Why Politicians Shouldn't Rush to Tax the Internet

Use of the Internet has yielded cost savings of $155 billion for U.S. businesses so far, and will produce another $373 billion in cost savings through 2010 - with much of those savings being realized by 2005 - says a new research study sponsored by Cisco Systems. The Net Impact study was conducted by Hal Varian of the University of California-Berkeley, Robert E. Litan of the centrist Washington DC think tank The Brookings Institution, and Austin-based Momentum Research Group.

Researchers looked at how Internet business solutions - initiatives that combine the Internet with networking, software and computing hardware technologies to enhance or improve existing business processes or create new business opportunities - would save companies money and enhance economic growth this decade.

The survey projects that increased adoption of Internet business solutions "could account for 40 percent of the U.S. productivity increase over 10 years, possibly making it the single largest private sector contribution to productivity growth over the next decade."

Why is that important? For nearly three decades after World War II, labor productivity grew at roughly 2.5 percent annually, a pace that enabled the standard of living of the average American to double about every 30 years. Productivity growth slowed to a 1.4 annual average rate from 1973 to 1995 but after that soarded to average growth of about 3 percent a year since 1995. "Virtually no one anticipated that outcome, either inside or outside the government," writes Litan of the Brookings Institution.

In a report, The Economy and the Internet: What Lies Ahead? , Litan and former Clinton Administration economic adviser Alice Rivlin write that "Clearly, heavy investment in computer and telecommunications technology in the 1990s - accounting for as much as a half of all plant and equipment investment in recent years - played a significant role in the recent productivity surge.

"Although the computer and telecommunications revolutions began earlier, they apparently did not have enough impact on business processes, practices and organization to show up in aggregate productivity growth until the second half of the l990s. The macroeconomic conditions of the late l990s - tight labor markets, low inflation, and fierce global competition - also encouraged firms to use new technologies as a way of economizing on labor while surviving in a fiercely competitive marketplace.

But how does the Internet drive productivity growth? Ecommerce - estimated between $100 and $200 billion annually including consumer and business transactions, "is too small in relation to the overall size of the economy to have had much impact on productivity growth," say Litan and Rivlin. "But, all that could and, we believe, likely will change, especially as Internet use becomes more prevalent. Given the recent demise of many of the 'dot coms' that symbolized the Internet revolution, it is tempting to think otherwise. But the real power of the Internet will be felt in the existing, or 'old,' economy,", which Litan and Rivlin expect will "make increasing use of the Internet to deliver benefits to consumers."

"Isolating the potential impact of the Internet on productivity is important because even a few tenths of a percent impact on the growth rate could represent a significant portion of any permanent surge in productivity that is maintained in the future."

Litan and Rivlin identify several ways the Internet will transform the economy and increase productivity growth. It will:
1. Significantly reduce the cost of many transactions necessary to produce and distribute goods and services;
2. Increase management efficiency, enabling firms to manage their supply chains more effectively and communicate more easily both within the firm and with customers and partners;
3. Increase competition by making prices more transparent, and broadening markets for buyers and sellers;
4. Increase the effectiveness of marketing and pricing; and
5. Increase consumer choice, convenience and satisfaction.

Of course, a lot of politicians want to raise taxes on the Internet. Even the leading Republican contender for governor in Tennessee talks warmly about big new taxes on ecommerce. But he and others would be wise to hold off on hobbling the coming Internet boom with new taxes. Jobs and a rising standard of living are at stake.