[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]







                          INTERNET TAX ISSUES

=======================================================================

                                HEARING

                               before the

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 16, 2000

                               __________

                             Serial 106-81

                               __________

         Printed for the use of the Committee on Ways and Means


                    U.S. GOVERNMENT PRINTING OFFICE
67-448 CC                   WASHINGTON : 2001

_______________________________________________________________________
            For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 
                                 20402




                      COMMITTEE ON WAYS AND MEANS

                      BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
BILL THOMAS, California              FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida           ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut        WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York               SANDER M. LEVIN, Michigan
WALLY HERGER, California             BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana               JIM McDERMOTT, Washington
DAVE CAMP, Michigan                  GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas                   MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington            WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia                 JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio                    XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania      KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma                LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida

                     A.L. Singleton, Chief of Staff

                  Janice Mays, Minority Chief Counsel

                                 ______

                       Subcommittee on Oversight

                    AMO HOUGHTON, New York, Chairman

ROB PORTMAN, Ohio                    WILLIAM J. COYNE, Pennsylvania
JENNIFER DUNN, Washington            MICHAEL R. McNULTY, New York
WES WATKINS, Oklahoma                JIM McDERMOTT, Washington
JERRY WELLER, Illinois               JOHN LEWIS, Georgia
KENNY HULSHOF, Missouri              RICHARD E. NEAL, Massachusetts
J.D. HAYWORTH, Arizona
SCOTT McINNIS, Colorado


Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.



                            C O N T E N T S

                               __________

                                                                   Page

Advisory of May 2, 2000, announcing the hearing..................     2

                               WITNESSES

Bell Atlantic Corporation, Victor Gomperts.......................    75
Citizens for a Sound Economy, Erick Gustafson....................    14
Federation of Tax Administrators, Harley T. Duncan...............    52
Harden, J. William, Bryan School of Business and Economics, 
  University of North Carolina at Greensboro.....................     6
League of United Latin American Citizens, Brent A. Wilkes........    79
National Retail Federation, and Ledger Furniture, Les Ledger.....    42
PSINet, John R. LoGalbo..........................................    66
Salons 4 U, and Glow Shop, Ronald R. and Margaret Honaker........    45
60 Plus Association, James L. Martin.............................    84
Software Finance and Tax Executives Council, Mark E. Nebergall...    60
Staples.com, Jeanne Lewis........................................    48
Strauss, Robert P., John Heinz III School of Management and 
  Public Policy, Carnegie-Mellon University......................    18

                       SUBMISSIONS FOR THE RECORD

American Federation of State, County and Municipal Employees, 
  AFL-CIO, statement.............................................    91
Americans for Fair Taxation, Argus Group, Alexandria, VA, Dan R. 
  Mastromarco, statement.........................................    92
CapitolWatch, Andrew F. Quinlan, statement.......................    99
Deloitte & Touche, statement.....................................   100
Federated Department Stores, Inc., Cincinnati, OH, Frank G. 
  Julian.........................................................   103
International Council of Shopping Centers, Alexandria, VA, 
  statement......................................................   105
Joint Venture: Silicon Valley Network, San Jose, CA, statement 
  and attachments................................................   107
Tober, Gary P., University of Washington School of Law, statement    30

 
                          INTERNET TAX ISSUES

                              ----------                              


                         TUESDAY, MAY 16, 2000

                  House of Representatives,
                       Committee on Ways and Means,
                                 Subcommittee on Oversight,
                                                    Washington, DC.
    The Subcommittee met, pursuant to call, at 2:26 p.m., in 
room 1100, Longworth House Office Building, Hon. Amo Houghton 
(Chairman of the Subcommittee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

                       SUBCOMMITTEE ON OVERSIGHT

                                                CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE

May 2, 2000

No. OV-18

           Houghton Announces Hearing on Internet Tax Issues

    Congressman Amo Houghton (R-NY), Chairman, Subcommittee on 
Oversight of the Committee on Ways and Means, today announced that the 
Subcommittee will hold a hearing on Internet tax issues within the 
Committee's jurisdiction. The hearing will take place on Tuesday, May 
16 , 2000, in the main Committee hearing room, 1100 Longworth House 
Office Building, beginning at 2:00 p.m.
      
    Oral testimony at this hearing will be from invited witnesses only. 
Invited witnesses include representatives from the telecommunications, 
software, retail, and Internet access industries as well as 
representatives from State and local government and consumer groups. 
However, any individual or organization not scheduled for an oral 
appearance may submit a written statement for consideration by the 
Committee and for inclusion in the printed record of the hearing.
      

BACKGROUND:

      
    In October 1998, Congress passed the Internet Tax Freedom Act 
(ITFA), Title XI of the Omnibus Appropriations Act of 1998 P.L. 105-
277). The ITFA imposed a three-year moratorium on new, multiple, and 
discriminatory taxes on Internet access and electronic commerce and 
established the Advisory Commission on Electronic Commerce to examine 
issues related to Internet taxation.
      
    The Advisory Commission was given 18 months, until April 2000, to 
study local, State, Federal, and international taxation of commerce 
conducted over the Internet, Internet access, and other related 
activities. The Commission was made up of three representatives from 
the Federal Government (the offices of the Secretary of Commerce, the 
Secretary of the Treasury, and the United States Trade Representative), 
eight representatives of State and local governments, and eight 
representatives from affected businesses. Congress required a two-
thirds majority in order for the Commission to make formal 
recommendations.
      
    On April 3, 2000, the Chair of the Advisory Commission, the 
Honorable James S. Gilmore, III, Governor of the Commonwealth of 
Virginia, transmitted the Commission's final report. A majority, though 
not the super-majority required to make formal recommendations, 
supported a number of measures including the repeal of the three 
percent Federal excise tax on telecommunications services, an extension 
of the current moratorium on multiple and discriminatory taxes on 
electronic commerce for an additional five years through 2006, and a 
moratorium on any international tariffs on electronic transmissions 
over the Internet.
      
    In announcing the hearing, Chairman Houghton stated: ``There is no 
question that the decisions involving taxation of the Internet and 
electronic commerce are bound to shape the dimensions of the new 
economic era. We need to make sure that all Americans have the chance 
to participate in the Information Age. We ought to take a few prudent 
steps to continue the expansion of electronic commerce and at the same 
time avoid crippling the infrastructure that has created so many 
opportunities.''
      

FOCUS OF THE HEARING:

      
    The focus of the hearing will be to consider matters in the report 
transmitted to Congress by the Advisory Commission on Electronic 
Commerce within the Committee's jurisdiction, and related topics, such 
as, the consequences of taxation of electronic commerce, 
telecommunications services, Internet access and measures to bridge the 
digital divide.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Any person or organization wishing to submit a written statement 
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch 
diskette in WordPerfect or MS Word format, with their name, address, 
and hearing date noted on a label, by the close of business, Tuesday, 
May 30, 2000, to A.L. Singleton, Chief of Staff, Committee on Ways and 
Means, U.S. House of Representatives, 1102 Longworth House Office 
Building, Washington, D.C. 20515. If those filing written statements 
wish to have their statements distributed to the press and interested 
public at the hearing, they may deliver 200 additional copies for this 
purpose to the Subcommittee on Oversight office, room 1136 Longworth 
House Office Building, by close of business the day before the hearing.
      

FORMATTING REQUIREMENTS:

      
    Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
    1. All statements and any accompanying exhibits for printing must 
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect or 
MS Word format, typed in single space and may not exceed a total of 10 
pages including attachments. Witnesses are advised that the Committee 
will rely on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
comments in response to a published request for comments by the 
Committee, must include on his statement or submission a list of all 
clients, persons, or organizations on whose behalf the witness appears.
      
    4. A supplemental sheet must accompany each statement listing the 
name, company, address, telephone and fax numbers where the witness or 
the designated representative may be reached. This supplemental sheet 
will not be included in the printed record.
      
    The above restrictions and limitations apply only to material being 
submitted for printing. Statements and exhibits or supplementary 
material submitted solely for distribution to the Members, the press, 
and the public during the course of a public hearing may be submitted 
in other forms.
      

    Note: All Committee advisories and news releases are available on 
the World Wide Web at ``http://waysandmeans.house.gov''.
      

    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.
      

                                


    Chairman Houghton. Thank you very much for coming to our 
hearing. I apologize for being late, we had a little mixup on 
the votes and I think we will be all right for at least another 
hour.
    I would like to say something before I make my opening 
statement. I hope that all the witnesses within earshot will 
remember to keep your statements to five minutes or less 
because we have a lot of people, a lot of issues, a short 
period of time and if you do that, it would be not only 
effective for you but also very helpful for us. Thanks very 
much.
    We are here today to discuss issues that get a lot of 
attention but are not particularly well understood--taxes 
relating to the Internet commerce. To many, the question is 
simply whether one supports or opposes taxes on Internet sales. 
The sales and use tax issues are not that simple. Also, there 
are many other issues that affect Internet commerce that do not 
receive the same attention but are every bit as important.
    Several of our witnesses today will testify as to whether 
Congress should impose taxes on Internet sales and if so, how 
to develop simple and fair ways to collect those taxes. 
Resolving this issue will take quite a bit of cooperation among 
State and local governments, consumers, businesses and also 
members of Congress. We will have to think out of the box and 
explore ideas that have been dismissed in the past or that have 
not even been developed if we hope to resolve the issue.
    Others will testify on issues such as repealing the 3 
percent excise tax on phone services extending, a moratorium on 
taxes on Internet access, and also international tariffs on 
electronic commerce and bridging the digital divide. These are 
issues that affect everyone in this room. They represent 
challenges that can be addressed and resolved relatively 
quickly.
    When we discuss taxes on Internet commerce, let us not 
overlook these important issues which will have a longlasting 
effect on the public. Let us move quickly and decisively to fix 
them this summer if it is conceivably possible.
    I look forward to a lively but constructive debate today 
and I am pleased to yield to our Ranking Democrat, Mr. Coyne.
    Mr. Coyne. Thank you, Mr. Chairman.
    Issues surrounding the taxation of Internet transactions 
continues to be debated throughout the country and here in the 
Congress. Without question, the Internet and e-commerce have 
changed all of our lives and this Nation's economy in very 
positive ways.
    There are many competing views on Internet taxation which 
merit our understanding and discussion. I commend Subcommittee 
Chairman Houghton for scheduling today's hearing. The hearing 
witnesses who will appear before the subcommittee were selected 
with politics aside and to provide a balanced discussion of 
Internet tax issues.
    I want to personally welcome one of our first panelists, 
Robert Strauss, who is joining us from Carnegie-Mellon 
University in Pittsburgh, Pennsylvania. Because the Congress is 
in the midst of approving a series of Internet bills urged by 
the high tech industry, it is important and timely that we step 
back and take a close look at the underlying Internet tax 
issues in controversy today.
    Testimony from our State tax administrators, brick and 
mortar businesses, Internet retailers and dot.coms and high 
technology providers will be most valuable to the oversight 
review today.
    Thank you very much.
    Chairman Houghton. Thank you very much, Mr. Coyne.
    Does anyone else have an opening statement? Mr. Portman?
    Mr. Portman. No, sir.
    Chairman Houghton. Mr. Weller?
    Mr. Weller. I have a brief statement.
    I want to commend you on holding what I feel is an 
extremely important hearing today particularly as we focus on 
some of the issues now presented to us by the new economy.
    There are some interesting statistics out there. Over 100 
million Americans use the Internet. In fact, it just took five 
years for 50 million Americans to use the Internet and it took 
38 years for radio to reach that same market. Clearly more and 
more Americans are going on line to access today's new economy.
    Also, I think it is important to point out that the average 
high tech wage is 77 percent higher than the average wage in 
other parts of our economy and that the Federal Reserve Board 
indicates that one-third of all new jobs are created by 
technology.
    That clearly means there is a tremendous amount of 
opportunity out there. Today we are going to focus on one of 
those issues we look at to find ways to keep the new economy 
tax-free, trade-barrier free and regulation-free. That is the 
tax treatment of Internet access and e-commerce.
    If you look at statistics, some talk about something called 
the digital divide and as we look at who today has access to 
the Internet, we notice in families with incomes of higher than 
$75,000, they are 20 times more likely than those with lesser 
incomes to have Internet access at home.
    If you survey those who do not have Internet access, 
particularly low and moderate income families, they cite the 
cost of Internet access as the chief barrier for their families 
to go on line.
    When I talk to educators back home, whether school board 
members or teachers, administrators or parents active in 
education, they point out they have noticed in the classroom 
that there is a difference when young children compete against 
each other in the classroom between those who have a computer 
at home and those who do not. I think we would all like to have 
every child to have the opportunity to participate in digital 
opportunity.
    Clearly, as we look at some of the issues today, I hope we 
focus on ways of reducing the cost of Internet access. I am 
proud that last week with the five-year extension of the 
Internet tax moratorium there is language in there which 
prohibits new taxes on Internet access from being imposed by 
local and State government. Today we passed legislation which 
would deny the FCC the ability to impose a tax or fee on 
Internet access, so that is progress.
    Tomorrow the Ways and Means Committee--I want to salute my 
friend, Mr. Portman, for his leadership on this--is going to 
vote to repeal the 3 percent excise tax on telephone use. It 
has been there a century. It was established to finance the 
Spanish-American War. That war has been over a long time. It is 
one of those temporary taxes that never went away.
    The reason it is so important is 96 percent of Americans 
who access the Internet use their telephone service, so if you 
impose a 3 percent tax on telephone use, you are increasing 
taxes on use of the Internet. Let us remember aggressive excise 
tax hurts the poor the most.
    Last, I want to call attention to a proposal that 
Representative Lewis and I are offering. We call it the ``Data 
Act,'' legislation which also helps make access to the Internet 
more affordable for working families. We are fortunate that 
many private sector companies have stepped forward to offer 
computers and Internet access as an employee benefit as one way 
of eliminating the so-called digital divide. I want to salute 
Ford Motor Company, American Airlines, Delta Airlines and Intel 
which now are offering 600,000 working families the opportunity 
to have a computer at home. Whether you are the janitor or the 
guy working in the shop or on the assembly line, you will have 
universal access to the Internet via this employee benefit, 
meaning their children will have a computer and Internet access 
at home and be able to do their school work.
    The Net is a good thing, it is good policy and many, many 
other Fortune 100 companies are looking at doing the same 
thing. However, their tax lawyers are telling them that if they 
move forward in providing and Internet access benefit for their 
employees, they are creating a taxable benefit, meaning the 
employees will be taxed.
    That is why the Data Act is so important as we clarify the 
tax code to ensure that the Treasury or the IRS cannot tax that 
computer and Internet access benefit and that it should be 
treated the same as an employer contribution to a pension or an 
employer contribution of health care benefits.
    This is an important hearing. I commend you for conducting 
this hearing. I hope we focus on finding ways to reduce the 
cost of access to the Internet and I look forward to the 
testimony from the witnesses.
    Chairman Houghton. Thank you, Mr. Weller.
    We are going to call our first panel: William Harden, 
Assistant Professor of Accounting, Bryan School of Business and 
Economics, University of North Carolina at Greensboro; Erick 
Gustafson, Director, Technology and Communications Policy, 
Citizens for a Sound Economy; and Robert P. Strauss, Professor 
of Economics and Public Policy, H. John Heinz, III School of 
Public Policy and Management, Carnegie-Mellon University.
    Thank you very much and Mr. Harden, I appreciate you 
passing along your view point on the tax notes. Will you 
proceed?

    STATEMENT OF J. WILLIAM HARDEN, ASSISTANT PROFESSOR OF 
ACCOUNTING, BRYAN SCHOOL OF BUSINESS AND ECONOMICS, UNIVERSITY 
                OF NORTH CAROLINA AT GREENSBORO

    Mr. Harden. Thank you for allowing me the opportunity to 
speak with you.
    As you know, the sales tax has been a substantial method of 
revenue generation for the States. As the transportation 
ability of consumers and mail order distribution methods of 
retailers increased, however, States were forced to implement a 
use tax. The issue of requiring the mail order retailer without 
a physical presence in a State to collect the tax has not met 
with success.
    Electronic commerce is interesting and it possesses 
characteristics of both mail order and traditional retail 
sales. The consumer does not physically move into contact with 
the retailer but at the same time, the electronic store allows 
more interaction than a mail order catalog.
    The implications of imposing this type of tax can be 
examined in terms of two extremes. Referring to the case of the 
tax on an expanding market, Exhibit 1, picture a product in 
which there is a given quantity demanded at various prices and 
a given quantity supplied.
    Next, assume demand for the product is increased. Assume 
the demand is created by the new presence of electronic 
commerce, this will shift the point at which the market demand 
and market supply meet to a higher level of consumption. When a 
tax is added to this scenario, however, the price of the 
product is increased by the amount of the tax. At this higher 
price, the consumer will want less of the product.
    It cannot be known in advance whether the consumer or 
producer will bear the incidence of the tax. What is known is 
that the level of production and consumption will be lower than 
they would have been in the absence of the tax.
    In very simple terms, this is the argument for not taxing 
electronic commerce. The imposition of a tax will slow the 
growth of electronic commerce.
    Next, refer to the case of the effects of a tax on an 
equilibrium market, Figure 2. Visualize a good that is 
available to consumers in two markets. Assume consumers have 
sorted themselves between the markets based on their personal 
preferences so that an equal price appears in both markets.
    Picture a tax added to one of the markets only. This causes 
the price of the good in that market to increase. As this 
occurs, consumers will move to the other market which now has a 
lower price. As consumers relocate their purchases to the new 
market, the price in that market will increase.
    Producers will now shift their products to this untaxed 
market where they can obtain a higher price. Eventually a new 
equilibrium state will occur but consumption levels will have 
increased in the untaxed market and decreased in the tax 
market.
    Again, in very simple terms, this is the argument for 
taxing electronic commerce. Failing to tax such commerce will 
cause a shift in consumption from traditional retailers who are 
required to collect the tax to electronic retailers and the 
States will suffer the erosion of their tax base.
    This situation provides a unique dilemma to the U.S. 
policymakers because the amount of electronic commerce is 
expected to be so large and could potentially dominate 
traditional retail for some products. Retailers are split over 
the issue because those that are electronic only and do not 
possess a physical presence in a State will not likely be 
required to collect the tax. At the same time, retailers who 
possess a physical presence in the State will be required to 
collect the tax.
    This presents an extraordinary result in that the intent of 
interstate commerce protection is to prevent an out of State 
party from being harmed by protectionist activity. In this 
case, however, the in-State party may be at a disadvantage 
since it may be required to charge a larger amount than the 
normal selling price (gross of the sales tax) for the product 
in order to obtain the same profit.
    In contrast, it is also possible that the amount of the 
sales tax will be effectively offset by additional shipping 
charges or other costs facing the electronic retailer.
    If the growth in electronic commerce comes from new 
economic growth rather than simply being a transfer from 
traditional sales, a tax on sales can be expected to slow this 
growth. If this tax combined with other costs is large enough 
to make the electronic retailer no longer price competitive 
with traditional retailers, electronic retailers will fail to 
survive.
    The States, on the other hand, have a reasonable fear that 
their tax bases will be eroded substantially if electronic 
sales are not taxed and the increase in these sales is at the 
expense of traditional retail sales.
    While the use tax is an adequate remedy in the case of 
goods requiring a license, it is not currently thought to be an 
effectively enforceable tax. In addition, there is a policy 
concern that exempting electronic sales from sales tax will 
make the sales tax even more regressive.
    As to the issue of unfair competition between different 
types of retailers, this is a question that will eventually be 
settled by factual evidence. At the present time, we can be 
certain of two things. First, imposing a tax on an expanding 
market will cause a decrease in the amount demanded if 
consumers are price sensitive.
    Second, if the same good is taxed differently in two 
markets where all other costs and revenues facing retailers are 
the same, the one operating with the lower tax will have an 
advantage if consumers can move between the markets.
    Likewise, the issue of whether the States will lose tax 
revenue is not yet settled. If the States cannot effectively 
impose the sales tax, they will certainly lose growth in their 
sales tax base relative to the growth they would have 
experienced had they been able to tax it.
    However, whether their tax bases will shrink relative to 
their current size or how much more slowly their bases will 
grow due to electronic commerce is not known. This question 
will also be decided based on consumer preferences and the 
ability of consumers to move between the traditional retail and 
electronic markets.
    My testimony here, along with the Tax Notes article I have 
written with Professor Biggart, is not intended to recommend 
what action the subcommittee should take regarding the taxation 
of Internet sales. Instead, the hope is you will have a better 
picture of the issues and motivations both for and against such 
taxation.
    I would be pleased to respond to your questions.
    [The prepared statement follows:]

Statement of J. William Harden, Assistant Professor of Accounting, 
Bryan School of Business and Economics, University of North Carolina at 
Greensboro

    Mr. Chairman and Distinguished Members of this 
Subcommittee:

    Thank you for allowing me the opportunity to speak with you 
regarding the subject of the individual states applying sales 
(or use) tax to the sale of tangible goods over the internet. 
This is a complex issue as you are doubtless aware, and 
unfortunately it is highly unlikely that a simple solution 
exists that will be satisfactory to all parties to this issue. 
Following is a background discussion of how we arrived at the 
sales tax dilemma we now face and a discussion of the 
implications of allowing such taxation as well as the 
alternative of disallowing such taxation.

                               Background

    As you are aware, the sales tax has been a substantial 
method of revenue generation for the states, and this is 
particularly true of states that do not impose an income tax. 
At the time of inception of the sales tax over half a century 
ago, the states' ability to employ such a tax was on solid 
ground. Since the majority of sales were made through physical 
retail distribution, it was reasonable to expect retailers to 
keep abreast of the sales tax rate as well as which types of 
goods were subject to the tax. As the transportation ability of 
consumers and mail-order distribution methods of retailers 
increased, however, states were forced to implement a use tax. 
Basically the use tax requires the consumer to pay the 
equivalent of the sales tax if a purchase is made that is not 
subject to sales tax.
    Of course, the product with which such a use tax strategy 
has been successful is the automobile. Because an automobile 
must be licensed, a state has a very simple task in requiring 
the payment of this tax should a consumer go to a different 
state to make the purchase. With unlicensed tangible goods 
purchased through mail-order channels, this enforcement 
mechanism is not present. Compliance with the tax is based on 
consumers paying the use tax to the state or by requiring the 
seller to make collection for the state. The issue of requiring 
the mail-order retailer, without a physical presence (nexus) in 
a state, to collect the tax has not met with success. Retailers 
that possess both a physical retail location in a state and 
provide mail-order sales in state are required to collect the 
tax on those mail-order sales.
    The current issue of electronic commerce is interesting in 
that it possesses characteristics of both mail-order and 
traditional retail sales. The consumer does not physically move 
into contact with the retailer, but at the same time, the 
electronic store allows more interaction than a mail-order 
catalog. It is arguable whether by entering the electronic 
store the consumer has entered into a retailer's ``space.'' 
Alternatively, it could be asked whether the electronic 
retailer has relocated itself into a state by allowing access 
of its electronic store by the consumers in that state or by 
having its electronic store reside on a server located in that 
state.

                        Analysis of Imposing Tax

    The implications of imposing this type of tax will be 
examined in terms of two extremes. This method is chosen 
because these two extremes often represent the expressed 
viewpoints of those parties interested in this debate. Of 
course this analysis is a simplification which looks at the 
issue from the product demand side. Reality lies somewhere 
between the two alternatives and involves more complexity.
    Referring to the case of the effect on an expanding market 
(Exhibit 1), picture a product for which there is a given 
quantity demanded at various prices and a given quantity 
supplied at various prices. Next assume that to this market 
demand for the product is increased. For purposes of this 
present debate, assume the demand is created by the new 
presence of electronic commerce. This will shift the point at 
which the market demand and market supply meet to a higher 
level of consumption. When a tax is added to this scenario, 
however, the price of the product is increased by the amount of 
the tax. At this higher price the consumers will want less of 
the product. Also, it cannot be known in advance whether the 
consumer or the producer will bear the incidence of the tax. 
What is known is that the level of production and consumption 
will be lower than they would have been in the absence of the 
tax. In very simple terms, this is the argument for not taxing 
electronic commerce. The imposition of the tax will slow the 
growth of electronic commerce. At the extreme, it can be fatal 
to the market by causing electronic businesses to be 
noncompetitive.
    Next refer to the case of the effects of a tax on an 
equilibrium market (Exhibit 2). Visualize a good that is 
available to consumers in two markets. Assume there are no 
market problems, and consumers have sorted themselves between 
the markets based on their personal preferences so that an 
equal price appears in both markets. Now picture a tax added to 
one of the markets only. This causes the price of the good in 
that market to increase. As this occurs, consumers will move to 
the other market which now has a lower price (because it is not 
taxed), or will choose not to consume the product. As consumers 
relocate their purchases to the new market, the price in that 
market will also begin to increase, as an indirect result of 
the tax. Producers will now shift their products to this 
untaxed market where they can obtain a higher price. Eventually 
a new equilibrium state will occur, but consumption levels will 
have increased in the untaxed market and decreased in the taxed 
market. Again in very simple terms, this is the argument for 
taxing electronic commerce. Failing to tax such commerce will 
cause a shift in consumption from traditional retailers, who 
are required to collect the tax, to electronic retailers and 
the states will suffer erosion of their tax base. At the 
extreme, electronic businesses could attract so much of the 
market that traditional retailers of some products will not be 
able to keep their doors open and the states would collect no 
sales tax on those products.

                              Implications

    This situation provides a unique dilemma to you as 
policymakers because the amount of electronic commerce is 
expected to be so large and could potentially dominate 
traditional retail for some products. You will doubtless hear 
from many points of view regarding this issue. Retailers are 
split over the issue because those that are electronic only, 
and do not possess a physical presence in the state, will not 
likely be required to collect the tax. At the same time 
retailers who possess a physical presence in the state will be 
required to collect the tax.
    This presents an extraordinary result in that the intent of 
interstate commerce protection is to prevent an out-of-state 
party from being harmed by protectionist activity. In this 
case, however, the in-state party may be at a disadvantage 
since it may be required to charge a larger amount, the normal 
selling price gross of the sales tax, for the product in order 
to obtain the same profit. You will note that this may be, but 
is not necessarily, the result. The cost structures for the 
competing firms may be such that the amount of the tax does not 
have an impact. In contrast, it is also possible that the 
amount of the sales tax will be effectively offset by 
additional shipping or other costs facing the electronic 
retailer.
    If the growth in electronic commerce comes from new 
economic growth, rather than simply being a transfer from 
traditional sales, a tax on sales can be expected to slow this 
growth. If the tax, combined with other costs, is large enough 
to make the electronic retailer no longer price competitive 
with traditional retailers, the electronic retailer will fail 
to survive. Therefore, both types of retailers have competing 
concerns over the issue.
    The states, on the other hand, have a reasonable fear that 
their tax bases will be eroded substantially if electronic 
sales are not taxed and the increase in these sales is at the 
expense of traditional retail sales. While the use tax is an 
adequate remedy in the case of goods requiring a license, it is 
not currently thought to be an effectively enforceable tax, due 
to difficulties in auditing consumers' purchases subject to the 
tax. In addition, there is a policy concern that exempting 
electronic sales from sales tax will make the sales tax, which 
is already considered regressive relative to income, even more 
regressive. Given that access to the Internet has a real cost 
to the consumer, those consumers that do not possess such 
access will be forced into making purchases subject to the tax, 
while those with access can purchase electronically and avoid 
the tax.

                           Concluding Remarks

    In the absence of activity on the part of Congress, the 
issue may not be immediately settled. Those retailers without 
physical presence will still have the judicial remedies 
available to mail-order retailers until the courts alter their 
position regarding nexus or establish a distinction between the 
electronic retailer and the mail-order retailer. Likewise, a 
continuation of the moratorium will not eliminate the ability 
of a state to impose the use tax, equivalent in amount to the 
sales tax, on its own residents. The issue again becomes one of 
enforcement by the states.
    As to the issue of unfair competition between different 
types of retailers, this is a question that will eventually be 
settled by factual evidence. At the present time we can be 
certain of two things. First, imposing a tax on an expanding 
market will cause a decrease in the amount demanded if 
consumers are price sensitive (the price is elastic). Second, 
if the same good is taxed differently in two markets where all 
the other costs and revenues facing retailers are the same, the 
one operating with the lower tax will have an advantage if 
consumers can move between markets (traditional retail versus 
electronic).
    Likewise, the issue of whether the states will ``lose'' tax 
revenue is not yet settled by factual evidence. If the states 
cannot effectively impose the sales tax they will certainly 
lose growth in their sales tax base relative to the growth they 
would have experienced had they been able to tax it. However, 
whether their tax bases will shrink relative to their current 
size, or how much more slowly their bases will grow due to 
electronic commerce is not known. This question will also be 
decided based on consumer preferences and the ability of 
consumers to move between the traditional retail and electronic 
markets.
    My testimony here, along with the Tax Notes \1\ article I 
have written with Professor Biggart, is not intended to 
recommend what action the Subcommittee should take regarding 
the taxation of Internet sales. Instead, the hope is that you 
will have a better picture of the issues and motivations both 
for and against such taxation. I would be pleased to respond to 
your questions.
---------------------------------------------------------------------------
    \1\ ``Tax Internet Sales? The Issue Is Not So Black and White.'' 
Tax Notes. Volume 87, Number 5, May 1, 2000, 705-710.

[GRAPHIC] [TIFF OMITTED] T7448.001

[GRAPHIC] [TIFF OMITTED] T7448.002

---------------------------------------------------------------------------
      

                                


    Chairman Houghton. Thank you.
    Mr. Gustafson?

    STATEMENT OF ERICK GUSTAFSON, DIRECTOR, TECHNOLOGY AND 
      COMMUNICATIONS POLICY, CITIZENS FOR A SOUND ECONOMY

    Mr. Gustafson. Thank you for the opportunity to share my 
views on the work of the Advisory Commission on Electronic 
Commerce, Internet communications taxes and the effect they 
have on the digital divide. I present these views on behalf of 
members of Citizens for A Sound Economy Foundation, a consumer 
education organization that promotes market-based solutions to 
public policy problems.
    The topic of today's hearing has long been an interest for 
us. Our activists were a force pressing for the passage of the 
Internet Tax Freedom Act and CSC Foundation staff and members 
have attended or participated in every meeting of the Advisory 
Commission over the past year.
    We were both pleased by the substance of the Commission's 
full report and frustrated by those commissioners whose 
abstention from several key votes limited the report's formal 
recommendations. We believe that Governor Gilmore and his 
colleagues have provided Congress with a valuable prescription 
for addressing a number of issues confronting consumers in our 
Nation's growing technology sector. In part, the House has 
already acted on the substance of the Commission's report by 
passing the Internet Nondiscrimination Act.
    When we at CSC Foundation examined the topic at hand, we 
began with two tenets essential to our mission. First, 
governments already collect too much money and individuals are 
taxed far too much. Second, excessive taxation and regulation 
of communications services is the greatest impediment to access 
to technology and further compounds the digital divide.
    Consider the following facts. Every State in America began 
the year with a budget surplus, the collective total of which 
exceeded $35 billion. State tax revenues have doubled in the 
last 10 years alone. Last year, State and sales taxes increased 
by 11 percent. State government spending in 1999 was up 8 
percent.
    At a time like this, the tax debate should be focused on 
cutting tax rates for consumers and small businesses, not 
adding new taxes to the Internet. Following the Commission's 
advice would be a solid step in that direction. In fact, 
adopting just three of the suggestions in the Commission's 
report will save American consumers billions of dollars.
    First, repeal the 3 percent Federal excise tax on 
telecommunications services. We all know it has been around for 
102 years and it is time it be repealed. The fact it still 
shows up on our monthly phone bills is another example of how 
difficult it is to remove a tax once instituted, no matter how 
onerous it may be.
    Next, extend the current moratorium on multiple and 
discriminatory taxation of electronic commerce for a minimum of 
five years. When the Internet Tax Freedom Act was passed, the 
Internet itself was in its infancy and e-commerce was virtually 
nonexistent. Today the specter of the taxes, right of way taxes 
and other onerous tax schemes are little more than a pigment of 
the overactive imagination.
    Also make permanent the current moratorium on Internet 
access taxes. Taxes raise the cost of going on-line and keep 
many Americans off-line every year.
    Each of these recommendations is a step in the right 
direction but undoubtedly someone will tell you America cannot 
move forward. You may hear that States and cities will lose too 
much revenue, that small mom and pop retailers are unable to 
take on a global market or that no retailer can compete against 
an Internet tax advantage.
    These arguments are unable to withstand a basic factual 
analysis. In the fourth quarter of 1999, the most recent 
holiday season, total retail sales exceeded $526 billion. Of 
that total, on-line resales constituted just $5.3 billion or 
.64 percent. To claim that States and cities will not be able 
to fund schools or law enforcement because of revenue lost to 
Internet sales is pure demagoguery.
    Small business have embraced the Internet in droves despite 
facing unfamiliar technologies and unproven ways of reaching 
customers. A newly released survey shows that small businesses 
out spent consumers by more than $5 billion last year as they 
made travel reservations and purchased office and computer 
equipment in record numbers.
    Those small businesses that do venture on-line find it far 
from being a threat. The Internet actually adds to their 
profitability. The Internet economy accounts for nearly one-
third of our Nation's economic growth. It is estimated that if 
taxes were applied to on-line sales, the growth in that new 
technology sector would be slowed by 24 percent. Intervention 
in the high tech market place creates fear and uncertainty 
among investors and threatens to destroy our economy and weaken 
the tax base.
    At the start of the 21st Century, we have both the 
opportunity and the ability to give consumers the full benefits 
of high technology without harming main street or state 
governments. The Advisory Commission on Electronic Commerce has 
pointed us in that direction. I urge Congress to heed their 
advice and send a strong message that the Internet will remain 
free from heavy government taxation.
    Thank you.
    [The prepared statement follows:]

Statement of Erick Gustafson, Director, Technology and Communications 
Policy, Citizens for a Sound Economy

    Mr. Chairman, and members of the Committee, thank you for 
the opportunity to share my views on the work of the Advisory 
Commission on Electronic Commerce (ACEC), Internet and 
communications taxes, and the effect they have on the digital 
divide. My name is Erick Gustafson, and I present these views 
on behalf of the members of Citizens for a Sound Economy 
Foundation (CSE Foundation), a consumer education organization 
that promotes free market solutions to public policy problems. 
At CSE Foundation, I am the director for technology and 
communications policy.\1\
---------------------------------------------------------------------------
    \1\ CSE Foundation does not receive any funds from the U.S. 
Government.
---------------------------------------------------------------------------
    More than a quarter-million strong, CSE Foundation's 
members are in every congressional district of America. Our 
members distinguish themselves as policy activists. They 
constantly remind us that decisions made in Washington, D.C., 
are felt in places far away from here; and that is where CSE 
Foundation is found. We at CSE Foundation believe that 
individual liberty and the freedom to compete expands consumer 
choice and provides individuals with the greatest control over 
what they own and earn.
    The topic of today's hearing has long been an interest for 
CSE Foundation. Our activists were a force pressing for passage 
of the Internet Tax Freedom Act and CSE Foundation staff and 
members have either attended or participated in every meeting 
of the Advisory Commission over the past year. We were both 
pleased by the substance of the Commission's full report and 
frustrated by those Commissioners whose abstention from several 
key votes limited the report's formal recommendations.\2\ 
Despite differing with the Commission on a few key points, we 
believe that Governor Gilmore and his colleagues have provided 
Congress with a valuable prescription for addressing a number 
of issues confronting consumers and our nation's growing 
technology sector.
---------------------------------------------------------------------------
    \2\ More than seven members of the Advisory Commission on 
Electronic Commerce abstained on 10 key votes during the Dallas Meeting 
on March 20-21, 2000.
---------------------------------------------------------------------------
    In part, Congress has already acted on the substance of the 
Commission's report by passing The Internet Nondiscrimination 
Act (H.R. 3709). This legislation would extend the current 
moratorium for five years and terminate a communications 
service tax currently being charged to some consumers for 
Internet access.
    When we at CSE Foundation examine the topic of Internet, 
communications taxes, and the digital divide, we begin with two 
tenets that are central to our mission:
     Governments already collect far too much money, 
and individuals are taxed far too much; and
     Excessive government taxation and regulation of 
communication services is the greatest impediment to access of 
technology and further compounds the digital divide.
    Consider the following facts: Every state in America began 
the year with a budget surplus, the collective total of which 
exceeded $35 billion. State tax revenues have doubled in the 
last 10 years. Last year alone, state taxes increased by 11 
percent. State government spending in 1999 was up 8 percent. 
\3\
---------------------------------------------------------------------------
    \3\ Background for these tax statistics available upon request.
---------------------------------------------------------------------------
    At a time like this, the tax debate should be focused on 
cutting tax rates for consumers and small businesses, not 
adding new taxes on the Internet. Rather than exploring new 
ways to tax the engine of our economic growth, government 
should be looking for ways to end outdated taxes and open the 
doors of the Internet to everyone. Following the Commission's 
advice would be a solid step in that direction. In fact, 
adopting just three of the suggestions in the Commission's 
report will save American consumers billions of dollars.
    Repeal the 3-percent federal excise tax on 
telecommunications services. The 3-percent federal excise tax 
on telecommunications services was introduced to fund the 
Spanish-American War. This tax costs Americans nearly $6 
billion each year simply for the ``luxury'' of keeping a phone 
in the house.\4\ The fact that this tax is still on our monthly 
phone bills 102 years after the Spanish-American War ended 
demonstrates just how difficult it is to remove a tax. 
Regrettably, this is just one of the many taxes and outdated 
regulations that make it more expensive for Americans to go 
online. We won the Spanish-American War more than 100 years 
ago; yet, the wartime levy still exists--it is time we win the 
war against taxes that expand the so-called digital divide.
---------------------------------------------------------------------------
    4  Mark Zuckerman, ``From 'Remember the Maine' to 'No New Taxes': A 
History of the Telecommunications Excise Tax'' Citizens for a Sound 
Economy Foundation, July 29, 1999.
---------------------------------------------------------------------------
    Extend the current moratorium on multiple and 
discriminatory taxation of electronic commerce for a minimum of 
five years. When the Internet Tax Freedom Act was passed, the 
Internet itself was in its infancy and e-commerce was virtually 
non-existent. Today the specter of bit taxes on emails, right-
of-way taxes on the transfer of information, and other onerous 
tax schemes are little more than a figment of overactive 
imaginations. Had any of these plans been allowed to take hold 
or had the Internet been treated differently from other types 
of remote sales it is extremely unlikely that we would have the 
economy we know today. The Senate should, without delay, follow 
the lead of the House and act to extend the current moratorium 
so that discriminatory taxes do not threaten electronic 
commerce. To preserve our rapidly expanding economy we must 
continue to allow consumers, small businesses, and students to 
browse, shop, and learn online without facing unique and 
harmful taxes.
    Make permanent the current moratorium on Internet access 
taxes. Taxes at the on-ramp to the Information super highway 
raise the cost of going online and keep too many Americans 
offline every year. Consumers pay between 20 percent and 30 
percent in taxes on communications services--tax rates similar 
to those on ``sin'' taxes.\5\ By imposing regressive rates of 
taxation while simultaneously proclaiming the need to rapidly 
expand technology to all regions and income levels, government 
officials only ensure that taxes will hit hardest those who can 
least afford it. Policymakers must understand, as they look for 
ways to bridge the digital divide, the best way to give 
consumers the full benefits of high technology is by removing 
the high taxes and obsolete government regulations that are 
barriers to competition and innovation.
---------------------------------------------------------------------------
    \5\ Jeffery Eisenach, ``The High Cost of Taxing Telecom,'' study 
prepared for presentation to the Advisory Commission on Electronic 
Commerce, September 14, 1999.
---------------------------------------------------------------------------
    CSE Foundation has long asserted, and a study by the 
Stanford Institute for the Quantitative Study of Society 
(SIQSS) has found, that eliminating taxes and regulations is 
the best approach the government can take to bridge the digital 
divide. The Stanford study found that demographics only account 
for 20 percent of the digital divide. Unfortunately, government 
efforts at bridging the digital divide have traditionally been 
designed to target specific demographic groups. This study 
indicates that these types of programs will not solve the 
problem. If government truly wants to get more people online 
the best solution is to lower the cost of going online. There 
are numerous free Internet Service Providers (ISPs), but 
Internet access fees and highly taxed phone lines are barriers 
to these ISPs. By eliminating discriminatory taxes on 
communications, the government could lower the cost of going 
online and take a huge leap forward in eliminating the digital 
divide. Now is the time for Congress to act and ensure that 
taxes will not keep Americans offline.
    Each recommendation is a step in the right direction, but 
undoubtedly someone will tell you that America cannot move 
forward. You may hear that states and cities will lose too much 
revenue, that small Mom-and-Pop retailers are unable to take on 
a global electronic market, or that no retailer can compete 
against an Internet tax advantage. Know that those who tell you 
such things either seek to increase tax revenue or to protect 
existing business models from competition.
    In the fourth quarter of 1999, the most recent holiday 
season, total retail sales exceeded $526 billion. Of that 
total, online retail sales constituted just $5.3 billion or 
0.64 percent.\6\ To claim that states and cities will not be 
able to fund schools or law enforcement because of revenue lost 
to Internet sales is an outright lie. The fact is, in spite of 
all the media attention lavished on e-commerce, an overwhelming 
number of retail sales still take place at bricks and mortar 
retailers. Moreover, Internet sales are subject to sales taxes 
in many instances--the same as catalogue sales have been for 
decades.
---------------------------------------------------------------------------
    \6\ ``Retail E-Commerce Sales for the Fourth Quarter 1999 Reach 
$5.3 Billion, Census Bureau Reports,'' U.S. Department of Commerce 
News, March 2, 2000.
---------------------------------------------------------------------------
    Researchers at the University of Chicago and Harvard 
University recently calculated the impact of Internet 
transactions on sales tax revenue. They found that online 
transactions reduce state and local revenues by only $430 
million annually--less than one-quarter of 1 percent of total 
sales tax revenues. Industry watchers expect online sales to 
grow by 70 percent per year over the next few years, but even 
then, the revenue lost will represent less than 2 percent of 
sales tax revenue in 2003.\7\
---------------------------------------------------------------------------
    \7\ Austan Goolsbee and Jonathan Zittrain, ``Evaluating the Costs 
and Benefits of Taxing Internet Commerce'' (Manuscript, May 20, 1999).
---------------------------------------------------------------------------
    Small businesses have embraced the Internet in droves 
despite facing unfamiliar technologies and unproven ways of 
reaching customers. A newly released survey shows that small 
businesses outspent consumers by more than $5 billion last year 
as they made travel reservations and purchased office and 
computer equipment in record numbers.\8\ Those small businesses 
that do venture online find that, far from being a threat, the 
Internet actually adds to their profitability.
---------------------------------------------------------------------------
    \8\ Access Markets International Partners Survey, released May 15, 
2000.
---------------------------------------------------------------------------
    The Internet economy accounts for nearly one-third of our 
nation's economic growth. It is estimated that if taxes were 
applied to online sales, growth in the technology sector would 
be slowed by 24 percent. Intervention in the high-tech 
marketplace creates fear and uncertainty among investors and 
threatens to destroy our economy. The government must be 
stopped from taxing to death the goose that laid the golden 
egg.
    At the start of the 21st century we have the opportunity 
and the ability to give consumers the full benefits of high 
technology without harming Main Street or state governments. 
The Advisory Commission on Electronic Commerce has pointed us 
in that direction, I urge Congress to heed their advice and 
send a strong message that the Internet will remain free from 
the heavy hand of government taxation.
      

                                


    Chairman Houghton. Thank you.
    Mr. Strauss?

  STATEMENT OF ROBERT P. STRAUSS, PROFESSOR OF ECONOMICS AND 
  PUBLIC POLICY, H. JOHN HEINZ III, SCHOOL OF MANAGEMENT AND 
    PUBLIC POLICY, CARNEGIE-MELLON UNIVERSITY, PITTSBURGH, 
                          PENNSYLVANIA

    Mr. Strauss. Thank you for the invitation.
    I have a ten-page statement that I would like included in 
the record. I have a one-page summary that I would like to go 
through.
    I think my remarks are perhaps more germane for an odd 
numbered year but perhaps by the end of my testimony, you will 
see merit in having the Treasury and Joint Tax Committee 
jointly look into ways the Federal Government can aid the 
States to collect use tax and have some hearings on the report.
    There are four premises to my remarks. First, the Internet 
needs a Federal steadying hand to promote web commerce. Also 
the States need to be able to collect use taxes from residents 
who don't pay them, but who are legally responsible to do so 
under current State use tax law.
    Second, State sales and use taxes are nothing to be proud 
of for citizens in any State. Taxes may be the cost of 
civilization but the way we tax ourselves in the States under 
consumption taxes is hardly worth bragging about.
    The table behind this one-page outline indicates that 
business on average pays 40 percent of consumption taxes in the 
States, which causes both inefficiencies and hides the true 
cost of government. I think both of those are unfortunate and 
to be avoided.
    Third, there is an obvious need to simplify State sales and 
use taxes, especially at the local level and move to one tax 
rate per State, and to do so in return for an expanded duty to 
collect and remit use by remote vendors.
    Business and government have been close to agreeing on 
this, but negotiations outside of the Congress have basically 
stopped, they are asking, at least on the business side, for 
more time.
    Fourth, final consumption should be the base of any sales 
tax. The States could readily lower their rates in many 
instances if they broadened the base to total consumption and 
eliminated business taxes on inputs.
    I have some numbers on this base broading matter. New 
York's sales and use tax rate could go from 4 to 2.6 percent if 
it was just on final household consumption; Pennsylvania could 
drop from 6 to 3.9 percent; California 6 to 5.6 percent and so 
forth.
    When you look at income taxation, the Internal Revenue Code 
has provided a template that the States have moved towards in 
the case of personal and corporate income taxes, but there is 
no such template in the consumption tax area. If there were a 
Federal sales tax, there might be something the States could 
agree on and that would simplify their systems.
    I don't think, given my reading of the economy and the 
kinds of debates that have occurred in this committee literally 
over the last ten years, that a national sales tax for States 
to piggy back on, or to move towards, in terms of a template, 
is a realistic option.
    What I would like to suggest to you next are four different 
ways this committees with jurisdiction, Ways and Means and 
Finance, could use its powers to enable the States to collect 
use taxes broadly and simplify consumption taxes dramatically.
    Last year, Senator Hollings introduced a 5 percent sales 
tax as a mechanism to encourage States to move towards that and 
if they did the tax would credit out. The difficulty with this 
kind of approach is that it mandates what the rate should be 
for the States. I think State sovereignty issues would 
overwhelm that sort of approach.
    Earlier last year, I suggested modifying the tax credit 
eligibility for FUTA to require vendors to collect and remit 
use taxes into States they sell into as one sort of Federal 
approach that would have the Internal Revenue Code encourage 
vendors to collect and remit.
    A second approach would be to create the construct of a 
``qualified sales and use tax base'' in the Internal Revenue 
Code and impose a ten percent excise on vendor sales into a 
destination State unless the vendor collected and remitted that 
State's use tax to the destination State, and, in so doing, 
would not be subject to the 10 percent Federal excise tax.
    Another variant of this, which could be done by the 
Commerce and Judiciary Committees, would be to make that 
mechanism I just described a penalty rather than a tax per se.
    These three approaches don't require the IRS to actually 
touch the use tax money. They do create templates against which 
the States would gravitate and would also leave the States free 
to choose the rate of tax, and make our consumption taxes far 
more transparent than they are today.
    This is probably not something that you want to jump on 
today, but come next year or the year after when main street 
becomes more persuasive, I suggest it is something you might 
want to take a look at.
    Thank you very much.
    [The prepared statement follows:]

Statement of Robert P. Strauss, Professor of Economics and Public 
Policy, H. John Heinz III, School of Management and Public Policy, 
Carnegie-Mellon University, Pittsburgh Pennsylvania

                            1. Introduction

    Chairman Houghton, Congressman Coyne, and members of the 
Ways and Means Subcommittee on Oversight, I want to thank you 
for the opportunity to testify this afternoon on certain state 
tax issues which arise from commerce occurring over the 
Internet. It has not been fashionable in recent years to view 
federal, state, and local taxes as intertwined. However, 
growing world economic interdependencies due to the spread of 
market economies and technological change obviously imply 
greater financial interdependencies for our governments.\1\ It 
is my judgment today that the states can not resolve such 
issues themselves. Federal legislation is necessary for the 
states to have a sensible structure of revenue instruments 
which will allow them to decide the rate of consumption tax 
necessary to finance the level of public services they agree 
on. As an alumnus of the US Treasury and Staff of the Joint 
Committee on Internal Revenue Taxation, I have some preference 
that such federal legislation as I describe below be the 
responsibility of the tax writing committees of Congress. You 
and your staffs have the expertise to deal with the 
complexities of design and fiscal implications of such design.
---------------------------------------------------------------------------
    \1\ The original 1913 federal personal income tax recognized such 
interdependencies by requiring all taxpayers to deduct state and local 
taxes in arriving at federal taxable income. At that time, federal 
ability to pay was thought to occur after taxpayers took care of their 
state and local tax responsibilities.
---------------------------------------------------------------------------
    There is a need in my view for a steadying federal hand in 
both the areas of electronic commerce and its taxation. In the 
case of especially retail electronic commerce, it will not 
flourish until there are in place, counterpart to existing 
paper institutions, electronic institutions that establish 
trust, customer-merchant and merchant-customer protections. It 
is difficult to envision Americans parting with large fractions 
of their incomes across the net for goods and services unless 
they are certain they are as protected as when they engage in 
face to face commerce. Since much of the appeal for electronic 
commerce is its increased speed across jurisdictional 
boundaries, only the federal government can effectively devise 
systems of standards that will make the appeal a reality. 
Related to the establishment of various standards for 
authentication, electronic record-keeping, and electronic 
notary services, is the supervision of such trusted third 
parties. For example, as the IRS and tax committees of Congress 
are learning, simply enabling but not closely supervising 
private agencies to transmit important electronic documents 
does not always work as planned.
    In my remarks to you this afternoon, I shall address 
alternative ways the tax committees of Congress can, through 
federal legislation, enable the states to deal constructively 
with their various consumption taxes. My focus will be on the 
use tax problems that arise from inter-state retail sales on 
the Internet, and alternative ways federal legislation can 
solve them.

2. The Problems of State Sales and Use Taxes and Possible 
Federal Roles

2.1 Problems of State Sales and Use Taxes

    Over time, state personal and corporate income taxes have 
become increasingly similar to their federal counterparts. 
Because there is no federal retail sales tax, there has been no 
comparable federal template for the states to choose to 
gravitate to. As you know, state sales and use taxes are 
extremely important to state budgets, and in some states, the 
same is true for local sales and use taxes. Among the states, 
the structure of state sales and use taxes vary considerably. 
Whether the seller or customer is liable for the tax, the 
precise nature of whether a good or service is taxable, the 
rate, and a myriad of other administrative provisions vary. As 
a result, it is very difficult for a customer or vendor new to 
a state, let alone a local area, to be confident about what 
their duty to collect and remit is.\2\
---------------------------------------------------------------------------
    \2\ See, Due, John and John L. Mikesell (1994). Sales Taxation: 
State and Local Structure and Administration. Second Edition. 
(Washington, D.C.: Urban Institute Press, 1994).
---------------------------------------------------------------------------
    Also, the fact that current sales and use taxes are 
substantially imposed on business input purchases is troubling 
from both economic and political perspectives. Such hidden 
taxes encourage purely tax motivated changes in business form 
(vertical integration), and hide from voters true tax burdens.
    Table 1 displays the design decisions each state makes with 
regard to its sales tax. The Constitution and Supreme Court 
decisions require that consumption taxes in classes A and C, 
and E and G be the same. From an economic perspective, state 
sales and use taxes would be much better were activities in 
classes E-G in Table 1 not taxed. Similarly, state sales and 
use taxes would be much better (and easier to administer) if 
the exemptions in the final consumption tax base, B and D, were 
as small as possible. The stricture ``broad base, low rate'' is 
as applicable to household or final consumption taxes as it is 
to income taxes.

                         Table 1: Classification of State Consumption Tax Design Problem
----------------------------------------------------------------------------------------------------------------
                                                               Final Consumption        Intermediate Production
                  Geography of Activity                  -------------------------------------------------------
                                                             Taxable       Exempt        Taxable       Exempt
----------------------------------------------------------------------------------------------------------------
Sales...................................................            A             B             E             F
Use.....................................................             C            D             G             H
----------------------------------------------------------------------------------------------------------------

    How much are business inputs taxed by current state sales 
and use taxes? Table 2 displays recent estimates by state of 
the extent to which households (Column 3) and non-households or 
essentially business (Column 4) pay sales and use taxes. On 
average about 40% of sales and use taxes are paid by business; 
the range is from 11% (West Virginia to 72% (Hawaii).\3\ (We 
shall return to Table 2 when I discuss what a reformed state 
sales and use tax system might entail.) Current state and local 
sales and use taxes are thus far from transparent, and, in my 
view, nothing citizens in each state should be particularly 
proud of as a way to finance their public services.
---------------------------------------------------------------------------
    \3\ The non-household share, Column [3] in Table 2, can be thought 
of as the ratio of (E + G) to (A + C + E + G) in Table 1.

  Table 2: State Sales and Use Tax Rates, Household's Share, and Estimated Final Consumption Sales and Use Tax
                                                      Rates
----------------------------------------------------------------------------------------------------------------
                                  January,  Household     Non-       1998       1998       Final        Final
                                    2000     Fraction  Household    Sales      Sales    Consumption  Consumption
                                   State     Of Sales   Fraction   Taxes as   Taxes as  State Sales   State Rate
                                  Sales &     & Use     of Sales     % of       % of    and Use Tax    as % of
             State                Use Tax     Taxes      & Use      State      State        Rate       Current
                                   Rates   -----------   Taxes     Personal   Personal -------------  State Rate
                                -----------           -----------   Income    Outlays               ------------
                                               [2]               ----------------------     [6]
                                    [1]                   [3]        [4]        [5]                      [7]
----------------------------------------------------------------------------------------------------------------
Alabama........................      4.0%      73.0%      27.0%       1.8%       2.2%        3.1%        76.3%
Arizona........................      5.0%      50.0%      50.0%       2.4%       3.0%        6.0%       119.4%
Arkansas.......................      4.6%      60.0%      40.0%       2.9%       3.7%        6.1%       132.7%
California.....................      6.0%      53.0%      47.0%       2.4%       3.0%        5.6%        93.5%
Colorado.......................      3.0%      60.0%      40.0%       1.3%       1.7%        2.8%        93.8%
Connecticut....................      6.0%      58.0%      42.0%       2.5%       3.1%        5.3%        89.0%
Florida........................      6.0%      50.0%      50.0%       3.3%       4.2%        8.4%       140.2%
Georgia........................      4.0%      64.0%      36.0%       2.1%       2.6%        4.1%       101.8%
Hawaii.........................      4.0%      28.0%      72.0%       4.1%       5.1%       18.2%       455.4%
Idaho..........................      5.0%      62.0%      38.0%       2.5%       3.2%        5.1%       102.4%
Illinois.......................      6.3%      68.0%      32.0%       1.7%       2.1%        3.1%        48.9%
Indiana........................      5.0%      54.0%      46.0%       2.2%       2.8%        5.2%       103.1%
Iowa...........................      5.0%      59.0%      41.0%       2.2%       2.8%        4.7%        94.8%
Kansas.........................      4.9%      67.0%      33.0%       2.5%       3.1%        4.6%        94.4%
Kentucky.......................      6.0%      54.0%      46.0%       2.8%       3.5%        6.5%       107.7%
Louisiana......................      4.0%      51.0%      49.0%       2.4%       3.0%        6.0%       149.4%
Maine (4)......................      5.5%      57.0%      43.0%       2.9%       3.7%        6.4%       116.5%
Maryland.......................      5.0%      60.0%      40.0%       1.7%       2.2%        3.6%        72.6%
Massachusetts..................      5.0%      62.0%      38.0%       1.5%       1.8%        3.0%        59.3%
Michigan.......................      6.0%      58.0%      42.0%       3.0%       3.8%        6.5%       108.9%
Minnesota......................      6.5%      56.0%      44.0%       2.8%       3.6%        6.4%        97.9%
Mississippi....................      7.0%      66.0%      34.0%       3.9%       4.9%        7.4%       106.0%
Missouri.......................      4.2%      64.0%      36.0%       2.0%       2.5%        3.9%        92.2%
Nebraska.......................      5.0%      60.0%      40.0%       2.2%       2.8%        4.7%        93.2%
Nevada.........................      6.5%      44.0%      56.0%       3.7%       4.7%       10.6%       163.4%
New Jersey.....................      6.0%      62.0%      38.0%       1.7%       2.2%        3.5%        58.6%
New Mexico.....................      5.0%      50.0%      50.0%       4.5%       5.6%       11.3%       225.2%
New York.......................      4.0%      66.0%      34.0%       1.4%       1.7%        2.6%        65.8%
North Carolina.................      4.0%      62.0%      38.0%       1.8%       2.3%        3.7%        91.4%
North Dakota...................      5.0%      60.0%      40.0%       2.6%       3.3%        5.5%       110.8%
Ohio...........................      5.0%      66.0%      34.0%       2.0%       2.5%        3.7%        74.8%
Oklahoma.......................      4.5%      66.0%      34.0%       2.7%       3.4%        5.2%       114.9%
Pennsylvania...................      6.0%      64.0%      36.0%       2.0%       2.5%        3.9%        64.3%
Rhode Island...................      7.0%      59.0%      41.0%       2.0%       2.5%        4.2%        60.4%
South Carolina.................      5.0%      61.0%      39.0%       2.7%       3.4%        5.5%       109.8%
South Dakota...................      4.0%      61.0%      39.0%       2.7%       3.4%        5.5%       137.8%
Tennessee......................      6.0%      63.0%      37.0%       3.1%       4.0%        6.3%       104.6%
Texas..........................      6.3%      53.0%      47.0%       3.0%       3.8%        7.2%       115.2%
Utah...........................      4.8%      63.0%      37.0%       2.9%       3.6%        5.8%       121.2%
Vermont........................      5.0%      56.0%      44.0%       2.2%       2.7%        4.8%        96.7%
Virginia.......................      3.5%      70.0%      30.0%       1.4%       1.8%        2.6%        74.0%
Washington.....................      6.5%      49.0%      51.0%       3.1%       3.9%        8.0%       123.4%
West Virginia..................      6.0%      89.0%      11.0%       2.8%       3.6%        4.0%        66.7%
Wisconsin......................      5.0%      62.0%      38.0%       2.3%       2.9%        4.7%        94.3%
Wyoming (3)....................      4.0%      54.0%      46.0%       3.0%       3.8%        7.0%       174.9%
Mean...........................      5.2%      59.4%      40.6%       2.5%       3.1%        5.6%       111.1%
Std Dev........................      1.0%       8.8%       8.8%       0.7%       0.9%        2.7%        61.4%
Min............................      3.0%      28.0%      11.0%       1.3%       1.7%        2.6%        48.9%
Max............................      7.0%      89.0%      72.0%       4.5%       5.6%       18.2%       455.4%
----------------------------------------------------------------------------------------------------------------
Notes: Column [1] from Federation of Tax Administrators Webpage www.taxadmin.org;
Column [2] and [3] from Raymond Ring, Jr. ``Consumers' Share and Producers' Share of the General Sales Tax,''
  National Tax Journal, LII, 1 (March, 1999), Table 1, p. 81.
Column [4] John L. Mikesell, ``Retail Sales Taxes, 1995-98: An Era Ends,'' State Tax Notes, Table 4, pp. 592-3.
Column [5]= Column [4]/.794, the ratio of 1998 BEA Consumer Outlays/BEA Personal Income
Column [6]=Column [5]/Column [2]
Column [7]=Column [6]/Column [1]

    The other emerging problem of state sales and use taxes, 
and the immediate reason for this hearing, is the likely 
erosion of states sales and use tax bases as retail electronic 
commerce grows. As you know, under Bella Hess and Quill, the 
states are not able to obligate remote sellers without a 
physical presence to collect and remit use taxes, although 
their residents remain legally obligated to pay them. 
Traditional merchants find themselves increasingly at a 
disadvantage as remote electronic vendors join remote mail and 
phone catalog vendors in arbitraging on price differentials 
that reflect use taxes not being collected. Business equity 
issues are thus becoming more pronounced. Michigan's experiment 
last month, which puts a use tax line on its personal income 
tax return,\4\ is carefully being watched by other states. 
However, vendor collection and remittance at the time of sale 
makes far more sense and eliminates customer record keeping. 
How might the federal government assist the states in obtaining 
better compliance with its use taxes?
---------------------------------------------------------------------------
    \4\ Line 30 of Michigan's personal income tax return, MI-1040, asks 
the taxpayer to report use tax due from a worksheet.

---------------------------------------------------------------------------
2.1 Alternative Federal Roles

    State Piggybacking onto New Federal Retail Sales Tax

    Periodically, there has been discussion about the 
desirability of moving to a federal consumption tax--either a 
value added tax or retail sales tax. In conjunction with such a 
redesign of federal revenues, it has been suggested that the 
states could piggyback onto federal administration. Time and 
space limitations do not permit an extensive discussion of 
whether or not it is a good idea to now consider a federal 
retail sales tax as a mechanism for either fundamental federal 
tax reform or as a way to help the states. However, let me 
state my conclusion, having looked at the issue closely several 
years ago,\5\ that the economic argument favoring federal 
consumption tax as a cure to lackluster economic performance is 
not as persuasive today as it was a decade ago. Even if the 
federal government were to enact its own national retail sales 
tax, it is unclear whether or not the states would be drawn to 
such a template, especially if they did not retain control of 
their own rate of tax.
---------------------------------------------------------------------------
    \5\ Robert P. Strauss, ``Administrative and Revenue Implications of 
Federal Consumption Taxes for the State and Local Sector,'' State Tax 
Notes, 15, 5 (February 1, 1999), 327-338.

    Federal Revenue Sharing to States of New Federal Retail 
---------------------------------------------------------------------------
Sales Tax

    Were the federal government to enact a national retail 
sales tax and then share back some or all of the revenues to 
the states, the states would still likely want to maintain 
their own sales and use taxes, although they might reduce 
reliance on their own. Issues of sovereignty would undoubtedly 
arise while the method or formula for federal revenue sharing 
would likely be a difficult issue for Congress to resolve. 
Moreover, this approach might not readily deal with the above 
mentioned use tax problems should the states retain their own 
sales and use taxes, nor would it deal with cascading or 
complexity issues either.

    Federal Assistance/Insistence but not Federal Collection of 
State Use Taxes

    If state piggybacking onto a new federal sales tax is not 
in the offing and revenue sharing is also not a plausible 
solution to state use tax issues, then what? What follows 
involves a solution based on the following tax policy pieces:
    a) agreement to dramatically simplify state sales and use 
taxes though state absorption of local sales and use taxes and 
the keeping whole of local governments which give up their 
local sales and use taxes,
    and
    b) federal assistance/insistence to ensure that remote 
vendors collect and remit use taxes.
    To these I would add the elimination of sales and use taxes 
currently imposed on business inputs. However, the ideas which 
follow can be put together without this. What is essential is 
one definition across all states imposing a consumption tax of 
what constitutes taxable consumption so that intra and inter-
state vendors can readily determine if the purchase is taxable 
or not.

3. The Grand Political Trade

    In good measure the growing complexities which traditional 
multi-state vendors were experiencing with local sales taxes as 
well as growing concerns states were having about use tax 
collections from catalog and Internet vendors precipitated 
industry-government discussions at the NTA Project and then 
ACEC. The basic idea still being discussed is to:
    legislatively overturn Bella Hess and Quill through an 
expanded duty on remote sellers to collect and remit use taxes 
to the jurisdiction of destination or use currently without 
such obligation
    in return for
    a vastly simplified sub-federal sales and use tax system 
that would eliminate intra-state diversity in sales and use 
taxation, and standardize administration across the states \6\ 

---------------------------------------------------------------------------
    \6\ Periodically the states have said they would engage in revenue 
sharing intra-state to keep those local governments now dependent on 
local sales and use taxes whole.
---------------------------------------------------------------------------
    Under this grand trade, states would agree to move to one 
tax rate per state that was revenue neutral, and business would 
join with state and local government to find suitable 
legislative vehicles to make it a reality. Some of the 
participants in the NTA Project also hoped that sales and use 
tax simplification would also lead to reform, e.g. agreement on 
a uniform final consumption tax base.
    Much of the impetus for extending the moratorium for a long 
period of time(say 5 years) is to give the states sufficient 
time to work out among themselves just what a simplified system 
might be. However, I am doubtful that such a voluntary or 
cooperative approach can work, and suggest that with some 
federal assistance or insistence, the states can readily adopt 
a model statute, with many simplifications, that will make the 
above grand political trade a reality. Below, I sketch out the 
essential pieces to this.

4. Simplifying and Reforming State Sales and Use Taxes

    There are two ingredients to devising a new system of state 
sales and use taxes:
     Creating a definition of final taxable consumption 
for all states with sales and use taxes that is workable, and
      Finding a credible mechanism to enforce the 
expanded duty to collect on remote vendors (e.g., catalog and 
Internet)

4.1 Defining Final Taxable Consumption

    There are several reasons to favor the states moving to the 
same definition of household consumption. First, it makes 
administration much more simple, especially for remote vendors, 
since one need not keep track of the extraordinary fine 
distinctions among goods and services which the states have 
made over the years for public policy and other reasons. 
Second, a broader base means that the rate of tax can be lower, 
and thus have a smaller impact on consumption choices made by 
households. Third, by just taxing final consumption, the states 
will inform their citizens about what the tax costs of 
government are.
    Historically there have been a variety of approaches to 
define what is taxable under state sales and use taxes, and how 
to exempt certain items, either in terms of the nature of the 
customer, or in terms of the nature of the good or service. A 
rather simple way to move a household final consumption sales 
and use tax base is to reverse the way sales and use tax laws 
are typically drafted, and to introduce a new construct for 
sales and use tax purposes, the ``taxable person.''
    Under the taxable person approach, sales and use taxation 
is an exception to a general prohibition on the taxation of 
anything. The exception is for anything purchased for or 
purchased by a ``taxable person'' for ``non-business use.'' 
What is a ``taxable person''? A ``taxable person'' is any 
natural person (and thus not a corporation or other recognized 
legal form of a business or government). ``Purchase'' would 
cover any consumer purchase or rental. This concept is quite 
broad; for example, consumer services would be automatically 
covered under this definition since they are paid for by a 
natural person who is not a business.\7\ The first phrase, 
``purchased for'' is necessary for sole proprietorships, and 
for closely held businesses, and more generally to avoiding 
passthroughs from businesses to persons as a way to circumvent 
the sales and use tax.
---------------------------------------------------------------------------
    \7\ Third party payments (e.g. health insurance) are a gray area 
but would seem to be an example of a business pass through to an 
individual which would thus be taxable to the third party (regardless 
if it was tax exempt or not). Anything purchased for personal use would 
be covered by the non-business use.
---------------------------------------------------------------------------
    How might such a system work in the world of web commerce? 
Unless a purchaser had a registration certificate, any 
purchase, main street or remote, would be taxable at a single 
state rate. Provision of the business registration number by 
the agent for the company making the purchase would preferably 
be in a uniform format (a single national registration form 
with a single structure to the registration number) and 
provided in a secure (encrypted) form to the seller. Just as a 
seller has to confirm the authenticity of a credit card number 
and any other identifying information prior to agreeing to the 
sale, the seller would confirm the business registration 
certificate number at a regional or central clearinghouse that 
would maintain this information in a secure fashion. To 
ascertain whether or not the purchase is a pass-through for 
personal use, the purchaser would have to be queried about 
this, and the proper response noted and recorded. The final 
issue involves the destination of delivery or use, and the 
application of the correct state sales and use tax rate. Again, 
the purchaser would need to be queried as to this and the 
seller would have to record it.\8\
---------------------------------------------------------------------------
    \8\ Evidently the new Russian Federation's Regional Sales Tax 
appears to be structured in a similar manner. See John L Mikesell, 
``Structure of the Russian Federation's New Regional Sales Tax,'' Tax 
Notes International, 18 (March 15,1999).
---------------------------------------------------------------------------
    Table 2 contains some preliminary estimates about what the 
range of sales and use tax rates might be if the tax base were 
final consumption rather than the current amalgam of both some 
household and some business purchases. Moving to broad-based 
final consumption from a hybrid base entails first a base 
narrowing in order to tax just households, and then a base 
broadening to include all items of consumer outlay. Column [6] 
of Table 2 displays by state a rough estimate of what the equal 
yield tax rate would have to be if the base were household 
outlays. The mean final consumption state sales and use tax 
rate is 5.6% compared to the current mean sales and use tax 
rate of 5.2%. Alabama could cut its current 4% state rate to 
3.1% if it levied it on all final household consumption. 
Similarly, California could lower its rate from 6% to 5.6%, and 
so forth. For states that have heavy tourism, such as Florida, 
Hawaii, and Nevada, the estimated final consumption tax rates 
undoubtedly overestimate the extent of change that would have 
to occur. Of course, if the model sales and use tax statute 
were to exempt necessities such as food, clothing, and 
medicine, then equal yield rates would have to be higher. I 
view these first estimates as generally encouraging.

4.2 Four Federal Approaches to Assisting/Insisting on An 
Expanded Duty to Collect and Remit Use Taxes

    After the issuance of the NTA Final Report in September, 
1999, the National Governors Association and National 
Conference of State Legislators began developing a proposal 
which they believed would enable the states through bilateral, 
cooperative agreements to obligate businesses which originated 
inter-state sales to remit to the destination state as a 
consequence of the cooperative agreement being in place. The 
states evidently view this approach to eliminating the need to 
come before the Congress to ask for federal legislation. 
Elsewhere \9\ I have characterized this as ``each state 
permitting the other to fiscally hunt in the dark.'' I am not 
alone in such pessimism, and I have heard that some governors 
are now wondering if their bilateral approach can be timely, 
practical and effective.
---------------------------------------------------------------------------
    \9\ Robert P. Strauss, ``Further Thoughts on State and Local 
Taxation of Telecommunications and Electronic Commerce,'' State Tax 
Notes, 17, 17 (October 25, 1999), 1113-1124.
---------------------------------------------------------------------------
    Certainly, there is no impediment to the Congress 
legislating to assist the states under its taxing or commerce 
powers. The general solution to what is usually called the tax 
harmonization problem I develop below involves federal 
participation to ensure compliance of remote vendors to collect 
and remit, but one that stops a bit short of actual federal 
piggybacking.
    One set of federal solutions lies in constructing a 
tentative (federal) tax which may be offset by a credit for 
other ``qualified'' (state) taxes that the seller collects and 
remits directly to the states. Failure to collect and remit 
means loss of the credit, and the payment of the tentative tax 
to the federal government rather than in effect zeroing it out 
with the payment of the state tax. Since there is a tentative 
federal tax, there will necessarily be a federal review of 
books and records (federal audit), and oversight of the 
remittances so they go to the proper state.
    Another set of federal solutions entails a free-standing 
federal penalty tax should non-compliance to collect and remit 
occur.

4.2.1 Hollings S1433

    In July,1999 Senator Hollings introduced S1433 whose 
purpose was to impose a federal tax on internet or catalog 
sales at a rate of 5%, but which could be offset by a credit 
for collection and remittance of state and local sales and use 
taxes at rates of up to 5%. The bill created the construct of 
sales by a ``local merchant'' to which the tentative tax and 
credit would not apply. The net federal proceeds of such an 
approach would go into a trust fund whose proceeds would be 
used by the Secretary of the Treasury to make grants, based on 
a population and poverty allocation formula, to each state and 
the District of Columbia to supplement salaries of primary and 
secondary public school teachers.
    The Hollings mechanism puts extreme pressure on the states 
to adopt use tax rates at 5%. This arguably will have a 
chilling effect on state sovereignty that might be far worse 
than pure piggybacking because most piggyback models permit 
state discretion in tax rate, but use a purely federal 
collection mechanism.

4.2.2 Expand FUTA Eligibility Requirements to Include Expanded 
Duty to Collect

    A second variant of this type of harmonization, and one 
that is more workable in my view, is to utilize an existing 
well harmonized federal-state tax instrument. What I have in 
mind here is to utilize the historical harmonization of federal 
and state unemployment taxes as a vehicle for assuring that the 
new duty to collect and remit use taxes is in fact honored. The 
idea would be to amend eligibility for the FUTA tax credit to 
require positive agreement by an employer to participate in the 
collection and remittance of the newly enabled use taxes. 
Remote sellers of any consequence have employees, and are thus 
necessarily involved in existing federal and state unemployment 
compensation programs. As a result, they are already subject to 
audit and regulation by both IRS and the US Department of Labor 
and their state counterparts.
    Under this scheme, qualification to take the historical 
credit for state unemployment taxes against the tentative 
federal unemployment tax would simply entail a new 
responsibility, namely demonstrably agreeing to collect and 
remit use taxes enabled under the grand political trade. One 
would amend current FUTA requirements to include reporting 
about all sales and the use tax remittances to aid in 
administration and audit. Under this approach, the states 
retain control over their use tax rates, get remittances 
directly from remote sellers, and IRS would perform some audit 
and oversight functions, but not deal with each transaction. 
This approach would also allow remittance mechanisms to evolve 
as technology develops, and as the market place provides 
software solutions to remote sellers. It is reasonable to 
expect that some form of vendor discount be made available to 
amortize the costs of such software investments.
    Whether or not the unemployment system can or should handle 
this new responsibility remains an open question. Also, given 
that current state use tax rates are in the 3-7% range, it is 
possible that remote vendors might simply forego taking 
advantage of the federal credit since 3 to 7% of their gross 
sales would dwarf any federal offset of state employment taxes.

4.2.3 Conditional 10 % Federal Sales Tax

    Another, related way to encourage remote vendors to collect 
and remit use taxes would be to obligate any federal taxpayer, 
engaged in remote sales, to pay to the IRS an excise equal to 
10% of its sales, unless it agreed to collect and remit use 
taxes to each destination state which had in place a reformed 
sales tax base contained in federal law (e.g. per Section 4.1 
above) at the state's use tax rate. If a state did not have in 
place the reformed or ``qualified sales and use tax ``, the 
state would not benefit from federal insistence on the 
remittance of the use tax. This would enable all non-sales tax 
states to remain sales tax free. As long as taxpayers collected 
and remitted, IRS would never see or touch any of the use tax 
monies. With suitable administrative mechanisms in place, 
states would continue to enjoy fiscal autonomy by virtue of 
having control (with suitable notification) of their sales and 
use tax rates.
    Compliance with this obligation to collect and remit would 
entitle the taxpayer to an exemption from the 10% federal sales 
tax. Presumably all taxpayers would understand they would do 
much better by collecting and remitting the use tax than 
standing in non-compliance and be subject to the 10% federal 
tax.

4.2.4 10 % Federal Penalty Approach

    A variant on the conditional 10% federal sales tax would be 
to structure the relationship between the taxpayer and a 
federal agency as a penalty for non-compliance, given that the 
destination state had in place a ``qualified state sales and 
use tax.'' Now, the penalty would be measured by a high 
percentage (e.g. 10%) applied to the taxpayer's sales. Arguably 
the penalty approach could be acted upon by a committee other 
than a tax committee of the Congress, although there would be a 
question of which federal agency to turn over any possible 
proceeds, as well as a question of which federal agency, if not 
Treasury/IRS, would be responsible for determining that any 
state indeed had in place a ``qualified'' sales and use tax.
    An advantage of these approaches is that they could be 
devised to leave both Quill and Bella Hess undisturbed, and 
thus not raise any nexus issues in other areas of state 
taxation (e.g. business income or franchise taxes). Remote 
vendors would be collecting and remitting simply to forestall 
an adverse, federally imposed financial consequence. By the 
same token, any state which felt strongly that its current 
sales and use tax base, imposed partly on households and partly 
on business, rather than on final consumption, was more 
meritorious than a ``qualified state sales and use tax'' could 
continue to enjoy its sovereignty over base and tax rate. In 
this circumstance, remote vendors would not be obligated under 
threat of federal penalty to collect and remit use taxes. Of 
course, such states would continue to find use tax remittances 
lagging, and, as electronic retail commerce grows, this could 
have increasingly serious financial consequences to them.
    Congress might find legislating under this second approach 
somewhat easier, because you would not be requiring per se that 
each state with a sales and use tax to necessarily adopt the 
``qualified state sales and use tax.'' Greater state 
sovereignty would be, of course, at the expense of 
simplification, ease of administration and compliance, and 
elimination of tax cascading.

5. Concluding Comments

    The objective of my remarks has been to explain several 
different ways the tax committees of the Congress might assist 
the states in moving to a simplified system of sales and use 
taxes, and in so doing ensure that remote vendors, currently 
without a duty to collect and remit use taxes, would do so in 
the future. The ideas I have presented contemplate a more 
integrated vision of tax policy in our federal system than has 
been fashionable in recent years. But it may also anticipate 
that, because our daily lives are increasingly affected by 
events far away, our fiscal institutions need to adapt as well. 
Federal leadership requires Congressional action. State 
cooperation to accomplish inter-state tax harmonization of 
state sales and use taxes, but without federal legislation, 
seems well intentioned, but not likely to be fruitful.
    The range of federal interventions I have suggested, 
various kinds of federal taxes to be imposed unless states have 
more uniform sales and use taxes, and vendors collect and remit 
use taxes to the destination state, requires further 
exploration to flesh out administrative details and their 
fiscal implications. I urge, if some sort of further moratorium 
is to become federal law, that you obligate in such extension 
legislation that the U.S. Treasury and Joint Committee on 
Taxation undertake a very serious examination of the sort of 
alternatives and related details that I have sketched out this 
afternoon. Such a joint executive-legislative study \10\ should 
be completed by a date certain. Afterwards, I think there 
should be a significant set of public hearings to discuss the 
findings also by date certain.
---------------------------------------------------------------------------
    \10\ Lists of various administrative details that would need to be 
addressed to simplify state sales and use taxes can be found in both 
the NTA Final Report and the ACEC Report to Congress. The NTA Final 
Report contains extensive discussion of most of the problems and 
options to simplify state sales and use taxes. Hopefully such a federal 
review would deal more extensively than either Report with the problems 
the states would face in keeping their local governments whole once 
local sales and use taxes were phased out. It is imaginable, for 
example, that new federal statistics on the intra-state patterns of 
local retail sales would have to be collected to enable the states to 
share back state revenues on an acceptable basis to local governments.
---------------------------------------------------------------------------
    I would be happy to respond to any questions you may have 
about this testimony or issues related to it.
      

                                


    Chairman Houghton. I am going to turn over the microphone 
to Mr. Coyne for questions.
    Mr. Coyne. Thank you.
    Mr. Strauss, I wonder if you could let us know what are the 
major points and general principles we ought to be considering 
here in Congress in evaluating the overall taxation of e-
commerce?
    Mr. Strauss. I talked to my daughter this morning back in 
Pittsburgh and she said, ``Daddy, what are you doing in 
Washington?'' I said, ``I am going to talk to the Congress 
about taxing things that you buy on the Internet.'' She said, 
``Oh, what will the money be used for?'' I said, ``To fix the 
Pennsylvania Turnpike and fix up our schools.'' She said, ``Oh, 
you mean like when I go into the store and pay the same tax?'' 
I said ``yes.'' She said, ``Well, that is cool.'' So she ``gets 
it.''
    My point to you this afternoon is I hope ultimately that 
the Congress ``gets it'' and helps the States collect its use 
tax. Treating same economic events in the same way is an 
important principle. In an interdependent world, the Federal 
Government helping the states deal with cross jurisdictional 
events in a reasonable fashion, I think, is another important 
principle.
    Third, I support low rate and broad base; I suggest to you 
the kinds of ideas I just described will encourage the States 
to clean up their consumption taxes, something that I would 
suggest they cannot do themselves or agree among themselves to 
do.
    Those are the principles I would suggest you consider.
    Mr. Coyne. Would you be able to give us your views on the 
Commission's final report and their informal findings?
    Mr. Strauss. There are a few things I agree with in the 
Commission's report, there are lots of things I disagree with. 
That would require more than 3.20 minutes. I just don't think 
the Commission's approach serves the public's interest in the 
21st Century which is to basically give the States the revenue 
instruments they need in a very interdependent world. It does 
not reflect the kind of overall view which the Congress can 
come up with.
    There is a lot of stuff in there that has some merit but 
there is frankly not enough detail to really give you advice.
    I come back to my notion of having the Treasury and the 
Joint Tax Committee look at the issues of use taxation and 
report back to the Congress. Frankly, I think on those two 
professional staffs you can get some very detailed insight, 
some good constitutional advice and deal with the issues the 
way this committee over the decades has dealt with them, in a 
very concrete, broad fashion.
    Mr. Coyne. I wonder if you could touch on the distribution 
implications of exempting Internet-based commerce from the 
sales tax?
    Mr. Strauss. There are a couple of reactions. First of all, 
if you look by income class at who is using the Net, and data 
is a little bit old, it is upper income families. So if you say 
they buy through the Net and don't have to pay the use tax, 
don't write down on the State income tax form if the State 
bothers to ask, what the use tax should be, they are the ones 
getting the free ride and the cost of public services are borne 
by everyone else. Most sales and use taxes in most States are 
regressive anyway, so it exacerbates it.
    The thing I dislike most about leaving use purchases across 
the Net tax free is that it makes liars out of us all the time. 
It is the same problem with catalog sales. We all know what we 
are supposed to pay; I think the vendors have the computer 
power and the mechanisms to readily do it. It is just a 
question of making sure that we are honest in an easy and 
practical fashion. I think there are a lot of different ways 
that can be accomplished.
    Mr. Coyne. Thank you.
    Chairman Houghton. Mr. Weller?
    Mr. Weller. I would like to focus my questioning to Mr. 
Gustafson. You noted in your testimony a point similar to what 
I stated in my opening statement, that is while we find that 
the higher the income in the household, the more likely they 
are on-line. Frankly, I have also seen statistics that show the 
educational level, whether high school or college or graduate 
school also increases the likelihood of being on-line, having a 
computer and Internet access at home.
    You also made the point that if government truly wants to 
get more people on-line, the best solution is to lower the cost 
of going on-line. You indicated right now consumers on average 
pay between 20 to 30 percent in taxes on communications 
services?
    Mr. Gustafson. Yes, that is correct.
    Mr. Weller. Is there any other part of our economy where 
that tax burden is higher?
    Mr. Gustafson. Perhaps sin, things like alcohol or tobacco, 
those sorts of things, things that are traditionally 
discouraged, we tax higher. That one of the problems with the 
sales tax structure, that you are able to single out certain 
items through the tax structure and encourage or discourage 
their use or consumption.
    Mr. Weller. So essentially, you are saying unless you smoke 
or drink alcohol, you are paying the highest level of taxation 
if you want to communicate?
    Mr. Gustafson. Pretty close, gasoline or something along 
those lines, but yes, for something that is encouraged within 
society, talking to one another and communicating, we tax it at 
a disproportionate rate compared to other things we try to 
encourage.
    Mr. Weller. The House has taken the lead in finding ways to 
reduce Internet access cost. We passed legislation last week 
that would prohibit State and local government from imposing 
new Internet access taxes or fees or charges. Today, we passed 
legislation out of the House which passed unanimously I believe 
which would prohibit the unelected bureaucracy at the FCC from 
imposing a new Internet access charge, so we blocked them off 
at the pass.
    Tomorrow, this committee is going to vote on legislation to 
eliminate the 3 percent excise tax which I call 3 percent 
Internet access tax.
    Are there any other measures or ideas out there that we 
could also consider as ways to reduce the cost of accessing the 
Internet?
    Mr. Gustafson. I think more than obviously taking those 
steps and looking at all the tax structures, encouraging States 
to lower their tax burdens and also not raising taxes like the 
e-rate tax which is another tax on long distance service, the 
Gore tax as it is often referred to, is something else out 
there that needs to be reexamined.
    At one point you are encouraging the substantization of the 
service because you want people to consume it, in this case 
Internet access, and on the other hand, you are taxing the 
number one way people go on line actually to consume that 
service. It seems a little paradoxical. Obviously it is the 
kind of thing that Congress should avoid.
    Aside from that while it is important to lower the cost of 
accessing the Internet, it is not necessarily important to get 
out there and actively subsidize its consumption. As I think 
you noted also, this particular type of technology is spreading 
more rapidly than any other sort of consumer technology in the 
history of mankind. It is something the market has already 
taken care of. I wouldn't necessarily get out there and 
encourage government spending to the people on-line.
    Mr. Weller. I think I have seen statistics that 7 new 
Americans go on-line every second with increased access to the 
Internet.
    I also would note with legislation we are going voting on 
tomorrow regarding the Federal excise tax if you consider the 
taxation on telephone service, which 96 percent of Americans 
use to access the Internet, I think I have seen figures where 
the taxation has gone up 62 percent in the last few years 
nationwide, local, State as well as Federal because of 
increased use of the telephone.
    I am concerned about the employee benefit of computers and 
Internet access that is now being provided by some employers--
American Airlines, Delta, Ford Motor Company, Intel. In talking 
with some of the workers who would like to take advantage of 
that benefit, they have learned it might be a taxable benefit 
and have expressed concern that they don't want to pay higher 
taxes if they give the opportunity to have a computer and 
Internet access at home.
    From the point of view of your organization, do you have 
any views on that?
    Mr. Gustafson. Obviously increasing the amount of taxes 
people pay is not something Citizens for A Sound Economy would 
support, so if you start examining the benefits of what an 
individual receives in terms of extending their tax base, I am 
not sure that is wise. We may as well start looking at the 
company picnic or the company Christmas party and treating 
those as taxable benefits as well.
    If they do decide to tax the benefit of a computer the 
company gives the individual, then they ought to at least 
accurately account for the cost of the computer and today, if 
you sign up for an Internet service provision plan can fall as 
low as $150 or less. Sometimes they are free computers, so it 
is not something we would actively encourage and oppose.
    Mr. Weller. Thank you. I see I have run out of time.
    Chairman Houghton. Mr. McDermott?
    Mr. McDermott. I want to commend the Chairman for having 
this hearing. I asked for it because I come from a State where 
we don't have income tax and all we have is sales tax. Having 
been a Ways and Means Chairman and having had to wrestle with 
where the money comes from, I look at the Internet as being a 
hole in the bottom of the bucket.
    I would ask unanimous consent to enter into the record a 
statement by Gary Tober, an Adjunct Professor of Law at the 
University of Washington. He is not here today in part because 
he is working on three IPOs in Seattle.
    [The information follows:]

Statement by Gary P. Tober, Adjunct Professor of Law, University of 
Washington School of Law

    Thank you Chairman Houghton and Mr. Coyne, for the 
opportunity to present this statement to the Committee on Ways 
and Means Subcommittee on Oversight on Internet Tax Issues. 
Thank you Mr. McDermott, for inviting me to submit this 
statement on the taxation of Electronic Commerce.
    Business activity on the Internet is rapidly increasing and 
has become an important part of the national economy. 
Consummation via the Internet of commercial and consumer 
transactions has become commonplace. Business activities are 
being developed or modified for the Internet. Some Internet 
businesses are proving to be successful; some are not. 
Manufacturers, mercantile businesses, and service providers are 
expanding their activities to include the Internet as part of 
how they conduct business. These are exciting times for 
entrepreneurs.
    One of the recurring challenges associated with the debate 
over Internet taxation is the lack of a consensus on a 
definition of electronic commerce. If electronic commerce is 
defined narrowly, the tax issues are camouflaged. If electronic 
commerce is given an all-encompassing definition, the task of 
addressing its taxation becomes impossible. A major part of the 
challenge, as well as the excitement, of electronic commerce is 
the constant enhancement and evolution in its capabilities that 
is taking place. The speed at which the Internet is expanding 
(not only its connections and content, but also its 
capabilities) and thereby becoming a larger part of each 
business day makes it difficult and maybe impractical to apply 
existing tax rules or develop appropriate tax rules.
    Many aspects of electronic commerce are dealt with by the 
existing tax code. Congress should not overlook this fact. The 
Internal Revenue Code provides an adequate basis for dealing 
with the federal tax ramifications of the solicitation and sale 
of tangible personal property through the Internet. The tax 
issues presented by these consumer transactions or business-to-
business transactions are the same ones presented and dealt 
with by Congress when technological advancements occurred in 
the past, such as the television, cellular telephones, and 
pagers, to name a few.
    However, the Internet allows business activity to be 
conducted in novel ways. Electronic commerce is difficult to 
tax under current tax principles primarily because it is at 
once everywhere and nowhere. Transactions completed via the 
Internet can reflect multiple aspects and a blending of 
attributes of various types of commercial transactions outside 
the Internet, none of which is dominant. When a single Internet 
transaction is a combination of providing services, selling 
goods, and licensing property rights, the current tax rules do 
not provide adequate guidance as to the correct tax result. The 
current tax consequences of commercial transactions conducted 
over the Internet and how they should be treated by the tax 
code warrants the attention of Congress.
    Electronic commerce is characterized by few barriers to 
entry by a new business. It takes only a small capital 
investment for an entrepreneur to start an Internet business. 
The ease and efficiency by which information can be 
disseminated on the Internet is remarkable. The potential 
market for a business is not limited by geographic or time 
constraints. Further, the consumer has been empowered with a 
tool to quickly compare price and quality, possibly negotiate 
better terms or price, and all at the consumer's convenience.
    My statement will touch on three areas of taxation of 
electronic commerce: state and local taxation; federal 
taxation; and international taxation. Each of these tax areas 
have challenges presented by the emergence of electronic 
commerce.

                        State and Local Taxation

    Each state and local taxing authority can put forth a 
legitimate basis for taxing business activity on the Internet. 
The primary issue that must be worked out is how to allow these 
taxing authorities to assert their taxing jurisdiction (or 
grant them the taxing authority), and to do so in such a way 
that commerce will flow unimpeded over the Internet.
    Jurisdiction of state and local governments to tax is 
separate and distinct from that of the federal government. 
State and local governments derive their authority to levy 
taxes from state constitutions. States impose a variety of 
taxes such as income, franchise, capital stock, gross receipts, 
ad valorem, and sales and use taxes.
    With the substantive shift in commerce made possible by the 
Internet, states have had to apply statutes to transactions 
that were not envisioned at the time the statutes were written 
and have had to use as precedent court decisions that were made 
at a time when such media did not exist. The current state and 
local tax systems were developed at a time when most 
transactions involving tangible goods were based primarily on 
the manufacturing and selling of goods and on concepts of 
physical assets, geographic locations, and over-the-counter 
transactions. However, electronic commerce is based on a 
technologically advanced, service-oriented economy and on 
technology where there is no locality or physical presence.
    A preliminary question that must be answered is: What 
attributes of an electronic commerce transaction should be 
considered a proper subject for taxation by the state and local 
governments? The types of potentially taxable electronic 
commerce include Internet access charges, sales of goods or 
services, digitized products, consulting services, searches of 
databases, gambling, stock trading and banking. Certain taxes 
are imposed on the business and certain taxes, such as the 
sales and use tax, are typically imposed on the buyer.
    The next question to be answered is: Which state, if any, 
can or should impose a tax? The U.S. Constitution provides for 
a system of checks and balances between the federal and state 
governments. The Due Process Clause, Commerce Clause, Supremacy 
Clause, and other provisions of the U.S. Constitution place 
limitations on state and local governments' power to levy 
taxes. The Commerce Clause focuses on limiting the effects of 
state regulations imposed on the national economy. The test 
that has become the standard for Commerce Clause analysis of 
state taxation of interstate commerce is Complete Auto Transit 
v. Brady. In that case, the U.S. Supreme Court held that a 
state tax must be ``applied to an activity with a substantial 
nexus with the taxing State.''
    State and local tax rules need to be re-examined. Congress 
passed the Internet Tax Freedom Act in 1998. This Act imposed a 
three-year moratorium on taxation of Internet access, multiple 
taxation and discriminatory taxation of electronic commerce. At 
this time, Congress is proposing to extend the moratorium until 
October 21, 2006. However, Congress should not postpone 
providing guidance by legislation to deal with the borderless 
market presented by the Internet. It is necessary to try to 
achieve a balance between encouraging the development of 
electronic commerce and the need for fairness in taxation, 
while at the same time taking into consideration the needs of 
the state and local governments. Some states rely heavily on 
sales taxes. No other state relies so heavily on sales taxes as 
does the State of Washington. The reliance on general sales 
taxes in Washington State is over twice the national average. 
Consequently, Washington State could be heavily impacted by the 
moratorium and a delay in developing appropriate rules for the 
imposition of sales tax on electronic commerce.
    The primary issue in the state and local tax area is 
whether the substantial nexus standard--a physical presence in 
the taxing jurisdiction--is a viable approach for electronic 
commerce. There has been confusion in the courts of how much 
physical presence is substantial enough to meet the 
``substantial nexus'' requirement, i.e., may it be manifested 
by the presence in the taxing State of the vendor's property or 
the conduct of economic activities in the taxing state 
performed by the vendor or its agent? Should there be a 
distinction between substantial nexus and substantial physical 
presence? The physical presence requirement loses viability 
when the Internet is used to supply services or intangible 
products to consumers.
    Secondarily, what is the appropriate basis of determining 
substantial nexus for the different types of state and local 
taxes? Some legal scholars have argued that the physical 
presence requirement only applies to sales and use taxes and 
not to all other state and local taxes. There are no uniform 
rules for determining nexus for all the different state and 
local taxes.
    Many of the state and local tax issues raised by electronic 
commerce also depend upon the characterization of items of 
income or transactions giving rise to income under definitions 
and concepts born in the age of bricks and mortar. In some 
cases these laws do not readily adapt themselves to the world 
of electronic commerce. A transaction on the Internet (such as 
a sale of software downloaded over the Internet), may be 
characterized as a sale of a tangible good; a sale of an 
intangible good, i.e., a royalty fee; or a service. Depending 
upon the characterization, there may be imposed one or all of 
the following taxes: a sales and use tax, a gross receipts tax 
or a service tax. It is difficult to determine with a high 
level of certainty under the existing rules the type of income 
derived from certain commercial transactions.
    Sales taxes are generally imposed on retail sales of 
tangible personal property and certain enumerated services 
purchased within the state. Generally, the purchaser pays the 
tax and the seller is responsible for collecting and remitting 
the tax. Businesses have argued that the cost of collecting 
sales taxes and filing tax returns for electronic commerce 
transactions would be overly burdensome. However, the 
collection and remittance of the taxes would be no more 
burdensome to electronic commerce businesses than to mail-order 
catalog businesses. It can hardly be said that the growth of 
Internet sales would cease or be severely halted because 
vendors would have to collect sales taxes. Mail-order sales 
were not reduced because certain mail-order companies were 
required to collect such taxes. The greatest advantage of 
Internet sales to the consumer is the ease and convenience of 
purchasing goods and services while never leaving home.
    Businesses want complete uniformity between state and local 
taxes. The current laws and court rulings are inadequate to 
reduce the risk of multiple taxation of a commercial 
transaction completed via the Internet. Although Congress has 
not provided guidance in the past, I encourage it to do so now.

                            Federal Taxation

    The only federal statute, regulation, ruling or case 
expressly dealing with tax aspects of electronic commerce is 
the Internet Tax Freedom Act which imposed a three-year 
moratorium (I note that the Internet Nondiscrimination Act of 
2000 would extend the moratorium until October 21, 2006) on 
taxation of Internet access and electronic commerce. The issues 
of federal taxation relating to electronic commerce are 
primarily related to residence, character of income, 
deductibility of expenses, source of income, and tax reporting 
and collection.
    The United States imposes tax on the worldwide income of 
its citizens and residents. Residence of corporations is 
determined by the place of incorporation. The Internet gives a 
business the ability to sell to and provide product or services 
to certain markets on a worldwide basis, but also creates the 
possibility of companies establishing themselves in low-tax 
jurisdictions, thereby limiting the amount of income reportable 
to the United States. In addition, the application of existing 
transfer pricing rules to related corporate groups, the arm's 
length standard, may be difficult where a company's operations 
are carried out electronically and results in the loss of 
identifiable comparable third party transactions.
    The Internal Revenue Code has traditionally focused on 
mercantile transactions, such as the sale of property, 
compensation for services rendered, and the receipt of 
royalties or rents for use of property or property rights. The 
Internet has made such characterization difficult where 
``digital goods'' can be downloaded for future use, to browse 
or use directly on-line. The issue of proper characterization 
of Internet transactions has important ramifications, not only 
for electronic commerce, but also existing mercantile 
activities.
    The Internal Revenue Code subjects income from United 
States sources to taxation regardless of whether derived by a 
United States citizen, tax resident of the United States or 
foreign person. The proper application of the source of income 
and expense rules, as currently provided by the Internal 
Revenue Code, to digitized goods or Internet services results 
in legitimate disagreements between business and tax 
administrators. Technological advancements for the Internet 
will only make determining the appropriate tax treatment more 
difficult.
    Businesses transacting with consumers may have no practical 
incentive to self-assess a tax which may apply to a 
transaction. Will the cost and burdens of filing tax returns 
for electronic commerce transactions be commensurate with the 
usefulness of the information provided the Internal Revenue 
Service? Is the imposition of a withholding tax a fair and 
efficient method of insuring collection of the tax due? As 
Congress considers the tax issues presented by the Internet, 
the development of a fair and efficient tax reporting and 
collection system will be of paramount importance.

                         International Taxation

    International income tax rules need to be re-examined and 
possibly re-formulated to deal with the borderless market 
presented by the Internet. The primary issue in this area is 
whether the international standard for nexus, permanent 
establishment, is a viable approach for determining nexus to 
tax electronic commerce. In broad terms, a ``permanent 
establishment'' is a fixed place of business through which the 
business of the enterprise is wholly or partly carried out. 
Limited business activities are granted a nexus exemption and 
do not constitute a permanent establishment, such as activities 
of a preparatory or auxiliary nature. However, certain 
circumstances will result in a non-resident being deemed to 
have a permanent establishment, such as a dependent agent. The 
permanent establishment concept loses viability when the 
Internet is used to supply services or intangible goods to 
consumers.
    Secondarily, what is the appropriate basis of determining 
source-based taxation? The Internal Revenue Code provides 
detailed rules for determining whether income derived from 
various transactions (sale of goods, provision of services, 
royalty derived from the licensing of property rights, etc.) is 
derived from U.S. sources and therefore subject to U.S. tax. 
Since a transaction on the Internet may carry attributes of a 
number of different commercial transactions, it is difficult, 
if not impossible, to apply the existing source rules to make a 
correct determination.
    Thirdly, how is income from electronic commerce to be 
characterized? Just as in the case of applying the source rules 
to transactions consummated via the Internet, it is difficult 
to determine under the existing rules with a high level of 
certainty the type of income derived from certain commercial 
transactions.
    In addition, what is the proper basis for attributing and 
allocating income and expenses from electronic commerce? Since 
U.S. companies are taxed on a worldwide basis, domestic 
businesses must rely on the credit of foreign taxes or an 
exemption from taxation provided by a tax treaty to reduce 
double or multiple taxation when more than one country asserts 
the authority to tax a commercial transaction. In the absence 
of a tax treaty, the United States subjects foreign persons to 
U.S. tax on income effectively connected with the conduct of a 
trade or business conducted within the United States. These 
rules may prove to be inadequate to reduce the risk of multiple 
taxation of a commercial transaction completed via the 
Internet.
    And finally in the area of taxation of income, what role 
will international tax treaties play in resolving potential 
conflicts with not just are treaty partners but also countries 
with which the United States does not have tax treaties? Should 
international tax treaties be the mechanism for resolving the 
tax issues presented by electronic commerce of nexus, source, 
characterization, and attribution and allocation of income and 
expenses?
    Not to be overlooked is the fact that business activity via 
the Internet will present tax issues relating to customs and 
duties, the imposition and collection of indirect taxes, e.g., 
value-added taxes, goods and services tax, sales tax, etc. If a 
country is not willing to give up these taxes, what 
documentation, hard copy, or electronic equivalent will 
businesses need to generate to satisfy the particular 
requirements of that country?

                               Conclusion

    In conclusion, the Internet presents some unique challenges 
to a taxing authority. I submit for your consideration that a 
sound tax policy for electronic commerce should provide for 
predictable and equitable taxes for businesses; should not 
result in multiple taxation of the same income; should not 
create a distortion in how the business use of the Internet 
will be conducted by exclusively internet businesses or non-
exclusively internet businesses; should allow a taxing 
authority to inexpensively verify the financial results of a 
transaction; and should not cause a distortion in the 
development of electronic commerce, whether conducted as the 
primary or secondary focus of a business.
    I want to thank Ms. Ada Ko, attorney-at-law, of the law 
firm of Lane Powell Spears Lubersky LLP in Seattle, Washington, 
for assisting me in the research and preparation of this 
statement.
      

                                


    Mr. McDermott. You have 3,900 jurisdictions in this country 
that levy sales taxes and you have 50 States. That is a fairly 
simple computer program, 3950 options. For people who can land 
on the moon, it doesn't seem to me to be a technical problem to 
give to each retailer a piece of software they could use that 
would pick out what ZIP code I live in and tell me what my 
sales tax is.
    I live in 98119 which is one of the ZIP codes in Seattle. 
You ought to be able to pull that up and put the tax on what 
they send out to me. I cannot see any technical problem with 
doing that. If you have an idea, I would love to hear it.
    Mr. Strauss. The State of Washington in its wisdom may not 
define bagels the same way we do in Pennsylvania or it may not 
define clothing in the same fashion. The real problem that 
remote vendors face selling into a State and not being sure 
about things is the definition of what is taxable and not the 
rate. That is why in my testimony I talked about the wisdom of 
going to a concept of final consumption that would be uniform 
across the States.
    That takes some of the fun out of the game at the State 
level of providing exemptions and the like, which those of you 
in State legislatures may remember fondly, but it certainly 
would simplify things if what was taxable was uniformly 
defined.
    It is very hard for the Congress to do that directly. You 
may be able to do it indirectly.
    Mr. McDermott. The State legislature had a long debate over 
whether candy was food or not. Food is not taxed, candy is, so 
I understand the point. How do you deal with that common 
definition then?
    Mr. Strauss. In my detailed testimony, I provide a very 
simple definition of what a taxable person is and what their 
consumption is. It is something that would take about half a 
paragraph of code language that would subject all services to 
taxation that we utilize for final consumption and would free 
up business inputs.
    Mr. McDermott. Would it tax food?
    Mr. Strauss. Sure. If you want to exempt food, you raise 
the rate; I have in my testimony hold harmless tax rates by 
State, sort of rough estimates.
    Mr. McDermott. Is there any way you can make the playing 
field level for local businesses and not tax the Internet? We 
went through this whole battle. Every couple of years, there 
would be a surge of sales. IREA was a big sales operation in 
our area and we would think how can we get access to what they 
sell out of State. We went around and around trying to figure 
out how to do that. We never figured out how to make it fair 
for somebody who bought with a catalog fair with going down to 
the store and buying it.
    Mr. Strauss. Your residents in Washington are liable, they 
just forget to pay it somehow. There is not a good mechanism. 
If you had a common definition across the country and one the 
States could live with, one that was adjudicated here once, put 
in the Code and left sacrosanct, I think you could go a very 
long way. That is not for today I hasten to add but I think it 
is an imaginable think. In the 21st Century, a little more 
uniformity, a little more clarity might be a desirable set of 
goals to work toward.
    Mr. McDermott. So you are suggesting a sort of uniform code 
like we have a Uniform Commercial Code that has been adopted by 
a number of States?
    Mr. Strauss. Yes.
    Mr. McDermott. You would have the same thing, a Uniform Tax 
Code by the States?
    Mr. Strauss. I would put it into the Internal Revenue Code 
as a qualified sales and use tax base and any State who adopted 
it, would then have a way for IRS to make sure remote vendors 
would collect and remit. Otherwise they would be subject to 
either Federal penalty or Federal excise tax themselves which 
wouldn't be very healthy. I am very mindful of the power of 
this committee, sir.
    Mr. McDermott. So you would basically give the IRS the 
enforcement power?
    Mr. Strauss. It might not ever have to be used but it would 
start there, yes. Look at FUTA as a mechanism that has worked 
over the decades, the Federal unemployment tax. This is a play 
on that idea. I hate to look at what is going on behind me but 
that is okay, I have tenure.
    Chairman Houghton. Mr. Portman?
    Mr. Portman. Mr. Strauss, I am glad you are mindful of the 
power of this committee. Sometimes the Judiciary Committee and 
the Commerce Committee don't understand our great power.
    Mr. Strauss. I would be happy sometime to explain to you 
how you can expand your power. When I served this committee, I 
was very mindful.
    Mr. Portman. We will have to have a hearing on jurisdiction 
after this one.
    I appreciate you holding this hearing, Mr. Chairman, in 
part for us to have the opportunity as Ways and Means members 
to take a look at some of these issues and see where our 
jurisdiction does fall, and also to look at the Advisory 
Commission on Electronic Commerce, and one of the 
recommendations of the Commission which was to end the tax on 
talking, the three percent excise tax we are going to get into 
in the next panel.
    I will not spend a lot of time on it now but just say that 
seems to me to be in the category of the extension of the 
moratorium on access fees and the ramp up to the Internet as 
Mr. Gustafson talked about which is to say Congress should pass 
that overwhelmingly and I think will once the committee marks 
it up this week and takes it to the floor next week.
    I have a couple of questions for you, Mr. Harden. Your 
article in Tax Notes was excellent, very balanced and I 
appreciate your being here today and giving us both sides of 
the story.
    I think Lyndon Johnson said, ``Bring me a one-armed 
economist on the one hand,'' and my only question to you would 
be where do you come down in terms of recommendations to this 
Congress as to where we should go from here? You seem to be 
saying that simplification would be very important State by 
State to create that level playing field between e-commerce and 
the brick and mortar companies but I don't see any specific 
recommendations. Maybe you are still trying to figure out where 
you come out.
    You have heard some interesting testimony from Mr. 
Gustafson who says we ought to repeal the sales tax altogether. 
E-commerce is like .64 percent of all commerce and we don't 
want to chill this important driver of our economic prosperity.
    Mr. Strauss talked about some realistic ways to come up 
with some uniform, simpler system. How do you come out on it?
    Mr. Harden. It is interesting you asked that question. When 
Dr. Biggert and I sat down to write the article, each of us 
thought it would be an easy answer as to which viewpoint was 
more correct and we disagreed on which was the more likely 
scenario.
    Mr. Portman. Where did you come out?
    Mr. Harden. As far as the argument that you should 
eliminate all taxes was the better argument or the argument 
that you should put the traditional retailers and electronic 
retailers on the same footing. We still disagree on that issue.
    At this point I am not sure we have enough information to 
make a long term decision on the issue. The easiest solution is 
to move away from the sales tax. Unfortunately, as was pointed 
out, the income tax is not palatable to many jurisdictions 
which would be one way of avoiding this issue.
    Barring that, moving toward a more consistent method of 
taxing between the States may help but I am not very optimistic 
about that because we have had the system in place since 1934 
or 1935 when Mississippi enacted the first sales tax and they 
have remained inconsistent since that time, so I am not sure 
barring Federal action, anything can be done about that.
    My personal bias is to not favor any type of regulation 
that can be avoided but in this case, the one thing we mention 
in our article is possibly taxing or allowing taxation at a 
very low or nominal rate, possibly the lowest sales tax 
existing among the 50 States and move from there. At this 
point, I am not sure we have enough data because we don't know 
how much electronic commerce will be hurt by imposing a tax. 
Likewise we don't know how much traditional retailers will be 
hurt.
    Dr. Biggart and I dealt with a clothing retailer and this 
particular retailer is one that operates in three areas, mail 
order, electronic commerce and traditional retail and they 
actually have set up the three divisions as three separate 
corporations. They are telling us their same store sales are up 
20 percent this year.
    This manager's opinion was that electronic commerce is not 
hurting at all. Our comeback was where would you have been in 
the absence of electronic commerce. At this point, we just 
don't think we have enough information to make that 
recommendation rationally.
    Mr. Portman. It sounds like you are a normal human being 
and you have two hands on the one hand and you are a normal 
economist, but maybe what you are saying is a moratorium might 
be appropriate to let things sift out a little over a period of 
at least a couple of years. It sounds as though you believe 
there is still more data to come in to be able to decide how to 
deal with this?
    Mr. Harden. Yes, that actually would be my recommendation.
    Mr. Portman. It is an even numbered year as Mr. Strauss 
noted earlier, so that is helpful, to put something off in an 
even-numbered year as controversial as this.
    I want to pose one more question and I will just throw it 
out and is looking at a VAT tax as compared to a sales tax, Mr. 
Strauss, what might that mean?
    Mr. Strauss. At the State level, sir?
    Mr. Portman. You talked about the template earlier and the 
fact that the Federal income tax provides a template and the 
Federal sales tax could provide another template.
    Mr. Strauss. I looked very carefully at that about four 
years ago and came away very worried about what the transition 
would be if there was a national VAT and States were to 
gravitate to it.
    One of the arguments in favor of a VAT historically has 
been that we haven't been growing enough but we now are doing 
just fine. In fact, we are growing too fast. I don't know what 
the Fed did but they didn't lower rates, so that is kind of one 
concern.
    Another concern is it wouldn't be more simple than the 
income tax. There is not a VAT we could administer to bring in 
the kind of money we are talking about nationally that wouldn't 
wind up complicated; you would find yourself making somewhat 
different kinds of decisions in this committee but very 
difficult ones.
    The history of the VAT in Europe is not attractive. I think 
we ought to stay where we are at the Federal level with income 
taxation.
    Chairman Houghton. Mr. Hulshof?
    Mr. Hulshof. Mr. Strauss, do you believe that traditional 
merchants at are at a competitive disadvantage due to remote 
mail and phone catalog vendors?
    Mr. Strauss. Yes.
    Mr. Hulshof. I think the Bella-Hess decision, if I am not 
mistaken, was in 1967?
    Mr. Strauss. Somewhere around there.
    Mr. Hulshof. Isn't it true that State and local governments 
and retailers have said even from the old days when Bella-Hess 
was first decided that there were going to be sales tax 
shortfalls?
    Mr. Strauss. They didn't grow as fast as they would have. 
It all depends on one's state of mind. Certainly use tax 
collections, if we look at it in those terms, have been not as 
significant as they would otherwise be.
    The other point is we have a far more independent country 
than we used to have so this issue we are talking about, use 
tax across boundaries, the Supreme Court cases and all that, it 
is growing. I can't give you the percentages but it is growing.
    Mr. Hulshof. I know in your longer statement, which I have 
had a chance to peruse, and your questions from Mr. Portman, 
you are talking about a larger picture template but certainly 
would you agree or disagree that mail and phone catalog vendors 
and purchases over the Internet should be treated consistently 
or do you see a reason we should treat Internet sales 
differently than catalogs?
    Mr. Strauss. No, not differently all the same. It is very 
simple equity.
    Mr. Hulshof. Mr. Harden, you seemed to key in on that 
question. Did you have any comment before I move on to Mr. 
Gustafson?
    Mr. Harden. Yes, sir. This relates to your question and to 
Representative McDermott's question.
    There may be a slight problem with regard to the case law. 
In the Bella-Hess decision, the mail order retailer that 
doesn't have a physical presence in the State is exempted under 
two clauses, the due process and the commerce clauses.
    In 1992, there was another decision called Quill which 
basically took away that due process argument because it said 
when you intentionally send mail order material into the State, 
you are on notice yourself that you are to solicit business 
there and therefore you should not be able to use the due 
process as an argument against it. The commerce protection was 
still there and it would be up to Congress to make a decision.
    With electronic commerce, you may fall back under due 
process being applicable as a defense even if you allow the 
States to collect the tax, they may have a judicial remedy 
simply because they don't intentionally go after a particular 
customer; it is open to anyone who can access the Web.
    Mr. Hulshof. Mr. Gustafson, in the panel coming behind you 
as you expect will be some of those traditional retailers and 
there have been arguments made by main street that they are at 
a competitive disadvantage because they have to collect sales 
taxes while e-retailers do not. What argument do you provide to 
that objection?
    Mr. Gustafson. I would suggest that both have competitive 
advantages and competitive disadvantages, both classes of 
retailers, traditional brick and mortar and also the e-tailer 
class. Brick and mortar have the added advantage of being right 
around the corner when you need something. Going on-line takes 
three days or overnight at a minimum. Each represents a means 
of providing consumers with a considerable good.
    They have been saying those sorts of things a long time now 
and we have not seen a slack in the builders of commercial 
retail sites. They are opening new malls at record paces. Tax 
revenues to States have not slacken at all, so it does not seem 
that e-tail will really draw much from the traditional brick 
and mortar. If anything, it may well add to the nature of brick 
and mortar sales.
    Mr. Hulshof. Personally I am a kick the tires, flip through 
the book in the book store shopper and I am not sure if I am in 
the majority or the minority any longer. I guess it sort of 
brings up the age old question that many small communities in 
the 9th District of Missouri or across the midwest and that is 
when you have the super center that builds on the outskirts of 
town and drawing away from the riverfront, downtown businesses 
or when the new mall opens across the State line 20 miles away 
and draws businesses away from that mom and pop store.
    Mr. Gustafson. You have described how retail evolves over 
time and the Internet is another means by which consumers and 
businesses can interact. It represents another time in our 
history that retail will be required to evolve. They are going 
to have to look and say how do you interact with this new 
medium. The genie is out of the bottle and they are going to 
have to learn to deal with it one way or another.
    There are certain implications for tax policy, of course, 
but to suggest it is going to drive brick and mortar out of 
business totally is not true. Shopping is too much of a social 
aspect of American life for that to happen.
    Mr. Hulshof. Thank you.
    Chairman Houghton. Ms. Dunn?
    Ms. Dunn. Mr. Strauss, I wanted to ask a question about 
another of the recommendations of the Commission. This was to 
expand the definitions of the TANF grant, what is eligible for 
expenditures by TANF dollars.
    I know we are all trying to expose children to the Internet 
and to a greater education. My only concern is if we decide to 
expand the definitions of what is eligible, it seems it may be 
spent for things that don't really provide for phasing children 
into better circumstances. I am wondering what you think about 
that recommendation.
    Mr. Strauss. I have a 17-year-old son who has access in his 
bedroom and he locks the door. He wants a bigger disk drive all 
the time. [Laughter.]
    I favor everyone having access to the Internet. I think it 
ought to be in libraries for people who can't afford it. If not 
available in their homes, I think it ought to be publicly 
provided and publicly supervised.
    When you ask the States to spend monies you used for 
training for this additional purpose, you face the question of 
who is going to supervise what they, the kids, really do, I 
have some concerns there.
    Second, if you are going to ask that my tax dollars be used 
to be spent for computer hardware, I would like to get 
something in return from the hardware vendors participating at 
the other end. I want them to collect and remit. That is my 
preference. I don't think you will go that way.
    I can see some merit in trying to use existing Federal 
expenditures to broaden access but I think it ought to be in 
the context of public institutions at the local level where 
there is public supervision and the Federal agency, HHS, would 
take a look and make sure it is not going into something very, 
very different.
    I am mindful that even though you think you are running a 
surplus and you think the States are running a surplus, there 
is less surplus there than you think. I would just make that 
additional comment.
    Ms. Dunn. Mr. Gustafson, in your written testimony you 
alluded to a Stanford study and it concluded that 
telecommunications taxation is a major contributor to the 
digital divide. Can you talk to us about how telecom taxation 
limits access to the Internet? Could you touch on different 
demographic groups?
    Mr. Gustafson. The Stanford Study concluded that 
affordability was the number one issue for going on-line, 
whether or not and individual would buy the hardware, subscribe 
to the service and all these things was one of I have a dollar, 
where do I spend it.
    Taxes that increase the bottom line make that decision bias 
in favor of something that is less costly. It is more about a 
mans of bringing information into your life than it is purely 
Internet access. So if the cost of that information is lower 
via the television, through cable or over the phone, if you are 
getting news from a friend or buying a newspaper, that is the 
basis by which an individual makes their decision.
    From our standpoint, at a time when Congress is talking 
about setting up programs to subsidize the spread of the 
Internet, the first thing they need to look at is are we taxing 
this, how are we treating the medium we are looking to 
subsidize. If you are taxing it with one hand and subsidizing 
it with another, that seems not to make a great deal of sense 
to those of us on this side of the podium.
    Chairman Houghton. Mr. McInnis?
    Mr. McInnis. Mr. Gustafson, has anyone with your think tank 
done any research when catalog sales first came out as to the 
remarks by retailers and government entities as to the taxation 
of catalogs when they first came on the retail scene back in 
the 1930s or 1940s?
    Mr. Gustafson. I have not personally done that research. 
There is anecdotal evidence all over the place about how Sears 
& Roebuck was going to drive smaller genuine mom and pop 
retailers out of business by virtue of their size and scope but 
we are writing a history of some of the telecommunications 
technology policies and that is due out later this fall. No 
doubt, that topic will be in there.
    Mr. McInnis. I think that research would be helpful because 
my guess would be you will find a lot of panic, the sky is 
falling in type of statements.
    I think it would be very helpful to compare the thought 
pattern back then as to now. I think there will be a lot of 
parallels.
    Mr. Strauss, I was interested by your remark that your 
statement was made because you have tenure. What would be the 
change in your statement if you didn't have tenure?
    Mr. Strauss. At a high tech university?
    Mr. McInnis. No, the statement you just made earlier.
    Mr. Strauss. My pattern has always been to speak my mind 
for better or for worse. I have explained myself.
    Mr. McInnis. I think it would be good to do away with 
tenure.
    The number the gentleman from Washington used, I have heard 
it all the time, that there are 3,200 taxing entities? What is 
that number?
    Mr. Strauss. Local jurisdictions, primarily counties that 
have their own sales and use tax and in your State they are 
quite prevalent.
    Mr. McInnis. Where did that 3,200 originate? I have heard 
it talked about a lot.
    Mr. Strauss. The Census Bureau measures it for one. Every 
five years they enumerate the kinds of governments we have in 
the country and what their taxing authority is. There are also 
some private companies like Vertex outside of Philadelphia 
which keep track of this.
    Mr. McInnis. Who said that number?
    Mr. Strauss. I have heard larger number, more like 7,000. I 
could look it up and write you a letter if you like.
    Mr. McInnis. That would be helpful. I am trying to figure 
out a source because when I look at the complexity of the 
current taxing system, based on a lot of what you said earlier 
which I think is correct, the bagel is not the same and in our 
State we have sewer districts and we have the Bronco stadiums 
in a different district. It is not as simple as a ZIP code with 
the implication you just zip it out and you have it figure out.
    I would appreciate it if you would contact me with some 
reliable source that I can look at and try to figure out.
    Chairman Houghton. I have one question I would like to ask 
Mr. Gustafson. You mentioned on the last page of your testimony 
the study by the University of Chicago and Harvard indicated 
there were minimum amounts of impact on sales tax revenues, one 
was 2 percent by 2003?
    I don't know whether those figures are right or not. We 
don't know what is happening five minutes from now but assume 
they are, aren't you really starting a trend? Isn't it sort of 
a way of life, sort of a mindset when you start doing this? I 
don't quite understand what your point was there.
    Mr. Gustafson. My point in including it in my testimony was 
merely to illustrate the opportunity costs of not having 
Internet taxes for States was minimal currently and even under 
projections far into the future, three years into the future 
now, that it would still not be a significant loss of revenue 
so to speak for States.
    In terms of creating an expectation, do you mean for people 
going on-line and buying goods on-line?
    Chairman Houghton. The expectation is there will be no tax 
forever and therefore it makes it difficult. If you have 
inequities which are not really highlighted in the Harvard or 
Chicago study, doesn't it make it difficult to reverse yourself 
a little later on once the pattern has been established?
    Mr. Gustafson. There are lots of stated purposes of tax 
policy, one of them being neutrality so economic activity is 
treated equally across the range of different taxing 
authorities and such, regardless of how the good is consumed, 
it is neutrally treated.
    The problem is less one of figuring out the correct 
technological solution and how to collect the tax, whether it 
is a ZIP code or something else, and more of an issue of 
whether or not the Constitution would permit it. We have heard 
about due process and the Interstate Commerce Clause. I think 
our objections to on-line sales taxes fall into those 
categories more than the fact that it is really not a great 
degree of loss revenue for States.
    We look at this and say, this is an issue, not a new issue 
to Congress, States or commerce in general. It has to due with 
where the State's power begins and ends and whether or not a 
certain type of transaction can be taxed by an extra 
territorial authority.
    We look at it and say this is a remote sale and unlike 
catalog, unlike anything along those lines and should not be 
treated as a brick and mortar sale.
    Chairman Houghton. Thank you very much. I appreciate your 
testimony.
    The second panel is Les Ledger, owner of Ledger Furniture 
in Copperas Cove, Texas on behalf of the National Retail 
Foundation; Ronald R. Honaker, Owner, salons4u and the Glow 
Shop, and he will be joined by his wife, Margaret. I am told 
they drove more than 15 hours to get here from St. Louis. We 
are delighted to have you here.
    Thirdly there will be Jeanne Lewis, President of 
Staples.com from Framingham, Massachusetts; Harley Duncan, 
Executive Director, Federation of Tax Administrators; Mark 
Nebergall, President, Software Finance and Tax Executives 
Council; and John R. LoGalbo, Vice President, Public Policy, 
PSINet from Ashburn, Virginia.
    Mr. Ledger?

  STATEMENT OF LES LEDGER, OWNER, LEDGER FURNITURE, COPPERAS 
      COVE, TEXAS, ON BEHALF OF NATIONAL RETAIL FEDERATION

    Mr. Ledger. Thank you and good afternoon.
    I appreciate you letting me come to testify before the 
subcommittee. My name is Les Ledger. I am the owner and 
operator of Ledger Furniture in downtown Copperas Cove. I am a 
small, main street furniture store. My store was started by my 
father in 1950.
    Today, we have 14 employees. I just called home and checked 
with my wife and they all showed up today. I am darned pleased. 
That has been a bit of a problem.
    Chairman Houghton. Do they do better when you are not there 
or when you are there?
    Mr. Ledger. I left mom at home. She is going to make sure 
they do very well.
    We have annual sales, and I want to say it loud so my 
competitors will know it, of $1.8 million. We hope and pray we 
continue.
    I am testifying on behalf of the National Retail Federation 
which has 1.4 million members or establishments and employs 22 
million employees. I am here to discuss a tax matter which 
unfortunately has not been addressed by Congress over the ACEC. 
This involves a loophole in the existing sales and use tax laws 
that allows many of my out-of-state competitors to avoid 
collecting a State sales tax and use tax.
    The ACEC not only ignored this issue, it lacked the super 
majority mandated by Congress for approval of its 
recommendations and I might point out it did not include a main 
street retailer on the commission as dictated in statutory 
language. So that makes me doubly proud that you have allowed 
me to speak.
    Under current law, 45 States impose sales tax and sales 
taxes on tangible goods. These States impose these taxes and 
require retailers like me to collect them and remit them. In 
the State of Texas I have exactly 20 days to get it to Austin.
    Some out of state retailers are exempted or are not 
required to collect and remit a State sales and use tax. 
Exempting these Internet and catalog sellers from collecting 
sales tax while I must creates an uneven tax playing field 
among retailers. Congress must address this issue in the same 
context as the other Internet tax issues to ensure that the 
level playing field exists.
    If a State wants to impose sales tax, I only want my 
competitors to collect the taxes just like I do. I want a level 
playing field. Tax policy should not determine who wins and who 
loses. In my industry margin that margin of profit is one, two, 
three percent. I can't absorb a six to eight percent tax 
differential.
    Consumers should pick their winners and losers based on 
selection, service, convenience and not tax. State and local 
governments will suffer. It is estimated by some projections 
that the Internet sales will be $300 billion by 2002. State and 
local governments could lose as much as $20 billion in 
uncollected sales tax.
    This tax also disproportionately hurts the poor. Mr. Weller 
pointed out that over 100 million are using the Internet and 
with the average Internet income user being about $70,000 the 
current system would allow the wealthy to escape the tax and 
let the people who do not have Internet access pay taxes 
locally.
    Folks, my conclusions are not borne out by conjecture but 
by personal experience in dealing with a business that is not 
required to collect sales tax and that operates less than seven 
miles from my front door.
    Our Store is located near Ft. Hood, Texas. Army Air Force 
Exchange operates a 17,000 square foot furniture store at its 
PX. We know the number of people who leave our store and buy 
from a facility that is not required to collect State taxes.
    The reason they leave is because my prices will always be 
8.25 percent higher but I am required by the wonderful State of 
Texas to collect its sales tax from my customers. I don't have 
to wait to see what the effect will be of tax free purchasing 
on my business. I already know how it feels, I see the dollars 
leave.
    If my sales suffer as a result of the current sales tax 
disparity, I will be forced to cut back my work force. In 
addition, the revenues I collect and pay to the State and 
Federal Government would decrease as I go down. I have 
collected $149,000 in sales tax in the last year. I have paid 
$31,000 in Social Security and FICA taxes. That is my portion. 
And I have paid $15,000 in personal property taxes.
    Congress has the responsibility to my business, my 
employees and my community to eliminate this existing tax 
inequity. A level playing field is all I want. As a retailer, 
my bottom line and the survival of my store is affected by 
numerous factors and Federal regulations. While I have learned 
to live with these setbacks, I cannot--and should not--be 
expected to live with an 8 percent tax pricing disadvantage 
compared to my Internet and remote commerce counterparts.
    Congress can act to address this disparity. It can give 
States the authority to collect sales and use taxes from out-
of-State sellers once the States have adequately simplified 
their sales tax structures.
    I appreciate you all letting me come, and I'm ready for any 
questions.
    [The prepared statement follows:]

Statement of Les Ledger, Owner, Ledger Furniture, Copperas Cove, Texas, 
on behalf of National Retail Federation

    Good afternoon, Mr. Chairman. My name is Les Ledger. I am 
the owner/operator of Ledger Furniture in Copperas Cove, Texas, 
a small main street furniture store first opened by my parents 
in 1950. Today, we have 14 employees (if everyone shows up) 
with an annual sales volume of around $1.8 million.
    I am testifying today on behalf of the National Retail 
Federation (NRF), the world's largest retail trade association, 
representing 1.4 million retail establishments that employ more 
than 22 million Americans. In addition, I am a past president 
of the Texas Retailers Association and the International Home 
Furnishings Association.
    The growth of consumer shopping on the Internet is 
expanding at a rapid rate. In 1999, 40 million Americans 
shopped online, up from 17 million in 1998. The total of goods 
and services traded on the Internet is expected to reach $300 
billion by 2002. The Internet provides retailers the 
opportunity to reach millions of people in markets never before 
imagined and provides consumers instant access to goods, 
products and services from around the world. As this new medium 
evolves, so too should government policy to ensure that no one 
is left behind, and that everyone competes on a level playing 
field.
    In 1998, Congress enacted a moratorium on any ``new'' 
Internet taxes until October 21, 2001, while creating a special 
advisory commission, the Advisory Commission on Electronic 
Commerce (ACEC), to address a host of Internet and remote 
commerce tax issues in the interim. Unfortunately, most of this 
debate has ignored a broader inequity that currently exists in 
the state sales and use tax systems that disadvantages 
mainstreet retailers and low-income consumers.
    Both the ACEC, as well legislation passed by the House of 
Representatives last week, failed to address the broader state 
sales and use tax inequity that exists today. Not only did the 
ACEC findings lack the supermajority consensus mandated by 
Congress for approval of its recommendations, it did not 
include a ``mainstreet'' retail representative, as was dictated 
in the original statutory language.
    Like many others, retailers oppose new taxes on the 
Internet, including ``bit'' and/or ``access'' taxes, and even 
the existing telephone ``excise'' tax. However, the retail 
industry feels that Congress must also address the broader more 
complicated state sales and use tax inequity as well.
    Existing sales and use tax law creates an ``unlevel playing 
field'' among retailers. Presently, 45 states and the District 
of Columbia impose sales and use taxes on purchases of tangible 
goods. Under current law, retailers are required by the states 
to collect these taxes from a customer and immediately remit 
this sales tax to the state. However, based on two Supreme 
Court rulings, some out-of-state retailers (those without a 
physical presence in the purchaser's state) are not required to 
collect and remit a state's sales and use tax. In this case, 
the consumer still has the legal responsibility to pay a 
``use'' tax directly to his or her own state. Since many 
Internet sites and remote sellers aren't located in a 
purchaser's state, they do not have to collect these taxes. 
Exempting some out-of-state sellers from having to collect 
sales and use taxes creates an ``unlevel playing field'' among 
retailers.
    Refusing to address the existing state sales and use tax 
inequity in the same context as other Internet tax issues 
ensures that an unlevel tax playing field will continue to 
exist. If the current inequity is not addressed soon, 
resolution of this issue could be deferred for years, with the 
result being continued erosion of the state tax base and 
continued discriminatory tax treatment that disadvantages 
store-front retailers and low-income consumers.
    Retailers only want a ``level playing field'' -where a 
product is taxed (or not taxed) the same regardless of how it 
is ordered or delivered. All retailers, regardless of the 
channel or channels in which they do business, should have the 
same collection responsibilities -no matter if the transaction 
is made in a traditional store, through a traditional store's 
own website, by a strictly e-commerce retailer or through any 
other type of remote seller.
    Government tax policy shouldn't determine the winners and 
losers. In the retail industry, where a 1-2% net profit margin 
is standard, a 6-8% tax differential (the average state sales 
and use tax rate) is a significant pricing advantage. Why would 
someone buy something in a store when they could pop onto the 
Internet and buy it for 8% less? Consumers should pick winners 
and losers based on factors which they decide are important 
such as selection, service, convenience, etc. Tax policy 
shouldn't provide one retailer a pricing advantage over 
another.
    A ``level playing'' field does not mean a new tax-consumers 
are already required to pay ``use'' taxes. Under current law, 
if sales tax is not paid on an out-of-state purchase at the 
time of sale, the purchaser is required by state law to pay a 
comparable ``use'' tax to his or her state, usually when they 
file their state income tax return. Historically, states have 
not enforced collection of ``use'' taxes, but they do exist.
    States and local government services will suffer as their 
revenue base decreases. On average, sales and use taxes account 
for approximately 40% of a state's total tax revenue (more than 
$150 billion in 1998). With projections of on-line sales 
estimated to exceed $300 billion by 2002, state and local 
governments could lose as much as $20 billion in uncollected 
sales taxes. Sales tax revenue is used to fund basic state and 
local governmental services including police and fire 
protection, school funding, etc.
    An ``unlevel playing field'' disproportionately hurts the 
poor. In 1998, 55 million people had access to the Internet. 
According to a recent Commerce Department study, wealthy 
individuals are 20 times more likely to have Internet access. 
With an average Internet household income of $70,000, an 
``unlevel tax playing field'' would benefit those with higher 
levels of income and shift the tax burden to lower income 
individuals who can only buy locally (and thus pay sales tax at 
the sales counter).
    My conclusions are drawn from personal experience in 
dealing with a business that is not required to collect sales 
taxes and that currently operates only 7 miles from my store. 
Our store is located next to Fort Hood, Texas. The Army/Air 
Force Exchange operates a 17,000 square foot furniture store at 
its PX. We can see the number of people who leave our store and 
buy from a facility that is not required to collect sales tax. 
The reason they leave is because my price will always be 8.25 % 
higher, because I am required by the state of Texas to collect 
and remit its sales tax. I don't have to wait to see the effect 
that tax-free purchasing has on my business. I already know how 
it feels to compete with an entity that has a government 
imposed tax subsidy.
    As consumers purchases shift to the Internet where some 
sales are exempted from sales and use tax obligations, the 
impact on my business and my community will be significant. 
Last year alone, I collected $149,000 in sales taxes that 
funded schools and police and fire protection efforts in my 
community. In addition, I paid $31,000 in payroll and social 
security taxes and $51,000 in local property taxes. If my sales 
suffer as a result of this tax inequity, I will be forced to 
lay off employees and the revenues I collect and pay to the 
state and federal governments will diminish significantly.
    Almost 51% of Texas' revenues come from sales tax 
collections. Should this revenue stream decrease significantly, 
Texas will have to seek other sources of revenue. Although 
Texas doesn't currently have a state income tax, it may be 
forced to move in that direction if tax-free sales continue on 
the Internet. In an interesting twist, federal revenues would 
actually decrease under this scenario if Texans began deducting 
their newly-imposed state income taxes from their Federal 
income taxes.
    Congress has a responsibility to my business, my employees, 
and my community to eliminate this existing tax inequity. A 
level tax playing field is fair and it is practical. As a 
retailer, my bottom line and, therefore, the survival of my 
store, is affected by numerous factors beyond my control 
including the economy, the weather, and numerous federal and 
local government regulations. While I've learned to live with 
many of these, I cannot and should not be expected to compete 
at an 8% tax pricing disadvantage compared to my Internet and 
remote commerce counterparts.
    Congress can act to address this disparity. It can level 
the sales tax playing field by giving States the authority to 
collect sales and use taxes from out-of-state sellers once the 
States have adequately simplified their sales tax structures.
      

                                


    Chairman Houghton. Thank you very much, Mr. Ledger.
    I think we should turn to Mr. Honaker.

 STATEMENT OF RONALD R. AND MARGARET HONAKER, OWNERS, SALONS 4 
             U, AND GLOW SHOP, ST. LOUIS, MISSOURI

    Mrs. Honaker. Mr. Chairman and members of the committee, my 
name is Margaret Honaker. I am President of salons4u.com. We 
currently own or maintain 51 web sites, while I am still a 
full-time cosmetologist. Ron and I would like to provide some 
thoughts about the implications of adding more taxes to the 
Internet, starting with a little background.
    Currently, my daughter, Heather, would like to own her own 
beauty salon, but it appears that the mall management companies 
do not favor the Mom & Pop shops. Their first question seems to 
be, ``How many salons do you have in your chain?'' Now, these 
mall management companies in our area are managing most of the 
commercial strip centers and applying the same policies to the 
Mom & Pop shops, driving any start-up businesses to the 
Internet. So we went to the Internet.
    To increase my business as a stylist, I found that a single 
page competing with the other 500 million web pages out there 
would not work, so we built our own community-service web 
search engine for the beauty industry. We provided free pages 
to every one of the 250,000 salons nationwide, free pages to 
the 1,200 beauty-related suppliers, and free listings for all 
beauty professionals, thus creating a one-stop place to find 
beauty-related information for both the public and the beauty 
professionals. How could this site be taxed more? Therefore, I 
have asked Ron to assess the effects of any additional taxation 
on our web sites.
    Mr. Honaker. We are in one of the most exciting times in 
history because of the Internet. Things are advancing so 
quickly, but change seems to be an opportunity to some and just 
downright scary to others.
    Margaret has become a powerful listener to the many clients 
that she has, and they all tell her they don't want another 
tax. Well, then, who would want more taxes? How about the small 
towns in America with eroding tax bases? Yes, they are very 
scared, and rightfully so, but it appears all they want to do 
is just do the easy thing, and that is just put more taxes on 
rather than use the Internet to work for them.
    We keep hearing in the media about ``no taxes on the 
Internet.'' The Internet already has at least two major sets of 
taxes, the front-end and back-end taxes. The front-end are the 
ones being paid on the profits made by the businesses using the 
Internet. The back-end taxes are the ones being paid by the 
Internet service providers. They are the ones that connect your 
computers to the Internet system. These ISPs pay taxes on their 
communication lines and their profit, passing on the cost 
directly to the Internet users.
    I guess the thought is, how can we be taxed in the middle?
    Creating an Internet tax based on web site pages, no matter 
how small, would close the books on salons4u. Even $1 per page 
would mean over $250,000 in taxes for salons4u.
    Where salons4u receives its revenue to support the 
maintenance costs is from salons, suppliers, and beauty 
professionals that choose to place additional information or 
custom information on their pages. Since these businesses are 
in absolutely every location of the country, a one-time 
service-based tax may seem easy, but the overhead costs of 
sending checks to each of their cities, counties, and States 
would be an accounting roadblock.
    To learn about commerce on the Internet--we call it e-
commerce--and for fun, we started theglowshop.com, a site where 
we items for resale, such as hats and glowsticks, electric 
shirts, lights, glow-in-the-dark vinyl, etc. We found out how 
Americans love gadgets and how innovative they can be with our 
products. In the short time that theglowshop.com has been on 
line, less than 1 percent of our sales are from Missouri 
residents, on which we collect and pay sales tax to the State 
of Missouri. Fortunately, we only have to pay one tax to the 
State, and they redistribute the taxes to the county we live 
in. If we had to pay monthly, quarterly, semiannually, and/or 
yearly to the thousands of cities, counties, and States, it 
would be devastating. Just think, the stamps and writing of 
checks would be overbearing.
    Sales tax in this case would not only turn the lights out 
for theglowshop.com, but would simply kill every small 
reselling business on the web.
    We believe that taxes are designed to raise revenue or for 
controlling such things as moving money to charities or slowing 
down sins. So if a State places taxes on servers, we will be 
confused why they are taxing the servers for the revenue or for 
control. I will tell you that people are loyal to lower prices 
and will move the servers out of the State to a tax-free zone. 
Small businesses have the advantage to change and quickly win 
all the prizes that come with hard work, but almost always have 
the disadvantage of not having the quantity of research funding 
that is available to larger businesses. Additional taxes will 
slow down the rate of new inventions by individual people.
    We are a very small business, and we thank you for 
considering the catastrophes that can happen to a very small 
business with any additional taxes. The people applaud Congress 
for providing the great economic environment for the new jobs 
in America that we have recently enjoyed. But for humor, let it 
be know that very few want a new job to exist in America called 
``Internet Tax Preparers.''
    [The prepared statement follows:]

Statement of Ronald R. and Margaret Honaker, Owners, Salons 4 U and 
Glow Shop, St. Louis, Missouri

    We currently own or maintain 51 web sites, while I am still 
a full time cosmetologist. Ron and I would like to provide some 
thoughts about the implications of adding more taxes to the 
Internet starting with a little background.
    Currently, my daughter, Heather, would like to own her own 
beauty salon, but it appears that the malls management 
companies do not favor the Mom & Pop shops. Their first 
question seems to be ``how many salons do you have in your 
chain?'' Now, these mall management companies in our area are 
managing most of the commercial strip centers and applying the 
same policies to the Mom & Pop shops, driving any start-up 
businesses to the Internet. So, we went to the Internet.
    To increase my business as a stylist, I found that a single 
page competing with the other 500 million web pages out there 
would not work. So we built our own community service, web 
search engine for the beauty industry. We provided FREE pages 
to every one of the 250,000 salons nation-wide, FREE Pages to 
the 1,200 beauty-related suppliers, and FREE listings for all 
beauty professionals. Thus, creating a one-stop place to find 
beauty-related information for both the public and the beauty 
professionals. How could this site be taxed more? Therefore, I 
have asked Ron to assess the effects of any additional taxation 
on our web sites.
    We are in one of the most exciting times in history with 
the Internet. Things are advancing so quickly, but change can 
be seen as opportunity to some and down right scary to others.
    Margaret has become a very powerful listener to the many 
clients she has and they tell her they do not want another tax. 
Well then, who would want more taxes? I don't think politicians 
would more taxes in an election year. Big business, a most 
likely YES. Or, how about the small towns in America with an 
eroding tax base? YES, they are very scared, and rightfully so. 
But appears they want to do the easy thing, just put on more 
TAXES rather than to use the Internet to work for them.
    The Internet already has at least two major sets of taxes. 
The front-end taxes and back end taxes. The front-end taxes are 
being paid on the profits made by the businesses using the 
Internet. The back end taxes are the ones that are the Internet 
Service Provides (ISP), and they are the ones that connect your 
computers to the Internet system. These ISPs pay taxes both on 
their communication lines and their profit, passing on the cost 
directly to the Internet users. I guess the thought is how can 
we be taxed the middle?
    Products on the Internet can be of two types, Real and 
Virtual. Real Products are those items which we have been 
traditionally been buying everyday and that you can touch, feel 
and ship by trucks. Virtual products for sale are newer. They 
are the digital stuff, such as music, movies, information and 
services. Can you image that we can tax things that do not 
really exist?
    Creating an Internet tax based on pages, no matter how 
small, would close the books on salons4u.com. Even just one 
dollar per page would mean over $250,000 in taxes for 
salons4u.com.
    Where salons4u receives its revenue to support the 
maintenance costs is by the salons, suppliers, and beauty 
professionals that choose to place additional or custom 
information to their page. (Service and Virtual Products) Since 
they are in absolutely every location in this country, a one-
time service base tax seems easy, but the overhead costs of 
sending out checks to each of their cities, counties, and 
states would be an accounting roadblock.
    To learn about commerce on the Internet (e-commerce) and 
FUN, we started theglowshop.com. A site that we have items 
relating to light, such as hats, glow sticks, electro-shirts, 
lights, glow in the dark vinyl, etc. We have found out how 
Americans love gadgets. By the way, less than one percent of 
our sales are from Missouri residents, which we collect and pay 
sales tax to Missouri. Fortunately, we only have to one tax to 
pay to the state and they redistribute the correct taxes to the 
county that we live in. If we had to pay monthly, quarterly, 
semi-annually and/or yearly to thousands of cities, counties 
and states. Just the stamps and writing checks would over 
bearing.
    Our forefathers were wise in their judgement about 
interstate taxes.
    We believe that taxes can be used to raise revenue or for 
controlling such things as moving money to charities or slowing 
down sins. So if a state places taxes on servers, we will be 
confused why they are taxing servers for (revenue or control). 
I will tell you that people are loyal to lower costs and will 
move the servers out of that state to a tax free zone.
    Small businesses have the advantage to change quickly and 
win all the prizes that come with hard work, but almost always 
have the disadvantage of not having research funding available 
to larger businesses. Additional taxes will slow the rate of 
new inventions by individual people.
    And, let's not forget about the not-for-profits and 501s. 
Like Gateway to a cure that raises research dollars for a cure 
for spinal cord injuries. We are very very close to finding the 
cure! Additional indirect taxes affect their bottom line 
contributions.
    Lets have a little fun here with a worst case for Internet 
sales taxes. Say a person in an airplane has a mobile Internet 
device, or even some new aircraft have Internet connections on 
board. A person flying aboard an aircraft over state 1 (tax1) 
orders a small gift for a person in another state. The 
communication link from the aircraft links to a communication 
tower in state 2 (tax 2) and connects to the Internet to server 
in state 3 (tax 3) for theglowshop in state 4 (tax 4), 
theglowshop has that item dropped shipped from another company 
in state 5 (tax 5) with its servers in state 6 (tax 6). The 
person in state receiving the gift in state 7 has to pay a use 
tax, which is a camouflage sales tax. Who knows which and where 
the connecting hubs are located.
    We, a very small business employ you to consider the 
catastrophes that can easily happen to small businesses with 
any additional taxes.
    While the people applaud Congress for providing the great 
economical environment for new jobs in America we have recently 
enjoyed, let be known only a very few will want a new job to 
exist: ``Internet Tax Preparers''.
    Thank you for inviting us, so we could be part of America's 
government process.
      

                                


    Chairman Houghton. Thank you very much.
    Would you like to say something, Mrs. Honaker?
    Mrs. Honaker. Just thank you for having us.
    Chairman Houghton. Well, we thank you both for being here.
    Now, Jeanne Lewis, President of Staples.com.

STATEMENT OF JEANNE LEWIS, PRESIDENT, STAPLES.COM, FRAMINGHAM, 
                         MASSACHUSETTS

    Ms. Lewis. Mr. Chairman and members of the committee, my 
name is Jeanne Lewis. I am the President of Staples.com, and I 
am honored to be here today to testify on behalf of Staples, 
the office supply superstore, and our e-commerce business, 
Staples.com.
    I thank you, Mr. Chairman, for holding this hearing to 
review the recommendations of the Advisory Commission on 
Electronic Commerce. I am pleased to have the opportunity to 
offer some thoughts and specific concerns on the issue of 
Internet taxation. Let me say at the outset that Staples 
supports the goals of States and most of our Nation's Governors 
to develop a system of taxation that provides uniformity, 
simplicity and fairness to all retailers, regardless of whether 
transactions occur in stores or on the Internet.
    We are very concerned, however, that the current moratorium 
and the proposed extension of the moratorium passed by the 
House last week will serve to make the Internet a very unfair 
market from a taxation perspective.
    As a first priority, I would like to clear up a common 
misconception about taxes on the Internet. Despite the recent 
assertions of some Members of Congress and the media, the 
Internet is not tax-free. The Internet tax moratorium that was 
extended by the House last week does not preclude the 
imposition and collection of State and local sales and use 
taxes. The Internet Tax Freedom Act, contrary to its misleading 
title, merely mandates a moratorium on the ability of State and 
local governments to impose new taxes on Internet services or 
electronic commerce. Nevertheless, reputable media sources such 
as National Journal in its May 13th issue proclaimed in a 
headline, ``House Extends Ban on Internet Taxes,'' and NBC 
Today Show news announced that the Internet would be tax-free 
for five more years. Local and Internet retailers, so-called 
``brick and click'' retailers, are still required to assess and 
collect sales taxes on Internet purchases when the purchased 
items are shipped to a State where the retailer has a store or 
other facility. Consequently, local merchants that sell on the 
Internet must collect sales taxes in States where they have a 
physical presence, while those retailers who sell only on the 
Internet largely escape State sales taxation.
    This ``physical presence'' test was reconfirmed in a 1992 
Supreme Court decision, Quill v. North Dakota. Ironically, 
Staples has since acquired Quill, an office supplies direct 
marketer. We wish that we could simply assert that the litigant 
was wrong, but unfortunately, such an assertion would not 
change the state of the law.
    To explain our concerns, let me offer an example of how 
Internet taxation affects ``brick and click'' companies. If a 
Staples Internet purchaser lives in Chairman Houghton's home 
State of New York, Staples is required to charge the purchaser 
8 percent State and local sales tax for any Internet purchase 
because Staples has a ``physical presence'' in New York. If you 
buy these same items from a so-called ``pure-play'' Internet 
retailer, one that has no retail stores or facilities in any 
States, or just one or two States, you are not charged sales 
tax because the Internet retailer does not have a physical 
presence in New York. This effectively means that New York 
consumers are getting up to an 8 percent discount from Internet 
retailers that do not charge sales tax. This also means that 
companies that have made investments in New York are being 
penalized on their Internet to New Yorkers for having made that 
investment.
    Staples has made investments of stores or distribution 
centers in many States--44 States as of today. This means that 
most consumers are paying sales taxes--if they live in a State 
that has a sales tax--when they purchase from Staples on the 
Internet. When one considers where to buy thousand-dollar-plus 
computer equipment, fax machines, office furniture, or other 
high value merchandise, this 4 to 8 percent ``discount'' is 
likely to make a difference in a person's purchasing decision.
    Of course, even if one decides to purchase goods from a 
pure-play Internet retailer that does not charge sales tax 
because it does not have a physical presence in the State of 
the purchaser, that State probably applies a use tax which is 
required to be remitted to the State in lieu of a sales tax on 
goods where sales tax has not been collected. However, a number 
of Governors have testified before Congress about the 
significant difficulties they face in enforcing this use tax; 
thus, these Internet goods remain virtually sales-tax free. 
Most States simply do not have the desire or the resources to 
conduct home inspections to determine if goods have been 
purchased without payment of a sales and use tax.
    If Congress moves to extend the current moratorium, as the 
House did last week, we believe that the only fair and 
equitable solution in the short term is to expand the 
moratorium to include all existing sales and use taxes on 
Internet transactions so that the Internet Tax Freedom Act 
truly lives up to its name. Extending the Internet tax 
moratorium without addressing this taxation inequity will 
perpetuate an unfair advantage to Internet pure-play retailers. 
We simply ask for a level playing field. Otherwise, retailers 
which sell locally and on the Internet will continue to be at a 
significant competitive disadvantage.
    As I said at the beginning of my testimony, Staples 
certainly understands and supports the position of State and 
local officials that the sales tax base must be protected to 
ensure adequate funding for State and local government. We 
cannot, however, be subsidizing our Internet competitors who 
compete for the same customers that we do in a given State 
simply because we have invested in facilities and people in 
that State. The enactment of the Internet Tax Freedom Act, 
without the revisions we have suggested, will result in the 
Congress aiding and abetting efforts to circumvent nexus or 
physical presence through the creation of questionable 
corporate tax mechanisms for the sole purpose of avoiding sales 
tax on Internet sales. Such a result would not only be poor tax 
policy; it would create chaos, as the Internet would simply be 
unfair to those who have already made substantial investments 
in States.
    [The prepared statement follows:]

Statement of Jeanne Lewis, President, Staples.com, Framingham, 
Massachusetts

    Mr. Chairman and Members of the Committee, my name is 
Jeanne Lewis. I am the President of Staples.com and I am 
honored to be here today to testify on behalf of Staples, the 
office supplies superstore, and our e-commerce business 
Staples.com.
    I thank you Mr. Chairman for holding this hearing to review 
the recommendations of the Advisory Commission on Electronic 
Commerce. I am pleased to have the opportunity to offer some 
thoughts and specific concerns on the issue of Internet 
taxation. Let me say at the outset that Staples supports the 
goals of states and most of our nation's Governors to develop a 
system of taxation that provides uniformity, simplicity and 
fairness to retailers, regardless of whether transactions occur 
in stores or on the Internet.
    We are very concerned, however, that the current moratorium 
and the proposed extension of the moratorium passed by the 
House last week will serve to make the Internet a very unfair 
market from a taxation perspective.
    As a first priority, I would like to clear up a common 
misconception about taxes on the Internet. Despite the recent 
assertions of some Members of Congress and the media, the 
Internet is tax-free. The Internet tax moratorium that was 
extended by the House last week does not preclude the 
imposition and collection of state and local sales and use 
taxes. The Internet Tax Freedom Act, contrary to its misleading 
title, merely mandates a moratorium on the ability of state and 
local governments to impose new taxes on Internet services or 
electronic commerce. Nevertheless, reputable media sources such 
as National Journal in its May 13th issue proclaimed in a 
headline ``House Extends Ban on Internet Taxes'' and NBC Today 
Show news announced that the Internet would be tax-free for 
five more years. Local and Internet retailers, so-called 
``brick and click'' retailers, are still required to assess and 
collect sales taxes on Internet purchases when the purchased 
items are shipped to a state where the retailer has a store or 
other facility. Consequently, local merchants that sell on the 
Internet must collect sales taxes in states where they have a 
physical presence, while those retailers who sell only on the 
Internet, largely escape state sales taxation.
    This ``physical presence'' test was reconfirmed in a 1992 
Supreme Court decision Quill v. North Dakota. Ironically, 
Staples has since acquired Quill, an office supplies direct 
marketer. We wish that we could simply assert that the litigant 
was wrong, but, unfortunately, such an assertion would not 
change the state of the law.
    To explain our concerns, let me offer an example of how 
Internet taxation affects brick and click companies: If a 
Staples Internet purchaser lives in Chairman Houghton's home 
state of New York, Staples is required to charge the purchaser 
8% state and local sales taxes for any Internet purchase 
because Staples has a ``physical presence'' in New York. If you 
buy these same items from a so called ``pure-play'' Internet 
retailer (one that has no retail stores or facilities in any 
states or just one or two states), you are not charged sales 
tax because the Internet retailer does not have a physical 
presence in New York. This effectively means that New York 
consumers are getting up to an 8% discount from Internet 
retailers that do not charge sales tax. This also means that 
companies that have made investments in New York are being 
penalized on their Internet sales to New Yorkers for having 
made that investment.
    Staples has made investments of stores or distribution 
centers in many states -44 states as of today. This means that 
most consumers are paying sales taxes (if they live in a state 
that has a sales tax) when they purchase from Staples on the 
Internet. When one considers where to buy thousand-dollar plus 
computer equipment, fax machines, office furniture or other 
high value merchandise, this 4-8% ``discount'' is likely to 
make a difference in a person's purchasing decision.
    Of course, even if one decides to purchase goods from a 
pure-play Internet retailer that does not charge sales tax 
because it does not have a physical presence in the state of 
the purchaser, that state probably applies a use tax which is 
required to be remitted to the state in lieu of a sales tax on 
goods where sales tax has not been collected. However, a number 
of Governors have testified before Congress about the 
significant difficulties they face in enforcing this use tax, 
thus these Internet goods remain virtually sales-tax free. Most 
states simply do not have the desire or the resources to 
conduct home inspections to determine if goods have been 
purchased without payment of a sales and use tax.
    If Congress moves to extend the current moratorium, as the 
House did last week, we believe that the only fair and 
equitable solution in the short-term is to expand the 
moratorium to include all existing sales and use taxes on 
Internet transactions so that the Internet Tax Freedom Act 
truly lives up to its name. Extending the Internet tax 
moratorium without addressing this taxation inequity will 
perpetuate an unfair advantage to Internet pure-play retailers. 
We simply ask for a level playing field. Otherwise, retailers 
which sell locally and on the Internet will continue to be at a 
significant competitive disadvantage
    As I said at the beginning of my testimony, Staples 
certainly understands and supports the position of state and 
local officials that the sales tax base must be protected to 
ensure adequate funding for state and local government. We 
cannot, however, be subsidizing our Internet competitors who 
compete for the same customers that we do in a given state 
simply because we have invested in facilities and people in 
that state. The enactment of the Internet Tax Freedom Act, 
without the revisions we have suggested, will result in the 
Congress aiding and abetting efforts to circumvent nexus or 
physical presence through the creation of questionable 
corporate tax mechanisms for the sole purpose of avoiding sales 
tax on Internet sales. Such a result would not only be poor tax 
policy, it would create chaos as the Internet would simply be 
unfair to those who have already made substantial investments 
in states.
      

                                


    Chairman Houghton. All right. Thank you very much. Very 
good, Ms. Lewis.
    Mr. Duncan?

 STATEMENT OF HARLEY T. DUNCAN, EXECUTIVE DIRECTOR, FEDERATION 
                     OF TAX ADMINISTRATORS

    Mr. Duncan. Thank you very much, Mr. Chairman and members 
of the committee. I appreciate the opportunity to be with you 
to present the views of the Federation of Tax Administrators on 
the issues of the taxation of electronic commerce. My name is 
Harley Duncan; I am the Executive Director of the Federation of 
Tax Administrators, which is an association of the State tax 
administration agencies in the 50 States, the District, and New 
York City.
    My primary message to you today is that the issue of 
collection of sales and use tax on remote sales, whether those 
are accomplished via mail order, catalogue, phone, or the 
Internet, is a serious and pressing issue for State and local 
governments and it is one that Congress does need to attend to. 
We think that the continued lack of ability to collect tax on 
remote sales where the vendor is not required to collect 
because they don't possess a physical presence has three 
significant impacts on State and local governments.
    The first is the erosion of the sales tax base, or the pure 
monetary issue. Work done by Bill Fox and Don Bruce at the 
University of Tennessee indicates that by the year 2003, the 
amount of uncollected sales tax will exceed $20 billion. That's 
both with respect to sales to individuals as well as sales to 
businesses. That will amount to over 4 percent of the total tax 
revenues in States like Florida, Nevada, South Dakota, 
Tennessee, and Texas that rely on the sales tax as opposed to 
an income or other significant tax.
    In addition to the base issue, there is the one of the 
unlevel playing field that Mr. Ledger and Ms. Lewis have spoken 
to very well. Basically, what you have under the current 
situation is a government-sanctioned and government-maintained 
competitive disadvantage that faces a fixed-base retailer that 
is required to collect tax, while those who operate outside the 
State are allowed to sell without the collection of tax. We 
don't think that can or should be sustained over the long term.
    The final impact is one of erosion of our Federal system. 
The sales tax is the single tax that States reserve primarily 
unto themselves to carry out their mission in the Federal 
system. If that tax is weakened by base erosion through 
electronic commerce and other forms of remote sales, we think 
that the Federal system will be weakened and that States will 
not be able to carry on their appropriate and proper role in 
the system.
    We think the solution to the issue of collection of tax on 
remote sales is relatively straightforward. Congress should 
exercise the authority that the Court has said is its under the 
Commerce Clause, reiterated in the Quill case, to authorize 
States to require remote sellers to collect sales and use tax 
on goods and services that they sell into the State. We believe 
an important part of that change in the nexus threshold should 
be one that shifts from physical presence to an economic 
presence. In other words, there should be a threshold above 
which you are required to collect on sales into a State at a 
dollar-denominated sales threshold; if you are below that on a 
national basis, you collect only where you are based. In other 
words, we shift from a physical standard to an economic 
standard. We think that's consistent with what the Court has 
said. It is appropriate and proper. In addition, it is very 
consistent with an increasingly digital and borderless world.
    The second part of the solution has to be that any expanded 
duty to collect has to be accompanied by significant 
simplification of the current sales tax system. The 
complexities of the current system, that you've heard 
discussed, are indeed accurate; it is a complex system, and 
Congress is well within its right to require States to simplify 
if they expect that the duty to collect is going to be extended 
to remote sellers.
    The second part of the message I would like to communicate 
to you today is that I think States are indeed serious about 
the simplification and are working today to undertake that. We 
have started a project that now has 30 States involved in it, 
really trying to look at a three-pronged attack on the 
complexity of the current system. One is some structural 
simplifications and common definitions across items that might 
be in the base or out of the base, and simplification of rates 
and changes in other aspects of the law. The second is to 
promote greater use of technology in collecting the tax, and to 
provide safe harbors for sellers that use that technology so 
that they are held harmless on audit. And a third part of it is 
for the States to pay for the system.
    We think the combination of those sorts of simplifications 
and an expanded duty to collect is an appropriate one.
    Just a comment on the work of the Advisory Commission on 
Electronic Commerce. I think most State and local officials 
have come to the reluctant conclusion that Congress should 
reject the recommendations contained in that report. Forty-two 
Governors have written, seeking that. Other State and local 
officials have, and a hundred academic economists have. There 
are three principal reasons for it.
    The first is, it contains a series of unwarranted tax 
preemptions that will seriously affect State and local fiscal 
conditions. The second is that it fails to deal in any 
meaningful fashion with this remote sales tax collection issue. 
And third, it is really an assault on the federalism and the 
sovereignty of the States that puts significant control over 
State and local taxes in the hands of the Congress, and it is 
one that you will have to continue to exercise if you take it 
on once.
    Thank you.
    [The prepared statement follows:]

Statement of Harley T. Ducan, Executive Director, Federation of Tax 
Administrators

Mr. Chairman and Members of the Committee:

    My name is Harley Duncan. I am Executive Director of the 
Federation of Tax Administrators. The Federation is an 
association of the principal state tax administration agencies 
in the 50 states, D.C., and New York City. Thank you for the 
opportunity to appear before you today on the general subject 
of the state and local tax issues involved with electronic 
commerce.
    The policy of our organization in this area has been 
established generally in two resolutions adopted by our members 
at the June 1999 Annual Meeting in Milwaukee, Wisconsin. The 
first resolution advocates simplification of state sales and 
use tax structures and administration as a prelude to requiring 
collection of sales and use taxes by all sellers above a de 
minimis sales volume threshold, regardless of whether they have 
a physical presence in the taxing jurisdiction. The second 
resolution contains a general position against federal 
preemption of state tax sovereignty and tax authority.
    In this testimony, I would like to achieve five goals:
     Provide a high-level overview of the essential 
features of state and local sales and use taxes;
     Outline the primary state and local tax issues 
associated with electronic commerce;
     Identify the expected revenue impact on states and 
localities of electronic commerce;
     Outline a general approach to an appropriate 
resolution of the issue; and
     Review the reasons that many state and local 
officials have called on Congress to reject the so-called 
'majority report' of the Advisory Commission on Electronic 
Commerce.

             Basics of State and Local Sales and Use Taxes

    Forty-five states plus the District of Columbia levy a 
sales and use tax. In addition, local governments in 
approximately 30 states are authorized to impose a local sales 
tax. In all but four states (Alabama, Arizona, Colorado and 
Louisiana), these local taxes generally ``piggyback'' on the 
state tax base and are collected by the state tax 
administration agency on behalf of the local government.\1\ 
Sales tax rates range from 3 percent to 7 percent at the state 
level; local option rates generally run from 1 to 2 percent. 
The ``average'' state and local tax rate in the U.S. is roughly 
6.0-6.5 percent.
---------------------------------------------------------------------------
    \1\ In these 4 states, local governments administer their sales 
taxes independently of the state. There may be differences in the state 
and local tax base, and returns, remittances, etc. are filed directly 
with the local governments.
---------------------------------------------------------------------------
    Every state with a retail sales tax also levies a 
``compensating use'' tax, often simply referred to as the use 
tax. A use tax is levied on all taxable goods and services that 
are used and consumed in the taxing state if there has not been 
paid an appropriate sales tax. Thus, goods and services on 
which no sales tax has been collected are subject to the 
compensating use tax.
    The sales tax is a consumption tax that is applied on a 
destination basis, meaning the tax is applied in and remitted 
to the jurisdiction in which delivery of the good or service is 
taken or where it is to be used or consumed. [Receiving goods 
at the time of sale is considered taking delivery. The point of 
delivery is presumed to be the jurisdiction in which 
consumption occurs.] Goods and services traveling through 
multiple jurisdictions or involving multiple jurisdictions are 
still taxable only in the state of consumption or use.
    A seller may not be required to collect use tax on goods 
shipped to a buyer in another state unless there is a 
sufficient ``nexus'' or level of contact between the seller and 
the state of the buyer. The U.S. Supreme Court has held that 
for an out-of-state seller to be required to collect use tax on 
goods and services sold into a state, the seller must have some 
physical presence in the state of the buyer, either directly or 
through the activities of a representative.\2\ If the sales or 
use tax is not collected by the seller because of the lack of a 
requirement to do so, the buyer is still responsible for 
payment of the use tax directly to the state in which the good 
or service is used or consumed.
---------------------------------------------------------------------------
    \2\ Quill Corporation v. North Dakota, 504 U.S. 298, 112 S.Ct. 
1904, 119 L.Ed.2d. 91 (1992); National Bellas Hess, Inc. v. Dept. of 
Revenue of Illinois, 386 U.S. 753, 87 S.Ct. 1389, 18 L.Ed.2d. 505 
(1967).
---------------------------------------------------------------------------

                Tax Issues Raised by Electronic Commerce

Collection of Tax on Remote Electronic Commerce Sales

    In terms of potential revenue effect, the largest and most 
immediate issue raised for state and local governments is, by 
far, the potential increased sales tax base erosion caused by 
the explosion in electronic sales \3\ on which no sales or use 
tax is collected because the seller has no nexus with the state 
in which the buyer resides. In many ways, electronic commerce 
can be likened to the longstanding issue of mail order or 
catalog sales in which state and local use tax is not collected 
because the seller has no physical presence or nexus with the 
state. This is particularly true of the sale of tangible goods 
where it is only the medium through which the transaction is 
conducted that differs, not the nature of the product.
---------------------------------------------------------------------------
    \3\ This includes sales of both digital products and, more 
importantly, tangible goods via electronic means.
---------------------------------------------------------------------------
    The remote sales tax collection issue arises because of the 
U.S. Supreme Court decision in Quill Corp. v. North Dakota 
(1992), upholding its decision of 25 years earlier in National 
Bellas Hess v. Illinois Department of Revenue (1967). The Court 
held that, under the Commerce Clause, a taxing state could not 
require an out-of-state seller whose only contacts with the 
state were the solicitation of orders by catalog and shipping 
goods by common carrier or U.S. mails to collect use tax on 
goods shipped into the state. Without such a physical presence, 
the Court held, requiring a seller to comply with the sales tax 
laws of each jurisdiction and the large number of local tax 
rates would create an undue burden on interstate commerce.\4\
---------------------------------------------------------------------------
    \4\ Some observers argue that the Quill and Bellas Hess decisions 
require a seller to have a ``substantial physical presence'' in the 
taxing state before it can be required to collect tax. The Quill 
decision does not use the phrase ``substantial physical presence'' it 
requires a ``substantial nexus'' with the taxing state, and says that 
nexus is satisfied if the seller maintains a physical presence in the 
taxing state.
---------------------------------------------------------------------------
    The combination of the Quill physical presence rule with 
the advent of electronic commerce exposes state and local sales 
tax system to a potentially large erosion of the tax base. A 
hallmark characteristic of the Internet is its ability to allow 
a seller to market directly to individual consumers on a 
worldwide basis while, at the same time, minimizing the 
physical facilities necessary to undertake such efforts. As a 
consequence, the exposure of state and local sales tax systems 
to remote sales is magnified exponentially.
    The issue is not limited only to purchases by individual 
consumers. State and local sales and use taxes generally apply 
to purchases by businesses where the item purchased is for use 
and consumption by the business itself, rather than for resale 
or incorporation into an item being resold to another consumer. 
Where tax is not collected by the seller (because of nexus 
reasons), the purchaser is to accrue and remit tax on its 
purchases. Use tax compliance among businesses is substantially 
better than among individuals because many of them routinely 
accrue tax and they are routinely subject to audit. 
Nonetheless, the noncompliance in the area of business 
purchases should be expected to increase as more sellers use 
the Internet to accomplish what once took sales personnel and 
in-state facilities.
    The consequences of a rapidly growing volume of retail 
transactions going effectively untaxed (even though the tax is 
owed by the consumer) are several: (1) Erosion of the retail 
sales tax base and revenue stream; (2) Violation of a principle 
of tax neutrality because sales of identical goods are taxed 
differently based only on the location of the seller; (3) 
Unfair competition with Main Street and other businesses 
required to collect tax on their sales; (4) Growing concerns 
about the long-term viability of the sales tax as a mainstay in 
the state and local tax structure.
    That is to say, the issue goes well beyond that of the 
amount of revenues available to states and localities although 
that too is an important issue. There is an important issue of 
the competitive disadvantage faced by fixed-base retailers and 
others who are required to collect tax. The threat to their 
survival from this built-in, government-sanctioned disadvantage 
is real. Likewise, the long-term threat to the sales tax as a 
whole cannot be overstated. If a tax is seen as increasingly 
unfair because some have to pay and some do not (and the only 
reason for the difference is the manner in which a purchase is 
made), the end result may be demands to repeal the tax for 
everyone.

Complexity of the Current System

    Another effect of electronic commerce has been to shine a 
spotlight on the complexity of the current sales and use tax 
system and its administration for sellers, particularly those 
operating on a multistate basis. As efforts to address the 
remote sales issue are undertaken, they run head-long into the 
complexity of the current system, and the ``undue burden'' it 
places on sellers required to comply. Discussions of the state 
and local tax issues associated with electronic commerce 
naturally include a discussion of ways in which the current 
system can be simplified and made more uniform across 
states.\5\ Likewise, any resolution of the remote sales issue 
will necessarily entail substantial simplification of the tax.
---------------------------------------------------------------------------
    \5\ For an extensive discussion of the types of simplifications 
that have been discussed, see the Final Report, National Tax 
Association Communications and Electronic Commerce Tax Project, supra.
---------------------------------------------------------------------------
    The complexity arises from the simple fact that the sales 
tax has been developed as a stand-alone tax in each state 
without a great deal of regard for the degree to which it 
conforms to similar taxes in other states. This is natural 
since when sales taxes were developed, most retail activity was 
confined to a single state. As a result, there are differences 
in tax bases across states, differences in administrative laws 
and procedures as well as differences in filing, returns and 
remittances.
    Another aspect of complexity in the current system is the 
extent to which local option sales taxes are used. Over the 
last 30 years, in an effort to reduce reliance on property 
taxes, states have increasingly authorized local governments to 
levy sales taxes (often only after approval by the voters). 
Local governments in 30 states now levy sales taxes. While the 
base and administration are generally piggybacked on the state 
sales taxes, the rate varies across some localities. The result 
is considered complex by multistate sellers that are required 
to identify the jurisdiction into which an item is being sold, 
determine the appropriate tax rate, and account for tax 
collected in each local jurisdiction.

     Impact of Electronic Commerce on State and Local Tax Revenues

    There have been several studies done of the impact of 
electronic commerce on state and local revenues.\6\ The most 
comprehensive has been prepared by Donald Bruce and William 
Fox, two University of Tennessee economists.\7\ Bruce and Fox 
use forecasts of electronic commerce sales into the future 
(2003) to look at the expected near-term magnitude of the 
impact. They also try to estimate the impact in both the 
business-to-consumer (B2C) and the business-to-business (B2B) 
markets. They also account for the current impact of mail order 
sales on state revenues and the substitution of e-commerce 
sales for mail order as well as the ``natural'' decline in 
state tax bases due to a shift to services in the economy.
---------------------------------------------------------------------------
    \6\ See, for example, Robert Cline and Thomas Neubig, ``The Sky is 
Not Falling.'' (published by the E-Commerce Coaliton) which projects 
that in 1998, the net impact of electronic commerce was to reduce state 
and local revenues by about $170 million. Forrester Research estimates 
that the comparable number for 1999 was $500 million. Both of these 
analyses examine only business-to-consumer sales.
    \7\ Donald Bruce and William F. Fox, ``E-Commerce in the Context of 
Declining State Sales Tax Bases,'' (mimeo) February 2000. [To appear in 
a forthcoming edition of the National Tax Journal.]
---------------------------------------------------------------------------
    The results of the Bruce and Fox analysis can be summarized 
as follows.

     In 2003, the total amount of state and local sales 
and use taxes going uncollected due to electronic commerce is 
projected to be $20.1 billion. The 'incremental' (i.e., sales 
newly shifted to electronic commerce) impact is estimated at 
$10.8 billion, of which about 70 percent is from B2B sales.
     On a state-by-state basis, the projected total 
state and local revenue impact due to e-commerce ranges from 
$31.8 million in Vermont to $2.8 billion in California. The 
expected impacts exceed $1 billion in each of New York, Texas 
and Florida.
     Expressed in terms of total tax revenues, the 
revenues not collected due to e-commerce range from 4.9 percent 
of total taxes in Texas to 1.5 percent in D.C. It is over 4 
percent in each of Florida, Nevada, South Dakota, Tennessee and 
Texas.
     On average, states would have to raise their sales 
tax rates by 0.5-0.75 percentage points to maintain constant 
revenues in 2003, i.e., to offset the impact of e-commerce on 
tax receipts.

         Potential Solution To Remote Sales/Use Tax Collection

Policy Objectives

    Congressional activity to address the issue of electronic 
commerce and remote sales should, in my estimation, focus on 
several policy objectives, including:
     Ensure that the tax system is neutral across all 
types of sellers, regardless of the channels through which they 
choose to market;
     Preserve the sovereignty of states to design their 
tax systems to fit their own circumstances , particularly as to 
the taxes employed, items to be taxed and tax rates;
     Promote substantial simplification and greater 
uniformity across states so as to minimize the burden imposed 
on sellers to comply, particularly smaller retailers;
     Foster the use of advanced technology in 
administration of and compliance with the sales tax system; and
     Protect the privacy rights of consumers

Expanded Duty to Collect

    From a tax administrator perspective, the answer to the 
potential erosion of the sales tax base by electronic and other 
remote commerce seems clear. Congress should use its authority 
under the Commerce Clause to authorize states to require 
sellers without a physical presence in the state to collect use 
taxes on goods and services sold into the state. Included 
within the authorization should be a requirement that states 
accomplish meaningful simplification of the sales tax and its 
administration as well as a de minimis threshold stated in 
terms of a dollars-denominated sales threshold below which a 
seller would not be required to collect tax for multiple 
states.\8\
---------------------------------------------------------------------------
    \8\ Sellers below the threshold level might be required to collect 
only on sales within the state(s)in which they operate or simply remit 
tax on all sales to that state. Such an approach would avoid placing 
undue burdens on the smallest sellers. A sales threshold de minimis 
would eliminate a large amount of litigation that occurs currently 
regarding what constitutes nexus and the required level of contact with 
a taxing state.
---------------------------------------------------------------------------
    There are at least two types of federal legislative 
vehicles that could be used to implement a system such as that 
outlined here. First, Congress could pass a law simply 
authorizing those states that modified their sales tax law to 
meet certain standards to require remote sellers above the de 
minimis threshold to collect tax. Congress has considered 
similar legislation in recent years.
    Alternatively, Congress could authorize states to form an 
interstate sales tax compact and authorize states that join the 
compact to require remote sellers to collect tax on goods and 
services sold into the state. A requirement of participation in 
the compact would be to adopt a sales and use tax law that met 
certain standards of simplification and uniformity that 
Congress considered necessary. Such a compact could achieve the 
same or greater simplification and uniformity objectives as 
federal legislation and leave a greater proportion of the 
details to the states. It could also provide a framework for 
ensuring continued uniformity and simplification over time.
    The Federation has not expressed a preference for one 
vehicle over another. We would urge the Congress to include an 
examination of the appropriate vehicle as it considers this 
issue

Simplification and Uniformity--Streamlined Sales Tax Project

    States and localities recognize that concomitant with any 
expanded duty to collect use taxes there must be a significant 
simplification and improvement in uniformity in state and local 
sales taxes and their administration. In an economy that is 
increasingly multi-jurisdictional, it is necessary for states 
to cooperate in the design and administration of their taxes so 
as to facilitate commerce and to reduce compliance burdens for 
the increasing number of multistate sellers. Simplification 
also has rewards for fixed-base retailers.
    States have initiated a project called the ``Streamlined 
Sales Tax System for the 21st Century.'' The Project is 
intended to overhaul the existing sales and use tax system to 
better accommodate interstate commerce, especially the changes 
presented by electronic commerce. The Project is aimed at 
developing a substantially simplified sales and use tax system 
while employing emerging technologies to remove or reduce the 
burden on sellers for collecting the taxes, with the states 
contributing substantially to the financing of the streamlined 
system. There are approximately 30 states participating in the 
Project at this time. Further information on the Project 
membership and organization is available at 
www.streamlinedsalestax.org.
    There are four key aspects to the Streamlined Sales Tax 
system being developed.

    Strategic Simplifications. The Project is developing a 
series of simplifications that will substantially reduce the 
burden associated with sales and use tax collection. Among the 
primary simplifications are uniform definitions of items that 
may be included in a tax base, simplified and uniform exemption 
administration, repeal of the ``good faith acceptance'' rule 
for exemption certificates, uniform sourcing rules, limitations 
on local tax rate changes, simplified returns and remittances 
and centralized registration. The simplifications being 
addressed are primarily those that have been identified as most 
critical by fixed-base and electronic commerce retailers.
    Use of Advanced Technologies. A second major component of 
the project is the use of emerging technologies to reduce the 
burden on sellers. A number of companies provide technology and 
services to assist sellers in calculating the taxes due on a 
given sale. The range of services offered varies from a simple 
tax calculator to compiling and filing returns and tax 
remittances. The aim of the project is to ``certify'' 
qualifying technology vendors as offering a service that meets 
the requirements of state sales tax law. Sellers that use 
certified technology would then be provided a ``safe harbor'' 
against future audit assessments for any failure attributable 
to the certified software.
    Paying for the system. The project is committed to 
financing as much of the system as it reasonably can for 
sellers. The primary method of financing sellers' participation 
will be through vendors' compensation--i.e., allowing sellers, 
or their tax service providers, to retain a portion of the 
sales and use tax collected as compensation for collection of 
the tax.
    Privacy concerns. Provisions will be included in all 
aspects of the project's work to ensure that personal 
information is not unnecessarily gathered and is not improperly 
used by persons engaged in the tax administration process. Tax 
administration agencies will not come into possession of 
personal identifying information for an individual paying tax 
at the time of a transaction. Tax calculation service providers 
will be prohibited from using personal information for any non-
tax-administration purpose.

Rationale

    Beyond the protection of the state and local revenue base, 
an expansion of the duty to collect sales and use tax under a 
simplified administrative system promotes several tax policy 
goals and strengthens federalism.
     It promotes neutrality in the tax system by 
treating all purchases of the same or similar products 
similarly, regardless of the seller.
     It will promote equity among sellers and eliminate 
an `unfair' competitive advantage now enjoyed by remote sellers 
who are not required to collect tax compared to the Main 
Street/shopping mall seller who is required to collect.
     It recognizes that the current approach of each 
state independently administering its own tax is inefficient 
and imposes undue burdens on multistate sellers. It recognizes 
that multistate cooperation and uniformity are required to 
promote simplification and avoid other more dire consequences 
such as federal intervention.
     By strengthening the sales tax, it will also 
strengthen our system of federalism. If the largest single 
state and local revenue source is crippled, the strength of 
states and localities as partners in that federal system is 
weakened.

 ``Majority Report'' of the Advisory Commission on Electronic Commerce

    The Internet Tax Freedom Act created the Advisory 
Commission on Electronic Commerce (ACEC). The Commission was to 
be a balanced representation of the public and private sector 
interests at stake in the issue of taxation of electronic 
commerce. Its mission was to undertake a thorough study of the 
federal, state and local tax issues associated with the 
taxation of electronic commerce and to make recommendations to 
Congress for ways to resolve those issues. Any recommendations 
to Congress were required to have the support of two thirds of 
the Commission members.\9\
---------------------------------------------------------------------------
    \9\ The Commission's report was presented to Congress in April 
2000. It is available at the Commission Web site 
www.ecommercecommission.org.

---------------------------------------------------------------------------
Shortcomings of the Report

    Many state and local officials have been forced to conclude 
that the Commission fell woefully short of its goal. Forty-two 
governors have written to the leadership of the Congress asking 
that they reject the Commission report.\10\ Over 100 academic 
economists have also signed a letter criticizing the report as 
reflecting inappropriate and misguided tax policy. State and 
local officials see four major shortcomings in the ACEC report.
---------------------------------------------------------------------------
    \10\ See testimony of Gov. Michael O. Leavitt before the Committee 
on Commerce, U.S. Senate, April 12, 2000.
---------------------------------------------------------------------------
    Unlevel Playing Field. Rather than promoting neutrality 
across marketing channels and creating a level playing field 
for all retailers, the ACEC recommendations further tilt the 
playing field against fixed-base retailers and others currently 
carrying the state and local tax burden. The ACEC 
recommendations would open many new opportunities for firms to 
actively engage in business in a state without incurring tax 
obligations. As such, they exacerbate, not eliminate, the 
competitive disadvantage faced by fixed-base retailers and 
other taxpayers.
    Failure to Address Remote Sales. The ACEC report fails to 
address in any meaningful way the remote sales tax collection 
issue outlined earlier. The report would have required states 
and localities to develop and implement a series of mandated 
simplifications, which process would have been followed by an 
elongated, inconclusive and likely negative review of whether 
tax collection obligations should be extended to remote 
sellers.
    Preemption of State Sovereignty. If adopted, the 
recommendations of the ACEC would constitute a frontal assault 
on the sovereignty and authority of states to determine their 
own tax structures. It would have, for the first time in our 
nation's history, placed nearly complete authority over the 
details of state tax law in the hands of the U.S. Congress. As 
such, the report showed little understanding of federalism or 
the role of the states in the federal system.
    Unwarranted Tax Preferences. The report recommends, with 
little or no justification in most instances, that Congress 
preempt state tax authority in several key areas. These areas 
include an exemption for Internet access charges and all 
digitally delivered goods and services as well as their 
tangible counterparts. In addition, the report calls for 
Congress to enact a federal law mandating that a series of 
activities (commonly carried on by electronic commerce firms) 
could not be considered to constitute nexus for sales and use 
or business activity taxes. Taken together, these nexus carve-
outs would enable electronic commerce firms to engage in a wide 
range of activities within a state without being required to 
meet tax obligations in the state and would exempt a 
considerable portion of their content and activities from tax. 
Estimates are that the combination of the tax preferences 
included in the ACEC report, discussed in more detail below, 
would reduce current law state and local tax revenues by as 
much as $25-30 billion per year.

Further Discussion

    Internet access. The majority report recommends making 
permanent the Internet Tax Freedom Act's moratorium on any 
transaction taxes on the sale of Internet access, including 
taxes that were grand fathered under the ITFA. At present, the 
following 11 states impose the sales tax (or a similar gross 
receipts tax) on such charges: Connecticut, Hawaii, New 
Hampshire, New Mexico, North Dakota, Ohio, South Dakota, 
Tennessee, Texas \11\ , Washington State and Wisconsin.\12\ In 
each case, the tax is part of a broader based tax (e.g., sales 
tax) and is not a levy targeted specifically at Internet 
charges. The impact of this repeal of the grandfather clause is 
approximately $75 million per year, according to information 
submitted by the states to FTA.
---------------------------------------------------------------------------
    \11\ Tax is imposed only on amounts over $25 per month.
    \12\ Certain cities in Colorado and Arizona also apply their tax to 
such charges.
---------------------------------------------------------------------------
    There are three additional issues that must be considered 
in any permanent or long-term moratorium: (1) Dealing with 
other services that may be bundled with access; (2) The 
addition of substantial amounts of content to a package 
including access; and (3) Apparent competitive issues that 
arise as Internet telephony technology improves and takes hold.
    Digitized goods and their counterparts. The majority report 
recommends a tax exemption for ``sales of digitized goods and 
products and their non-digitized counterparts.'' Such 
preemption would do substantial damage to the tax base of a 
number of states. Twenty-eight states currently consider 
downloaded software to be taxable, and nineteen states consider 
downloaded information to be taxable. About fifteen states tax 
a broad category of ``electronic information services.''
    An exemption for ``digitized goods and products'' would 
logically apply to all subscriptions to on-line databases and 
information services, on-line publications, on-line photos and 
movies, and a variety of services that produce digitized 
products (e.g., photo finishing). And, if taxing the ``non-
digitized counterparts'' of digitized goods and products were 
also preempted, states and localities would lose the ability to 
tax all sales of newspapers, books, music and CDs, periodicals, 
photos, software, movies, cable services, etc.
    In one estimate, including the states of Florida, Texas, 
Washington and Wisconsin, this provision would reduce state and 
local sales tax revenues by over $1 billion per year in just 
these four states. Another estimate sets losses of state and 
local tax revenues at $5.7 billion per year.
    Nexus standards. The majority report purports to attempt to 
``clarify'' the circumstances under which a seller has a 
sufficient nexus, or connection, with a state to be required to 
collect and remit sales and use taxes and to report and pay 
business activity taxes to that state, by listing nine 
activities that, individually or in combination, would not 
establish nexus for that seller in the state. The net effect of 
these nexus ``carve-outs'' would be to allow a firm, especially 
electronic commerce firms, to engage in a wide range of 
activities in the state, either directly or indirectly through 
affiliates and representatives, without incurring a direct tax 
obligation or a sales/use tax collection responsibility. As 
such, they would further tilt the playing field against fixed-
base retailers.
    Space does not allow a full explication of all the 
potential ramifications. A few examples should, however, 
suffice to demonstrate the issues.
     The report would prohibit the consideration of the 
relationship between an out-of-state seller and an affiliate 
with a physical presence in the taxing state as a basis for 
establishing nexus, which opens up the potential for an 
``Internet kiosk'' arrangement. That is, a seller could 
establish kiosks in the stores of an affiliate through which 
goods are ordered from the seller and, if the goods were 
delivered from outside the state, the seller would not be 
required to collect tax. (For example, a barnesandnoble.com 
kiosk inside a Barnes and Noble store.)
     The report would prohibit the consideration of the 
use of telecommunications services from an in-state provider in 
making a nexus determination. This prohibition would create a 
safe harbor by which a telecommunications provider could be 
acting as the representative of a seller, a situation that 
would create nexus under current law. In addition, the 
prohibition creates opportunities for resellers of 
telecommunications to operate in the state without establishing 
nexus.
    The report would prohibit states from considering the 
ownership of intangibles in the state as a factor in 
determining income tax nexus, as states now do. With this 
restriction in place, a financial services company could 
conduct its entire menu of operations with every person in a 
state -i.e., it could make loans, hold accounts receivable, 
finance purchases, etc. -without tax obligations. In addition, 
to the extent that a physical presence was considered 
desirable, it could use an affiliate to perform the services 
and still avoid any tax liability for the income arising from 
that state.

Conclusion

    Any serious effort to address the state and local tax 
issues associated with electronic commerce must confront the 
issue of sales/use tax collection by remote sellers. State tax 
administrators believe that the exercise of congressional 
authority to require remote sellers with sales in excess of a 
specified threshold to collect tax on goods and services sold 
into a state is appropriate and necessary for the long-term 
survival of the sales/use tax. It also represents sound tax 
policy that promotes neutrality in the treatment of similarly 
situated taxpayers and eliminates a competitive disadvantage 
faced by retailers that currently collect tax.
    States recognize that an expansion of the duty to collect 
must be accompanied by substantial simplification and improved 
uniformity in the sales tax and its administration. They have 
begun in earnest to address that task through the Streamlined 
Sales Tax Project.
    The Report of the Advisory Commission on Electronic 
Commerce unfortunately, in the opinion of most state and local 
officials, does not further the goals of sound tax policy and 
administration in this area. Instead, it contains 
recommendations for substantial preemption of state tax 
authority that are not only detrimental to the fiscal position 
of states and localities, but will likewise cement into place 
the unlevel playing field facing fixed-base retailers and other 
current taxpayers.

                    Federation of Tax Administrators
           Statement of Federal Grants and Contracts Received
                              FY 1998-2000
           Filed in Accord with House Rule XI, Clause 2(g)(4)
                       Fiscal Year Ending June 30

                                                                  2000
                                          1998         1999      (est.)

Federal Highway Administration--          $20,000    $25,000    $25,000
 Development and Presentation of
 Training Courses on Motor Fuel Tax
 Evasion and Investigation..........
Federal Highway Administration--         $185,000    $51,000        -0-
 Contract to develop and implement
 an Internet-based electronic filing
 application of International Fuel
 Tax Agreement returns..............


      

                                


    Chairman Houghton. Thanks very much, Mr. Duncan.
    Okay, Mr. Nebergall?

STATEMENT OF MARK E. NEBERGALL, PRESIDENT, SOFTWARE FINANCE AND 
                     TAX EXECUTIVES COUNCIL

    Mr. Nebergall. Thank you, Mr. Chairman, and good afternoon. 
My name is Mark Nebergall and I am the President of the 
Software Finance and Tax Executives Council, or SoFTEC. On 
behalf of my members I thank you for the opportunity to testify 
this afternoon on the report of the Advisory Commission on 
Electronic Commerce.
    SoFTEC is a new organization, formed to address public 
policy issues for the software industry in areas of tax, 
finance, and accounting. SoFTEC's members have long been 
interested in the issue of taxation of electronic commerce. 
SoFTEC's members make software that enables the Internet to 
operate, and they use the Internet as a means to efficiently 
distribute their products.
    Mr. Chairman, the beauty of the Internet is that it enables 
all vendors, both small and large, to access global markets 
with minimal capital investment. Small vendors in small towns 
can compete with large vendors for customers, wherever the 
customer may be. However, the imposition of multi-State tax 
compliance obligations in the current form would pose an 
insurmountable barrier to small vendors. Congress must not 
relax the current rules that prohibit States from imposing tax 
collection and remittance obligations on out-of-State vendors 
with no taxable presence, unless it is certain that the cost of 
compliance by small-and medium-sized vendors would be minimal.
    All parties to the debate over collection and remittance of 
sales taxes agree that the current system is much too complex. 
Indeed, the Supreme Court in the Quill decision has ruled that 
the current system constitutes an impermissible burden on 
interstate commerce in violation of the Commerce Clause of the 
Constitution.
    SoFTEC believes that the focus in the near term should be 
on making the system of multi-State taxation of remote sellers 
simple and uniform. Only when the system has been made simple 
and uniform should Congress give any consideration to relaxing 
the current rules.
    In short, Mr. Chairman, SoFTEC advocates simplification 
now, perhaps taxation later.
    The question rises as to how to achieve a simple and 
uniform State sales and use tax system. We believe that the 
Advisory Commission hit upon the ideal mechanism in 
recommending that the task be given to the National Conference 
of Commissioners on Uniform State Laws, or NCCUSL. NCCUSL is an 
organization over 100 years old whose sole mission is the 
creation and enactment of uniform State laws. While its 
crowning achievement is the Uniform Commercial Code, it has 
been responsible for drafting such laws as the Model Probate 
Code, the Uniform Trade Secrets Act, and dozens of other model 
and uniform State acts.
    Mr. Chairman, SoFTEC believes that any simple and uniform 
State sales and use tax law must be developed with the 
participation of both taxpayers and tax collectors. Without 
such participation, such a proposed law cannot be assured of 
the level of support necessary for enactment. SoFTEC is 
confident that the transparent and open procedures used by 
NCCUSL to draft uniform and model State laws would ensure that 
both taxpayers and tax collectors have been put into the 
drafting. Indeed, SoFTEC believes that NCCUSL would not report 
a proposed uniform law unless it was certain that it had the 
support of all constituent parties.
    Mr. Chairman, it is true that the recommendation that 
NCCUSL undertake drafting a uniform sales and use tax act did 
not receive a supermajority of the Advisory Commission. 
However, one thing is clear: all of the Commissioners supported 
the notion that a simple and uniform system is essential. They 
only disagreed on the details.
    SoFTEC supports the recommendation of 11 Commissioners that 
NCCUSL is best suited to craft a proposed uniform State sales 
and use tax act.
    Mr. Chairman, the majority of the Commission also suggested 
that Congress establish a second commission to oversee the work 
of NCCUSL and to pass judgment on whether its work product 
would constitute a system simple enough to eliminate the burden 
on interstate commerce. SoFTEC does not support the creation of 
a second commission for such a purpose. We are confident that 
NCCUSL's process is so open and transparent that oversight is 
not necessary.
    Also, while a proposed law may look simple on paper, the 
proof of its simplicity is in the actual practice. No 
consideration should be given to overturning Quill until it is 
clear that the new system truly is simple and workable.
    Mr. Chairman, a majority of the Commissioners also 
recommended that Congress clarify the standards to be used to 
determine when a business had a taxable presence or nexus in a 
State, both for sales and use tax collection purposes and for 
business activity tax purposes. The current physical presence 
standard has proven to be imprecise. Many States exploit this 
imprecision by claiming nexus where none exists, creating 
uncertainty. SoFTEC supports the recommendation that Congress 
enact bright line rules for determining when a business has 
taxable presence in a particular State.
    Mr. Chairman, this concludes my testimony, and again I 
thank the subcommittee for inviting me to testify this 
afternoon, and I welcome any questions that you or other 
members of the subcommittee might have, and I bequeath any 
excess time to the people to use more of theirs. [Laughter.]
    [The prepared statement follows:]

Statement of Mark E. Nebergall, President, Software Finance and Tax 
Executives Council

    Good afternoon Mr. Chairman and members of the 
Subcommittee. My name is Mark Nebergall and I am the President 
of the Software Finance and Tax Executives Council. My members 
and I thank you for the opportunity to testify on the report to 
Congress of the Advisory Commission on Electronic Commerce.
    SoFTEC is an organization comprised of the major software 
companies of the United States and its mission is to provide 
software industry focused public policy advocacy on tax and 
finance issues. Taxation of electronic commerce is an issue in 
which software companies have long held a keen interest. We 
make the software that enables the Internet to operate 
efficiently and also use it a low-cost mechanism to distribute 
software to customers worldwide.
    SoFTEC advocates policies that promote fair and efficient 
interstate and international taxation of goods and services 
contracted for and delivered using the Internet. The 
cornerstone of these policies is neutrality of tax treatment. 
Because the work of the Advisory Commission on Electronic 
Commerce (ACEC) touched on these issues, we followed its work 
very closely.
    Given the Commission's uncertain start, we initially held 
out little hope that it would ever reach agreement on the 
important issues. We were surprised when a coalition of 
business and government commissioners formed and came to 
agreement on a comprehensive set of proposals. While these 
proposals did not receive a supermajority of the Commissioners 
as required by the enabling legislation and therefore did not 
rise to the level of a formal recommendation, in our view, the 
Commission made strides in articulating reasonable proposals 
for interstate and international taxation of electronic 
commerce.
    SoFTEC applauds the House of Representatives for passing HR 
3709 by an overwhelming margin. This legislation would extend 
the moratorium of the Internet Tax Freedom Act for an 
additional 5 years and would completely eliminate state taxes 
on Internet access charges, both of which were included in the 
ACEC's majority report. However, as we explain below, the 
Congress has much work ahead of it in terms of tackling 
simplification and taxable presence issues. My testimony this 
afternoon will focus on these other elements of the majority 
report of the ACEC.

SoFTEC's Overarching Policy Position:

    As noted above, SoFTEC advocates policies that promote fair 
and efficient interstate and international taxation of goods 
and services contracted for and delivered using the Internet. 
The cornerstone of these policies is neutrality of tax 
treatment. Before discussing the proposals contained in the 
ACEC's report, we thought it important to provide some 
explanation of what we mean by neutrality of tax treatment.
    SoFTEC members firmly believe that similar transactions 
ought to be taxed similarly and that the method of distribution 
of a product should have no impact on its tax treatment. Today, 
many products are marketed with catalogs where orders are taken 
either by phone, telefax or the mail. Such vendors typically 
have only one physical location and their products are shipped 
to customers all over the world. The Commerce Clause of the 
United States Constitution generally insulates these direct 
marketers from any obligation to collect transaction taxes from 
their customers and remit those taxes to another state where 
the customer resides. SoFTEC's members believe that there 
should be no difference of tax treatment merely because an 
order for a product was placed using the Internet instead of 
the telephone or the mail.
    Because of the multitude of state sales and use tax 
systems, the Supreme Court ruled that forcing an out-of-state 
mail order vendor with no physical presence in a state to 
collect and remit taxes would impose an impermissible burden on 
interstate commerce in violation of the Commerce Claus. Indeed, 
large firms with physical presence in many states find it quite 
expensive to meet their multistate tax collection and 
remittance obligations. The costs of these multistate tax 
obligations would put the marketing of products from a single 
location to customers in many states out of reach of small and 
medium sized vendors.
    SoFTEC also advocates neutrality of tax administrative 
burden. Small Main Street vendors selling products over the 
counter typically are required to collect sales taxes from 
their customers on a single tax rate. Further such vendors have 
but one set of tax rules to learn and abide imposed by a single 
tax authority. SoFTEC believes that if this burden borne by the 
small Main Street vendor could be replicated for the multistate 
vendor, then the constitutional infirmities to imposing a 
collection and remittance obligation would be reduced. Of 
course, the only way to achieve neutrality of administrative 
burden is through simplification and unification of the state 
sales and use tax systems of the several states.
    The problem of complexity of the state sales and use tax is 
not new. Since at least the 1960's, states have been on notice 
that their system of sales and use taxation of interstate 
commerce was too complex and burdensome. The Willis Commission 
report and the Supreme Court's decision in National Bellas Hess 
provided adequate notice that reform was in order. The message 
was reiterated in 1992 with the Supreme Court's decision in 
Quill v. North Dakota. Despite the passage of time and the 
adequacy of the notice, the States have made no movement 
towards simplification and unification of their sales and use 
tax systems. It is only with the advent of the Internet as a 
medium of commerce and the potential for revenue loss that has 
galvanized the states into considering simplification.
    SoFTEC supports Congressional intervention in the area of 
simplification and unification of state sales and use taxes. We 
believe that it is within Congress' role to create an 
environment in which a workable simplification plan can be 
developed and implemented. We also believe that any such effort 
should include participation by both taxpayers and tax 
collectors. We are suspicious of any process that seeks to 
develop a simplified and uniform sales and use tax system that 
excludes taxpayer input.
    I now turn to the elements of the ACEC's majority report 
that touch upon the issues of tax simplification.
                           Tax Simplification

A. NCCUSL

    The majority's report (pp. 19-20) proposes a process for 
developing a simple and uniform sales and use tax system. 
Specifically, the report suggest that Congress recommend that 
the National Conference of Commissioners on Uniform State Laws 
(NCCUSL) undertake the task of drafting a uniform sales and use 
tax act. We believe that this proposal has merit and should be 
explored further.
    NCCUSL is an organization, more than 100 years old, 
comprised of state appointed commissioners who come together to 
craft uniform and model state legislation. The commissioners 
themselves are lawyers in private practice, judges, state 
legislators, and academics. Each state has appointed several 
commissioners and there are roughly 300 of them. Their most 
well-known and widely adopted uniform act is the Uniform 
Commercial Code (UCC), parts of which have been adopted in 
almost every state.
    NCCUSL's practice is to appoint a drafting committee to 
develop a proposed uniform or model act. The meetings of the 
drafting committees are open to the public and their 
participation in the drafting process is encouraged. Once the 
drafting committee has completed its work (usually after 
several meetings over an 18-24 month period), the full 
commission considers the draft and if accepted, it is released 
to the state legislatures for their consideration and passage. 
Frequently, the full commission sends a draft back to the 
drafting committee for more work. NCCUSL will not approve an 
act and release it to the states unless it believes that the 
act has the support of all of the effected parties.
    SoFTEC endorses the ACEC's majority recommendation that 
NCCUSL's process be used to develop a simplified and uniform 
sales and use tax act. Their process ensures the participation 
of all interested parties and it leaves ultimate decision 
making regarding the details to the NCCUSL drafters. Our belief 
is that the insertion of a neutral third-party between the 
various business and government groups would facilitate the 
drafting process.

B. A Second Advisory Commission

    The ACEC majority recommendation also suggests the 
appointment of another federal advisory commission to oversee 
the NCCUSL drafting process and to assess whether NCCUSL's 
final product meets the goals set by Congress. We do not 
believe another federal advisory commission on this subject is 
necessary. NCCUSL has long established and transparent 
procedures for drafting uniform and model legislation and we do 
not believe oversight by a federal advisory commission is 
necessary or desirable. In addition, because NCCUSL is not 
likely to release any uniform sales and use tax act unless it 
believes it has the support of both business and government, an 
assessment by a federal advisory commission of whether the 
Congressionally mandated goals have been achieved is not 
necessary.
    The proposed federal advisory commission also is to render 
an assessment whether NCCUSL's uniform sales and use tax act is 
simple enough that states that adopt it should be permitted to 
enforce tax collection and remittance obligations against out-
of-state sellers. We do not believe it appropriate for an 
advisory commission to be making such an assessment prior to 
enactment by states of such a system and before taxpayers and 
tax collectors have some experience operating under such a 
system. At the end of the day, it is for Congress or the courts 
to decide when the collection and remittance burden on out of 
state vendors is no longer so heavy as to be constitutionally 
infirm.
    SoFTEC does not support the creation of a federal advisory 
commission to oversee the development of a simplified and 
uniform state sales and use tax act.

C. Digital Products

    The majority recommendation of the ACEC's report suggests 
that Congress prohibit, for a period of five years, on the 
imposition of state sales and use taxes on digital goods and 
their non-digital equivalents. This would bar states from 
imposing a sales or use tax on transactions in digital products 
(such as software, music, video, data, books) both interstate 
and intrastate. It also would bar states from imposing a sales 
or use tax on nondigital equivalents of digital products. This 
would mean that states could not require local bookstores, 
record stores, or computer stores from collecting sales taxes 
from their customers on sales of these products. The 
recommendation to exempt digital products from the sales and 
use tax is based on a recognition that enforcement is 
difficult. It would be very easy to locate digital product 
delivery servers beyond the reach of the taxing authorities. 
The recommendation to exempt nondigital equivalent products 
from sales taxes was based on an attempt to achieve neutrality 
of tax treatment with the digital versions.
    SoFTEC does not support the exemption for digital products 
and their nondigital equivalents. We know of no tax policy that 
favors exempting such products. An exemption for these types of 
products violates SoFTEC's bedrock principle that equivalent 
transactions should be treated similarly. The fact that digital 
products can be delivered using the Internet, in our mind, is 
not justification for an exemption.

                            Taxable Presence

    The ACEC's majority report recommends that the rules for 
determining when a company has a taxable presence in another 
state be clarified for both business activity tax purposes and 
for purposes of imposing a sales or use tax collection and 
remittance obligations. SoFTEC supports these recommendations.
    Today, businesses face tremendous uncertainty as to when 
their activities within a state might trigger tax obligations. 
The physical presence standard set by the Quill case is 
imprecise. State tax administrators are increasingly creative 
in their claims that business activities give rise to physical 
presence. In the sales and use tax context, it must be 
remembered that the customer is the taxpayer and the vendor 
merely the collection agent for the state. If the vendor has a 
collection obligation but nevertheless fails to collect the tax 
from the customer, the vendor becomes liable for the tax. The 
vendor will have little recourse by way of recovering the tax 
from the customer after the transaction has been completed. 
When a state makes a claim against a business based on some new 
theory of physical presence, the business must decide whether 
to litigate the claim or settle. Many times, the amount 
involved does not justify the costs of litigation. Thus, the 
validity of the state's legal theory avoids a test in court.
    The same is true with regard to business activity taxes, 
which include taxes on gross or net income or franchise taxes. 
A state may make a claim that an out of state vendor has a 
taxable presence and should file an income tax return and 
allocate a portion of its income to that state. Software 
companies frequently receive claims that because they license 
their products to customers in their state, they have a taxable 
presence and should file income tax returns and pay income 
taxes. We have even seen states claim that because a software 
company provided its customers with telephone support, and 
because some customers were in the state and could reach the 
telephone support center in another state, the company had a 
sufficient presence to trigger an income tax return filing 
obligation. If the ability of in-state customers to reach an 
out-of-state vendor by telephone is sufficient to give rise to 
a tax return filing and tax payment obligation, then every 
business would have a taxable presence in every state.
    The states vigorously oppose any clarification of the 
standards for determining when a business has a taxable 
presence. They claim improper infringement of states rights. 
However, the Constitution gives the Congress plenary power in 
this area. Indeed, Congress exercised that power in the area of 
income taxation of multistate business when it enacted P.L. 86-
272 in 1959. Given the states' continued abuse of their taxing 
power by making frivolous claims against nonresident taxpayers, 
we believe it appropriate for the Congress to intervene and set 
bright line standards. The factors set forth in the ACEC's 
report are, we believe, appropriate for consideration.

                               Conclusion

    The ACEC and its staff worked very hard in trying to reach a 
consensus on the details of a coherent plan for taxation of remote 
sales. While they did not reach a consensus within the meaning of the 
Internet Tax Freedom Act, the Commissioners nevertheless moved the ball 
forward with regard to many of the items set forth in the majority's 
report. We are hopeful the Congress will roll up its sleeves and 
complete the work the ACEC only started.
    Mr. Chairman, this concludes my remarks and I stand ready to answer 
any questions you or the other members of the subcommittee might ask. 
Thank you again for the opportunity to testify this afternoon.
      

                                


    Chairman Houghton. Well, thanks very much, Mr. Nebergall. 
That was great.
    Now, Mr. LoGalbo?

 STATEMENT OF JOHN R. LOGALBO, VICE PRESIDENT, PUBLIC POLICY, 
                   PSINET, ASHBURN, VIRGINIA

    Mr. LoGalbo. Mr. Chairman, Mr. Ranking Member, members of 
the subcommittee, thank you for the opportunity to appear 
before you this afternoon. I am John LoGalbo, Vice President of 
Public Policy for PSINet.
    PSINet is an Internet supercarrier. We've built a global 
electronic commerce infrastructure over our own optical fiber, 
satellite, wireless, and web hosting facilities. We serve more 
than 2 million users across 27 countries, and we offer the 
entire range of Internet services--primarily to business 
customers, but also to other ISPs and to telecom carriers.
    Today I would like to focus on one of the proposals in the 
report of the Advisory Commission on Electronic Commerce, to 
make permanent the moratorium on Internet access taxes. Let me 
illustrate for the subcommittee some of the tax issues 
presented by one of PSINet's typical service offerings, what we 
call a ``virtual private network'' or ``VPN.''
    A VPN ties together several offices of a single company, 
often located in different States, over broadband circuits 
using Internet protocols. The first issue we face, in those 
States that currently tax Internet access, is which part of our 
service is considered access, and which part is considered 
traditional telecommunications? This is important, because 
telecom services are excluded from the moratorium. If we bundle 
those services together--as we must--then we are faced with 
attempts to tax the entire cost of the bundled service, 
including the tax-exempt access portion.
    Second, our business customers typically look to us for 
value-added services that build on the basic connectivity 
provided by the VPN. These include firewalls, encryption, 
packet filtering, and monitoring security over the network. 
Several States go beyond taxing access and impose taxes on what 
they call ``enhanced'' Internet services, not only the ones 
I've just mentioned but also Web hosting, Website design, and 
server-based applications like e-mail.
    Third, we find that telecom and access taxes have a 
tendency to build on one another, so that the customer ends up 
paying a tax on other taxes. For example, Federal and State 
excise taxes can be built into the base for computing State 
sales taxes.
    Fourth, in many States, manufacturing equipment is exempt 
from sales tax because it is used as a business asset to create 
products that are taxed when they are sold to the consumer. A 
very few States extend this resale exemption to telecom 
equipment, but almost none of them do so for Internet Service 
Providers. Even when the resale exemption is available, ISPs 
sometimes face a form of double taxation. When we buy a circuit 
to build the customer's network, we pay sales tax on that 
purchase; and when we deliver the circuit as part of the 
Virtual Private Network, the customer pays that tax again.
    Finally, whenever we deliver an integrated network solution 
to businesses across several State lines, we encounter the 
astonishing complexity of State and local sales taxes in 
multiple jurisdictions. The most commonly-cited figure is over 
7,500 separate taxing jurisdictions, each with its own tax 
rates, its own definitions of taxable goods and services, and 
its own filing requirements and exemptions.
    The point is that the fine line between Internet access and 
other services, particularly for business customers, is 
becoming blurred. ISPs are increasingly drawn into the 
administration not only of sales taxes on access, but also 
Federal, State, and local telecommunications taxes. A recent 
report observed that a full-service telecom provider, operating 
nationwide, would be required to file 55,748 tax returns a 
year, with total effective tax rates exceeding 20 percent in 10 
States, with Texas topping the list at 28.56 percent.
    In our view, taxing Internet access is like building a toll 
booth on the on-ramp to the information superhighway.
    Thank you very much for the opportunity to be here. I will 
be happy to answer any of your questions.
    [The prepared statement follows:]

Statement of John R. LoGalbo, Vice President, Public Policy, PSINet, 
Ashburn, Virginia

    Mr. Chairman, Mr. Ranking Member, members of the 
Subcommittee, thank you for the opportunity to appear before 
you this afternoon. I am John LoGalbo, Vice President of Public 
Policy for PSINet. More than 10 years ago--before the Internet 
became a household word, long before the proliferation of 
``dot.com'' companies, certainly before anyone conceived of 
billions of dollars of commercial activity riding on a stream 
of electrons--PSINet's chairman and founder, Bill Schrader, had 
a vision of the future of telecommunications. That vision was 
founded on the realization that every kind of communication--
voice, text, pictures, sound, video--can be ``digitized,'' 
broken up into electronic pulses, carried anywhere in the world 
over diverse paths, and reassembled into its original form at 
the destination. The key was the ability to carry data over a 
new kind of robust, inexpensive network that crossed all 
proprietary boundaries--without regard to operating systems, 
network protocols, or physical communications media. Bill 
Schrader formed PSINet as the first company to attempt to 
transform that vision into a commercial reality, on a global 
scale, and he has succeeded beyond anyone's wildest 
expectations (except perhaps his own).
    Today PSINet is an Internet Super Carrier, having built a 
global e-commerce infrastructure over our own optical fiber, 
satellite, Web hosting, and switching facilities. We serve more 
than two million users in 800 metropolitan areas in 27 
countries on five continents, offering a full suite of retail 
and wholesale Internet services through wholly-owned PSINet 
subsidiaries.
    At the heart of all PSINet services is our advanced 
Internet Protocol (``;IP'') network. Connected to over 900 
points-of-presence (``;POPs'') worldwide, and designed for 
nearly unlimited growth, the PSINet network is one of the 
primary backbones that comprise the Internet.
    We are building our e-commerce Web hosting centers, 
designed to support critical Internet applications in secure, 
managed environments, in key financial and business centers 
around the world. Our eight hosting centers (in New York City, 
northern Virginia, Los Angeles, Tokyo, Toronto, Geneva, London, 
and Amsterdam) are ideal for e-commerce applications. By the 
end of 2000, our plans call for 24 centers with two million 
square feet of revenue-producing space to be completed or under 
development. At present PSINet hosts many of the most highly 
visible and complex Web sites in the world.
    With the acquisition of Transaction Network Services in 
1999, PSINet is now at the forefront of the high-growth, high-
margin world of electronic commerce. As purchases and 
transactions migrate to the web, companies need to be able to 
tap into a network that can process them efficiently and 
safely. TNS is the leading worldwide provider of e-commerce 
data communications solutions, handling more than 19 million 
transactions daily from two million businesses.
    Finally, as an Internet Super Carrier, PSINet provides the 
ideal infrastructure to support other companies offering 
Internet services. We are, in effect, the Internet Service 
Providers' ISP, supporting a full spectrum of dial-up and 
dedicated access services, security solutions, Web hosting, e-
mail and fax applications that can be privately labeled and 
sold to end-users by ISPs, telecommunications carriers, or any 
group with a large customer or membership base. As part of 
PSINet's partnership with the NFL's Baltimore Ravens--which 
includes naming rights for PSINet Stadium at Camden Yards--we 
created the first affinity ISP in professional sports history.
    The report of the Advisory Commission on Electronic 
Commerce, submitted to the Congress in April, makes significant 
recommendations with respect to ISPs. The Subcommittee has 
asked that we address those that relate to Internet access, and 
that would specifically impact ISPs.
    The Advisory Commission, by a vote of 11 Yeas to 1 Nay, 
with 7 Abstentions, proposed to make permanent the current 
moratorium on any transaction taxes on the sale of Internet 
access, including taxes that were grandfathered under the 
Internet Tax Freedom Act. We strongly support this majority 
proposal of the Advisory Commission and we look forward to a 
permanent ban on Internet access taxes. At this point, we 
express our appreciation to the House of Representatives for 
the vote taken last Wednesday to extend the moratorium on 
Internet access taxes for a five-year period. In addition, we 
thank the House for its foresight in rescinding the grandfather 
clause for the nine states who currently impose taxes on 
Internet access. The margin of approval in the House -352 to 
75--is very heartening to those of us in the Internet and 
telecom sector.
    PSINet believes that a permanent ban on Internet access 
taxes is a substantial, but only preliminary, step toward the 
type of radical simplification and reform of traditional tax 
systems that must take place if those systems are to continue 
to function in the coming decades without suppressing the 
technological dynamism that powers the American economy.
    When we refer to Internet access, generally we think of 
consumer-oriented, modem-based, ``narrowband'' dial-up access 
from a home PC, for prices ranging from $9.95 to $29.95 per 
month, sometimes at a flat rate and sometimes with an 
additional premium for hours of usage above a certain level.
    My goal, however, is to illustrate for the Committee the 
type of Internet access that PSINet has always focused on--the 
provision of more complex, dedicated, high-bandwidth access to 
businesses, often accompanied by additional value-added 
services. The issues we confront when dealing with the tax 
systems of states and localities in that context are similar to 
that of other backbone providers and business-oriented ISPs. It 
is very difficult to separate taxes on Internet access from the 
plethora of other taxes to which we are subject, particularly 
as we utilize our IP-optimized network to take on some of the 
functions of traditional telecommunications companies.
    Let me use as an example one of PSINet's core service 
offerings to business customers--our ``virtual private 
network'' (VPN) solutions, known as PSINet IntraNet.. . . In 
the past, businesses seeking to tie together the private data 
networks of geographically dispersed offices have had to rely 
on traditional wide-area networking, requiring them to lease 
expensive, dedicated telephone circuits running between each 
remote office location. Building on our extensive backbone 
network, PSINet can offer secure and reliable data connections 
between remote offices at a fraction of the cost of traditional 
dedicated networks. Customers need only purchase circuit 
connections between each office and the nearest PSINet POP 
(instead of circuits spanning thousands of miles between the 
offices themselves). We carry the customer's data traffic 
between remote offices over our own backbone network, but we 
isolate it from traffic on the public Internet by means of 
frame relay technology or, for more advanced services, by 
encryption.
    Typically, a customer seeking a VPN solution is also 
concerned about network security, since the data traffic 
between headquarters and satellite offices may include highly 
sensitive confidential and proprietary business information. If 
the customer's objective is to extend its exchange of data with 
its business suppliers or customers over a VPN (known as an 
``extranet''), the security concerns may be even greater. 
PSINet offers additional services--beyond the basic 
``connectivity'' solution--to address these issues, by means of 
firewalls, packet filtering, encryption technologies, and other 
value-added security services. Many of these solutions include 
hardware, software, on-site and remote service and maintenance 
components, in addition to connectivity.
    Let's examine the tax implications of this fairly 
straightforward package of services. Since the moratorium was 
enacted, nine states continue to tax Internet access 
(Connecticut, Hawaii, Ohio for commercial customers, New 
Mexico, North Dakota, South Dakota, Tennessee, Texas, and 
Wisconsin). The District of Columbia, Iowa, and South Carolina 
have--wisely, in our view--repealed their Internet access taxes 
after the moratorium went into effect. Which of the services 
offered in this VPN package fall under the definition of 
``Internet access'' in the Internet Tax Freedom Act? Perhaps 
because the answer is unclear, several states now impose tax on 
some or all ``enhanced'' Internet services, including not only 
network security but also Web hosting, Website design, 
application service provider (``;ASP'') offerings, and others.
    The industry is also finding that there can be dramatic 
state and local tax implications depending on how basic ISP 
access services are ``bundled'' together with other value-added 
services. Specifically, a service may be exempt if invoiced to 
the customer on a stand-alone basis but taxable if bundled with 
other services. Many business customers are moving away from 
simple dial-up access to higher-bandwidth connections using 
dedicated circuits, digital subscriber lines (``DSL''), cable 
modems, and other means--and ISPs, naturally, are providing 
those connections as part of a package. Where there is a 
separate charge for connectivity, most states are likely to tax 
it (since ``telecommunications'' are expressly excluded from 
the definition of ``Internet access'' under the Internet Tax 
Freedom Act). Where connectivity is bundled with Internet 
access into a single charge, states may attempt to tax the 
entire charge, including the otherwise exempt access fees.
    Not only are connectivity charges subject to 
telecommunications taxes, but installation charges, disconnect 
fees, and associated charges face varying tax treatment among 
the states and localities. These traditional telecom categories 
introduce extraordinary levels of complexity and expense, with 
over 300 types of taxes and fees potentially applicable, at 
combined rates that reach and (in some cases) exceed 20%.
    The interaction of multiple taxes adds insult to injury. 
Frequently taxes build on one another, where the base for 
calculation of one tax may include other taxes applied to that 
service--thereby assessing a ``tax on tax.'' Federal and state 
excise taxes, for example, could be built into the base for 
computation of a state sales tax.
    Similarly, there are too frequent instances of pyramiding 
of tax--payment of tax at both the wholesale and retail 
levels--which increase bottom-line service costs to the 
customer. For instance, while 13 states allow 
telecommunications companies a sales tax exemption on equipment 
used to deliver their services, only New York and, to a very 
limited extent, Virginia do so for Internet Service Providers. 
ISPs generally cannot avail themselves of resale exemptions 
with respect to the telecom connectivity services provided as a 
necessary part of the offer of Internet access. One concrete 
example is Connecticut, where regulations flatly deny a resale 
exemption even where a dedicated circuit is resold directly to 
the customer. As such, an ISP may pay tax on the lease of a 
circuit from the customer to its POP, then be forced to bill 
its customer for the tax again when it passes through the 
circuit cost.
    Finally, which jurisdictions are entitled to impose their 
specific array of taxes on which portions of the entire package 
of services (the VPN and security services, in our example)? By 
definition, a virtual private network spans several locations, 
usually with the headquarters or ``hub'' in one state and the 
satellite or remote offices in others. Tangible products (such 
as routers) may be shipped to specified locations and taxed 
there, but the services (such as connectivity, remote 
monitoring, and network design) may span a variety of 
jurisdictions--each with its own tax rates, its own definitions 
and rules for determining the amount of the overall transaction 
applicable to its jurisdiction, and its own exemption 
requirements--many of which may be contradictory or 
inconsistent with those of other jurisdictions.
    A recent report noted that a full service 
telecommunications provider operating nationwide would be 
required to file 55,748 tax returns a year, with total 
effective tax rates exceeding 20% in ten states (with Texas 
topping the list at 28.56%).\1\
---------------------------------------------------------------------------
    \1\ Committee on State Taxation's Fifty State Study and Report on 
Telecommunications Taxation, p. 5 (September 7, 1999).
---------------------------------------------------------------------------
    It is difficult to overstate the burden these complexities 
place on ISPs as the tax collection agents for these 
overlapping tax systems--not to mention their customers, as 
they attempt to sort out the taxes included in their bills. As 
another tax expert observed in a recent authoritative study:
    [C]ompared to other advanced industrialized nations, the 
sales tax in the United States is complicated by the large 
number of state, county, and local jurisdictions that impose 
sales and use taxes. Currently, 45 states and the District of 
Columbia impose sales or use taxes at the state level. . . .In 
addition to the states, approximately 7,500 counties, cities, 
towns, transportation districts, and other special local 
jurisdictions impose sales or use taxes on transactions 
occurring within their borders.
    . . .By contrast, in the European Union, there are only 15 
countries and generally only 15 different national value-added 
tax rates. There are no local or county value-added tax rules 
or rates to be complied with.\2\
---------------------------------------------------------------------------
    \2\ Karl Freiden, Cybertaxation: The Taxation of E-Commerce 
(Chicago: Arthur Andersen LLP, 2000), p. 82.
---------------------------------------------------------------------------
    A fair assessment of the value of Internet access taxes 
should therefore take into consideration the negative effects 
that saddling U.S. companies with these administrative costs 
may inflict on their competitiveness in the global economy.
    Besides going a short distance to reduce the burdens and 
costs of collection on ISPs, a permanent moratorium on Internet 
access taxes would have an immediate positive impact by 
reducing the costs of Internet access for both consumers and 
businesses. Reducing access costs is a quick and obvious way to 
boost American competitiveness and to lower the ``Digital 
Divide'' that threatens to exclude from the information economy 
those citizens with fewer resources to spend on computers and 
Internet connectivity.
    Making the moratorium permanent and applying it to Internet 
access taxes previously excluded by the grandfather clause 
would not threaten state and local revenues in any significant 
way. States could radically simplify and decrease the telecom 
taxes that are now imposed on the channels by which Internet 
access is delivered to their citizens--telephone lines, 
wireless transmissions, and cable television and satellite 
communications -and still maintain substantial revenue from 
these sources. Income taxes, both corporate and individual, 
from income generated by the growth of electronic commerce 
would be unaffected. Sales and use taxes on most in-state 
purchases would continue to be collected. Revenue losses from 
abolishing Internet access taxes and decreasing other telecom 
taxes would therefore be minimal.
    There is much more to the Advisory Commission's report, of 
course, than the recommendation that all Internet access taxes 
be subject to a permanent moratorium. PSINet supports both the 
Formal Findings and Recommendations of the Commission and the 
policy proposals adopted by the majority of the Commissioners.
    Significantly, the Commission's report observed that it is 
early to predict the trends and outcomes of many aspects of e-
commerce as it continues its development, and that empirical 
assessments of these trends are just beginning to be made.
    We are grateful to the Chairman and this Subcommittee for 
their leadership in holding these hearings, and for extending 
this opportunity to PSINet to present its perspective. We hope 
you will continue to look to PSINet to work with you on the 
issues arising from tax policies, electronic commerce, and the 
Internet.
    We look forward to answering any questions you may have.
      

                                


    Chairman Houghton. Thanks very much, Mr. LoGalbo.
    Ms. Dunn, would you like to ask some questions?
    Ms. Dunn. Thank you very much, Mr. Chairman.
    And thank you very much, panel; you have been fascinating 
in your comments.
    I wanted to address my comment to you, Mr. Duncan, because 
I think that you are familiar with Washington State's system of 
taxation. We rely on the State sales tax. There has been an 
issue of grandfathering other taxes, however, into the system, 
and just recently when we passed the moratorium last week, 
Washington State's B&O tax came into question. I am wondering, 
with your background, if you could talk a bit about whether it 
would be affected as we move through these changes.
    Mr. Duncan. There is no clear answer as to whether the B&O 
tax would be preempted under the prohibition on Internet access 
taxes. In speaking with representatives from Washington State 
in the Department of Revenue, looking at the tax and looking at 
the way the Internet Tax Freedom Act is written, I have come to 
the conclusion--and I think they have come to the conclusion--
that the tax is at risk. It is a gross receipts tax that 
applies to a wide range of businesses, including the provision 
of Internet access services. As a gross receipts tax, it is a 
price-based tax, or it effectively operates as a price-based 
tax, and economically, the incidence of that tax is exactly the 
same as a sales tax. So it looks and acts, for all purposes, 
like the sales tax that most people are concerned with. That's 
point A.
    Point B, if you look to the definition of ``tax on Internet 
access'' in the Internet Tax Freedom Act, it certainly doesn't 
provide any exclusion for any type of tax such as the B&O tax. 
And for that reason I think the people at the State level have 
been concerned that it is certainly at risk because it is not 
spoken to specifically, and traditionally when we have talked 
about those States that were included in the grandfathering, 
the Washington B&O tax was included.
    Chairman Houghton. Congressman McDermott?
    Mr. McDermott. Thank you, Mr. Chairman
    I had an interesting experience, and I want to ask Mr. 
Ledger a question. I went to a camera store, and the manager 
got to talking to me about this Internet tax business. He said 
a man came in, looked at about seven cameras, and tried out all 
the lenses and everything, and then he wrote down the numbers 
very carefully and left. He said he went home to buy them over 
the Internet because he could save 8.3 percent as opposed to 
buying them there in the city.
    Now, is it possible for me to come into your furniture 
store and get the numbers of the Sealy Posturepedic Mattress 
that I want, and then go home and buy it over the Internet?
    Mr. Ledger. Yes, sir. You could also go to the PX with a 
friend and have them buy it for you, tax-free.
    Mr. McDermott. Is there anything in your store that can't 
be bought over the Internet?
    Mr. Ledger. Perhaps some art, some specific lamps, but 
major pieces of furniture can be bought over the Internet. They 
have been doing that for a good many years--not on the 
Internet, but over the telephone. It is well known that people 
come in and shop our stores, use our sales people's time, take 
down numbers, fabrics, and go back and use the Internet or use 
the telephone to order furniture tax-free.
    Mr. McDermott. Okay.
    That brings me to the second question. Ms. Lewis, you 
talked most about this issue, and I want to understand this 
question of nexus. Maybe you and Mr. Duncan can work it out for 
me.
    I am sitting in D.C. at my computer, and I order from 
amazon.com $500 worth of books. Their offices are in Seattle, 
but their warehouse is in Portland, Oregon. If I have them sent 
to me here in D.C., will I pay the tax as opposed to having 
them sent to me in Seattle--theoretically, if they were 
collecting the tax?
    Ms. Lewis. I can speak about Staples. We charge tax based 
on the ``ship to'' location.
    Mr. McDermott. So it is assumed that when I buy something 
over the Internet, I am at the place where it's shipped to, is 
that correct?
    Ms. Lewis. No. You tell us where you need it shipped to; 
otherwise, we wouldn't be able to get it to you.
    Mr. McDermott. But I'm not physically there. I'm just 
shipping it somewhere.
    Ms. Lewis. Correct.
    Mr. McDermott. So you use the ``ship to'' as where I am, as 
far as you're concerned?
    Ms. Lewis. Yes.
    Mr. McDermott. Is that correct?
    Mr. Duncan. That's right, sir. The sales tax is a 
destination-based tax. You want to tax the consumption where it 
occurs, and the rule that is generally applied is that the 
``ship to'' address is presumed to be the point at which it is 
used, so the tax will be applied--and the nexus rules will be 
applied--based on the ``ship to'' address. In your example, 
shipping from--whether it's Portland with amazon.com or 
Seattle--if amazon.com does not have a physical presence in the 
District, I presume that they would not be required in any way 
to calculate tax on that transaction. It would be up to you to 
report it directly to the D.C. Office of Tax and Revenue as a 
use tax.
    Mr. McDermott. And are the offices of the company 
considered a ``physical presence'' or whatever that term was 
you used, or is it actually where the books are, in a 
storehouse, in a storeroom?
    Mr. Duncan. We're talking all one entity, amazon.com, all 
one entity. They would be required to collect tax wherever they 
would have a physical presence. So if they had their offices in 
Washington, a warehouse in Kansas, a warehouse in Oregon, they 
would be required to collect on their shipments to Washington 
State and to Kansas regardless of whether they came out of 
Washington, Oregon, or Kansas--wherever they have that physical 
presence on their own behalf, or through the activities of a 
representative on their behalf.
    Mr. McDermott. So, Staples, do you have people in every 
State?
    Ms. Lewis. Pretty much, yes. We are nationwide.
    Mr. McDermott. So you are at a disadvantage, not being just 
in one or two places?
    Ms. Lewis. That's right. Our customers are taxed almost 
across the board, across the States, across the country. And 
the pure-play competition who have limited or minimal physical 
presence across the country does not charge tax, and we feel it 
puts us at a disadvantage.
    Mr. McDermott. Thank you, Mr. Chairman.
    Chairman Houghton. Okay, thanks.
    I would like to mix it up a little bit. I mean, we're 
talking back and forth here, but you all have such different 
ideas. Let me just give you an example.
    Mr. Duncan, you talked about a Streamlined Sales Tax.
    Mr. Nebergall, how do you feel about that?
    Mr. Nebergall. Well, my members are all for simplification, 
and the Streamlined thing sounds like a movement towards 
simplification. My concern about the Streamlined Project that 
Mr. Duncan referred to is that it is not a cooperative effort 
between taxpayers and tax collectors. My understanding is that 
they conduct most of their meetings behind closed doors and 
they do not allow anyone except their own members to 
participate in those activities.
    Chairman Houghton. You would like to comment on that, Mr. 
Duncan?
    Mr. Duncan. Yes, please, Mr. Chairman. Thank you.
    The Streamlined Project is a project of States, principally 
State and local government tax administrators, trying to 
develop a simplified system. It is not, however, a closed 
project. Each project meeting has a part that is open to the 
public; testimony can be taken, people can ask to attend. There 
are workgroup sessions that are closed, but people can be 
invited to provide input.
    The final thing is that the product that we come up with, 
which we expect to have done in April, will be released with 
widespread public input.
    The primary reason that we have taken this approach is that 
we have probably spent now on the order of half a dozen years 
in discussions and negotiations with people in the mail order 
business, the retail industry, and the electronic commerce 
industry, taking input and negotiating and discussing what it 
is that we ought to do to simplify the tax. We thought it was 
time to get down to the task of deciding what should be done, 
seeing how we can actually implement these simplifications, and 
no longer engage in some prolonged negotiations, and that's why 
we have chosen the model that we have.
    Mr. McDermott. Mr. Chairman, could I ask a follow-up 
question?
    Chairman Houghton. Absolutely.
    Mr. McDermott. If you come to a uniform rate or some kind 
of simplified national schedule--let's say, 5 percent across 
the Nation, a State can charge up to that--is it possible, 
then, for there to be a two-tiered system in a State--I pay 8.2 
percent in King County because that's what the retail sales tax 
is right now, and 5 percent if I buy it over the Internet?
    Let me give you the reason I raise it. In our State we have 
a Constitution that says everything has to be taxed at a 
uniform rate, all property has to be at the same rate. We can't 
have an income tax because we can't have a graduated--we can 
have a flat income tax, but not a graduated income tax, because 
everybody has to be taxed at the same rate.
    Now, if you set up this two-tier, I wonder what kinds of 
problems you create.
    Mr. Duncan. The recommendations that we intend to come out 
of the Streamlined Project will have to go--first, our primary 
focus is on State legislatures, and they will have to be passed 
into law, particularly if you do something with rates. They 
will have to be subject to State legislative action. And if it 
were to contravene a State Constitution, then it simply 
couldn't be done.
    Now, under Federal law or Federal Constitutional 
interpretation, I believe you could have one rate on over-the-
counter transactions and one rate on interstate transactions, 
or transactions coming in from out-of-State, as long as the one 
on the ones coming in from out-of-State was lower than the 
lowest one in the State. But if that doesn't pass 
Constitutional muster at the State level, it can't be done.
    The focus that we have is really to try to do two things. 
One is to promote some simplification of those local rates, but 
the second is to try to accommodate the differing local rates 
as much as possible through advanced technology. Coupled with 
that, though, would be a safe harbor for the sellers. In other 
words, if they use certified technologies, make the good faith 
effort to get it right, they're not held up by an audit if they 
get it wrong.
    Chairman Houghton. All right. Is that okay, Jim?
    Mr. McDermott. Okay.
    Chairman Houghton. Fine.
    One other question. I would like to have three people 
involved here.
    Mr. LoGalbo, you talked about ``pyramiding.'' I'm not 
really quite sure what you mean, but maybe you could explain 
it.
    Also, I would like to ask Mr. Honaker and Mr. Ledger what 
they feel about this. Why don't you explain it, and then I'd 
like to get a comment.
    Mr. LoGalbo. When I referred to pyramiding of taxes, I was 
referring to the example that I used where we're selling a 
service to our customer, and necessarily as part of that 
service we are purchasing telecom circuits from other 
providers, like Bell Atlantic or a regional Bell operating 
company. We pay taxes on that circuit when we purchase it, 
because we want to be a one-stop shop for our customer. We 
don't want the customer to have to purchase something that is 
essential for us to provide our Internet service to the 
customer.
    So we purchase the circuit; we pay tax on it; we then pass 
it through at no additional charge to the customer as part of 
our Internet service. The customer has to pay tax on that same 
circuit again, in some States.
    The other aspect of pyramiding is building-in excise taxes, 
for example, at the Federal and State levels, into a State 
sales tax. So we are paying taxes on taxes.
    These are just a couple of small examples of the phenomenon 
of telecom taxes in general, and other witnesses before you 
today have talked about how telecom taxes are taxed almost at 
the rates of sin taxes on alcohol and tobacco. It seems to me 
that telecommunications is a great aspect of the coming economy 
and it performs a fantastic service to citizens and residents, 
and why it should be taxed in a manner that is almost punitive 
is a question that I think this Committee might want to 
address.
    Chairman Houghton. Thank you very much.
    And now, in true political style, you can answer that 
question or you can make a statement, anything that you like, 
in this regard.
    So, Mr. Honaker and Mr. Ledger, I just want to give you a 
chance to express yourselves, and Mrs. Honaker, also.
    Mr. Ledger. I spoke first, so I will yield to my friends to 
the left.
    Chairman Houghton. All right.
    Go ahead.
    Mr. Honaker. I can't speak for all small businesses; I can 
just speak for us.
    My father was a pioneer aviator, and he didn't have a 
background in business, but he did leave me with one thought 
which I didn't understand until I was older: if you understand 
what people want or need, you will be successful.
    If we take that one thought that he left me with, the small 
business today has a problem with fraud. If we can tie this 
together--and credit card fraud is a big, big problem for them, 
for us--if we tie that in to when they use charges, the 
technology is there today to have zero fraud over the Internet. 
We can use the credit card system to tie the tax rates, the 
tables, the matrix all to it, and it gets added on to their 
credit card statements, so that the individual small businesses 
do not have to worry about the multitudes--they put on that 
they bought $100 worth of merchandise; it goes through all the 
checks and balances in the gateway; and then when the credit 
card people have the statement, they see that it's an over-the-
Internet buy. They go to their 9-digit ZIP Code and place the 
appropriate amount for that tax.
    Now, that takes care of Staples, the furniture stores, they 
all have the same--it doesn't overburden the small businesses 
with how to calculate each of those, and it takes care of the 
small business fraud problem. So you make the small 
businesspeople happy. For us--for Margaret and me--I don't mind 
paying our local sales tax on everything we sell if you can 
solve the fraud problem. And it's there; we just need the 
Government's help to make it happen.
    Chairman Houghton. Okay. Thanks very much.
    Mr. Ledger?
    Mr. Ledger. Sir, I am against access taxes, buy taxes, 
anything of that nature. I just want a level playing field. If 
I'm supposed to collect sales tax in Texas, I want people that 
are selling products to my fellow Texans to collect the tax and 
remit it back to my State. It's simple.
    Chairman Houghton. All right.
    Well, thank you so much. We really appreciate your being 
able to be with us and your thoughts. We will take a look at 
them and study them and inwardly digest them. Thank you very 
much.
    Chairman Houghton. Now I am going to call the next panel: 
Mr. Victor Gomperts, who is Vice President, Tax Administration, 
Bell Atlantic in New York; Mr. Brent Wilkes, who is Executive 
Director of League of United Latin American Citizens; and Mr. 
James Martin, President, 60 Plus Association, Arlington, 
Virginia.
    Well, gentlemen, thank you very much for being with us.
    Mr. Gomperts, would you proceed, please?

 STATEMENT OF VICTOR GOMPERTS, VICE PRESIDENT FOR TAXES, BELL 
            ATLANTIC CORPORATION, NEW YORK, NEW YORK

    Mr. Gomperts. Yes, sir, thank you. Good afternoon, Mr. 
Chairman, Mr. Coyne, Mr. Portman. My name is Victor Gomperts. I 
am Vice President for Taxes for Bell Atlantic Corporation. 
Thank you for inviting me to testify before you this afternoon.
    Although I speak only on behalf of Bell Atlantic today, 
there is a broad coalition of interests, of which Bell Atlantic 
is a member, that I believe would agree with my comments. This 
coalition includes consumers, computer and high technology 
associations, small businesses, communications providers, 
unions, and groups representing minority and ethnic interests, 
and is working actively with Mr. Portman and Mr. Matsui to pass 
H.R. 3916. Two of my colleagues from the coalition are present 
also on the panel this afternoon.
    Over 100 years have passed since the Communications Excise 
Tax was originally enacted in 1898 to help fund the Spanish-
American War. At that time, it was considered a luxury tax. 
Over the years the tax has been labeled a ``war tax,'' a 
``luxury tax,'' and finally, a ``deficit reduction tax.'' It is 
the only significant Federal excise tax that is neither 
dedicated to a trust fund for a particular governmental 
purpose, nor considered a tax on a product whose consumption 
Government wishes to discourage for public policy reasons, such 
as alcohol and tobacco.
    Obviously, we can no longer justify the tax for funding a 
war or for taxing a luxury. Moreover, if deficits exist, they 
should be funded by general revenue taxes, not special industry 
taxes. Therefore, I believe there is no public policy reason to 
continue its imposition. In fact, there are many good reasons 
to repeal it as soon as possible.
    One of the principal reasons to repeal this tax is that it 
is extremely regressive. Under one measure of tax fairness, the 
``ability to pay'' principle, tax burdens should be distributed 
among taxpayers in proportion to their ability to pay. Low 
income Americans pay a higher percentage of their income to the 
telecommunications excise tax than do middle-or upper-income 
individuals. Thus, this excise tax falls disproportionately on 
the poor and is indeed regressive and unfair.
    If the tax were repealed, it would annually save consumers 
over $5 billion, with the benefit extending to 94 percent of 
American families. As the tax is regressive, the proportional 
benefit to the poor would be greater than average.
    A second way to measure fairness is to look at the benefits 
derived from the tax. The benefit principle holds that the 
burdens of a tax should be distributed according to the 
benefits that taxpayers receive from the public goods and 
services those tax revenues provide. This is the case with many 
excise taxes that are used for trust funds for particular 
purposes, like highways or airports. But the benefit principle 
does not apply to the 3 percent Federal excise tax, since the 
revenues simply go to fund general Government services.
    Another principle of tax fairness is that taxes should 
apply equally to comparable transactions. There is the 
potential that comparable services provided to customers using 
different technologies may not be subject to excise tax. For 
example, will the tax be applied equally to telephony provided 
by telephone companies, such as my company; cable companies; 
and Internet providers, all of who are capable today of 
providing telephone service?
    The result is that a traditional telecommunications 
provider like Bell Atlantic may collect a discriminatory tax 
from our customers that our competitors may not collect on 
comparable services. This is the so-called level playing field 
concept that has been discussed by many previous speakers 
today.
    Telecommunications has become one of the most dynamic 
sectors of the economy and will continue to be so for the 
foreseeable future. The new high-tech services are more price-
sensitive than basic telephone service. Today's tax burden, 
Federal, State and local, on the typical telephone consumer 
averages almost 20 percent of their monthly bill, and can be as 
high as one-third of their bill. Taxes are definitely a 
deterrent to use of these services, including the Internet.
    Repealing the 3 percent Federal excise tax will be an 
important statement by Congress that taxes imposed on engines 
of growth and technology, like the Internet, are 
counterproductive. We are confident that should Congress make 
that statement, it would certainly help us approach States and 
local governments to follow suit.
    The telecommunications tax is also complex and costly to 
administer. There are numerous exemptions that apply to certain 
classes of customers and to various types of services. For many 
of the exemptions, the customer must file annual certificates 
that must be retained by the telephone company and made 
available to the IRS on audit. Obtaining, storing, and 
recovering these documents is a significant burden.
    In conclusion, in the subcommittee's announcement of 
today's hearing it stated that the focus of the hearing would 
be on matters within the Ways and Means Committee's 
jurisdiction contained in the ACEC report. The ACEC recommended 
repeal of the Federal excise tax. Your committee has clear 
jurisdiction over this tax and should exercise that 
jurisdiction once and for all to eliminate it.
    Thank you.
    [The prepared statement of follows:]

Statement of Victor Gomperts, Vice President for Taxes, Bell Atlantic 
Corporation, New York, New York

    Good afternoon, Mr. Chairman, Mr. Coyne, and other 
distinguished Members of the Subcommittee. My name is Victor 
Gomperts. I am the Vice President-Taxes for Bell Atlantic 
Corporation. Thank you for inviting me to testify before you 
this afternoon. Although I speak only on behalf of Bell 
Atlantic today, there is a broad coalition of interests (of 
which Bell Atlantic is a member) that I believe would agree 
with my comments. This coalition includes: consumers, computer 
and high technology associations, small businesses, 
communications providers, unions, and groups representing 
minority and ethnic interests and is working actively with 
Messrs. Portman and Matsui to pass H.R. 3916.
    Eleven years ago, I testified before the full House Ways 
and Means Committee on behalf of the United States Telephone 
Association to urge that the 3% Federal excise tax on 
telecommunications services not be extended permanently. 
Despite our efforts at that time, the tax was made permanent 
the year after I testified as part of a package of ``deficit 
reduction'' tax increases. For all the reasons I will discuss 
today, I am optimistic that this time the result will be 
different.
    Over one hundred years have passed since a communications 
excise tax was originally enacted in 1898 to help fund the 
Spanish-American War. At that time it was considered a 
``luxury'' tax that applied to less than 2,000 access lines 
then in existence. Over the years the tax on telecommunications 
has ranged from 1% to 25% and has been labeled a ``war'' tax, a 
``luxury'' tax, and finally a ``deficit reduction'' tax. It is 
the only significant federal excise tax that is neither 
dedicated to a trust fund for a particular governmental 
purpose, nor considered a tax on a product whose consumption 
government wishes to discourage for public policy reasons (such 
as tobacco or alcohol). Obviously, we can no longer justify the 
tax for funding a war or for taxing a luxury. Moreover, if 
deficits exist, they should be funded by general revenue taxes, 
not special industry taxes. Therefore, I believe there is no 
public policy reason to continue its imposition. In fact there 
are many good reasons to repeal it as soon as possible.

Regressivity and Fairness

    One of the principal reasons to repeal this tax is that it 
is extremely regressive. Under one measure of tax fairness (the 
``ability to pay'' principle), tax burdens should be 
distributed among taxpayers in proportion to their ability to 
pay. Unless a tax is intended to discourage consumption, one 
might presume that for a tax to be ``fair'' it should at least 
be proportional to income and not regressive in nature. A 
number of scholarly works (including the 1987 Treasury Report, 
the 1990 Congressional Budget Office Report, and a recent paper 
by George Washington University Professor Joseph Cordes) 
demonstrate that low-income Americans pay a higher percentage 
of their income to the telecommunications excise tax than do 
middle or upper-income individuals. Thus, this excise tax falls 
disproportionately on the poor and is indeed regressive and 
``unfair.''
    Today, telecommunications is a necessity, one that the 
poor, the elderly, and the infirm literally require as a 
lifeline to the world. To continue to impose a flat-rate 
regressive consumption tax on this segment of the economy is 
poor public policy. If the tax were repealed, it would annually 
save consumers over $5 billion with the benefit extending to 
94% of American families. As the tax is regressive, the 
proportional benefit to the poor would be greater than average.
    A second way to measure fairness is to look at the benefits 
derived from the tax. This ``benefit'' principle holds that the 
burdens of a tax should be distributed according to the 
benefits that taxpayers receive from the public goods and 
services those tax revenues provide. This is the case with many 
excise taxes that are used for trust funds for particular 
purposes, like highways or airports. But the benefit principle 
does not apply to the 3% Federal excise tax since the revenues 
simply go to fund general government services.

Competitive Neutrality

    A third principle of tax fairness is that taxes should 
apply equally to comparable transactions. With regard to the 
telecommunications excise tax, there is a great potential for 
disparities in treatment. New technologies and new providers 
are dramatically increasing the potential for inconsistent 
application of this tax. Today, there are thousands of new 
providers of telecommunications services, like cable companies, 
satellite companies, and Internet providers. There is the 
potential that comparable services provided to customers using 
different technologies may not be subject to the excise tax. 
For example, will the tax be applied equally to telephony 
provided by telephone companies, cable companies, and Internet 
providers? The result is that a traditional telecommunications 
provider like Bell Atlantic may collect a discriminatory tax 
from our customers that our competitors may not collect on 
comparable services. This puts many companies at a competitive 
disadvantage.

Technology and Growth

    Telecommunications has become one of the most dynamic 
sectors of the economy and will continue to be so for the 
foreseeable future. No longer do consumers look to their phone 
companies solely for basic telephone service. Our customers now 
demand high speed Internet connections; Internet service; call 
waiting; voicemail; long distance; wireless; wireless data; and 
many other services. These high tech services are more price 
sensitive than basic telephone service. Today's tax burden 
(federal, state, and local combined) on the typical telephone 
consumer averages almost 20% of their monthly bill and can be 
as high as a third of their bill. Taxes are definitely a 
deterrent to the use of these services, including the Internet. 
Repealing this 3% Federal tax would be an important statement 
by Congress that taxes imposed on engines of growth and 
technology like the Internet and telecommunications are 
counterproductive.
    America is clearly the technology leader in the world, and 
other markets are watching our transition from a heavily 
regulated utility regime to a more competitive 
telecommunications industry. We need to set an example to 
minimize taxation on technology rather than to allow stifling 
taxes to continue. Every time we introduce innovative products, 
this broad tax applies to our services. For example, wireless 
technology, which was introduced in the middle and late 
eighties, is now a significant part of the base for this tax. 
If Congress fails to repeal this tax, the introduction of new 
technologies could be adversely affected by the high rate of 
telecommunications taxes.

Complexity and Administration

    The telecommunications excise tax is also complex and 
costly to administer. Over the years we collected this tax, 
which is levied on our customers, by adding an additional 3% to 
their phone bills. You might think this is an extremely easy 
tax to administer that happens to bring in lots of revenue. 
However, there are numerous exemptions that apply to certain 
classes of customers and to various types of services that make 
it very difficult and costly to administer. For example, the 
news media is exempt from the tax, but only on long distance 
service used to collect or disseminate the news. For many of 
the exemptions, the customer must file annual certificates that 
must be retained by the telephone company and made available to 
the IRS on audit. Obtaining, storing, and recovering these 
documents is a significant burden.
    There are other administrative issues associated with 
measuring the base for this tax. For example, in some 
jurisdictions the tax will apply to local 911 fees, while in 
others it does not. The tax applies to many state and local 
taxes, but not to others. Applying all of these rules is a 
complex undertaking, and if there is a discrepancy, we must 
deal with the IRS or with irate customers.
Conclusion

    In the Subcommittee's announcement of today's hearing, it 
stated that the focus of the hearing would be on matters within 
the Ways and Means Committee's jurisdiction contained in the 
Advisory Commission on Electronic Commerce (ACEC) report and 
related topics. The ACEC recommended the repeal of the Federal 
excise tax. Your Committee has clear jurisdiction over this tax 
and should exercise that jurisdiction once and for all to 
eliminate it.
    I will be more than happy to answer any questions you might 
like to ask me.
      

                                


    Chairman Houghton. Thanks very much.
    Mr. Wilkes?

  STATEMENT OF BRENT A. WILKES, EXECUTIVE DIRECTOR, LEAGUE OF 
                 UNITED LATIN AMERICAN CITIZENS

    Mr. Wilkes. Good afternoon, Mr. Chairman, Mr. Coyne, Mr. 
Portman. My name is Brent Wilkes, and I am the National 
Executive Director of the League of United Latin American 
Citizens. We are the largest and oldest Hispanic organization 
in the United States. I am pleased to be before you today to 
talk about an effort to repeal the 3 percent Federal excise tax 
on telephone services.
    This is a regressive tax that disproportionately affects 
the Hispanic community. I am here today to express support for 
H.R. 3916, which was introduced by Representatives Portman and 
Matsui, to repeal the Federal excise tax on telephone services.
    Today there are over 35 million Hispanics living in the 
United States. Hispanics are more likely than average Americans 
to have relatives and friends who live outside the United 
States. Not surprisingly, Hispanics are heavy users of long 
distance and other telecommunications services. In some Sates, 
long distance bills for Hispanic families average twice that of 
non-Hispanic families.
    The increased use of long-distance services as a means to 
keep in touch with family and friends--not as a luxury--is an 
added burden. Because Hispanic families tend to pay 
disproportionately higher phone bills, Hispanics also tend to 
pay this Federal excise tax on telephone services in 
disproportionately higher amounts. And because Hispanic 
households have median incomes that are only 65 percent of non-
Hispanic white households, the burden on low-income Hispanic 
families is disproportionately greater as well.
    These are reasons why the Hispanic community feels strongly 
about the repeal of this regressive tax.
    I have a chart that is entitled, ``Savings per Income Class 
as a Percentage of Income After Taxes if the Telephone Excise 
Tax was Repealed in 2000,'' which I would like to submit for 
the record.
    [The referenced chart follows:]
    [GRAPHIC] [TIFF OMITTED] T7448.003
    
    [GRAPHIC] [TIFF OMITTED] T7448.004
    
    [GRAPHIC] [TIFF OMITTED] T7448.005
    
    Mr. Wilkes. What this chart clearly shows is that low-
income Americans disproportionately pay a higher percentage of 
their income in this Federal excise tax.
    When you add taxes by State and local governments to the 
Federal excise tax, the combined taxes on telephone services 
can be as high as 32 percent. In California, all telephone 
taxes equal 20 percent. At those levels, taxes take a real bit 
out of the monthly budgets of low-income families. Congress 
should take the lead in ameliorating this regressive burden by 
repealing the 3 percent Federal excise tax on telephones.
    Thanks to our strong economy, Congress will consider 
several tax cut proposals this year. The FETT should be 
Congress' first priority because it provides a similar amount 
of tax relief to Americans of all income levels. Throughout its 
102-year history, the off-and-on nature of the tax on telephone 
services shows that this justification has been a wartime tax 
or in times of budget deficits. Those times, thankfully, have 
passed. We should not keep a tax that is unjustified simply 
because we are so charmed by the revenues it continues to 
raise.
    The FETT is a regressive, outdated tax, and the LULAC has 
encouraged its membership, as part of a broader coalition, to 
seek to repeal this tax. We thank you for your support of H.R. 
3916 and hope that you report it favorably out of the 
committee.
    One last point. Our organization has been one of the 
leading Hispanic organizations seeking to address the digital 
divide. We have been setting up community technology centers 
all across the United States, and we have encouraged our 
members to get on line. I think cost is a major obstacle to our 
community for getting on line, and we believe that this is one 
tax that Congress can repeal that will go a long way toward 
helping to addressing the digital divide.
    Thank you.
    [The prepared statement follows:]

Statement of Brent A. Wilkes, Executive Director, League of United 
Latin American Citizens

    Good afternoon, Mr. Chairman, Mr. Coyne, and distinguished 
Members of the Ways and Means Subcommittee on Oversight. My 
name is Brent Wilkes, and I am Executive Director of the League 
of United Latin American Citizens. I am pleased to be before 
you today to talk about an effort to repeal the three percent 
federal excise tax on telephone services. This is a regressive 
tax that disproportionately affects the Hispanic community. I 
am here today to express support for H.R. 3916, which was 
introduced by Representatives Portman and Matsui, to repeal the 
federal excise tax on telephone services.
    Today there are 35 million Hispanics living in the United 
States. Hispanics are more likely than average Americans to 
have relatives and friends who live outside of the United 
States. Not surprisingly, Hispanics are heavy users of long 
distance and other telecommunications services. In some states, 
long distance bills for Hispanic families average twice that of 
non-Hispanic families.
    The increased use of long distance services as a means to 
keep in touch with family and friends, not as a luxury, is an 
added burden. Because Hispanic families tend to pay 
disproportionately higher phone bills, Hispanics also tend to 
pay this Federal Excise tax on telephone services in 
disproportionately higher amounts. And because Hispanics have 
incomes that are often below the national average, the burden 
on low-income Hispanic families is disproportionately greater 
as well. These are the reasons why the Hispanic community feels 
strongly about the repeal of this regressive tax.
    When you will look at the chart attached Savings per Income 
Class as a Percentage of Income after Taxes if the Telephone 
Excise Tax was Repealed in 2000,it is very clear that the 
federal excise tax on telephone services hits those who can 
least afford it hardest.
    When you add taxes by state and local governments to the 
Federal Excise Tax, the combined taxes on telephones can be as 
high as 32 percent. In California all telephone taxes equal 20 
percent. At those levels, these taxes take a real bite out of 
the monthly budgets of low-income families. Congress should 
take the lead in ameliorating this regressive burden by 
repealing the three percent federal tax on telephones.
    There are many budget priorities that Congress will debate 
this year that are important to the country as a whole, as well 
as to the Hispanic community. Many of them we support. But we 
should not in a time of budget surplus choose to fund these 
priorities on the backs of telephone bills, because that is a 
particularly regressive tax that falls hardest on those who can 
least afford to pay. Throughout its 102 year history, the off 
and on nature of the tax on telephone services shows that its 
justification has been as a war-time tax or in times of budget 
deficits. Those times, thankfully, are passed. We should not 
keep a tax that is unjustified, simply because we are so 
charmed by the revenues it continues to raise.
    The FETT is a regressive outdated tax and the LULAC has 
activated its members as part of a broader coalition that is 
working to repeal this tax. We thank you for your support of 
H.R. 3916 and hope that you will report it favorably from the 
Committee.
      

                                


    Chairman Houghton. Thanks very much.
    Now, Mr. Martin.

 STATEMENT OF JAMES L. MARTIN, PRESIDENT, 60 PLUS ASSOCIATION, 
                      ARLINGTON, VIRGINIA

    Mr. Martin. Thank you, Mr. Chairman, Mr. Coyne, Mr. 
Portman. I am Jim Martin, President of the 60 Plus Association; 
60 Plus has, on average, about 1,000 to 1,200 members per 
Congressional District, working against taxes that affect 
seniors and their families.
    Indeed, our slogan at 60 Plus is ``tax fairness for 
seniors,'' and this Congress, thus far, has been very ``senior-
friendly''--for instance, in abolishing the earnings limit that 
was essentially a 33 percent tax on seniors' benefits. And I 
believe the best is yet to come, now that this Congress is once 
again poised to provide tax relief for seniors as it considers 
H.R. 3916, a truly bipartisan bill that does the right thing 
for those living on fixed incomes by repealing the antiquated 
100-year-old Federal excise tax on telephones.
    I repeat, this bill is strongly bipartisan, coauthored by 
your colleagues, Mr. Portman and Mr. Matsui, and by an 
impressive array of Republicans and Democrats, as well as the 
distinguished members here today as cosponsors, and 60 Plus has 
sent a letter to your colleagues endorsing H.R. 3916.
    As the head of a senior citizens group, let me put this 
issue into some historical perspective, if I may. I worked on 
Capitol Hill about 38 years ago; I came here to work on the 
Hill, and I've seen a lot of taxes come, I like to say, but not 
very many go. And I think the time for this tax to go has 
surely come.
    While it was considered a temporary luxury tax back in 1898 
to fund the Spanish-American War, when few owned telephones, 
telephones are a necessity now, so this tax is clearly 
regressive in that those on lower and fixed incomes, such as 
senior citizens, pay a disproportionately higher part of their 
available funds. Thus it makes it more expensive for seniors 
who may be calling their children, their grandchildren, or--
perhaps even more importantly--calling their pharmacy.
    The FETT, if it were repealed today, would mean about a 
$1.1 billion tax cut just for families headed by a person age 
65 or older. Mr. Chairman, we have a chart that we submitted 
for the record, but repealing it in your State alone would mean 
about an $85.5 million tax cut for seniors.
    I have submitted for the record an outline of the history 
of this temporary tax and how it has been repealed, reimposed, 
reduced, increased, ad infinitum. Its temporary status over 100 
years, if I might conclude here, reminds me of a story about 
President Nixon who recalled that as a young Navy Lieutenant 
during World War II, there were temporary trailers and wooden 
offices built down on the Washington Mall grounds to process 
incoming and outgoing military personnel. Well, by the time 
that he was elected and inaugurated in 1969, those temporary 
buildings had become permanent, if you will, providing an ugly 
eyesore for visitors to our Nation's Capital. The newly-elected 
President Nixon ordered them razed, restoring the beauty of the 
Mall.
    So it is long past time, I believe, to disconnect the 
temporary 102-year-old telephone tax, and 60 Plus hopes that 
you will report H.R. 3916 favorably from committee and move 
swiftly to pass this bill. I am looking forward to sending that 
senior-friendly message into all 435 Congressional Districts at 
an early date. On behalf of those of us who are 60 Plus, I 
thank you for your time.
    [The prepared statement follows:]

Statement of James L. Martin, President, 60 Plus Association, 
Arlington, Virginia

    Good afternoon, Mr. Chairman, Mr. Coyne, and distinguished 
Members of the Ways and Means Subcommittee on Oversight. My 
name is Jim Martin. I am the President of the 60 Plus 
Association. The 60 Plus Association has more than 500,000 
citizen-lobbyists working against taxes that affect seniors and 
their families.
    Indeed, our slogan at 60 Plus is ``tax fairness for 
seniors'' and this Congress, thus far, has been very ``senior 
friendly,'' for instance, in abolishing the earnings limit that 
was essentially a 33% tax on seniors' benefits. Now this 
Congress is poised, I believe, to once again provide tax relief 
for seniors as it considers H.R. 3916, a truly bipartisan bill 
that does the right thing for those living on fixed incomes by 
repealing the antiquated 100 year old federal excise tax on 
telephones.
    I am here today on behalf of all seniors who support H.R. 
3916 co-authored by Representatives Rob Portman (R-OH) and 
Robert Matsui (D-CA). 60 Plus has written a letter endorsing 
H.R. 3916 and urging support for H.R. 3916.
    When the tax was imposed in 1898 to fund the Spanish 
American war, it was intended as a ``temporary'' luxury tax on 
telephones. Today the telephone is essential to so many seniors 
in so many ways. Seniors rely on the telephone to provide 
essential emergency services and for regular consultation with 
physicians. Just as important, the telephone is the main source 
of contact with family members.
    As the head of a senior citizens group, let me put this 
issue into historical perspective. Having worked on or around 
Capitol Hill since 1962, 38 years, I've seen a lot of taxes 
come, but not many go. The time for this tax to go has surely 
come. Considered a ``luxury'' back in 1898 when few owned 
telephones, it is clearly regressive in that those on lower and 
fixed incomes, such as senior citizens, pay a 
disproportionately higher part of their available funds. Thus, 
it makes it more expensive for seniors who may be calling their 
children, their grandchildren, or perhaps even more importantly 
calling their pharmacy.
    The FETT is no longer a tax on luxury items. In fact the 
FETT is a regressive tax that hits older Americans who live on 
fixed incomes the hardest. If the FETT were repealed today it 
would mean a $1.1 billion tax cut for families headed by a 
person aged 65 or over. Mr. Chairman, repealing the FETT would 
mean an $85.6 million dollar tax cut for seniors in your State 
of New York. These savings can be used to pay for medicine, 
food or other necessities that are a burden on those with a 
fixed income. There are plenty of reasons to eliminate the 
FETT.

    Let me just cite a few:

     If a family started in 1940 to save the direct 
amount of tax they've been required to pay since then, they'd 
have $25,000 in savings today.
    That is enough money to pay off a home mortgage for many 
seniors or pay Medicare deductibles or for prescription drug 
coverage.
     If a small ``five and dime'' with four business 
lines in 1940 started saving the direct amount of telephone tax 
they've been forced to pay all these years, the store would 
have $88,000 available in that fund.
    Perhaps it would be helpful if I submitted for the record 
an outline of the history of the federal excise tax on 
telephone services. (see attached)
    It's ``temporary'' status over 100 years ago reminds me of 
a story by President Nixon upon taking office in 1969. He 
recalled that as a young Navy Lieutenant after World War II 
there were ``temporary'' trailers and wooden offices built down 
on the Washington mall grounds to process the paper work of 
departing and arriving military personnel. Some 25 years later, 
these ``temporary'' buildings had become permanent, providing 
an ugly eyesore for visitors to our nation's capitol. Newly 
elected President Nixon had them razed, restoring the beauty of 
the mall.
    So it's long past time to disconnect the ``temporary'' 102 
year old telephone tax!
    We thank you for your support of H.R. 3916 and hope that 
you will report it favorably from the Committee and move 
swiftly to pass this important legislation.

From the Spanish American War Till Today--

the ``Temporary'' Telephone Excise Tax Endures

        Major Moments in FET History--The Tax That Won't Go Away

    1898--Temporary tax on telephone services adopted to help 
fund the Spanish American War.
    1914--The long distance luxury telephone tax is imposed at 
a rate of one cent per call with the purpose of paying for some 
of the costs of World War I.
    1916--The tax is repealed.
    1917--Tax is reinstated at a rate of five cents per call 
once the United States enters the war.
    1918--Tax is expanded to cover additional telephone 
services.
    1924--The telephone excise tax is repealed.
    1932--The tax is reinstated at per-call rates ranging from 
10 cents to 20 cents, depending on the cost of the call.
    1942--Tax rate is changed to a flat 20 percent rate.
    1943--Tax rate is increased to 25 percent.
    1954--Tax rate is reduced to 10 percent.
    1959--Tax rate is slated to expire in 1960.
    1960-64--Expiration schedule is delayed annually.
    1965--As part of the excise tax reform project, the 10 
percent communications excise tax is scheduled to be phased out 
over three years.
    1966--Phase-out delayed for one year.
    1968--Phase-out restructured to conclude in 1973.
    1969--Phase-out delayed for one year.
    1970--Schedule replaced by a ten year plan beginning in 
1973.
    1973--Phase-out begins.

    1981--Excise tax down to 1 percent but elimination is 
deferred. One percent is extended through 1984.
    1982--Tax rate is increased to 3 percent with elimination 
in 1985.
    1984--Three percent rate is extended through 1987.
    1987--Three percent rate is extended through 1990.
    1990--Three percent Excise tax made permanent in 1990.
      

                                


    Chairman Houghton. Thanks very much, Mr. Martin.
    Mr. Coyne?
    Mr. Coyne. Thank you, Mr. Chairman.
    I want to thank each of the panelists for their testimony, 
and ask Mr. Gomperts this. Bell Atlantic's telephone bills are 
extremely complicated, very difficult to understand, even for 
the average person. There isn't a week that goes by when I go 
back to the district that there aren't senior citizens who come 
and tell me about the very complicated nature of the monthly 
telephone bill that they get, and I'm sure that Mr. Martin's 
organization receives inquiries about that problem as well.
    Is there anything that Bell Atlantic can do to make them 
more simplified and easier to understand, particularly for 
senior citizens?
    Mr. Gomperts. The telephone bill itself is considered by 
Bell Atlantic as an important marketing tool. It's not just a 
bill. The company is extremely cognizant of exactly the type of 
issues you have just discussed. There is an ongoing effort--in 
fact, there is a whole group committed to this--to simplifying 
that bill. Periodically you would notice that the bill does 
come in with a new format, in an effort to simplify it. But 
just like bank statements, there is a certain amount of 
information that must appear on that bill, and there is no way 
to condense it or aggregate it at a higher level. For instance, 
all the local calls, all the toll calls if the bill reflects 
toll calls, all the regulatory fees, regulatory surcharges, 
State taxes, local taxes, the Federal excise tax--for at least 
a short period longer, until it is repealed--all these items 
are required to be on the bill.
    I think that it's just the nature of the animal that it 
can't ever be as simple as the constituency would like to see 
it. But given that, the marketing people realize that this is a 
competitive issue, the bill, and as we move into long distance 
service as a local telephone company, starting in New York--and 
hopefully soon to follow in Pennsylvania, your jurisdiction--we 
are making every effort to simplify the bill even more. But I 
can't tell you that it will ever be as simple as a 3-or 4-line 
statement; it's always going to be somewhat complicated for the 
reasons that I have stated.
    Mr. Coyne. Well, the complaints that I get are not so much 
about each itemized line item. I understand that they have to 
be on there. But the descriptions and terminology that go 
beside each charge are something that people have a very, very 
difficult time understanding.
    Mr. Gomperts. In many cases--
    Mr. Coyne. And what they do is come to us, who they feel 
have some influence over what can be done about the problem, 
and tell us they just don't understand their phone bill.
    Mr. Gomperts. In many cases that terminology that you refer 
to has its origin with the Public Utility Commission in the 
State. They will label a particular charge, for whatever 
purpose motivates them, with a title, like ``subscriber line 
charge.'' Now, the average person wouldn't have a clue as to 
what a subscriber line charge is. The Public Utility Commission 
labels the charge as a certain description; we are required, 
when we put that on the bill, to in fact mirror the Public 
Utility Commission law that describes that charge.
    I think your point is well taken, though, and I will 
certainly bring back to the company the notion that we should 
make every effort to try to put these terms in real English so 
that the customers can understand what they're being charged 
for, and that it doesn't just mirror the statutory language of 
the Public Utility Commission, which is often the origin of 
those charges.
    Mr. Coyne. Well, as you indicate, you are trying to be 
customer-friendly, and you use your telephone bills, your 
monthly bills, to try to attract the good will of the customers 
that you serve. So it would seem to me, then, that if the PUC 
or whatever jurisdiction is mandating that these charges be on 
there, and these descriptions be on there, maybe you could even 
go a little bit further and put a line below it to put it in 
English, what that particular charge is.
    Mr. Gomperts. I think your point is well taken, Mr. 
Congressman, and I will certainly bring that point back to the 
company.
    Mr. Coyne. Thank you.
    Chairman Houghton. Mr. Portman?
    Mr. Portman. Thank you, Mr. Chairman.
    Again, late in the hearing here, I want to thank the 
Chairman for letting us get into ``tax on talking'' and having 
a hearing on it. Your testimony is excellent and I appreciate 
the work that you all do at the coalition. Mr. Coyne and Mr. 
Houghton are both cosponsors of this legislation; in fact, the 
vast majority of the members of this committee who would 
normally sit here during a full committee hearing--and a markup 
which is going to take place tomorrow, I believe--will be 
supportive of it. So I feel as if we have a very good 
opportunity this year to finally drive a stake into the heart 
of the ``temporary luxury tax'' put in place for the Spanish-
American War back in 1898. It turns out that the Spanish were 
tougher than we thought. [Laughter.]
    Mr. Portman. But I do have a few questions that would be 
important to get on the record, if you all would indulge me a 
little bit, because I know some of these answers are pretty 
obvious, but I think it's important that we create a record 
here.
    The first one is--I guess, Mr. Gomperts, you're the best 
one to respond to this--how can we be sure that telephone 
companies won't turn around and raise their rates to make up 
the difference between this 3 percent excise tax that's in 
place now, and the repeal that we would all like to see?
    Mr. Gomperts. As a practical matter, and as a matter of 
law, that is impossible. The regulatory regime in place now in 
every State where Bell Atlantic operates is something which is 
commonly called ``price cap.'' This is distinguished from 
previous regulatory regimes which were in place for 100 years, 
which were rate-based rate-of-return, where the company used to 
compute its investment, and then the State Commission would 
allow a fair return on that investment, and then that total 
dollar amount would then be spread among all consumers.
    The new regulation, which is ``price cap,'' fixes the price 
that the company can charge the consumer for its monthly 
service. That price can only be changed if the company can 
bring forth a showing that there has been an increase in so-
called ``exogenous costs,'' and the company is then allowed to 
reflect those exogenous cost increases in its rates--with an 
offset, however, for productivity. So it's a netting process 
that allows the company to increase rates.
    The reduction or the repeal of the Federal excise tax under 
State law would not be an occasion to raise rates--
    Mr. Portman. In fact, it should be just the opposite, and 
in fact--I want to get to the next question, which is that your 
administrative costs should be reduced, as well as the 3 
percent excise tax on the consumer?
    Mr. Gomperts. That's exactly true. In fact, the excise tax, 
as you pointed out, Mr. Portman, is not really a tax on the 
company at all. It is a tax on the consumer. With the repeal of 
the excise tax, we would just take the last line on the bill--
which I think is in pretty good English; it says, ``3 percent 
Federal excise tax''--and we would just eliminate that line, 
and with that we would eliminate 3 percent of the bottom line 
of the phone bill. There is no way that we would raise the bill 
to compensate for that and to, in effect, redirect that money 
to Bell Atlantic. That money would no longer be collected from 
the consumer, and would be in their pockets to spend on other 
goods and services in the economy. And again, predominantly 
that money would go to lower-income individuals, and certainly 
to residence customers versus business customers.
    Mr. Portman. Right. The bulk of it is among residence 
individuals, not businesses, which is a good point to be made.
    You had begun to answer the second question by talking 
about the impact of repeal on the economy, but as you 
indicated, your company, Bell Atlantic, and other companies 
pass this along to the consumer. One of the questions that I 
sometimes get asked by my colleagues is, because these 
companies don't even pay this tax, why do they care about it? 
Why does Bell Atlantic care about getting this tax repealed?
    Mr. Gomperts. Well, I think there are several different 
answers to that question, and I will take it from two different 
perspectives. One is the corporate perspective, and then 
there's the perspective of the consumer, our customer.
    From the corporate perspective, this tax increases the cost 
of our services. Our service is unlike basic telephone service, 
which has a fairly low elasticity of demand, meaning you could 
raise the price and still have everyone stay with you. The new 
generation of high-tech services have much greater elasticities 
of demand, and if you raise the price, you will have people not 
buy your service--or if you cannot lower the price, you will in 
effect discourage people from acquiring that service, which 
will obviously impact the company's revenues.
    The second point from the corporate side is that there is a 
tremendous burden in administering this tax for the IRS or for 
the Federal fist. We must collect it from the customers and 
remit it on a very regular basis. In fact, we bill it and 
collect it and remit it before we ever get the money from the 
customer. So we actually remit the tax on a ``when billed'' 
basis, and we don't actually get the money from the customer 
until an average of 25 to 30 days later. So we're actually out 
of pocket for that money for that period of time.
    But beyond that, the other issue has to do with the whole 
evolution of the Internet and other high-tech services. The 
marketplace today is demanding that they be presented one-stop 
shopping, or a bundled rate, for all the services they want to 
consume. For instance, what we're getting from our marketing 
data is that customers would like to be charged a flat rate--
let's say, $88 a month--and then they could have all they could 
eat, all the local, all the long-distance, all the video on 
demand, all the wireless, all the high-speed Internet 
connections.
    In order to package rates and meet customer demand--and 
that is the way the market is moving--it is impossible under 
the present tax structure because by bundling all of the 
elements I have just described, you would be combining taxable 
services, such as local, with nontaxable excise services, such 
as Internet access. And as a result, you would taint the entire 
bundle and make it taxable. Our rates would in effect go up to 
the end consumer because of the incremental tax.
    Mr. Portman. That's very helpful. I appreciate that.
    I want to get a chance to ask Mr. Wilkes and Mr. Martin a 
question, but let me just say that to me one of the incredible 
things that came out of the Advisory Commission hearings was 
the statistic that major telephone companies are filing 
something like 100,000 tax returns annually, and there is a 
compliance burden here, obviously, at the company level which 
is also passed on to the consumer. There are also, as you say, 
other administrative issues that the Federal Government has to 
deal with, including the IRS. And finally, as you say, this is 
a tax imposed on growth, and this interest of the consumer in 
bundling is one that is consistent with the fact that we are 
increasingly turning to e-commerce and want, as consumers, to 
see that done as efficiently as possible. So this is a bigger 
issue than just telephones; it's about whether 
telecommunications is going to continue to be that driving 
engine of our economic growth.
    If I could quickly ask, Mr. Chairman, about the impact on--
Mr. Wilkes, your group, and you talked about the fact that 
Hispanic households on average have higher telephone bills. I 
assume part of that is long-distance calls. Can you perhaps 
expand a little on why it is that your organization is so 
interested in this issue?
    Mr. Wilkes. Certainly. That's exactly correct. Hispanics on 
average, in many States, are using twice the level of long-
distance services of other populations. So we think that's a 
disservice to our community because our community is about 65 
percent of the median income. So when you look at the community 
that is least able to pay the tax, in some cases we have to pay 
almost double the tax that other communities are paying. So it 
is really kind of socking it to the poor in this case.
    Mr. Portman. It is also a tax that hits small businesses 
disproportionately, and to the extent that you represent small 
businesses--which I know that you do--it's something that I 
assume you have a special interest in as well.
    Mr. Wilkes. We certainly do. The Hispanic community has a 
tremendous growing small business population, so that's been 
very beneficial. But it does impact small businesses as well. 
These are folks who can least afford to pay this tax, so we 
would like to see it removed.
    Mr. Portman. Mr. Martin, I see from your testimony that 
there is a $1.1 billion impact on seniors annually, and the 
fact that is a disproportionate impact, and that seniors depend 
on the telephone for health care needs, for food needs, for 
staying in touch with their relatives and loved ones who take 
care of them, since often they are bound to their apartments or 
homes. I think that's a very important aspect of this that we 
need to get on the record.
    Could you expand a little bit more on why this is a 
disproportionate impact on seniors?
    Mr. Martin. Sure. Well, you've covered it, and as Mr. 
Wilkes point out, too--my membership, by the way, they're not 
wealthy, that I personally know of. These are lots of low-
income seniors--
    Mr. Portman. Not like Ted Turner. [Laughter.]
    Mr. Martin. I would say to that, by the way, Mr. Portman, 
we've talked about that before; the resemblance of Mr. Turner. 
I have a son who goes to school in Atlanta. When I go down 
there, the upshot is I get the best seat in the house. 
[Laughter.]
    Mr. Martin. The downside is, everybody expects me to pick 
up the tab. [Laughter.]
    Mr. Martin. I would add, though, sir, that clearly 
seniors--shut-ins, if you will--the phone is a necessity. It's 
their link to the outside world in many, many cases, as you 
just pointed out--not just their children or grandchildren, but 
their friends. It is their true link to the outside world. It 
is a necessary tool that they have to have. So clearly, it 
impacts them.
    Mr. Portman. Well, I really appreciate your being part of 
the coalition, and you, Mr. Wilkes, and your organization. This 
has been a bipartisan--almost nonpartisan, I would say--effort 
from the start as well, and I appreciate the efforts of Mr. 
Coyne and Mr. Matsui and others to make it so. I think this is 
one that we ought to go ahead and finish off. The war is over; 
it's time to celebrate. [Laughter.]
    Mr. Portman. Thank you, Mr. Chairman
    Chairman Houghton. Thank you.
    I just have one question of Mr. Gomperts which affects the 
rural taxpayers. You said there was sort of a disproportionate 
impact on them. Could you break that down, just very quickly?
    Mr. Gomperts. Yes. The reasoning behind that, and the 
statistics that I've been shown, is that rural taxpayers, 
because of the geography and the distance that their phone 
calls have to travel, they are mostly making long-distance 
telephone calls because of the distances, and a higher 
proportion of their telephone calls vis-a-vis people living in 
inner cities are long-distance calls. And as a result, they are 
bearing a higher proportionate burden of the excise tax, where 
local calls are flat-rated.
    Chairman Houghton. All right. Thanks very much.
    Well, gentlemen, thank you. I certainly appreciate your 
testimony, your thoughts, and your patience.
    [Whereupon, at 4:53 p.m., the hearing was adjourned.]
    [Submissions for the record follow:]

Statement of American Federation of State, County and Municipal 
Employees, AFL CIO

    The American Federation of State, County and Municipal 
Employees (AFSCME) submits the following statement for the 
hearing record expressing our concern over the non-collection 
of sales taxes on remote purchases.
    The originally-enacted Internet Tax Freedom Act (47 U.S.C. 
151) imposed a three-year ban, ending September 30, 2001, on 
any new state and local taxes on Internet access and multiple 
or discriminatory taxes on electronic commerce. During this 
time, the Commission was to make recommendations for dealing 
with taxation of the Internet. Unfortunately, this Commission 
failed to complete its work and make any official 
recommendations. As a result, state and local governments are 
suffering from the non-collection of sales taxes on remote 
purchases.
    In our opinion the practical effect of this law has been to 
exacerbate the existing de facto tax-exempt status of most such 
remote sales that result from the inability of states to 
collect sales taxes from purchases made by state residents from 
Internet and catalog sales. As a result, AFSCME believes that 
the moratorium should be allowed to expire in September 2001 
and not be extended through calendar year 2006. More 
importantly, we believe there needs to be some affirmative 
action taken by Congress to ensure the collection and 
enforcement of collection of sales taxes already owed on remote 
purchases.
    While the states are demonstrating that they can attack 
this challenge in a constructive and cooperative fashion, more 
action needs to be taken immediately. State and local 
governments already may be losing on the order of $5 billion in 
sales tax revenues annually from their inability to tax most 
mail-order sales. With Internet sales growing rapidly, these 
governments could be losing an additional $15-20 billion 
annually by 2003 if Internet purchases remain effectively tax-
exempt. Revenue losses would continue to mount thereafter, as 
Internet sales grow over time.
    The loss of state and local tax revenue significantly 
impairs the ability of states and localities to meet demands 
for education funding and other critical services such as 
public safety and transportation. This scenario is particularly 
troubling in the context of education. There is agreement that 
primary and secondary education in the United States is in need 
of constant improvement so that our children receive the 
foundation that will allow them to fill the demand for high-
skilled, well-educated workers in the information economy. 
Improving the education system requires investment. In fact, 
state education budgets consume 35 to 40 percent of state 
revenues. It is ironic that the Internet, the very tool 
fostering today's high-tech explosion, stands to play a pivotal 
role in the states' inability to fund the desperately needed 
improvements in the education system.
    Main Street retailers are also at risk of losing 
considerable business to remote sellers so long as they must 
add sales tax to their prices at the cash register while 
Internet and mail-order merchants can sell tax-free. There is 
evidence that this tax advantage is already distorting retail 
competition by compelling large retail chains to reorganize 
their operations solely to be able to compete with their tax-
exempt Internet rivals. As this disparity comes into sharper 
focus, it will not only result in lost tax revenues, but it 
will also harm communities.
    For these reasons, AFSCME supports stronger enforcement and 
more active collection of existing sales tax due on remote 
purchases. Accordingly, we call upon Congress to take swift and 
effective action.
      

                                


Statement of Dan R. Mastromarco, Argus Group, Alexandria, VA, on behalf 
of Americans for Fair Taxation

Dear Mr. Chairman and Members of the Subcommittee on Oversight:

    On behalf of the Americans for Fair Taxation (AFT), I am 
pleased to submit this testimony to discuss tax issues relative 
to the internet and electronic commerce. AFT is a nonpartisan 
grass roots organization that supports the FairTax national 
sales tax plan (H.R. 2525). As you know, the FairTax was the 
subject of a recent hearing before the full Committee. The 
FairTax would repeal all income based Federal taxes, including 
personal and corporate income taxes, self-employment and 
payroll taxes, capital gains and death taxes, and replace these 
multiple and often hidden taxes with a visible, single rate 
national sales tax. The FairTax would effectively remove any 
tax on savings and investment, on exports, on educational 
expenditures and on charitable contributions. It would apply 
only to the final retail purchase of new goods and services and 
not business-to-business (B2B) purchases.
    This Committee should be applauded for highlighting the 
Commission's findings,\1\ and for stressing the need to ensure 
multiple and discriminatory taxes are not imposed on the 
internet. Congress is rightfully consumed with ensuring the 
internet is not dashed on the shoals of ill-conceived Federal 
tax policy. There should be no new taxes on the internet. 
However, as tax-writers, the Members of this Committee have an 
equally important obligation. You have an obligation to 
transcend the impassioned rhetoric that has characterized the 
debate over internet taxation to address the very real problems 
that the income tax system will increasingly bring to 
electronic commerce.
---------------------------------------------------------------------------
    \1\ Advisory Commission on Electronic Commerce, established by the 
Internet Tax Freedom Act (ITFA), Title XI of the Omnibus Appropriations 
Act of 1998 (P.L. 105-277) to examine issues related to Internet 
taxation.
---------------------------------------------------------------------------
    Often, we hear the catchphrase phrase ``don't tax the 
internet.'' It has become a mantra. However, if you look beyond 
the rhetorical flourishes, you will find one disturbing 
reality: that the internet is already heavily taxed today. 
Investors in internet companies are taxed on their income 
multiple times. They are taxed when they invest. The companies 
are taxed on their earnings--resulting in lower profits, higher 
prices goods or lower wages to workers. They must still pay 
state and Federal income tax on the income from sales of goods 
and services. The shareholders are taxed on their dividends and 
capital gains. Internet company employees are taxed on their 
wages with both payroll and income taxes. Internet companies 
are taxed again when they buy goods and services since producer 
prices reflect hidden taxes imposed upstream. Through the 
combination of double and treble taxation of savings and 
investment income and high marginal rates, we already impede 
the internet. We are driving internet business offshore, not 
though new taxes through the same old multiple and 
discriminatory taxes we refuse to reform.
    Despite this reality, some appear to take the phrase 
literally. In their zeal to be knighted protectors of the 
internet, some policymakers flirt with abandoning the primary 
economic directive in tax policy -neutrality.
    Most of us who believe the internet is an efficient vehicle 
for conveying information would hardly argue that the internet 
needs to be subsidized (provided with corporate welfare if you 
will) beyond other means of conveying information or 
transacting business. If policymakers subscribe to the 
importance of leveling the competitive playing field, tax 
policy should strive to be indifferent to the internet: it 
simply ought to neither subsidize it nor punish it. Sound tax 
policy must follow sound economic policy. Internet sales should 
be treated no differently than other forms of purchase or 
informational dissemination.
    But perhaps most importantly, the superficial rhetoric of 
the debate has not been entirely benign: it has ignored that 
reliance on an income tax itself will itself, ironically, sow 
the seeds of extensive internet regulation. The internet and 
income tax cannot peacefully coexist. This will become 
increasingly apparent as the internet matures. In the digital 
age, income can be moved around the world at the speed of light 
(or rather a key punch). Therefore, if the Committee seeks to 
ensure ``no new taxes on the internet,'' and ``no new 
regulation of the internet,'' either the Committee must look to 
fundamental tax restructuring of our extraterritorial tax 
system or it must become an unwitting accomplice in a slow 
drift toward total regulation of the internet. The latter would 
be ironic given the ostensible support for freedom on the 
internet.
    As every American is now learning, the information-age 
opens a new chapter in world history. The internet is already 
assured of its prominent place. The internet is empowering 
entrepreneurial firms to compete where huge capital outlays 
were once necessary. It is stimulating entrepreneurial spirit 
unmatched since the gold rush. Each day businesses small and 
large seek to insinuate the internet into the very fiber of our 
economy. Every place information exchange adds value, from 
education, to comparing mortgage interest rates, to buying 
music, the internet will bring the promise of greater 
prosperity, greater options, lower cost, higher quality goods 
and services and yet more innovation. The transformations the 
internet has brought to the marketplace of goods, services and 
ideas are but a glimpse of its potential as new applications of 
this technology matriculate into every corridor of the global 
marketplace.
    The phrase ``don't tax the internet,'' however, is not 
worthy of the Digital Age. It is the political equivalent of 
saying ``taxes bad; internet good; taxes on internet bad.'' 
This testimony discusses the problems commonly overlooked by 
the political side of the internet tax debate. It recommends 
that the best possible tax system in the Digital Age, and the 
system most consistent with the Digital Age, would be a broad-
based consumption tax (the FairTax national sales tax plan) 
which eliminates the tax on savings and investment. The FairTax 
would stimulate the growth of the internet industry by lowering 
marginal rates through expanding the taxable base, taxing 
income only once and imposing a single rate. It will enhance 
the export of American manufactured goods and American 
services, as opposed to the export of internet jobs, by 
untaxing exports. It would give internet companies the highest 
form of neutrality possible -it would impose a zero rate of 
tax. It will eliminate the need for internet regulation and 
intrusions into privacy because it would eliminate the need to 
track the capital gains, investment income and savings of 
individuals. It will encourage harmonization of state law to 
make enforcement simpler. The FairTax is fundamental tax reform 
worthy of the Digital Age.

I. The Internet Will Make Income Tax-Based Systems Obsolete

    Let us begin by discussing how the internet will facilitate 
flight capital. Those who are schooled in tax revenue 
statistics might point out a disturbing trend in tax 
enforcement: our current tax system is not faring too well. 
According to the IRS' Commissioner's Annual Report, more than 
$200 billion--20 percent of all income taxes collected--are 
evaded. Another $100 billion is overpaid. Tax evasion has 
increased almost 70 percent as a function of GDP over the last 
decade. Tax evasion represents more than 2 percent of GDP or 
nearly one good year of economic growth. We all pay about 20 
percent more than we need to because cheaters do not pay. 
Because more and more taxpayers view the system as unfair, 
compliance is decreasing further.
    Despite this poor compliance rate, we may have reached the 
limits of what we are willing to pay in pecuniary and non-
pecuniary costs to increase compliance. More than 34 million 
civil penalties are assessed each year, 2 million accounts are 
levied and more than 1 billion information returns are filed. 
Individual returns request information so invasive that we must 
confess more of our private lives to the IRS than we would tell 
our children. Every few years, the Congress parades the victims 
in the public view, so that we might all criticize a thankless 
agency charged with enforcing the complex laws that are really 
at the root of the problem. Every few years, we enact yet 
another penalty reform or episode of the Taxpayer Bill of 
Rights. Most policymakers now know the inescapable truth: the 
genesis of the problem is the income tax system itself.
    So how will our current tax system fare when the internet 
has fully bloomed? What will be the extent of tax evasion under 
the internet? The short answer is that the internet may soon 
make international tax evasion a household sport, dwarfing the 
current evasion rates.
    As Dr. Richard Rahn (former Chief Economist of the U.S. 
Chamber of Commerce) points out in his book, ``The End of 
Money:''
    In order to understand what is about to happen, remember 
that the revolution taking place in electronic commerce means 
that banks and other organizations will be able to create their 
own money for transactional or investment purposes and 
literally move these monies around the globe at the speed of 
electrons. The definition of money as a government-created 
legal tender will become less and less relevant.
    Things that can be transformed instantaneously into 
something else and moved to anyplace in the world with no paper 
or electronic trail will become nearly impossible to tax. By 
using public key cryptography, one can have electronic bank 
notes certified without the issuer knowing to whom they were 
issued. And smart cards used as an electronic purse can have 
the same anonymity as paper cash.
    And what may become even more obsolete is the vast body of 
statutes, court cases, regulations, revenue rulings, private 
letter rulings and other pronouncements that try to define 
``income'' or the many nuances of international law, including 
personal holding company , passive foreign investment company 
income and Subpart F provisions. Under the internet, once 
offshore, income is free to tour the world without a passport 
or a visa.
    To take a simple illustration, assume you are a wealthy 
individual whose income is totally dependent upon stock 
dividends. Between golf rounds, you invest over the internet 
with electronic money. The internet account is held by your 
bank in the Turks and Caicos, which provides a prison term and 
a hefty financial penalty for one who dares to merely inquire 
into the ownership of your account. Your account is also 
encrypted under constantly evolving encryption systems that 
make numbered accounts anachronistic. As your income comes in, 
the electronic bank sends you the money which you download onto 
your computer and then transfer to your smart card. You can pay 
your bills. Only you decide what electronic and paper records 
to create and keep. You can imagine that the Turks and Caicos 
bank account might also be a trust which invests directly in 
U.S. business.
    In the Digital Age, it will be as easy to move or create a 
financial portfolio anywhere in the world with total 
anonymity--as easy as logging on to your computer. The internet 
will be the host to trillions of transactions that shift 
capital around the world in nanoseconds, both encrypted as to 
the owner, anonymous because of the sheer volume of 
transactions and protected from disclosure by the many willing 
tax havens of the world. Moreover, income includes both income 
from business and individuals, as well as income from 
investment and savings.
    When taxpayers can easily avoid reporting particular types 
of income or transactions with no danger of being caught, than 
our tax will become, quite literally, voluntary. This world is 
not far off. The first to evade will be those who are creating 
inbound transactions into the United States, nonresidents with 
whom we have but a tangential fiscal relationship. Next will be 
those with capital to invest or profits to disguise, wealthier 
Americans or those wanting to launder monies. Before long, our 
tax system will depend upon those who pay out of a sense of 
public duty and those who are paid in wages (working class 
Americans).

II. An Income Tax System Virtually Guarantees An Attempt at 
Extensive Regulation of the Internet

    The government can respond in one of two ways to the 
eventuality of an intolerable level of tax evasion on such non-
egalitarian terms. Because of the difficulty in enforcing the 
income tax, we can impose record levels of financial regulation 
so that global transactions are monitored or we can adapt new 
rules to accommodate the new reality.
    If the Congress chooses the former, Americans will have to 
be willing to relinquish their right to privacy over the 
internet. Non-U.S. internet companies with no minimum contacts 
with the U.S. must be willing to freely exchange information 
with the U.S. government.
    Think about the vast resources that will be required to 
routinely obtain the most rudimentary information needed for 
the enforcement of an income tax (such as one's social security 
number). Our State Department will have to work round the clock 
to secure information exchange agreements and to improve upon 
the ones in effect. Today, we have fewer than 50 bilateral tax 
treaties, and while information exchange is ostensibly part of 
them, most Nation's do retain their secrecy laws and they have 
adopted or signed on to evidentiary and letters rogatory 
procedures which make it difficult if not impossible to obtain 
financial information on transactions or income.\2\ In fact, it 
is already happening. The OECD plans to, inter alia, develop 
new information technology capabilities that will permit both 
the ``detection of suspicious on-line transactions and 
verification of the customer'' and ``to ensure that electronic 
commerce technologies, including electronic payment systems, 
are not used to undermine the ability of revenue authorities to 
properly administer tax law.'' \3\
---------------------------------------------------------------------------
    \2\ For example, see the ``CONVENTION ON THE TAKING OF EVIDENCE 
ABROAD IN CIVIL OR COMMERCIAL MATTERS'' (Concluded March 18, 1970). The 
signators of this convention sought to improve mutual judicial co-
operation in civil or commercial matters, by allowing a State to 
request the competent authority of another Contracting State to provide 
evidence intended for use in judicial proceedings however evidence 
cannot be obtained unless the underlying actions was contemplated or 
commenced. This means that it is not available to mere auditors and it 
is not available in a criminal action until after indictment -even 
though the information is needed for indictment.
    \3\ See, for example, Financial Action Task Force on Money 
Laundering (Released February 3, 2000) at http://www.oecd.org/fatf/pdf/
2000typ-en.pdf and http://www.oecd.org//publications/
pol--brief/9701--POL.HTM#14.
---------------------------------------------------------------------------
    The truth is that many countries in the world promote 
themselves as tax havens. They consider their barrage of 
nondisclosure rules the ramparts of a noble sanctuary for 
flight capital. The rules are not only a symbol of sovereignty, 
but a bona fide source of income--tourism, if you will, for 
electronic money. This Committee might note that the Caribbean 
Basin Initiative made a condition of favorable treatment the 
signing of a disclosure of information agreement. Of course, 
the illusive concept of a tax haven is itself a problem. As 
once stated by Professor Harvey Dale, a tax haven is any land 
mass visible at low tide. If we are to enforce the income tax 
in the electronic age and on a global scale, we will need 
access to information in each of these tax havens and the 
constantly good relations necessary for inter-governmental 
cooperation.
    For this reason, some believe the future tax will simply 
not include financial capital (productive savings) because 
financial capital will always elude regulators. Regulation will 
not succeed because those who are developing the means of 
evasion -in partnership with world secrecy laws--will be one 
step ahead of those who are tying to restrict it. The cost of 
trying to enforce taxation of highly mobile financial capital 
probably will exceed the revenue collected and certainly will 
exact a price in terms of lost efficiency and lost privacy 
rights that exceeds the benefits of their continued taxation. 
We will have transformed the internet into a vehicle for 
financial crimes by unnecessarily insisting on taxing savings 
and investment. We will have developed the most extensive net 
of regulations and checks and international agreements in an 
attempt to chase financial butterflies.

III. A National Sales Tax Will Be Much More Enforceable

    How can the Congress adapt our tax system to the new 
reality? We suggest that it must do so by adopting fundamental 
tax reform that is consumption-based, and that does away with 
taxation of savings and investment and the need to move it 
outside of the U.S.
    First, consumption is a more conspicuous base for taxation 
than is income. While a determined tax evader can easily place 
income out of reach, it is much harder to place the sale of 
goods and services out of reach. While income, its timing and 
its source are complicated legal concepts that can be nothing 
more than the entry in an electronic ledger, consumption often 
involves tangible transport of goods and a paper trail. The 
future tax base will have to rely on real and tangible property 
or payments for tangible services or goods. Taxes tied to real 
property or tangible personal property or the sales of goods 
and services to the public are much more difficult to evade.
    Second, taxes tied to the operation of businesses dealing 
with the public or with many business customers are more easily 
enforced because of the necessarily public and open nature of 
such businesses. A study conducted in California by a member of 
the Franchise Tax Board (Ernest Dronenberg) showed that 85 
percent of the sales taxes were collected by 15% of the 
retailers. Hence, the vast majority of retail sales are by 
large established firms.
    Third, under the FairTax plan, much of the problem areas of 
enforcement that would still apply to a consumption tax--are 
simply eliminated. While imports can be captured at the border, 
consumption B2B is not taxable under the FairTax -only personal 
consumption at final retail sale. Exports are not taxable. Used 
goods are not taxable. Hence, the vast amount of internet sales 
would simply not be of enforcement concern.
    Certainly, some services sold over the internet will cause 
continuing enforcement concern. For instance, an attorney or an 
architect might send a product to a client over the internet. 
Potential problems exist anytime there is a conveyance of 
intellectual property where the internet is the medium of 
exchange. However, this form of tax evasion can occur today and 
with higher marginal rates and therefore a greater reward for 
cheating. Moreover, many of these businesses are registered and 
sales tax audits would reveal these discrepancies. Equally 
important, the clients would have to enter in to the necessary 
conspiracy in most of these cases. Remember, the sales tax is a 
withholding tax.
    The FairTax would have greater enforceability, greater 
compliance with less intrusiveness. Administrators can focus 
resources on far fewer taxpayers, with far fewer opportunities 
to cheat, far smaller incentives to do so, and a far greater 
chance of getting caught if they do. The incentive to cheat is 
dramatically reduced because marginal tax rates are the lowest 
they can be under any sound tax system. Therefore, cheaters 
profit far less from cheating. Second, it will be easier to 
catch cheaters, since the number of tax filers will drop by as 
much as 90% as individuals are removed entirely from the tax 
system, requiring enforcement authorities to monitor far fewer 
taxpayers. Third, simplicity and visibility add to enforcement. 
In the internet age, the more than 211 million taxpayers can 
cheat in the privacy of an office and bury their cheating in 
the unnavigable 7,000 code sections with plausible deniability 
that the taxpayer, preparer, or even the IRS itself even 
understood the law. If one is willing to evade the law (as 
opposed to avoid, evasion is the violation of a known legal 
duty), the internet will provide the getaway vehicle. The 
FairTax increases the likelihood tax evasion would be uncovered 
and leaves little room to hide between honesty and outright 
fraud. The only question asked of retailers is: how much did 
you sell to consumers?

IV. A Territorial Income Tax System Will Export Investment and 
Internet Jobs

    If we try to tax savings and investment, we will have the 
unintended effect of driving money offshore. U.S. dollars will 
be expatriated to tax havens around the world, where they will 
be invested in foreign plants, facilities and infrastructure. 
Moreover, our insistence on an income tax will not only 
encourage the expatriation of investment dollars offshore in 
the search of tax free returns, it may drive internet business 
itself offshore.
    This will occur two ways: legally and illegally. Internet 
business may be driven offshore for tax planning purposes. 
Current tax law provides that income effectively connected with 
a U.S. trade or business is taxed under the U.S. taxing laws. 
The Internal Revenue Service has taken the position that the 
mere demonstration of product and solicitation of orders is 
considered to be engaged in the trade or business in the U.S. 
But how should a foreign internet provider and marketer of 
goods and services be taxed when the only advertisement is that 
the solicitation appears on a global web? An argument can be 
advanced that the global web is not a U.S. trade or business 
since there is no presence in the U.S., and no office based 
here. The Congress will be disinclined to impose Federal tax on 
such transactions in an international environment when it 
denies the ability ot states to impose out-of-state taxes. 
Certainly, the sales would be so treated if a fixed place of 
business were required by the income tax treaties. If that is 
the case, then sales into the U.S. will be legally income tax 
free, whereas sales by U.S.-based firms will be subject to tax. 
This will discriminate against American manufacturing 
facilities by encouraging the location of internet businesses 
offshore as tax free zones. It might also be noted that the 
difficulty of determining the ownership of the internet 
business and the elimination of the need for a fixed location 
makes adherence to the extraterritorial tax system effectively 
optional.

V. The Objective of Internet Tax Policy Needs to Be Better 
Understood

             The National Sales Tax Will Untax the Internet

    There is a great deal of misunderstanding inherent in the 
catch phrase ``don't tax the internet.'' Some use the phrase so 
loosely that they clearly imply any item sold though the use of 
a telephone line or a modem, or a DSL line, should be magically 
tax free. In other words, retailers who sell through brick and 
mortar facilities should pay tax, but retailers who sell 
through a web site should for some reason be exonerated from 
tax. Somehow the medium of transporting information over a 
personal computer is worthy of tax exemption but over-the-
counter sales are not?
    Of course, if this were literally true, it would raises 
numerous tax administration questions on a national level. If 
``internet transactions'' were not to be taxed, how do we 
determine if a sale went through the internet. If a retailer 
uses a point of sale device that dials up a computer, is that 
the internet? What if the product is discovered on a web site, 
but the buyer calls up to order?
    There is also a small problem in the truthfulness of the 
economic assertion. Today, as we discussed, the internet is 
taxed heavily. There are excise taxes on telephone calls, of 
course, that were the subject of the Commission's report; but 
there are also the full host of general revenue taxes. There 
are, of course, the corporate income tax that every company 
involved in internet sales pays. This includes the income paid 
by the retailer, the software manufacturer, the internet 
provider, the hardware manufacturer, the phone companies and 
others. There is the individual income tax that the 
shareholders in the companies pay. There is the payroll taxes 
paid by the employees of the companies. There are capital gains 
taxes paid by investors in these companies. If the Congress 
truly wanted to exempt the internet from taxation, it would 
have to repeal a growing portion of the Federal tax base today.
    Finally, such a view implies a serious breach in 
understanding sound economic principles that should underlie 
internet tax policy. In truth, despite its deification, the 
internet is simply a means of communicating information in the 
same manner as the telephone which preceded it, shoppers 
networks on television or mail order catalogues. If the 
internet is more efficient, than why does it need special 
subsidies?
    Some commentators have used the enthusiasm for the 
moratorium against internet taxes to seek to advance an 
erroneous argument that a national sales tax would ``tax the 
internet.'' Sometimes they suggest that this is a 
constitutional issue. These arguments are advanced mainly by 
supporters of an alternative tax plan, like Majority Leader 
Dick Armey's hybrid subtraction method VAT (aka flat tax).
    However, a Federal national sales tax has nothing to do 
with state sales taxes. Moreover, it would clearly tax the 
internet far less than either the flat tax or current law. That 
is because both of these plans tax the business itself, as well 
as the wages of the employees, and both impose hidden costs on 
internet companies when they buy goods and services for resale.
    Most importantly, that is not what the legislation recently 
passed by the House provides. The Internet Tax Freedom Act 
which recently passed the House in revised form imposes a 
moratorium on internet access taxes, bit taxes and multiple or 
discriminatory taxes. It would prohibit taxes on the internet 
except for taxes on net income, fairly apportioned business 
licenses taxes and fees and sales taxes to the extent those 
sales taxes would be imposed on mail-order sales from the same 
vendor.
    A national sales tax is not only consistent with the spirit 
and letter of the moratorium, it is far more consistent with 
the spirit and letter of the moratorium than any other tax 
plan. Under the Fair Tax, sales made over the internet or mail 
order sales would be subject to federal tax just like any other 
vendor selling new goods and services for final consumption. 
However, while the FairTax taxes the purchase of new goods for 
final consumption, the FairTax would untax the internet 
companies themselves. There would be no more tax on the income 
received from internet sales. There would be no more tax on the 
dividends and earnings of internet companies. There would be no 
tax on the capital gains of internet companies or for those 
investors who sell their stock.
    Moreover, the Fair Tax would adhere to the fundamental rule 
of economic policy -neutrality. It would treat mail order and 
internet sales like any other sales. Sales made over the 
internet or through the mail are subject to the same tax as 
sales made on main street. A good or service should not be tax 
preferred or tax disadvantaged because it is sold or delivered 
to a consumer in a particular way.

 A National Sales Tax Will Harmonize Onerous State and Local Sales Tax 
                                  Laws

    Finally, the FairTax will work to alleviate the primary 
burden imposed by states on internet sales: a balkanization of 
state and local sales tax laws. It will do so by fostering 
harmonization of state juridical taxation issues and bases by 
providing a single, national standard. As the states have 
conformed to the Federal definition of Adjusted Gross Income in 
order to ease administrative costs on the states for tax 
collection, the states would be expected to conform to the 
Federal sales tax base, eliminating the concern over double 
taxation.
    In fact, the FairTax will rectify the central problem 
sought to be addressed by the internet moratorium. The FairTax 
envisages that the states will be the primary administrators of 
the national sales tax. States that conform to the federal 
sales tax base and become part of national sales tax system 
would be able, for the first time since National Bellas Hess, 
to require vendors to collect and remit sales tax on mail order 
and internet sales into their state. The federal government 
would facilitate information sharing and enforcement 
cooperation and among the states. States that were not part of 
the federal system would, however, be unable to collect sales 
tax on mail order sales into their state.
    In National Bellas Hess, Inc. v. Department of Revenue of 
Illinois, 386 U.S. 753 (1967), the Supreme Court ruled that a 
State's attempt to require an out of state mail-order house to 
collect and remit use tax on goods purchased for use within the 
State was a violation of the Due Process Clause of the 
Fourteenth Amendment and the Interstate Commerce Clause of the 
U.S. Constitution. In Quill Corporation v. North Dakota, 112 S. 
Ct. 1904 (1992), the Court overruled National Bellas Hess in 
part by ruling that an out of state mail-order house may have 
the ``minimum contacts'' with a State required by the Due 
Process Clause yet lack the ``substantial nexus'' required by 
the Commerce Clause. In Quill, the Court noted that ``our 
decision is made easier by the fact that the underlying issue 
is not only one that Congress may be better qualified to 
resolve, but also one that Congress has the ultimate power to 
resolve.'' Both Quill and its predecessor, Bella Hess, made 
clear that under the Commerce clause states can still tax out-
of-state income as long as the Federal government pre-empts the 
jurisdictional issue though legislation. The Federal government 
has done this many times in the past with respect to air, rail 
and bus transportation and other matters.
    The FairTax would not explicitly provide that preemption. 
However, it would encourage states to harmonize their rules, 
ensure no overlapping taxation and reduce the burden on out-of-
state sellers.

Conclusion

    Mr. Chairman: the incongruity between an extra-territorial 
income tax system (as exists in the United States) and the 
internet will soon become obvious. Without substantial 
intrusions into our financial privacy and without heavily 
regulation, the internet will make an already precarious tax 
system totally voluntary. The internet enables capital to moved 
around the world with the click of a button. In this 
environment, anyone who has the desire to, can escape taxation. 
This Subcommittee must look beyond the popular rhetoric best 
explained by the phrase ``don't tax the internet'' to better 
understand that we already seek to regulate the internet under 
a tax system that resembles the information age's equivalent of 
the passenger pigeon. Moreover, if this committee fears special 
internet taxes or regulations, this Committee should consider 
what types of rules would need to be in place in order to 
enforce a tax system based on income.
    The FairTax national sales tax will help to neutralize tax 
policy so that economic decisions over the vitality of the 
internet will not be based on Congress's choice of winners and 
losers. The FairTax would harmonize rules so that the internet 
is not doubly taxed, but can compete head to head against brick 
and mortar retailers. The FairTax will help to head-off onerous 
tax regulations that will be required if the income tax remains 
in place.
    While the civilian sector's use of the internet will bring 
greater prosperity and convenience to Americans, this Committee 
should never forget that the technological innovations of the 
21st Century are in stark contrast to our anachronistic notions 
of 19th century tax policy. Sound internet tax policy must 
reflect sound economic policy.
      

                                


Statement of Andrew F. Quinlan, Executive Director, CapitolWatch

    On behalf of CapitolWatch and its 250,000 supporters, I 
thank you for the opportunity to submit a statement on the 
general topic of state and local taxes on the Internet. 
CapitolWatch supports the current five-year moratorium on all 
Internet taxes, and endorses a permanent ban on Internet taxes, 
including state and local sales taxes. We endorse a permanent 
ban, for among other reasons, because there is no connection, 
or nexus, on which to fairly base these taxes without harming 
American e-commerce's competitive edge.
    CapitolWatch, and its 250,000 supporters, firmly believe 
that the Internet should remain free of sales and use taxes.

                               Background

    States and other local jurisdictions do not have a 
sufficient nexus, or connection, with Internet companies--whose 
only contact with the jurisdictions is the fulfillment of an 
order for a customer--to support sales or use taxes. Any system 
of sales and use taxes placed on the Internet by various state 
and local authorities would be Unconstitutional, unwieldy, and 
discriminatory. Therefore, CapitolWatch feels that Congress 
should codify the Supreme Court decision in Quill v. North 
Dakota in order that the Internet and the economy can continue 
to grow and prosper without fear of destructive efforts to 
over-regulate it.
    In Quill the Supreme Court ruled that: ``a vendor whose 
only contacts with the taxing State are by mail or common 
carrier lacks the 'substantial nexus' required by the Commerce 
Clause.'' Although Quill was written about direct mail 
companies, Internet companies are very similar in that they 
still rely on the mail or common carriers to ship their 
merchandise to the states. For example, the merchandise could 
be a plane ticket FedExed or a teddy bear sent through the 
United States mail. The added contact of the phone line to the 
customers does not constitute a sufficient Constitutional nexus 
as the Court also wrote: ``we expressed 'doubt that termination 
of an interstate telephone call, by itself, provides a 
substantial enough nexus for a State to tax a call.''' 
Furthermore, a customer viewing a company's Internet Web site 
has been effectively granted a license to view its software as 
the Court discussed when it stated: ``We therefore conclude 
that Quill's licensing of software in this case does not meet 
the 'substantial nexus' requirement of the Commerce Clause.''

                       The Need to Make Quill Law

    More important than the fact that the Commerce Clause 
clearly makes taxing the Internet Unconstitutional, are the 
reasons the Court felt so strongly. For the Court has 
explicitly stated that only Congress can make laws regulating 
interstate commerce. As long as Congress is considering such 
laws, it is important that they remember the reasons for the 
Quill decision and how those reasons are even more valid today.

                 The Explosion of Taxing Jurisdictions

    The Commerce Clause's nexus requirement is a ``means for 
limiting state burdens on interstate commerce.'' Any sales or 
use tax on the Internet would severely burden the Internet and 
would only get worse as times goes on. An example commonly 
cited is the difficulty associated with complying with the 
differing tax laws of multiple jurisdictions. Opponents counter 
that the states could pass a uniform sales tax. Forgetting for 
the moment the problems of obtaining the agreement of all 50 
states on such a tax--let alone imposing such a tax on those 
four states that currently have no sales tax--the 50 states 
constitute just a few of the taxing jurisdictions in the United 
States today. The number is growing at such an alarming rate 
that it would be difficult for any Internet company, small or 
large, to comply with all the rules.
    For example, in the 1965 case National Bellas Hess, Inc. V. 
Illinois the Supreme Court stated that: ``For if Illinois can 
impose such burdens, so can every other State, and so, indeed, 
can every municipality, every school district, and every other 
political subdivision throughout the Nation with power to 
impose sales and use taxes. The many variations in rates of 
tax, in allowable exemptions, and in administrative and record-
keeping requirements could entangle National's interstate 
business in a virtual welter of complicated obligations to 
local jurisdictions with no legitimate claim to impose 'a fair 
share of the cost of the local government. '' ' The Bellas Hess 
court added that: ``Local sales taxes are imposed today [1965] 
by over 2,300 localities.'' By 1992, the time of the Quill 
case, the number of jurisdictions had almost tripled. The Court 
wrote: ``North Dakota's use tax illustrates well how a state 
tax might unduly burden interstate commerce.On its face, North 
Dakota law imposes a collection duty on every vendor who 
advertises in the State three times in a single year. Thus, 
absent the Bellas Hess rule, a publisher who included a 
subscription card in three issues of its magazine, a vendor 
whose radio advertisements were heard in North Dakota on three 
occasions, and a corporation whose telephone sales force made 
three calls into the State, all would be subject to the 
collection duty. What is more significant, similar obligations 
might be imposed by the Nation's 6,000-plus taxing 
jurisdictions.
    A mere eight years later, today the number of taxing 
jurisdictions has risen to over 7,600, another 25% increase. 
Even worse, the Advisory Commission on Electronic Commerce 
wrote that there are over 30,000 potential taxing 
jurisdictions. Thus, the fears of the burden on interstate 
commerce, which the Supreme Court expressed in 1965, are even 
more valid today then at the time they were first mentioned.

                        The Cost and Conclusion

    The cost of such taxes would be devastating. For small 
firms doing business in the 46 states with sales taxes, the 
cost could be as high as 87% of the sales taxes collected, 
according to a report by Ernst & Young. Robert Cline, director 
of state and local tax policy for Ernst & Young, calls 
computing sales taxes across state lines ``a horror show for 
retailers.''
    Such sales taxes would also have the effect of 
discriminating against the Internet. A traditional brick and 
mortar business has to comply with one sales tax, while an 
Internet business would have to comply with 7,600 a year. This 
would effectively destroy electronic commerce and halt the 
Internet in its tracks. According to statistics accumulated by 
Institute for Policy Innovation, in 1994--the year Netscape 
made the Internet browser famous--states collected $123 billion 
in sales taxes. In 1995, as the first real e-commerce 
transactions started taking place, states collected $132.2 
billion in sales taxes. Each year since, as the amount of 
electronic commerce taking place over the Internet grew, state 
revenues rose--$139.4 billion in 1996, $147.1 billion in 1997, 
and $155.3 billion in 1998. The Internet has been such a 
driving force behind the new economy that it helped provide the 
states with an $11 billion in surpluses in 1998.
    Therefore, Congress should follow the well-reasoned logic 
of the Supreme Court and pass a law permanently banning the 
application of sales and use taxes on the Internet. The 
Subcommittee on Oversight of the Ways & Means Committee should 
get the ball rolling and exercise their jurisdiction and pass a 
law banning sales taxes on the Internet and thus codify Quill.
    CapitolWatch would be glad to answer any additional 
questions that the committee may have and may be contacted at 
202-544-2600 or visit us on the Web at ``http://
www.CapitolWatch.
      

                                


Statement of Deloitte & Touche LLP

Mr. Chairman and Members of the Subcommittee:

    Deloitte & Touche LLP appreciates this opportunity to 
present its views on the numerous issues encompassing the 
taxation of electronic commerce to the Oversight Subcommittee 
of the House Ways and Means Committee.
    Deloitte & Touche is a one of the world's leading business 
advisory firms with 28,000 people in more than 100 cities in 
the United States and operations in over 130 countries. 
Deloitte & Touche serves nearly one-fifth of the world's 
largest companies as well as large national enterprises, public 
institutions and fast-growing companies.

                              Introduction

    On October 1, 1999, Deloitte & Touche hosted a group of leading 
policymakers, economists, accountants, and attorneys from throughout 
the country at University of California, Berkeley to examine policy 
options concerning e-commerce taxation. Consequently, a report was 
drafted to help the Commission and Congress understand the issues 
involved and to provide criteria for assessing and evaluating the many 
different ideas, proposals, and methods for ``fixing'' the taxation of 
electronic commerce.
    The advent of the Internet and e-commerce is revolutionizing the 
way individuals communicate, changing the way government interacts with 
and provides services to its citizens, and altering the way business 
operates--particularly with respect to the sale of goods and services 
to other businesses and to consumers. This dynamic evolution means 
there are many different constituencies involved in this debate, 
including state and local governments, traditional ``brick and mortar'' 
businesses, ``dot.coms,'' financial intermediaries and consumers. The 
testimony presented here captures the key points of the Berkeley report 
by providing a framework of issues and questions that the Subcommittee 
should review when considering different proposals.

                               Background

    The dramatic increase in e-commerce and Internet usage is 
changing businesses operations, creating new sources of 
revenue, and eclipsing traditional laws and practices. At the 
heart of this new medium is the fundamental issue of sales and 
use tax collection.
    State governments fear erosion of the state sales tax base. 
State sales tax collections rank second only to property tax 
and there is concern that a massive migration of companies to 
the Internet will reduce state and local revenue. Just as the 
Internet has forced businesses and individuals to address new 
challenges, it will also require state and local governments to 
reassess the fundamentals of sales and use tax imposition and 
collection.
    On the other hand, vendors and consumers would not welcome 
an expansion of inefficient and burdensome sales and use taxes 
applied to Internet sales by remote vendors. State sales tax is 
inefficient and burdensome in its application to remote 
vendors. The complexity of compliance, tax base definitions, 
rates, and the sheer number of jurisdictions are only a few of 
the problems making sales tax an undue burden on vendors. For 
example, large multistate corporations often waste valuable 
resources to file tens of thousands of returns each year, 
merely to remain compliant.

                           Proposal Criteria

    Several proposals before Congress are intended to address 
some or all of the many issues presented in this debate. The 
proposals range from simply extending the current moratorium on 
multiple and discriminatory taxes on electronic commerce for an 
additional five years to completely replacing the sales and use 
tax collection systems of each state with a single streamlined 
``Interstate Sale and Use Tax Compact'' adopted by all 50 
states.
    As the Subcommittee examines these various issues, Deloitte 
& Touche suggests that a set of criteria be used to assess each 
proposal. The questions stated below are broken down into six 
general areas: simplification, taxation, burden on sellers, 
international aspects, technology, and government autonomy. 
These questions represent guidelines for further research and 
discussion and establish a baseline of criteria that the 
Subcommittee should address as it considers the feasibility of 
each proposal. The Subcommittee will find few if any clear 
answers. It must, however, consider all of these issues if it 
seeks to find a balanced and acceptable solution.

Simplification

    Clarification: Does the proposal fundamentally simplify the 
existing system of sales tax collection? (Examples include 
common definitions, clarification of nexus standards, and a 
single tax rate per state.) A new system should be 
characterized by simplicity, uniformity, neutrality and 
efficiency.
    Definition: Does the proposal define, distinguish, and 
propose to tax information, digital goods, and services 
provided electronically over the Internet? Tax systems that 
lack clear definition may increase compliance and enforcement 
costs on businesses.
    Compliance and Record Keeping: Does the proposal permit or 
require standardization of record keeping requirements and tax 
return information? Compliance costs and record keeping 
requirements impose a tremendous burden on businesses. Typical 
compliance burdens include identifying each taxing 
jurisdiction, defining various products for tax purposes, 
determining exemptions, defining the tax base, and establishing 
sourcing rules. Moreover, tax returns vary widely from state to 
state; return and payment due dates vary from quarterly to 
monthly; and there is no central registration point for uniform 
application registration that covers all sates. Further 
complicating matters is the fact that taxpayers are subject to 
separate audit by all states--and, in some instances, by 
separate cities and counties.
    Standardizing these requirements would enhance 
simplification, increase the productivity of technological 
solutions, and reduce the compliance burden on businesses. Any 
new tax system should allow time for companies to modify their 
tax and accounting systems. Any broadening of the collection 
responsibilities should include compensation for vendors, 
protection against penalties for good-faith compliance efforts, 
and sufficient lead-time to implement changes to business 
processes and systems.
    Audit Protection: Does the proposal protect against 
wasteful multiple audits? Auditing to curb tax evasion is a 
necessary component of any tax system. However, multiple audits 
are economically difficult to justify and result in an 
increased tax burden. A new system should coordinate audits, 
which would lead to increased economic efficiency.
    Multiple Jurisdictions: Does the proposal provide for a 
single uniform system of assessing and collecting sale and use 
tax? Costs to comply with multiple taxing jurisdictions include 
increased labor, training, computer systems, audits, and 
others. Frequent changes to tax rules and forms can make 
compliance complicated and costly, and software systems 
designed to assist compliance can be expensive to implement and 
maintain.

                                Taxation

    Tax Burden: Does the proposal impose new or increased taxes 
on Internet access or Internet sales? Does it result in new 
taxes on consumers? Would the proposal reduce or increase 
telecommunication taxes? Does it reduce or increase taxes, 
licensing fees, or other charges on services designed for 
access to or use of the Internet?
    Revenue Base: What will the impact of the proposal be on 
the revenue base of federal, state, and local governments? 
Changes in tax revenue generally must be offset immediately or 
in the future by expenditure or other revenue changes in 
government budgets. The net impact of a particular policy 
should take into account additional effects of likely revenue 
or expenditure offsets. Additionally, revenue estimates 
resulting from implementing changes to current sales tax 
systems should take into consideration changes in behavior by 
both consumers and businesses.
    Physical Presence: Does the proposal impose any tax related 
burdens. Does the proposal impose licensing or reporting 
requirements, collection obligations, or other fees on parties 
other than those with a physical presence in a particular state 
or political subdivision?
    Uncertainty: Does the proposal provide the tax certainty 
necessary for effective business planning? Does each proposal 
address the current uncertainty surrounding sales and use tax 
obligations, which results in businesses structuring contracts 
and making capital investment decisions solely for the purpose 
of reducing taxes. Often, such behavior is economically 
inefficient. Proposed changes to the existing tax system should 
be structured to reduce incentives to avoid sales and use tax 
obligations. In evaluating various tax policy options, 
consideration should be given to how business behavior may 
change.

                           Burden on Sellers

    Compliance Burden: Does the proposal remove the financial, 
logistical, and administrative compliance burdens of sales and 
use tax collections from sellers?
    Discrimination: Does the proposal treat purchasers of like 
products or services the same when implementing a new policy or 
system? Does the proposal discriminate against out-of-state or 
remote vendors or among different categories of vendors?
    One question that is not yet fully answered is the extent, 
if any, to which sales growth from e-commerce transactions have 
drawn sales from traditional mail order and retail businesses. 
If e-commerce sales are substituting for other sales, then 
there is a potential for revenue loss. However, if consumers 
continue to purchase goods at retail stores and through mail 
order catalogues as well as making online purchases, then the 
potential for revenue loss is not as great. This question will 
be difficult to answer until studies measuring the revenue 
impact of each category of consumer goods are conducted--for 
example, comparing book sales of ``Main Street'' stores with 
sales of online stores.
    Small Business Exception: Does the proposal include any 
special treatment with respect to small, medium-sized, or 
start-up businesses? Compliance costs can be far greater and 
the tax burden far more onerous for small businesses. The 
establishment of de minimus rules would help limit the negative 
impact on small businesses.

                          International Issues

    Competitiveness: Does the proposal enhance U.S. global 
competitiveness? Can the proposal be scaled to the 
international level?
    International Conformity: Does the proposal conform to 
international tax systems, including those that are based on 
source rather than on destination? Is the proposal harmonized 
with the tax systems of U.S. trading partners?
    With growing international economic integration, households 
and businesses have ever-greater opportunities to choose 
foreign vendors for the products they seek. Failure to extend 
any sales or use taxes imposed on U.S.-based vendors to foreign 
vendors would result in a competitive disadvantage for U.S. 
vendors.

                               Technology

    Feasibility: Is the proposal technologically feasible, utilizing 
widely available software to enable tax collection? What are the 
initial costs of this new collection system and the costs required for 
updating the new system? Who would bear those costs?
    Privacy: Does the proposal protect the privacy of purchasers? From 
an economic standpoint, it should be recognized that a trade-off 
between efficient collection and administration of a new tax system and 
privacy of consumers may be necessary. This is particularly true if the 
new tax collection system is operated by a third party.

                          Government Autonomy

    Constitution: Is the proposal constitutional? The constitutionality 
of a proposed method is a question of law, not economics. It should be 
noted, however, that a positive relationship often exists between good 
laws and economics of efficiency.
    Sovereignty: Does the proposal protect the sovereignty of states 
and Native Americans? How does the proposal treat local governments' 
autonomy and their ability to raise a greater or lesser amount of 
revenues depending on the needs and desires of their citizens?

                               Conclusion

    Long-term solutions to this issue will not be resolved 
easily or quickly. The ultimate approach to e-commerce taxation 
requires thoughtful consideration of the many ways such 
policies affect e-commerce vendors, the industry, state and 
local governments, consumers, and the global economy.
    Deloitte & Touche supports the Subcommittee's efforts to 
work towards an equitable solution that satisfies the many 
parties involved in this debate.
    For additional information, please contact Martin 
McClintock, Managing Partner, National E-Business Tax Services 
Group at 408.920.2430 (e-mail: [email protected]) or 
Richard Prem, Partner, National E-Business Tax Services Group 
at 415.783.4518 (e-mail: [email protected]).
      

                                


Statement of Frank G. Julian, Operating Vice President and Tax Counsel, 
Federated Department Stores, Inc., Cincinnati, OH

                              Introduction

    Federated Department Stores, Inc. (``Federated'') is 
pleased to present its views on certain aspects of the 
collection of state and local sales and use tax on Internet 
sales to the Subcommittee on Oversight of the Committee on Ways 
and Means of the U.S. House of Representatives.
    The author of this presentation is Frank G. Julian, 
Operating Vice President/Tax Counsel for Federated. Federated 
is one of the nation's leading department store retailers. 
Headquartered in Cincinnati, Ohio, it operates more than 400 
department stores in 33 states under the names of 
Bloomingdale's, Macy's, Lazarus, The Bon Marché and 
others. Federated also has a significant direct mail catalog 
and electronic commerce business with its Fingerhut, 
Bloomingdale's By Mail, Macy's By Mail and Macys.com 
subsidiaries.
    Although Bloomingdale's By Mail, Macy's By Mail and 
Macys.com are each separate subsidiaries, they collect sales 
tax on sales into any state where Bloomingdale's and Macy's, 
respectively, have department stores.

                          Summary of Position

    Federated supports the ``Majority Policy Proposal'' 
contained in the April, 2000 Report to Congress submitted by 
the Advisory Commission on Electronic Commerce (the ``ACEC'').
    Moreover, Federated believes that the myriad of state and 
local sales tax systems that are in place today are too 
complex; these systems should be substantially simplified and 
made more uniform. Federated also believes that all sellers 
that are required to collect sales tax should receive a 
collection allowance from the respective states to compensate 
them for the costs of collecting sales tax.
    Finally, Federated believes that Congress should not pass 
any legislation that would give states the right to require 
sellers without physical presence in a state to collect that 
state's sales tax unless and until (i) the states substantially 
simplify their sales tax systems and make them more uniform, 
(ii) such simplification has been fully and fairly evaluated by 
an objective group, and (iii) all sellers are assured that they 
will receive a reasonable collection allowance for collecting 
sales tax.

                               Discussion

    The ACEC hearings raised an awareness, in an unprecedented 
manner, of the level of complexity burdening the current sales 
tax system. Even though the ACEC could not reach a two-thirds 
majority on the nexus issue, there was near universal agreement 
that the 46 different state sales tax systems are in dire need 
of substantial simplification.
    Federated collects and remits over $1 billion per year in 
sales tax for the state and local governments where it does 
business. It incurs substantial costs in collecting and 
remitting these taxes, and in administering the many audits 
that follow. Substantial simplification of the sales tax 
systems will make it much easier for the states to administer 
and enforce the tax, and will make it much easier for sellers 
to comply with the tax.
    Set forth below are just a few examples of some of the 
burdensome complications and complexities of the current 
system:
    1 Determination of Taxable Items. Determining the 
taxability of certain categories of products, such as clothing, 
food and medicine, is extremely complicated for a multi-state 
business. Several states exempt these items, in whole or in 
part, but the states all have different definitions and/or 
interpretations for the same general exemption. As a leader in 
the apparel industry, Federated is most familiar with the 
challenges imposed by the clothing exemptions. There are nine 
states with permanent or temporary clothing exemptions. 
Handkerchiefs, for example, are considered clothing, and thus 
exempt, in five of these states, but are not considered 
``clothing,'' and thus taxable, in the remaining four. The 
software that is available today cannot accurately determine 
the taxability of all articles of clothing in these nine 
states, because each state has its own set of peculiar rules. 
To accurately tax an article of clothing in a multi-state 
environment, the retailer must assign one of dozens of 
``clothing product codes'' to each and every item, or SKU, 
which that retailer sells. Whether you are an e-commerce 
retailer with 30,000 SKU's, or a department store with 3 
million SKU's, the current compliance burdens are overwhelming. 
It is critical for the states to adopt single, uniform 
definitions of food, clothing and medicine, so that the 
``product code'' decision is a simple choice. Although 
development of new software is also important, the key to 
success lies in simplification and uniformity.
    2. State and Local Tax Rates. There are currently over 
7,000 different state and local jurisdictions across the 
country that impose a sales tax. Although there is software 
available that can determine, with a reasonable degree of 
accuracy, the tax rate by Zip Code, there are many Zip Codes in 
which more than one sales tax rate applies. Before states are 
permitted to require remote sellers to collect sales tax, there 
should only be one sales tax rate per state. Moreover, as a 
matter of fairness and equity, this rate should apply to in-
state sales as well as to remote sales. It would be grossly 
unfair to consumers as well as sellers if the states are 
permitted to impose one rate for sales made by remote commerce 
and another rate for sales made in local stores.
    3. Collection Allowance. It is extremely expensive for 
sellers to collect and remit sales tax. Studies have shown that 
the cost to collect sales tax is typically greater than 3% of 
the tax collected. However, of the 45 states with a sales tax, 
only seven provide for an uncapped collection allowance of over 
1%. As a matter of fundamental fairness, all sellers should 
receive a reasonable and adequate collection allowance for the 
sales taxes they are required to collect.
    4. Exempt Customers. The sales tax systems should be able 
to accommodate purchases by customers that are entitled to 
various types of exemptions in a manner that does not impose 
burdens on either the seller or the customer. A non-exhaustive 
list of these exemptions includes: purchasers with resale 
certificates, purchasers with direct pay permits, sales to 
charitable organizations, sales to religious organizations, 
sales to foreign diplomats, certain sales to Native Americans, 
sales to governmental agencies, etc.
    5. Privacy of Customers. Maintaining customer privacy will 
be critical to the success of a sales tax system, particularly 
for sales made over the Internet. Under no circumstances should 
a retailer ever be required to disclose the name and/or address 
of its customers to the states or to any agent of the states.
    6. Third Party Gift Sends. Under current law, if a person 
who lives in California, for example, orders a gift to be sent 
directly to a third party in New York, neither state may impose 
a sales or use tax on the transaction. California has no 
authority to tax the transaction because neither title nor 
possession of the merchandise was transferred to the buyer in 
California. New York cannot impose its tax on the buyer because 
the buyer lacks nexus in that state, and it cannot impose its 
tax on the recipient of the gift since the recipient did not 
pay any consideration for the merchandise. A sales tax system 
will be constitutionally flawed if it is unable to recognize 
this type of transaction.
    7. Applicability to Mail Order and Check Sales. The 
position of many who have commented on this issue presumes that 
all payments are by credit card, which, in fact, is not the 
case. A substantial portion of direct marketing customers pay 
by check, and for certain market segments, checks and money 
orders remain the preferred method of payment for a majority of 
customers. Sales tax systems must address the many difficulties 
associated with these type of sales.
    This is far from an exhaustive list of the problems sellers 
face under the current sales tax systems or of the elements 
that need to be implemented before ``substantial 
simplification'' can be deemed to have occurred. These 
examples, however, make it clear that the existing sales tax 
systems are in dire need of substantial simplification. 
Moreover, Federated believes that there should be an 
independent, objective evaluation of any simplification adopted 
by the states before Congress passes any legislation that would 
permit states to require sellers without physical presence in a 
state to collect that state's sales tax. Finally, states should 
not be permitted to require sales tax collection unless they 
provide for a reasonable and meaningful collection allowance to 
the sellers that collect the tax.
      

                                


Statement of International Council of Shopping Centers, Alexandria, VA

    The International Council of Shopping Centers (ICSC) 
appreciates this opportunity to present its views to the 
Oversight Subcommittee of the House Ways and Means Committee on 
the need to apply existing state sales and use taxes to 
electronic commerce.
    ICSC is the global trade association of the shopping center 
industry. Its 40,000 members in the United States, Canada and 
more than 70 other countries around the world include shopping 
center owners, developers, managers, investors, lenders, 
retailers and other professionals. The shopping center industry 
contributes significantly to the U.S. economy. In 1999, 
shopping centers in the U.S. generated over $1.2 trillion in 
retail sales and over $47 billion in state sales tax revenue, 
and employed over 11 million people.
    Simply stated, ICSC believes that all goods, regardless if 
they are purchased over the Internet, via catalog or in 
traditional retail stores, should be subject to the same state 
and local tax collection requirements. One form of commerce 
should not receive preferential tax treatment over another. 
Unfortunately, existing tax law is structured to favor 
electronic commerce over sales made in local retail stores.
    Contrary to popular belief, it is not the existing 
moratorium on Internet taxes that precludes states from 
requiring out-of-state retailers to collect sales and use taxes 
on their behalf. Instead, it is a 1992 Supreme Court case, 
Quill v. North Dakota, that held that remote merchants are not 
required to collect sales and use taxes for states in which 
they do not have substantial physical presence or ``nexus.'' 
The moratorium--which expires in October 2001--applies only to 
access charges and new, multiple and discriminatory taxes on 
electronic commerce.
    ICSC does not support the enactment or implementation of 
Internet access charges, or new, multiple or discriminatory 
taxes on electronic commerce. Instead, we believe that existing 
sales and use taxes should be collected uniformly on all types 
of retail sales. The taxes which states should be able to 
require remote sellers to collect are not new taxes. Instead, 
they are existing use taxes which buyers are currently 
obligated to remit to their state and local governments. 
However, as a practical matter, most individuals are either 
unaware of their tax obligations, or simply do not bother to 
comply.
    ICSC supports electronic commerce and believes it should be 
fostered. In fact, many traditional brick-and-mortar retailers 
are incorporating Internet commerce into their businesses in 
order to obtain new customers and better serve existing ones. 
However, as a matter of fairness and sound tax policy, 
Internet-based retailers should not receive a competitive 
advantage over traditional brick-and-mortar merchants simply 
because electronic commerce is a new and growing form of 
transacting business.
    Although the extent to which Internet sales will displace 
traditional retail sales is unknown at this time, the 
competitive tax advantage that Internet-based retailers 
currently enjoy could negatively affect many local retailers, 
shopping centers and their communities in the near future. Not 
only would traditional retailers sell fewer goods, but their 
employees would suffer from reduced working hours, wages or 
layoffs.
    In addition, state and local governments would receive less 
sales tax revenues that go to provide essential public services 
(i.e., education, police and fire protection, road repairs). 
Governments that rely heavily on sales tax revenues would 
either have to cut back on such services or increase other 
taxes on local businesses and residents, such as property and 
income taxes. If governments decide to increase sales tax rates 
to make up for lost revenues, lower-income individuals would 
have to pay an even higher disproportionate share of their 
income on sales taxes since they are less likely to own 
computers and purchase products on-line.
    It is this reason why many state and local governmental 
organizations support a level playing field for all types of 
retail sales. These government groups include the National 
Governors Association, Council of State Governments, National 
Conference of State Legislators, U.S. Conference of Mayors, 
National Association of Counties, National League of Cities and 
International City and County Management Association.
    Our critics assert that electronic commerce is a new and 
growing industry and, therefore, should not be saddled with 
``old world'' sales tax collection requirements. They say we 
should not kill the goose that lays the golden egg. Our 
response is that, while electronic commerce is a growing and 
important part of our economy, subjecting it to the same sales 
tax collection requirements that traditional merchants have 
been subject to for decades would not harm its growth or 
vitality. Electronic commerce will continue to flourish, 
regardless of whether or not sales and use taxes are imposed on 
it.
    These critics also claim that forcing Internet retailers to 
collect sales and use taxes for the thousands of state and 
local taxing jurisdictions across the country would be too 
burdensome on electronic commerce and cannot be done. We agree 
that all businesses, especially small businesses, should not be 
overburdened by sales tax collection requirements and that 
state and local governments need to simplify their sales tax 
systems. However, inexpensive software exists today that can 
assist electronic retailers in determining how much sales and 
use taxes needs to be collected on their out-of-state sales.
    Another argument made by our opponents is that states and 
localities are flush with cash and do not need to tax 
electronic commerce. While it is true that most state and local 
governments are currently enjoying budget surpluses, there is 
no guarantee that this economic prosperity will last 
indefinitely. (In fact, Kentucky and Tennessee are currently 
experiencing budget deficits. Their Governors strongly believe 
that collection of their states' use taxes would be extremely 
beneficial to their economies.) If and when our economy 
softens, many state and local governments, as well as 
traditional merchants, could suffer significant financial harm, 
especially if electronic commerce continues to displace 
traditional sales tax bases.
    ICSC is disappointed that the Advisory Commission on 
Electronic Commerce failed to reach agreement that all 
retailers should be on a level playing field with regard to 
state and local sales taxes. Even more so, we are disappointed 
at the process of the Commission itself. To begin with, even 
though a traditional local retailer was supposed to be 
represented on the Commission, no such individual was 
appointed.
    Second, the Commission sent a report to Congress that was 
agreed to by only 10 out of 19 Commissioners, clearly short of 
the 13 votes that was required under the Internet Tax Freedom 
Act. Third and most importantly, the majority report fails to 
address the level playing field issue.
    Instead, it recommends (although not through an official 
``finding'' or recommendation'') that Congress permanently 
extend the moratorium on Internet access charges, extend for 
five years the moratorium on multiple and discriminatory sales 
taxes, repeal the 3-percent telecommunications excise tax, 
establish special ``nexus'' carve-outs for Internet-based 
businesses, and create sales tax exemptions (such as those on 
``digitized'' goods and their ``non-digitized'' counterparts) 
that would directly benefit the ``business caucus'' members of 
the Commission.
    ICSC does not oppose the actual substance of the current 
moratorium (e.g. its ban on Internet access charges and new and 
discriminatory taxes). However, we are deeply concerned that 
the longer the moratorium is extended, the more difficult it 
will be for Congress to level the playing field for all 
retailers with regard to existing sales and use taxes. 
Therefore, we oppose legislation, such as the Internet 
Nondiscrimination Act (H.R. 3709), that would extend the 
moratorium for five years but not subject Internet merchants to 
the same tax collection requirements as traditional retailers. 
ICSC, however, would support legislation that provides for a 
short-term extension of the moratorium (e.g., two years), so 
long as it also allows states that simplify their sales and use 
tax systems to require remote sellers to collect and remit use 
taxes to such states.
    The U.S. Supreme Court has recognized Congress' authority 
to enact legislation that would allow state and local 
governments to require out-of-state retailers to collect sales 
and use taxes. Therefore, we urge Congress to enact legislation 
that would level the playing field among Internet-based and 
traditional retailers.
    Thank you for this opportunity to express our views on this 
very important matter.
      

                                


Statement of Joint Venture: Silicon ValleyNetwork, San Jose, CA

  Summary of Approaches for Applying Sales & Use Taxes to E-Commerce 
             Prepared by the Joint Venture Tax Policy Group

    Purpose: The following chart lists eleven approaches 
representing the types of suggestions for resolving issues of 
applying sales and use taxes to e-commerce. The approaches are 
not listed in any particular order. The approaches are analyzed 
using five criteria that are important to both governments and 
businesses. The criteria are also not listed in any particular 
order. The criteria are applied to each of the approaches to 
indicate the following:

    + Has a positive impact on meeting this criteria
    o Does not appreciably help or hinder meeting this criteria
    - Has a negative impact on meeting this criteria

    This analysis is intended to provide an objective 
perspective to understanding and distinguishing various options 
for applying sales and use taxes to e-commerce. Ideally, this 
analysis will help to identify a shorter list of approaches -or 
a combination of approaches that should be further explored.
    This analysis only addresses sales and use taxes. E-
commerce also raises issues for telecommunications taxes, 
utility user taxes, and income taxes. To obtain a summary of 
the approaches, the explanation for the rating (+/o/-) 
assigned, and a list of observations about the approaches, 
visit the Joint Venture Tax Policy Group's web site at: 
``http://www.jointventure.org/i tiatives/tax/tax.html .


----------------------------------------------------------------------------------------------------------------
                                                               Provides
                                                                  an        Provides
                                                               effective      for         Allows
                                                               mechanism   consistent   state and     Does not
                                                 Simplifies       for     application     local     discriminate
              Approach/Criteria                  compliance   collection    of sales   governments   against any
                                               over multiple   of tax on    and use       to set       type of
                                               jurisdictions   purchases   taxes for    their own     commerce
                                                                 from      all types    tax system
                                                                remote    of commerce
                                                                vendors
----------------------------------------------------------------------------------------------------------------
 A. Allow the Internet Tax Freedom Act's                o             o           o            +             +
 moratorium to expire in October 2001........
B. Extend the current federal moratorium on             o             o           o            -             -
 new taxes permanently.......................
C. Legislatively define nexus (taxable                  +             -           +            o             +
 presence) at the federal level for sales and
 use tax purposes............................
D. Allow states to collect sales and use tax            -             o           +            +             +
 from remote vendors (reverse Quill).........
E. Have a third party serve as the collector            +             o           +            o             +
 of sales and use taxes......................
F. Exempt all or a portion of e-commerce from           o             o           -            -             -
 sales and use taxation......................
G. Create federal level tax for remote e-               o             o           +            -             +
 commerce and mail order sales...............
H. Apply the origin basis (vendor location)             o             +           +            +             o
 to all sales and use taxes..................
I. Simplify existing sales and use tax                  +             o           o            o             +
 systems.....................................
J. Educate consumers about the use tax and              +             o           +            +             +
 encourage states to collect it from
 residents who buy from remote vendors.......
K. Resolve issues of applying sales and use             +             +           +            o             +
 taxes to e-commerce in the broader context
 of improving existing sales and use tax
 systems.....................................
----------------------------------------------------------------------------------------------------------------

                             Mini-Glossary

    Moratorium--Refers to the federal Internet Tax Freedom Act 
(ITFA) which imposes a 3-year moratorium (from 10/1/98 through 
10/21/2001) on state and local taxes on Internet access, unless 
the tax was generally imposed and actually enforced before 
October 1, 1998. The moratorium also prohibits state and local 
governments from imposing multiple or discriminatory taxes on 
e-commerce [Public Law 105-277, 10/21/98]
    Nexus--Sufficient nexus must exist in order for a state to 
subject a vendor to sales and use tax collection obligations. 
Nexus may be thought of as a connection between the vendor and 
state such that subjecting the vendor to the state's sales tax 
rules is neither unfair to the vendor nor harmful to interstate 
commerce. These two requirements of fairness to the vendor and 
no impediment to interstate commerce stem from the U.S. 
Constitution--respectively, from the Due Process Clause and the 
Commerce Clause. Both of these requirements must be satisfied 
before a state may impose sales and use tax collection 
responsibilities on a vendor.
    Quill Decision--In this 1992 decision, the U.S. Supreme 
Court held that North Dakota could not impose use tax 
collection obligations on an Illinois merchant with no physical 
presence in the state because it would be contrary to the 
Commerce Clause. [Quill Corporation v. North Dakota, 504 U.S. 
298 (1992)]
    Remote Vendor--A vendor that does not have a presence in 
the state for tax purposes. For example, today, vendors must 
have a physical presence in a state in order for the state to 
impose use tax collection obligations on them.
    Use Tax--This tax complements a state's sales tax and is 
imposed at the same rate. A use tax generally applies when a 
taxpayer buys a taxable item outside of the state for use 
inside the state. For example, when a resident buys a book from 
a remote vendor, the resident is responsible for submitting the 
use tax to the state taxing agency.

                    Why E-Commerce Raises Tax Issues

    E-commerce represents a new business model. As such, it 
creates some challenges to tax systems that were designed with 
a different model in mind. Two key reasons help explain why e-
commerce raises tax issues:
    1. Location--Existing tax systems tend to determine tax 
consequences based on where the taxpayer is physically located. 
The e-commerce model enables businesses to operate with very 
few physical locations.
    2. Nature of products--E-commerce allows for some types of 
products, such as newspapers and music CDs, to be delivered in 
digitized (intangible) form, rather than in tangible form. 
Digitized products may not be subject to sales tax in some 
states. Also, the ability to deliver digitized products, as 
well as services over the Internet also reduces the need for 
physical locations, thus creating fewer taxing points.

                  Who Cares About Sales and Use Taxes?

    Sales and use taxes are significant revenue sources for 46 
of the U.S. states plus the District of Columbia and most other 
cities. Sales and use taxes represent about 33% of tax revenues 
for the states, on average. However, the percentage of revenues 
derived from sales and use taxes varies tremendously among the 
states. For example, in Nevada, it represents about 85% of the 
revenue base, 57% for Florida, 21% for New York, and 32% for 
California.
    For California cities, sales and use taxes represent the 
largest source of general revenues at 27%.

                           Myths & Realities

    Myth: The ITFA exempts e-commerce transactions from 
taxation.
    Reality: The ITFA provides a temporary moratorium on state 
and local taxes on Internet access, and multiple or 
discriminatory taxes on e-commerce. The ITFA preserves state 
and local taxing authority to the extent a particular tax is 
not covered under the moratorium. Thus, sales and use taxes 
still apply to sales of taxable items made via e-commerce.
    Myth: The ITFA prevents states from imposing use tax 
collection obligations on remote sellers.
    Reality: The 1992 Quill decision prevents states from 
imposing use tax collection obligations on remote sellers, not 
the ITFA.
    Myth: Loss of sales and use taxes on e-commerce 
transactions will not hurt state and local governments. Other 
revenue sources exist.
    Reality: The impact of the loss of sales and use tax 
revenues varies across jurisdictions. In California, sales and 
use taxes represent 32% of tax collections at the state level, 
and for cities, these taxes represent 27% of general revenues. 
For states without an income tax, the loss is even more 
significant. Even in states with a corporate and personal 
income tax, most local governments neither have an income tax 
nor receive income tax revenue from the state government.
    Joint Venture: Silicon Valley Network 
(www.jointventure.org) is a civic incubator working to ensure 
that all people in our region have opportunity to succeed in 
the new economy. Joint Venture introduced to Silicon Valley a 
model of regional collaboration that is now being replicated 
across the United States and around the globe. A non-profit 
organization, Joint Venture is supported by 120 investors 
representing government, community organizations and industry.
    Joint Venture's Tax Policy Group consists of individuals 
from high tech industry, government, and academia who analyze 
various state and federal tax rules and proposals to consider 
the impact to local governments and high tech industries. The 
Group's current work encompasses international tax reform, 
worker classification, R&D incentives, major federal tax 
reform, incentives for donations of technology to K-14, and 
sales tax issues of electronic commerce. The Group works to 
promote better understanding of tax and fiscal issues of 
significance to the Silicon Valley economy, through 
distribution of its reports and quarterly Tax and Fiscal 
Newsletter, sponsorship of seminars and discussion forums, and 
submission of testimony to legislators and tax administrators.
    For further information about e-commerce taxation issues 
and a more detailed explanation of the chart on the reverse 
side, please see http://www.jointventure.org/initiatives/tax/
tax.html.

                       Tax Policy Group Position:

          How to Address Taxation Issues Raised by E-Commerce

    We recommend that the following points be considered in 
evaluating any legislative proposal to address taxation of 
electronic-commerce.
1. Treat E-Commerce the Same as Other Forms of Commerce

    E-commerce is commerce and in most situations, existing 
taxation rules adequately address its tax treatment. Thus, 
strong consideration must be given to any legislative proposal 
that calls for modifying an existing rule or creating a new 
rule to address e-commerce transactions, including specifically 
exempting e-commerce from taxation that applies to other forms 
of commerce.

2. Changes Must Not Solely Remedy E-Commerce Issues

    Our existing sales and use tax had several flaws prior to 
today's discussions about e-commerce and taxation. Sales and 
use taxes are regressive, they are a cascading tax, in most 
states they apply primarily to tangible personal property, 
there are numerous definitions and special rules and multiple 
rates that make the system complex, and these taxes cannot be 
collected from remote vendors, such as mail order or e-commerce 
businesses. Thus, it would be useful to work on resolving these 
problems as a whole, rather than isolating the debate to e-
commerce. In addition, the global context of e-commerce and 
taxation must be considered.

3. It's Not Just a Sales Tax Issue

    While most e-commerce taxation discussions of the past few 
years have focused almost exclusively on sales and use taxes, 
issues also arise for income taxes and telecommunications taxes 
that must also be explored at the same time.

4. Any Tax Law Changes Must Adhere to Constitutional Principles

    Any proposal that is contrary to case law or Constitutional 
principles should not be considered because enactment of such a 
law is doomed to court challenge and results in time lost that 
could have been used to improve the tax system.

5. Local Services Depend on Sales & Use Taxes

    For California cities, sales and use taxes represent the 
largest source of revenue at 27%, a significant portion of 
which is from business-to-business sales. The issue of sales 
taxes and the Internet constitute a ``double whammy'' in that 
it has the potential to reduce both sales taxes from consumer 
purchases as well as taxes from business-to-business 
transactions. This illustrates why local governments are 
concerned about maintaining sales and use tax revenues that 
provide core services.

6. There is a Need to Improve California's Fiscal Structure

    There is a critical need to examine California's existing 
fiscal structure in a meaningful manner so that a long-term 
fiscal strategy can be developed for both state and local 
governments. This approach will better ensure that tax 
structures provide both adequate and appropriate revenues to 
allow for continued economic growth and prosperity.

Why this Issue is Important to Silicon Valley--The Internet and 
e-commerce are significant elements of the Silicon Valley 
economy. Many of the companies that enable e-commerce to 
flourish are located in Silicon Valley. Thus, issues 
surrounding taxation of e-commerce are a concern for many 
businesses, individuals, and local governments in Silicon 
Valley. Joint Venture has been actively involved in seeking to 
improve our current tax system, including ensuring that it does 
not hurt the competitiveness of businesses or the fiscal 
strength of local governments.

    More Information: See http://www.jointventure.org/
initiatives/tax/taskforce.html.
    Joint Venture: Silicon Valley Network 
(www.jointventure.org) is a civic incubator working to ensure 
that all people in our region have the opportunity to succeed 
in the new economy. Joint Venture introduced to Silicon Valley 
a model of regional collaboration that is now being replicated 
across the U.S. and around the globe. A non-profit 
organization, Joint Venture is supported by 120 investors 
representing government, community organizations and industry. 
One of Joint Venture's initiatives is the Tax Policy Group.

              Dot.Commerce, Dot.Taxes and Local.Government

             Prepared by the Joint Venture Tax Policy Group

    Sales taxes and the Internet is one topic that most 
Americans have heard about, but few of us have a clear 
understanding of the specific issues or how they might be 
addressed by various legislative proposals. Similarly, local 
government services affect everyone, yet their relationship to 
sales and use taxes is not well known. This article summarizes 
how sales and use taxes and other revenues relate to local 
services for citizens and businesses.
The funding of local services

    Most California cities rely on four to six primary revenues 
that fund basic city services, such as fire, police, libraries 
and parks. As shown below, the primary tax revenues are sales 
taxes, property taxes, utility users taxes, vehicle license 
fees, franchise fees, and hotel occupancy taxes.

              Typical Revenue Sources for California Cities
------------------------------------------------------------------------
                                                  Typical
                                                  Share of     Range,
                 Revenue Source                     All        Various
                                                  Revenues     Cities
------------------------------------------------------------------------
Sales and Use Taxes............................       30%        13-43%
Property Tax...................................       19%         7-32%
Utility User Tax...............................       16%         5-26%
Vehicle License Fees...........................       14%         6-25%
Franchise Fees.................................        6%          2-9%
Hotel Occupancy Tax............................        6%         1-15%
------------------------------------------------------------------------

    Sales and use taxes have eclipsed property taxes as the 
largest revenue source for cities. This trend is the result of 
Proposition 13 limits on property taxes, and the diversion of a 
number of traditional ``local taxes'' (e.g., liquor license 
fees and cigarette taxes) to the State. Today, only 14% of 
property tax revenue is allocated to cities while 16% is 
allocated to counties, 13% to special districts and 52% to the 
State.
    In 1993, the California Legislature created the Educational 
Revenue Augmentation Fund (ERAF), which diverted about 18% of 
property taxes that formerly went to cities, counties, and 
certain local districts. In 1999, for example, ERAF diverted 
$2.8 billion from counties, $537 million from cities, and $285 
million from special districts to the State.
    Another aspect of local revenues that is not well known is 
how little of the sales taxes we pay at the register is used 
for local government services. In Santa Clara County, where the 
sales tax rate is 8.25%, 15% of sales tax revenues fund 
transportation services and regional transportation improvement 
measures, and 12% goes to the city where the sale occurred. The 
remaining 73% goes to the State, where it is used for prisons, 
education, and other programs.
    Beyond the challenge of maintaining existing revenue 
sources is the difficulty of establishing new revenue sources 
to meet increasing service demands. State limitations have made 
it more difficult for cities to create a more diversified tax 
base (for example, Proposition 218, the ``Right to Vote on 
Taxes Act,'' a1996 initiative, requires a vote of the people to 
approve new taxes or increase existing taxes). One of the 
adverse effects of these limited alternatives is that cities 
are much more dependent on sales tax revenues to meet 
increasing demands for municipal services.

Implications of sales and use taxes as the major source of 
local revenue

    Some critics would point out that increasing reliance on 
sales and use taxes can lead to ``fiscalization of land use,'' 
whereby cities may feel compelled to seek or even compete for 
new developments that produce new sales taxes. For instance, a 
city may approve a development that generates considerable 
traffic or the need for infrastructure and services in return 
for needed revenues. If that revenue is later diverted or 
reduced, the city must still contend with the long-term impacts 
of servicing the land use decision.
    Sales taxes are a fairly volatile revenue source. One 
aspect of this is tied to changes in the economy: a general 
drop in retail sales will affect local stores, or changes in a 
particular industry may cause a major industrial business to no 
longer be viable, causing a loss in city revenues. Also, when 
an industrial sales tax generator, such as a software company 
or an equipment manufacturer, relocates its designated ``point 
of sale'' to a facility in another city but otherwise continues 
to operate its local facility as before, the community has to 
deliver the same level of service with less revenue.

The link between e-commerce, sales and use taxes, and local 
services

    The issue of sales and use taxes and the Internet 
constitutes a ``double whammy'' in that it has the potential to 
reduce revenues from both consumer purchases as well as from 
business-to-business transactions. For many cities, business-
to-business revenues often equal or exceed business-to-consumer 
revenues, particularly in the Internet economy where software 
and equipment sales are a major part of the local tax base. 
Internet sales are subject to sales and use taxes--except when 
there is an electronic delivery of a product rather than a 
tangible product such as a CD ROM (some have suggested that the 
tax code definition of ``taxable sale'' be amended to be 
consistent with the transfer of anything that would constitute 
a ``copy'' under a software licensing agreement).
    The Congressional ``Internet Tax Freedom Act'' (ITFA) 
doesn't change any of this. Contrary to popular belief, the 
ITFA does not eliminate Internet-related sales and use taxes. 
All sales and use taxes established and in effect prior to ITFA 
continue to apply, much like sales taxes on catalog sales. The 
ITFA created a moratorium on new taxes on Internet access, 
although very few state or municipal governments have even 
proposed these.
    For local governments, the Internet sales tax issue comes 
down to this: maintaining current rules by which retail and 
business-to-business transactions provide sales and use tax 
revenues to fund local government services. Most Internet sales 
were taxable before ITFA and are still taxable today, and 
cities are trying to hold on to this fundamental revenue source 
as they provide services to the ``new economy.''
    All of this illustrates why local governments and business 
are concerned about maintaining sales and use tax revenues that 
provide core services. Under California's existing tax 
structure, the lion's share of city revenues already comes from 
businesses, and a decline in these revenues would impact the 
ability of cities to provide the basic services expected by 
citizens and businesses alike.
    A more detailed analysis and summary for addressing 
Internet sales tax and related tax reform issues can be found 
at http://www.jointventure.org/initiatives/tax/taskforce.html.
    [An additional attachment is being retained in the 
Committee files.]

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