Taxing e-sales without hindering the 'Net

The growing debate on taxing electronic commerce generally, and Internet transactions specifically, underscores the obsolescence of our current tax system and the need to reform it fundamentally.

The problem is compounded by the fact that both of the major proposals being seriously debated - one to tax "e-commerce" fully and the other to exempt it totally - contain serious shortcomings.

Surely, taxing e-commerce sales as fully as conventional sales will run afoul of all sorts of practical barriers stemming from the continually advancing technology used by this new form of marketing and its complex interaction with numerous state tax structures.

In addition, subjecting this innovative form of doing business to full taxation during its formative period could reduce the prospects for its ultimate widespread use. Although the "infant industry" argument has been abused over the centuries, it is not totally devoid of merit. In view of the interstate nature of so much e-commerce, a race by state governments to maximize their revenues from this new economic activity will be particularly disruptive. It also would expand the role of a tax that falls disproportionately on the poor.

On the other hand, it does seem unfair to base the decision to tax a purchase solely on whether or not it is made through a conventional sales outlet. Yet it seems unlikely that the various state legislatures will be able to design revised sales taxes that effectively and fairly cover e-commerce. The traditional response has been to add complexity to the revenue structure in order to deal with the specific problems that arise. Such a patchwork approach is neither efficient nor sustainable.

What's needed is an overhaul of the US tax system so it can deal effectively with the dynamic, high-tech economy of the future. The starting point should be the conversion of the traditional federal income tax into a comprehensive consumption tax. This means the taxpayer deducts all the saving made during the year when reporting taxable income.

Substantively, the advantages of such a savings-exempt income tax are numerous. Using the truism that income equals consumption plus saving (income less saving thus equals consumption), the new tax structure effectively becomes a tax on all consumption.

This type of "top down" consumption tax generates the various benefits of sales taxation, such as encouraging more saving (the seedcorn for economic growth), hence helping to achieve a rising standard of living.

Moreover, this comprehensive tax would operate without interfering with individual sales or purchases.

The taxpayer would still rely on filing an annual return to determine federal tax liability rather than paying a tax each time a purchase was made.

Also, unlike the "bottom up" sales tax, which is levied on individual transactions, the top-down consumption tax return would contain a rate table. Such a table provides great flexibility in designing a tax structure.

The result could be as progressive a tax as today's income tax, if Congress found that to be desirable. In any event, issues of fairness and equity - which arise so prominently in debates on the merits of sales taxes - would be properly dealt with.

The savings-exempt income tax advocated here possesses advantages not accompanying other proposals for general tax reform. For instance, the designers of a national sales tax would have to face the difficult question of how to handle individual e-commerce transactions. With the flat tax, the criticism remains that it lacks adequate progressivity.

In contrast, my tax proposal would not interfere with the growth of e-commerce, and such consumption outlays would still be subject to taxation.

Because many states key their income taxes to the federal system, they would have full opportunity to base their revenues on the federal tax base reported to the Internal Revenue Service by their citizens.

*Murray Weidenbaum is chairman of the Center for the Study of American Business at Washington University in St. Louis.

(c) Copyright 2000. The Christian Science Publishing Society