September 25, 1998
The Internet Tax Freedom Act's
"Advisory Commission on Electronic Commerce":
Preserving Flexibility to Consider All Options
by Michael Mazerov
The "Internet Tax Freedom Act" (ITFA, S. 442) may be brought to the Senate floor again in the next few days. The manager's amendment that will be offered contains a "tax moratorium" provision that reasonably implements the originally stated goal of ITFA's sponsors. That goal was to impose a short, temporary "time-out" preventing new state and local taxes on Internet purchases until a federally-sponsored "Advisory Commission on Electronic Commerce" can develop rules that might permit states and localities to tax Internet transactions in a simpler and more standardized manner.
Active efforts are still underway, however, to amend the portion of the proposed legislation establishing the Advisory Commission. Some of those amendments would undercut the Commission's ability to formulate policy recommendations that can achieve a long-term solution to Internet commerce taxation issues. The amendments would prevent the Commission from even discussing or considering whether there is a need for Congress to reverse the U.S. Supreme Court's 1992 Quill decision. Quill denies state and local governments the legal authority to require most Internet and mail-order merchants to charge the same sales taxes that "Main Street" retailers are legally obligated to collect. Pre-judging this issue could prevent the Advisory Commission from crafting the best, economically-neutral policy for state and local taxation of Internet commerce.
- Language that may either be incorporated into a manager's amendment to the version of ITFA adopted by the Finance Committee or offered as a separate amendment would mandate that the Advisory Commission's agenda be limited to considering model state legislation that would establish standards for how all states could tax Internet commerce. While consideration of such legislation is an essential component of the Commission's agenda, so, too, is an examination of the possible need for federal legislation that would reverse Quill at least under certain conditions.
Without an authorization to consider federal legislation that might be needed to implement its recommendations, the Advisory Commission would have to take the sales tax loophole created by Quill as a given. This would mean that the Advisory Commission would not be able to formulate tax policy recommendations that include a requirement that Internet merchants collect appropriate sales taxes on on-line sales in exchange for states and localities agreeing to a simplified, standardized method of sales tax collection. (These types of trade-off have been discussed widely in other forums, such as the National Tax Association Communications and Electronic Commerce Tax Project.) Without such an agreement, states and localities would have to attempt to collect sales taxes due on Internet purchases directly from consumers. Many states have been actively and unsuccessfully attempting to do this on mail-order sales for over a decade.
- The restricted agenda that would be established for the Advisory Commission by this language would all but ensure that the Internet would become what Deputy Treasury Secretary Lawrence H. Summers has said it must not become: "a tax haven that drains the sales tax and other revenues that our states and cities need to educate our children and keep our streets safe."
- The language that is in the version of ITFA approved by the Finance Committee is more flexible and preserves for congressional consideration the full range of options. This original language permits the Advisory Commission to consider the possibility that states and localities should be authorized to apply their sales taxes equally to Internet, mail-order, and retail store purchases through a reversal of Quill.
Blocking the Advisory Commission from Even Considering the Possibility that the Quill Decision Should Be Reversed Would Make a Workable Agreement between State/ Local Government and the Internet Industry on Taxation of Electronic Commerce Much Less Likely
State and local governments have been actively negotiating for over a year with the Internet industry toward an agreement that would explicitly trade-off considerable simplification and standardization of their diverse sales tax rules in exchange for the industry's agreement to charge sales tax on most on-line sales. Most parties on both sides understand that if such an agreement can be reached, it is likely to require federal legislation that would reverse Quill and authorize states to mandate sales tax collection on Internet sales in at least some circumstances. The potential to adversely affect the relative competitiveness of Internet businesses is the major reason that federal legislation would likely be necessary. For example, Amazon.com cannot reasonably be expected to voluntarily charge sales tax on its Internet book sales even under the simplest and most uniform set of rules imaginable if its competitor, Barnes and Noble.com, would remain free not to charge tax.
If ITFA is enacted, the federal Advisory Commission on Electronic Commerce will effectively become the forum in which the current negotiations between state and local governments and the Internet industry will be brought to final resolution. It is therefore essential that the Commission and its agenda be structured in such a manner that an agreement between state and local governments and the Internet industry is realistically attainable.
As a substitute for the existing language in the Finance Committee bill setting the agenda of the Advisory Commission, some Senators are seeking a provision mandating that the Advisory Commission's study be limited to considering model state legislation that would establish standards for how all states could tax Internet commerce. While consideration of such legislation is an essential component of the Commission's agenda, so, too, is an examination of the possible need for federal legislation that would reverse Quill at least under certain conditions.
It will be almost impossible to reach an agreement if a reversal of Quill under any circumstances is off the table from the outset of the Advisory Commission's deliberations. Every major state and local government organization including the National Governors' Association and the National League of Cities is on record that Quill should be reversed by federal legislation. (Those organizations' positions also provide that such legislation should also protect small businesses from having to collect out-of-state sales taxes in most states and provide interstate sellers with simplified rules and procedures not available to other taxpayers.)
State and local representatives have been open to considering the possibility that businesses could be relied upon to pay sales taxes on goods and services they purchase over the Internet directly to state and local governments. However, after years of unsuccessful state efforts to collect sales taxes on mail-order purchases directly from individual consumers, state and local government organizations are rightfully skeptical that a significant share of the taxes owed by individuals can be collected unless the taxes are collected by Internet merchants who are responsible for turning them over to state and local treasuries just as "Main Street" stores currently must do. If this latter possibility is "off the table" from the outset, there is little chance that the Advisory Commission could formulate meaningful solutions to Internet commerce tax issues. Indeed, a good argument could be made that there would be no point in convening a Commission at all.
True "Technological Neutrality" in the Taxation of Internet Commerce Realistically Can Only Be Achieved If the Quill Decision Is Reversed
In introducing the Internet Tax Freedom Act (ITFA), Senator Wyden and Representative Cox stated that their goal was to ensure that any state and local taxes levied on Internet transactions be "technologically neutral" that is, that Internet transactions neither be targeted for new, special taxes nor treated under existing taxes differently than non-Internet transactions. Senator Wyden and Representative Cox are concerned that states will discriminate against Internet sellers. But the fact is that tax discrimination runs in precisely the opposite direction, favoring Internet merchants over local retailers. As a result of the Quill decision, states and localities are already barred from requiring most Internet and mail-order companies to charge and remit the same sales taxes that "Main Street" retailers physically present in a state must collect.
So long as some businesses can sell goods and services into a state over the Internet or by mail without an obligation to charge sales tax, while local merchants are required to collect this tax from their customers, "technological neutrality" in taxation cannot be achieved. Retailing using one class of technologies the Internet, 1-800 telephone numbers, mail-order catalogs, etc. will continue to have a competitive advantage over retailing using another technology the local store because "Main Street" retailers must add six to eight percent sales taxes to their prices while remote sellers need not.
Potential Consequences for State and Local Services, Lower-Income Taxpayers, and Main Street Merchants
If states and localities remain legally powerless to require Internet and mail-order merchants to charge sales tax, the consequences potentially would be severe:
- State and local governments, which are already losing $3-4 billion in sales tax revenues a year from their inability to tax most mail-order sales, would lose billions more. Numerous studies project $300 billion-$500 billion in combined consumer and business purchases over the Internet by 2002. An inability to require Internet merchants to charge sales tax could result in $10 billion in additional annual sales tax revenue losses by that time, as existing taxable sales migrate to an effectively tax-free Internet. Permanent extension to Internet sales of the mail-order loophole would seriously erode the sales tax, which alone provides roughly one quarter of all state and local government tax revenues. Revenue losses of this magnitude could significantly impair the ability of some states and localities to meet needs fully for education funding and other traditional state and local government functions, along with their new responsibilities for devolved health and welfare programs.
- Sales taxes would steadily become even more burdensome for low- and moderate-income households than they are now. A recent study by the Commerce Department reported that households with incomes above $75,000 are seven times more likely to have Internet access at home than households in the $15,000-20,000 income range. Effectively exempting purchases of goods over the Internet from sales taxation thus disproportionately benefits the highest-income segments of the population.
For the foreseeable future, only relatively affluent households are likely to be able to afford the computers and Internet access accounts and have the access to credit that is needed to engage routinely in online shopping. If states and localities cannot tax goods and services purchased online, lower-income households who shop in stores will be left paying an ever-greater share of sales taxes. If states and localities seek to preserve a given level of sales tax revenues in the face of sales tax base erosion resulting from online shopping by increasing tax rates, low-and moderate-income households will be further burdened in absolute as well as relative terms.
- A long-term inability to tax goods and services sold over the Internet will devastate what is left of the small local business sector and lead to ever-greater distortion of retail competition. The outlook for neighborhood bookstores provides a graphic example. The CEO of Internet bookseller Amazon.com, Jeff Bezos, has openly acknowledged that he deliberately headquartered his company in a relatively small state because he wanted to be able to tap into the potential market of populous states like California and New York with the competitive advantage arising from not having to charge sales tax. (Amazon.com charges sales tax only on its sales to Washington customers, the state in which it is located). Now, Barnes & Noble is attempting to play the same game. Although it has stores in most states, and this "physical presence" would ordinarily require it to charge sales tax on the sales by its Internet operation into these states, it has separately incorporated its Internet business as a subsidiary in an effort to avoid having to charge tax in most of the states where the stores are located. Yet its advertisements often jointly promote both its Internet and book store operations. Retail margins in the bookselling industry are too narrow to allow what is left of small, neighborhood bookstores to long continue to compete with the likes of these tax-free Internet sellers.
This pattern will be repeated in other retail segments as well, from the small neighborhood computer store to the local toy shop. Unless Congress soon creates a level competitive playing field by authorizing states to require all Internet and mail-order businesses above a certain size to charge sales taxes (authority states and localities have sought for a decade), Main Street businesses will steadily disappear. Companies like Amazon.com and Barnes and Noble.com will be rewarded for engaging in ever-more creative and socially wasteful tax planning activities aimed at avoiding an obligation to charge sales taxes.
For all of these reasons, it is likely that better long-term policy will result if the Advisory Commission on Electronic Commerce is allowed to consider whether and under what conditions Main Street, mail-order, and Internet sales should be taxed equally by state and local governments.