Subj: Future of Taxation: Perspectives of IPI: Center for Technology Freedom From: Bartlett Cleland Institute for Policy Innovation To: Internet Caucus Advisory Committee [Footnotes are not included in the original -- JN] For years supply-siders and other proponents of economic dynamism and limited taxation have complained about static concepts of revenue generation, in which tax policy and tax rates are assumed to have little or no impact on the actual economic activities that generate revenues for the government. In the budget process this static notion has impeded tax reduction by underestimating the revenue take, simultaneously feeding the growth of government in an era of anti-debt mania. In the world of the tax collector this same misbegotten concept has made every technological, marketing, and pro-consumer innovation look like a new 'loophole' that must be closed lest the revenue base be 'gutted'. Consider for a moment why public officials complain about the Internet destroying their revenue base at a time when they have more revenue than they need. One reason is that those 'rational administrators' who dominated the 20th century forgot what we knew as far back as Alexander Hamilton, who observed that sales and excise taxes 'contain limits to their own burden:' that is, at some level of taxation they reach a point of diminishing returns. An 18th century Laffer Curve, as it were. As Hamilton put it in Federalist 22, "taxes on articles of consumption ... prescribe their own limit, which cannot be exceeded without defeating the end proposed-that is, an extension of the revenue. ... If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds." It may be that these types of self-limiting taxes are more appropriate to the national government, where citizens (including corporations) have few opportunities to 'vote with their feet' as they do at the state level. Income taxes, which are not so abruptly responsive to changes in the rate (and which may be modified at the taxable base as well), may be more in need of the 'citizen exit option' to keep them under control, and for that reason may be more appropriate at the state than federal level. Hamilton recognized that direct taxes, such as those on property and wealth as well as income, lack the self-limiting nature of indirect taxes on consumption. That is why he urged explicit constitutional constraints on direct taxes, and why (prior to the 16th Amendment) the Constitution barred direct federal taxes that could not be 'apportioned' among the states, so that the federal government would be obliged to rely on self-limiting indirect taxes. It is also worth noting that if the Internet expands as many predict, state sales taxes may indeed become obsolete unless either 1. levied and collected at the point of origin, i.e. in the 'seller state'; or 2. made nationally uniform to facilitate collection at the point of purchase. It is this conundrum that has no doubt led many Governors to find a constitutionally dubious middle ground of nationalizing the sales tax de facto without nationalizing it in law.41 That kind of exchange of taxing authority needs long thought and careful consideration of how it might ever be implemented without violating the guidelines we have set forth above, particularly how to do it without increasing the overall tax burden and producing a multiplicity of revenue sources at each level of government. The business community, which is interested in a simple, consistent, certain tax regime with which they can live nationwide, certainly does not want that result. But neither should it want a state of tax harmony at the cost of harmonizing the tax burden relentlessly upward. Not every form of simplicity is good for business. But there is another way to apply the static/dynamic dichotomy to tax policy in the Internet era. One reason the 'rational administrators' have been reluctant to embrace lower tax rates and allow 'gaps' in the tax base is that they are wedded to the notion that they, as experts, are responsible for producing and protecting a rational, consistent, seamless revenue system, with the administrators themselves the arbiters of fairness and balance. But as we have seen with regard to income taxation in recent decades, what the tax collector (or legislator) thinks is 'fair' and ' rational' may be nothing of the kind. If the Reagan tax cuts proved anything, they showed the output-maximizing income tax rate is less (sometimes much less) than the revenue-maximizing rate. What politicians and bureaucrats calculate may be 'best' for the public (i.e. the government) may not really be good for the country at all. For a bureaucrat to acknowledge that letting go some of his or her power over revenues (by helping let the market find the output-maximizing rate) would be sacrilege, the ultimate surrender of authority-something Public Choice theory tells us (rightly) that bureaucrats will not do. We don't know yet where the output-maximizing point for Internet commerce may lie, but for once we have a chance to let the market determine that without bureaucratic or political interference. That the Internet's economic dynamism is cranking out income, payroll, and even sales tax revenues for all levels of government - even if (or because?) there may be some inherent slippage in collections due under ideologically-pristine theories of taxation - is undisputed. By all means let's follow the mantra of " Don't Tax the Internet", if we interpret that to mean "let' s let the Internet work its magic in creating jobs, revenues, and new markets before we try to throttle it with obsolete 20th century theories of taxation and bureaucratic management." The Internet is not the ultimate tax shelter, not the cyberspace tax haven the tax professionals decry. It is, or can be, the ultimate catalyst of economic activity, and the most dramatic example yet of the power of markets, unencumbered by heavy-handed government intervention, to make the world a better place. This experiment in freedom needs to go forth and prosper, and it is incumbent on our public officials to hold their fire.