Forget taxing Internet sales. In fact, just forget sales taxes altogether.
New York Times; New York, N.Y.; Mar 8, 2001; Hal R. Varian

THE proposed Bush tax cut is getting all the attention, but another tax issue has recently reappeared in the halls of Congress: the thorny problem of how to collect sales taxes on the Internet. A three-year moratorium established by the Internet Tax Freedom Act of 1998 expires in October, and the states are urging Congress to resolve this longstanding issue.

The Supreme Court decided several years ago that one state cannot require businesses in another state to collect taxes for it, since the power to regulate interstate commerce is reserved for Congress.

Although Congress certainly has the power to develop a solution, it is reluctant to take the heat for imposing a ''new'' tax, particularly when it doesn't have the opportunity to spend any of the revenue. But this is a bread-and-butter issue for the states, and they continue to press Congress to take action.

Eventually, Congress will probably bless a system that allows the states to collect taxes on remote purchases -- those made through catalogs or over the Internet -- in exchange for the states' agreeing to simplify and standardize their sales tax rules.

But allow me to propose a more radical solution: states should drop the sales tax entirely and substitute other ways of raising revenue. The sales tax is one of the worst taxes we have, and no amount of chewing gum and bailing wire will fix it.

Sales taxes are a relatively recent phenomenon; most of them were enacted between 1935 and 1937 as temporary measures to raise revenue during the Depression. ''Rejected by most economists as medieval anachronisms,'' the economist John F. Due wrote in 1950, ''the taxes were drawn up hastily, with little thought to their exact aims beyond raising money, their economic effects, or the best structures in terms of the desired purposes.''

Sales taxes have three big defects from an economic point of view. The first is that only 40 percent of expenditures are actually subject to sales tax because purchases of many forms of food and services are exempt in most places.

Economic theory shows that the distortion of economic activity resulting from a sales tax increase is the square of the tax rate. This means that it would be better to have a 3.2 percent tax on all consumption expenditures than an 8 percent tax on 40 percent of them.

The second problem with the sales tax is that it imposes double taxation on business purchases. If a business buys office furniture, it typically has to pay a sales tax. This increases the cost of doing business, which is ultimately reflected in higher prices for consumers. Businesses pay about 40 percent of all sales taxes collected, so almost half of our consumption expenditures are taxed twice.

The third problem with the sales tax is remote purchases. One economic cost of taxing local and remote sales differently is that this distorts business's decisions about where to locate. has bought warehouses in Nevada near the California border to serve the West Coast market, even though a warehouse in California's Central Valley would probably be more cost-effective. But a physical presence in California would make Amazon responsible for collecting sales taxes on items sold to Californians, something Amazon would like to avoid.

If the sales tax is so bad, why is it so widely used? In the minds of politicians, the sales tax has one huge advantage that outweighs its problems: it is a hidden tax. You know how much income tax and property tax you pay each year, but you probably have no idea how much sales tax you pay. This makes sales taxes extremely attractive from a political viewpoint.

A few extra pennies on each purchase doesn't seem like much, but those pennies add up. In 1998, state sales taxes generated about $192 billion, roughly 25 percent of state and local tax revenues. This amounts to about 5 percent of household income and is equivalent to a tax of $2,000 per household. Increasing state personal income taxes 5 percent would raise roughly the same revenue as the sales tax and leave the total tax burden unchanged. It would also avoid double taxation, be much simpler to administer and eliminate the problems with remote purchases, all of which are big pluses.

One supposed advantage of a sales tax is that it is a tax on consumption rather than income. But if you want a consumption tax, there is a much easier way to do it than to track and tax each and every purchase.

Consumption is, by definition, income minus savings, so a tax on consumption is the same as a tax on income minus savings. Since many forms of savings, like Keough plans, I.R.A.'s and pension contributions, are deducted from income before the tax is computed, our current federal and state ''income'' taxes are effectively consumption taxes, at least for many taxpayers.

Making savings tax-deductible is better than direct taxation of consumption since it has much lower administrative costs. And the definition of savings can be adjusted so that only saving that leads to real capital formation qualifies for a deduction.

This brings us back to President Bush's proposal. Cutting federal income tax rates will certainly reduce tax payments, especially for those at the upper end of the income distribution. But another way to cut federal taxes is to make more savings tax-deductible. For example, Congress could increase the maximum I.R.A. contribution from $2,000 to $5,000 and relax restrictions on who can contribute.

Essentially, such a policy would transfer a portion of the forecast budget surpluses into private savings by encouraging baby boomers to put aside more for retirement. Given the problems that an aging population creates for Social Security, if we're going to have a tax cut, it makes a lot of sense to design it to stimulate private savings rather than private consumption.