After a year of contentious hearings, extensive
testimony, debate, and seemingly endless political grandstanding,
the congressionally appointed Advisory Commission on Electronic
Commerce submitted its final report to Congress on April 12, just
before the deadline required by the Internet Tax Freedom Act of
1998.
Although the commission was unable to generate the two-thirds
supermajority vote required by the act to send a "formal"
recommendation to Congress on the subject of taxing electronic
commerce, a simple majority of its 19 members did agree on a fairly
comprehensive plan that addresses many Internet and
telecommunications tax policy issues.
As
the debate over Internet taxation shifts back to Capitol Hill,
Congress would be wise to study the commission's final report
closely, culling from its thoughtful analysis many important
principles and recommendations. Specifically, lawmakers should look
to establish firm rules for how the government levies taxes on this
vibrant sector in the Information Age. One bill, the New Economy
Tax Simplification Act (S. 2401), has been introduced to do just
that. It would establish a set of ground rules for determining the
types of activities that would be subject to state and local sales
and use taxes.
Establishing such ground rules is vitally
important because it would codify, extend, and clarify
long-standing principles of fair and constitutional taxation that
the Supreme Court has supported for many years. These "nexus"
guidelines would preserve the taxing authority of state and local
governments while simultaneously keeping the interstate electronic
marketplace free of inefficient and potentially unconstitutional
tax burdens. S. 2401, the nexus proposal introduced by Senators
Judd Gregg (R-NH) and Herbert Kohl (D-WI), adheres to these
principles. It would apply the Founding Fathers' governing tenet of
"no taxation without representation" to the thorny issue of
Internet taxation by clarifying that taxes should be levied only on
those companies that have a substantial physical presence in a
taxing jurisdiction.
THE COMMISSION'S REPORT
The
bipartisan Advisory Commission on Electronic Commerce sought to
examine all sides of the Internet taxation issue but in the end was
able to achieve only a simple majority for most of the items upon
which it voted. The commission's final public meeting, which took
place in Dallas, Texas, in late March, demonstrated the difficulty:
It became bogged down in parliamentary procedure and the
obstructionist efforts of some members who hoped to discourage
consensus. Most troubling were the actions of the three members
appointed by the Clinton Administration who consistently abstained
from voting on salient matters.
Under the Internet Tax Freedom Act (ITFA)
of 1998, a formal recommendation on Internet taxation could be
presented to Congress only if it was approved by a supermajority
vote of 13 of the commission's 19 members. The most important and
comprehensive proposal debated by the commission in Dallas,
generally known as the business caucus proposal, received 11 votes.
This proposal recommended:
-
Extending the
current ITFA moratorium on Internet taxes for five years;
-
Prohibiting the
taxation of digitized goods and products and their non-digitized
counterparts;
-
Banning all
taxes on Internet access;
-
Abolishing the
102-year-old federal excise tax of 3 percent that Congress imposed
on telephone calls in 1898 to fund the Spanish-American War;
-
Encouraging
state and local governments to reform industry-specific
telecommunications taxes;
-
Establishing
firm "nexus" rules for electronic commerce to make it clear when
state and local governments could levy taxes on vendors of
interstate commerce;
-
Encouraging
state and local officials to work together to simplify their sales
tax collection systems and make them more uniform; and
-
Establishing a new Advisory
Commission to monitor these ongoing efforts and to determine
whether states and localities should be allowed to collect taxes on
out-of-state Internet vendors once tax code simplification is
complete.
Many
critics of the business caucus proposal, however, claimed that it
represented "special interest politics" that would starve
governments of sales tax revenue and hurt Main Street businesses.
Subsequently, many politicians and business groups that want
Internet commerce to be taxed labeled the commission's effort a
failure and vowed to fight to stop any of its recommendations from
being implemented by Congress.
Despite such acrimony, the commission's
proceedings helped widen public awareness of the issue and provided
an exceptional framework for debating complex tax issues. Moreover,
the business caucus proposal represents a very balanced and
generous compromise among the commission's members, since it
provides a mechanism whereby state and local officials eventually
could tax Internet sales if they simplified their tax systems to
minimize compliance costs for vendors.
The
opposition to the commission's report among many state and local
tax officials typifies a "tax first, reform later" mentality that
the majority of the commission's members rejected. As stressed by
several members, the burden of proof rests on the shoulders of
state and local governments to show that their tax systems and
policies would not unduly burden interstate commerce; only then
should they be allowed to expand their tax collection authority
over interstate transactions. The pro-tax forces, by arguing
against the commission's compromise, apparently want government at
all levels to be free to impose any tax scheme on interstate
commercial activity regardless of the impact it would have on
consumers or companies.
Finally, with state and local surpluses
and Main Street retail business revenues at an all-time high, it is
difficult to accept the "sky is falling" logic of the proponents of
Internet taxes. For example:
-
The National Trust for Historic
Preservation's recently released 1999 National Main Street Trends
Survey finds that sales for historic Main Street districts are
booming and that the overall number of retail stores locating in
historic downtown areas is growing. Moreover, it finds that the
Internet is helping to drive this dramatic growth--increasingly,
historic Main Street businesses are using the Internet to reach
both new and existing customers.
- Similarly, recent U.S. Department of
Commerce aggregate retail sales figures have shown that retail
activity has grown so much in recent months that the Federal
Reserve is contemplating taking steps to ensure that the economy
does not overheat.
OPTIONS FOR CONGRESS
Although it is unlikely that the business
caucus proposal will be adopted in its entirety by Congress, elements of
the plan have been introduced as legislation by various Members.
The most common proposals currently on the table either would
extend the Internet Tax Freedom Act's existing moratorium on
"multiple and discriminatory taxes" on the Internet for another
three to five years or would make that moratorium permanent.
Although this rather uncomplicated
approach has broad bipartisan support in Congress, it unfortunately
would do very little to help resolve the more complicated issue of
how state and local consumption taxes will be levied on sales made
over the Internet. The reason: A moratorium on "multiple and
discriminatory taxes," whether temporary or permanent, would do
nothing to prohibit state and local officials from moving forward
with plans to tax electronic commerce. Congress could take the more
radical step of banning all state and local sales and use taxes on
Internet transactions to solve this matter, but that approach
probably would meet with stiff political opposition and raise a
number of constitutional concerns regarding outright federal
preemption of state and local taxing authority.
The
Gregg-Kohl nexus clarification proposal offers a practical, yet
very principled, solution to this problem. S. 2401 would allow
state and local governments to impose tax collection obligations on
interstate vendors only when they have a "substantial physical
presence" in their jurisdictions.
As
the commission recommended in the business caucus proposal, S. 2401
also would create a series of sales tax "safe harbors" or "bright
line tests" for interstate vendors to clarify when they were
required to remit taxes. For example, under the Gregg-Kohl
proposal, the following activities would not, in and of themselves,
establish tax nexus for interstate vendors of electronic
commerce:
-
The solicitation of orders or contracts
for tangible or intangible property or services that are approved
outside a state and are fulfilled from a point outside the
state;
-
The presence or use of intangible property
in a state, such as patents, copyrights, trademarks, logos,
securities contracts, money, deposits, electronic or digital
signals, and Web pages;
-
The use of the Internet to maintain a Web
site accessible by customers in a state;
-
The use of an Internet service provider
(ISP), on-line service provider or other type of Internet access
provider, or World Wide Web hosting services, to maintain, take, or
process orders via a Web page site or server located in a
state;
-
The use of any service producer for
transmission or communication by cable, satellite, radio,
telecommunication, or similar systems;
-
The affiliation with a person located in a
state unless the person is an "agent" of the business entity who
meets the substantial physical presence standard; and
- The use of independent contractors or
representatives for warranty or repair services.
What
makes the Gregg-Kohl nexus clarification effort so important is
that it provides legal certainty for companies and consumers
engaged in interstate commerce, regardless of what channel they use
(such as the Internet, catalogs, mail order, and 800 numbers). By
codifying firm principles of fair taxation, it essentially
modernizes the Founding Fathers' tenet of "no taxation without
representation" by making it clear that there will be no taxation
without physical presence for vendors engaged in interstate
commerce.
Some
Members of Congress may be reluctant the engage in a debate over
nexus matters because of the issue's legal complexity, or they may
believe that the courts are better able to handle such matters.
Such reluctance, however, would be a serious mistake. Federal
legislators cannot continue to rely on the courts to do their job
for them. Although legislative debate over nexus will be
challenging, Congress accomplished a similar task after debating
income tax nexus policy. Moreover, continuing to rely on
court-based interpretations of nexus is tantamount to a dereliction
of duty and invites endless and costly litigation to resolve what
is, at its core, a congressional responsibility--the regulation of
interstate commerce.
For
policymakers who fear that a debate over nexus will invite a heated
showdown with state and local governments, it is important to
stress that the codification of nexus principles by Congress would
not prohibit all forms of Internet taxation by states and
localities. S. 2401, for example, would provide state and local
officials with clear guidelines on what is constitutional in taxing
interstate goods, services, and technologies. Once these nexus
rules of the road for electronic commerce were in place, states
could choose to tax sales made over the Internet, but they also
would be restricted to levying taxes only on activities that met
the bright-line nexus standards established under S. 2401's
guidelines.
These nexus rules would, in turn,
encourage the states to adopt a clear and constitutional "sourcing"
rule for the taxation of electronic commerce. In other words, by
making it clear that extraterritorial taxation would be prohibited
in virtually all cases, S. 2401 would encourage state and local
governments to adopt an "origin-based" tax methodology under which
they would levy sales taxes only on companies whose principal place
of business resided within their taxing jurisdiction. Sourcing all
sales to the location of origin instead of the destination of sale
would enable state and local governments to impose taxes on
Internet (and catalog) sales in the same way they impose them on
traditional Main Street retail sales.
Unreliable and increasingly unenforceable
use taxes could be completely extinguished under this system, since
governments would tax only transactions that originated in their
states.
Such an origin-based system of electronic commerce would level the
playing field with traditional retail merchants and also fit
squarely within the confines of the Constitution and nexus rules,
since it would meet the requirement that the business must have a
"substantial presence" within a jurisdiction before it can be
taxed. Moreover, it would encourage vigorous state-by-state tax
competition, since governments would need to be wary of the burdens
their tax systems imposed on their companies and citizens.
Other states might reject product-based
sales taxation altogether and instead opt to tax consumption
through an income tax. In other words, instead of trying to
continue the increasingly difficult process of tracing the movement
of goods in order to tax individual consumption, states could adopt
a savings-exempt income tax that excludes all savings from taxation
and taxes the consumption portion of individual or corporate
incomes. This would allow state and local government to continue to
impose consumption taxes while at the same time scrapping their
increasingly unworkable and inefficient sales and use tax
systems.
Keeping in mind the commission's
conflict-ridden proceedings and findings, as well as a legislative
calendar abbreviated by this year's presidential elections, the
most prudent course of action for Congress would be to:
-
Make permanent or extend the
existing ITFA moratorium on multiple and discriminatory taxes;
-
Codify firm nexus ground rules that
clarify how states and localities may impose taxes on electronic
commerce; and
- Abolish the 3 percent federal excise
tax, a century-old "tax on talking" whose repeal has achieved
broad bipartisan support.
This
is a reasonable agenda for Congress this year and, if necessary,
next year. Once the foundation has been established, state and
local officials can decide for themselves what types of tax
reforms, if any, they need to undertake within their
jurisdictions.
CONCLUSION
A
simple extension of the Internet Tax Freedom Act's current
moratorium on Internet taxes will not be sufficient to resolve the
Internet tax impasse policymakers face today. Firm rules of the
road, in the form of codified nexus rules for the economy in the
evolving Information Age, offer the most optimal resolution of this
issue.
A
nexus proposal of the sort found in the Gregg-Kohl legislation
would apply clear principles of fair taxation to the world of
electronic commerce. S. 2401 would not prohibit all forms of
Internet taxation, but it does demonstrate the principle that there
should be "no taxation without representation." Just as this
principle guided America's founding, so too should it govern
policymaking for today's high-tech economy.
Adam D. Thierer is a former Alex C. Walker
Fellow in Economic Policy Studies in the Thomas A. Roe Institute
for Economic Policy Studies at The Heritage Foundation.
Endnotes