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.


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, 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, 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:

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.

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