The Implications of Electronic Commerce for Fiscal Policy (and Vice Versa)

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P artly as the result of historical circumstance, most people in the United States are not paying sales taxes on their purchases over the Internet. As a result, many state and local officials have become quite agitated that the rise of the Internet will severely erode the state and local tax base. Their fear, as spelled out by Newman (1995), is that “state and local government finances are becoming road kill on the information superhighway.” Although sales taxes on physical goods have received most of the attention, other tax issues such as the taxation of Internet access and international taxation of Internet commerce are also important. In the last two years, a debate over taxes and the Internet has raged at the highest levels. In 1998, Congress passed the somewhat misleadingly titled Internet Tax Freedom Act. Contrary to popular impression, this act did not place a moratorium on sales taxes on Internet purchases, only on discriminatory taxes and on Internet access taxes. The act did create a commission to study the sales tax issues, but the commission was unable to reach a consensus (Advisory Commission, 2000). Congress has since proposed extending the Tax Freedom Act temporarily, but the major issues have not been resolved. In this paper I will consider both sides of the relationship between electronic commerce and fiscal policy. For the impact of electronic commerce on fiscal policy, I will pay particular attention to the potential sales tax revenue losses. The data suggest that the potential losses are actually modest over the next several years. I will also consider the reverse relationship—how fiscal policy affects Internet com-