[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
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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
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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.
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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
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House Office Building, by close of business the day before the hearing.
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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
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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).
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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.
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\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.
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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.
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\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.]
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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\
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\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.
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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\
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\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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