Why Subsidize Purchases Made on the Internet?

Can our state and local governments afford to subsidize businesses that conduct their sales only on the internet, rather than through physical retail stores? And if we could, is there a good reason to do so?

These are the two most obvious questions when addressing the issue of whether internet businesses, such as the e-commerce pioneer Amazon.com, should have to collect and pay the same sales taxes as your neighborhood brick-and-mortar music store (if you have one) has to do. Currently they do not.

On the affordability question, the answer appears to be no and getting more no. Fiscal year 2009 begins in a few weeks, and at least 29 states plus the District of Columbia are facing budget shortfalls. According to the Center on Budget and Policy Priorities, these states have faced a combined shortfall of $48 billion, or more than 9 percent of their general fund budgets.

Although many of these states have been taking measures to close their budget gaps, the current projections are likely to wind up being over-optimistic. The recession in this country has barely begun, and most governments are very likely under-estimating their revenue declines for the coming fiscal year. The housing bubble that accumulated between 1996 and 2006 gave homeowners an extra $8 trillion of paper wealth. But what a bubble giveth, it taketh away too, and only about half of this bubble has deflated.

As the rest of the bubble collapses, there will be a lot less property tax revenue to fund schools, police, and other government services. As the recession deepens, unemployment rises, and consumers cut back on spending, state and local government revenue from income tax, sales tax, and other sources will decline more than anticipated. Unlike the federal government, most states cannot borrow to cover an operational budget deficit. This means that they will cut spending, including such items as health insurance for children and low-income families, child care, and elementary education. In fact, at least 18 states are already making these kinds of cuts, and the recession has barely started.

In the last recession, which lasted only eight months and was mild compared to what can be expected this time, more than a million people lost health coverage because of state spending cuts.

So we cannot afford to lose tens of billions of dollars in state and local tax revenues by exempting internet sales. But even if it were affordable, there is no good economic reason to do so. Why should our governments favor far-away internet distribution centers over local businesses? This is not good for local or regional economic development. The problem will worsen as internet sales increase each year.

It has been argued that the burden of following the sales tax regulations for 50 states and thousands of local taxing jurisdictions is too much for internet businesses. But the availability of software and service companies has taken the wind out of this argument. Others complain that sales taxes are in general regressive - that is, such taxes take proportionately more from lower-income groups. This is true, but exempting internet sales makes the tax system even more regressive, since internet buyers as a group have higher-than-average income.

So if your local sporting goods store can collect and pay a sales tax on the running shoes that it sells, the big internet retailers can do the same. No need to give e-commerce a 4 to 9 percent advantage to ship from across the country and use more packaging and delivery services. They can compete on the same terms as everyone else, and stop draining badly needed revenue from our state and local governments.