is to respectfully spur state and local government officials to start thinking now about how they can tap into a national tax on digital commerce. Even though the total revenue potential today is probably less than $100 billion across all market segments, it's almost inevitable that Congress will eventually need to target this superfast-growing sector of the economy. Whether it's to help pay for swelling federal debt service, national defense, new infrastructure or something like Medicare for All, the low-hanging revenue streams in this sector of the economy cannot be ignored much longer on Capitol Hill. The European Union is already staking its claim.

State and local governments have been fighting U.S. meddling in the administration of their own online sales taxes, in legal disputes over remote commerce. They also have advanced congressional proposals for "marketplace fairness," which would allow states to tax online sales of companies with no physical presence within their borders. My suggestion here is that their policy teams should think outside their sandbox and start working for a healthy piece of a bigger federalist pie. Presuming that Uncle Sam will never tax e-commerce is like believing the earth is flat. There is no state and local constitutional monopoly for sales taxes, and the Constitution's Commerce Clause clearly tells us who holds the winning cards on interstate taxing authority.

Of course, such a tax would have powerful enemies. Industry lobbyists will howl bloody murder while their clients keep raking in billions. Stalwart Tea-Party conservatives in Congress will oppose any new tax reflexively, arguing that it would impede vital economic growth. Alarmists will suggest that it's just a foot in the door for a national value-added tax (VAT) or a federal general sales tax (GST).

Some liberals will resist as well, pointing out that sales taxes are socio-economically regressive. That is untrue, however, for cloud-services revenues and software-as-services for affluent customers. A digital advertisement tax hits businesses, not households. And if richer investors in these mega-cap companies suffer a negative wealth effect from reduced market share, the overall economic impact would not be regressive. Eventually those who complain that the United States is the only developed economy without national health care will someday realize that, alarmists' concerns notwithstanding, we are also the biggest outlier without a national VAT or GST. They could pair any such tax with fat-cat levies such as an income surtax on One Percenters. Political moderates would say this is just the price Americans must eventually pay for years of federal fiscal irresponsibility.

The novel concept of revenue sharing through federal taxation of a broad spectrum of e-commerce is complex and needs thoughtful policy analysis. Many tech startups rely on ad revenues before they can lure users into paying for services directly, so a small-business exemption is essential. Where to draw the line on taxing software as a service and data storage for consumers versus companies will be an issue. An equally obvious challenge will be determining which companies must collect and pay over such taxes, and how to exclude small retailers that use a common platform like Shopify for their online sales. Whether a federal tax on interstate e-commerce should apply to the local or in-state sales by the goliaths that also have physical stores is debatable, unless the in-state revenues are passed down entirely. (While Congress is at it, lawmakers should consider taxing lucrative online gambling, leveraging federal criminal enforcement power over tax evasion by large illegal operators.)

It's hard to imagine the status quo in this realm standing much longer, particularly given the direction Europeans are heading and the mounting congressional discomfort with Big Tech. State and local policy advocates need to play to where the puck is heading.

Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.

Girard Miller is the finance columnist for Governing. He can be reached at
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