Taxing the Internet

Thank you, Mr. Chairman and members of the Committee, for the invitation to testify today on legislation concerning the “Streamlined Sales Tax Project.”

Over the past several years, a number of attempts have been made in Pennsylvania to enact the essential first step in extending the Commonwealth’s sales tax to out-of-state purchases—including those made over the Internet. (In Pennsylvania, as you know, such purchases are subject to a “use tax” which is to be remitted by the buyer, but collection of the tax is sporadic, as the state Department of Revenue has acknowledged in the past that the cost of collection would likely exceed the amount of revenue generated.) These efforts, along with similar actions in other states, are aimed at implementing the national initiative known as the “Streamlined Sales Tax Project” (SSTP).

While there has been much talk of “fairness,” “simplification,” and “modernization” as the main goals of the SSTP, a much larger motivation driving this project has been the notion that government is “losing” revenue that it is owed as a result of these online purchases. In short, the belief is that government must continually seek out and capture every possible source of tax revenue. This is a severely flawed approach that has, as practiced in Pennsylvania, undermined its fiscal discipline and severely limited the state’s economic growth and job creation numbers.

Recent Pennsylvania budget data underscore just how profligate state government has been with the taxpayer dollars it already receives. For example, during the last eight-year gubernatorial administration (from the start of the 1995-96 fiscal year to the end of the 2002-03 fiscal year), the average annual inflation rate was 2.4 percent. During the same time period, Pennsylvania General Fund expenditures increased by an average of 3.4 percent annually, or 42 percent above the concurrent average inflation rate. The difference in dollar terms is staggering.

If General Fund spending growth had simply been limited to the previous year’s inflation rate during each of the eight budgets examined here, Pennsylvanians would have seen nearly $7.3 billion more in their paychecks overall between 1995-96 and 2002-03.

When the analysis is expanded to encompass total state operating expenditures, the lack of fiscal discipline from 1995 to 2003 becomes even more glaring. Total state operating expenditures rose from approximately $31.3 billion in 1995-96 to nearly $46.1 billion in 2002-03—an increase of 47.2 percent, or 176 percent above the concurrent rate of inflation. Again, if spending growth had been limited to inflation, taxpayers would have been able to keep almost $27.5 billion more of their money to invest, save, and spend between 1995-96 and 2002-03.

The preceding figures show that just a modicum of spending restraint on the part of Pennsylvania state government would have allowed for even more substantial tax reductions than those actually passed during the time period in question—let alone obviated the search for more revenue.

At the same time that Pennsylvania government was growing at a rate far in excess of inflation, the commonwealth lagged far behind the nation on a number of key economic indicators.

  • Between 1990 and 2001, Pennsylvania’s Gross State Product growth rate was 18.3 percent lower than the national growth rate.
  • Pennsylvania’s employment growth rate was 56.3 percent below the national growth rate between 1990 and 2003.
  • During the same period, Pennsylvania’s personal income growth rate was 22.9 percent slower than the national growth rate.
  • Even more ominous for Pennsylvania’s future is that Pennsylvania’s working age population grew by just 2.5 percent between 1990 and 2000. This paltry growth rate was less than one-sixth of the national rate of growth during the same period.

The desire to take more money from citizens—for which the SSTP is a vehicle—reveals the insatiable spending desire of some politicians. But, again, the problem should be recognized as one of excessive spending, not a lack of revenue. By any measure, Pennsylvanians are over-taxed, not under-taxed. However, even if one disagrees with this premise, extending the reach of Pennsylvania’s sales tax is still bad policy.

In May 2001, The Commonwealth Foundation analyzed the fiscal and economic effects of extending its 6 percent sales tax rate. Using tax revenue data from the U.S. General Accounting Office, our study found that if Pennsylvania had extended its sales tax to include out-of-state purchases in 2002, it would have extracted between $102 million and $380 million in net new tax revenues from consumers and businesses—but the state would have lost the opportunity to create between 24,391 and 92,123 jobs.

Over the period from 2002 to 2004, our dynamic economic model estimated that Pennsylvania would have reaped between $310 million and $1.16 billion in net new tax revenue from citizens—but the state would have foregone as many as 94,794 jobs as a result of the expanded sales tax.

Many supporters of the SSTP process, however, have downplayed the negative economic effects of their plan, viewing it as merely a way to allow states to voluntarily “simplify” and “streamline” their sales and use tax systems, thereby reducing the burden of multi-state tax collection for businesses. But in reality, they want states like Pennsylvania to cede important control over aspects of their sovereign tax systems to a national cartel via a two-step process.

First, a state would be asked to adopt enabling legislation—such as HB 2678—allowing it to enter into a multi-state agreement for the purpose of “simplifying” and “modernizing” its sales and use tax regime. Second, once in the agreement, the state must pass additional legislation conforming its sales and use tax laws to the multi-state plan. With these changes—which will be “significant” for states with “more complicated sales tax laws”—state legislators would need to remain in substantial compliance with the agreement for any future sales and use tax changes.

In addition, these changes would almost certainly require that some items currently exempt or excluded from state sales taxes lose their tax-free status—which, at current tax rates, would lead to a significantly higher tax burden above and beyond that imposed by the extension to out-of-state purchases. In order to avert such an outcome, states losing exemptions/exclusions would need to reduce sales tax rates and/or eliminate other taxes.

The ultimate goal of the SSTP process is that if enough states formally sign on to the agreement, its advocates will be able to convince Congress—the only body that can regulate interstate commerce under the federal Constitution—to allow the states to make their “voluntary” sales and use tax collection system mandatory. Congressional action would be needed because businesses with no physical presence in a given state are not required to collect sales and use taxes for that state—a major stumbling block for proponents.

Supporters of the SSTP also say that they just want to “level the playing field” for “brick-and-mortar” retailers. However, the real competition is not between traditional and online sellers, but between large and small retailers. Many large national retailers are already using some type of electronic, multi-state tax collection system, so they are in a much better position to absorb any additional “streamlined” collection costs than smaller, less established firms—online or not. Also, the proposal would provide taxpayer subsidies to participating business to help them recover these costs.

If followed to its logical conclusion, the “Streamlined Sales Tax Project” would result in a stealth tax hike on Pennsylvania consumers that would enrich the state’s coffers, but also diminish Pennsylvania’s autonomy to shape its tax policy, cost its economy thousands of jobs, and devastate its burgeoning “e-commerce” sector.

There is broad consensus that slow economic growth threatens the Commonwealth’s future. However, this tax increase movement, coupled with the tax increases already signed into law in 2002 and 2003, will, if enacted, bring the precious little economic momentum remaining in Pennsylvania to a grinding halt.

Thank you, and I would be happy to answer any Committee questions.