U.S. GOVERNMENT PRINTING OFFICE

67–448 CC WASHINGTON : 2001

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

(

For sale by the U.S. Government Printing Office

Superintendent of Documents, Congressional Sales Office, Washington, DC 20402

ii

COMMITTEE ON WAYS AND MEANS

BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois

BILL THOMAS, California

E. CLAY SHAW, JR., Florida

NANCY L. JOHNSON, Connecticut

AMO HOUGHTON, New York

WALLY HERGER, California

JIM MCCRERY, Louisiana

DAVE CAMP, Michigan

JIM RAMSTAD, Minnesota

JIM NUSSLE, Iowa

SAM JOHNSON, Texas

JENNIFER DUNN, Washington

MAC COLLINS, Georgia

ROB PORTMAN, Ohio

PHILIP S. ENGLISH, Pennsylvania

WES WATKINS, Oklahoma

J.D. HAYWORTH, Arizona

JERRY WELLER, Illinois

KENNY HULSHOF, Missouri

SCOTT MCINNIS, Colorado

RON LEWIS, Kentucky

MARK FOLEY, Florida

CHARLES B. RANGEL, New York

FORTNEY PETE STARK, California

ROBERT T. MATSUI, California

WILLIAM J. COYNE, Pennsylvania

SANDER M. LEVIN, Michigan

BENJAMIN L. CARDIN, Maryland

JIM MCDERMOTT, Washington

GERALD D. KLECZKA, Wisconsin

JOHN LEWIS, Georgia

RICHARD E. NEAL, Massachusetts

MICHAEL R. MCNULTY, New York

WILLIAM J. JEFFERSON, Louisiana

JOHN S. TANNER, Tennessee

XAVIER BECERRA, California

KAREN L. THURMAN, Florida

LLOYD DOGGETT, Texas

A.L. SINGLETON, Chief of Staff

JANICE MAYS, Minority Chief Counsel

SUBCOMMITTEE ON OVERSIGHT

AMO HOUGHTON, New York, Chairman

ROB PORTMAN, Ohio

JENNIFER DUNN, Washington

WES WATKINS, Oklahoma

JERRY WELLER, Illinois

KENNY HULSHOF, Missouri

J.D. HAYWORTH, Arizona

SCOTT MCINNIS, Colorado

WILLIAM J. COYNE, Pennsylvania

MICHAEL R. MCNULTY, New York

JIM MCDERMOTT, Washington

JOHN LEWIS, Georgia

RICHARD E. NEAL, Massachusetts

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records

of the Committee on Ways and Means are also published in electronic form. The printed

hearing record remains the official version. Because electronic submissions are used to

prepare both printed and electronic versions of the hearing record, the process of converting

between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process

is further refined.

iii

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

(1)

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:]

2

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

SUBCOMMITTEE ON OVERSIGHT

FOR IMMEDIATE RELEASE CONTACT: (202) 225–7601

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.’’

3

FOCUS OF THE HEARING:

The focus of the hearing will be to consider matters in the report transmitted to

Congress by the Advisory Commission on Electronic Commerce within the Committee’s jurisdiction, and related topics, such as, the consequences of taxation of electronic commerce, telecommunications services, Internet access and measures to

bridge the digital divide.

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

Any person or organization wishing to submit a written statement for the printed

record of the hearing should submit six (6) single-spaced copies of their statement,

along with an IBM compatible 3.5-inch diskette in WordPerfect or MS Word format,

with their name, address, and hearing date noted on a label, by the close of business, Tuesday, May 30, 2000, to A.L. Singleton, Chief of Staff, Committee on Ways

and Means, U.S. House of Representatives, 1102 Longworth House Office Building,

Washington, D.C. 20515. If those filing written statements wish to have their statements distributed to the press and interested public at the hearing, they may deliver 200 additional copies for this purpose to the Subcommittee on Oversight office,

room 1136 Longworth House Office Building, by close of business the day before the

hearing.

FORMATTING REQUIREMENTS:

Each statement presented for printing to the Committee by a witness, any written statement

or exhibit submitted for the printed record or any written comments in response to a request

for written comments must conform to the guidelines listed below. Any statement or exhibit not

in compliance with these guidelines will not be printed, but will be maintained in the Committee

files for review and use by the Committee.

1. All statements and any accompanying exhibits for printing must be submitted on an IBM

compatible 3.5-inch diskette in WordPerfect or MS Word format, typed in single space and may

not exceed a total of 10 pages including attachments. Witnesses are advised that the Committee

will rely on electronic submissions for printing the official hearing record.

2. Copies of whole documents submitted as exhibit material will not be accepted for printing.

Instead, exhibit material should be referenced and quoted or paraphrased. All exhibit material

not meeting these specifications will be maintained in the Committee files for review and use

by the Committee.

3. A witness appearing at a public hearing, or submitting a statement for the record of a public hearing, or submitting written comments in response to a published request for comments

by the Committee, must include on his statement or submission a list of all clients, persons,

or organizations on whose behalf the witness appears.

4. A supplemental sheet must accompany each statement listing the name, company, address,

telephone and fax numbers where the witness or the designated representative may be reached.

This supplemental sheet will not be included in the printed record.

The above restrictions and limitations apply only to material being submitted for printing.

Statements and exhibits or supplementary material submitted solely for distribution to the

Members, the press, and the public during the course of a public hearing may be submitted in

other forms.

Note: All Committee advisories and news releases are available on the World

Wide Web at ‘‘http://waysandmeans.house.gov’’.

The Committee seeks to make its facilities accessible to persons with disabilities.

If you are in need of special accommodations, please call 202–225–1721 or 202–226–

3411 TTD/TTY in advance of the event (four business days notice is requested).

Questions with regard to special accommodation needs in general (including availability of Committee materials in alternative formats) may be directed to the Committee as noted above.

f

4

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,

5

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.

6

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.

7

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

8

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:]

9

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 mailorder 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 marVerDate 20-JUL-2000 16:42 Jan 08, 2001 Jkt 061710 PO 00000 Frm 00013 Fmt 6633 Sfmt 6602 K:\HEARINGS\67448.TXT WAYS3 PsN: WAYS3
10

kets. 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 mailorder 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).

11

1 ‘‘Tax Internet Sales? The Issue Is Not So Black and White.’’ Tax Notes. Volume 87, Number

5, May 1, 2000, 705–710.

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.

12

13

f

14

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.

15

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

16

1 CSE Foundation does not receive any funds from the U.S. Government.

2More than seven members of the Advisory Commission on Electronic Commerce abstained

on 10 key votes during the Dallas Meeting on March 20–21, 2000. 3 Background for these tax statistics available upon request.

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.

problems. At CSE Foundation, I am the director for technology and communications

policy.1

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.

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

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.

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 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

17

5 Jeffery Eisenach, ‘‘The High Cost of Taxing Telecom,’’ study prepared for presentation to the

Advisory Commission on Electronic Commerce, September 14, 1999. 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. 7 Austan Goolsbee and Jonathan Zittrain, ‘‘Evaluating the Costs and Benefits of Taxing Internet Commerce’’ (Manuscript, May 20, 1999). 8 Access Markets International Partners Survey, released May 15, 2000.

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 onramp 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.

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.

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

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.

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

18

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 H

Mr. Strauss?

OUGHTON. Thank you.

f

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

19

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, CarnegieMellon 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

20

1The 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. 2See, Due, John and John L. Mikesell (1994). Sales Taxation: State and Local Structure and

Administration. Second Edition. (Washington, D.C.: Urban Institute Press, 1994).

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.

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

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.

21

3The 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 1: Classification of State Consumption Tax Design Problem

Geography of Activity

Final Consumption Intermediate Production

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.

Table 2: State Sales and Use Tax Rates, Household’s Share, and Estimated Final Consumption Sales and Use

Tax Rates

State

January,

2000

State

Sales &

Use Tax

Rates

Household

Fraction

Of Sales

& Use

Taxes

NonHousehold

Fraction

of Sales

& Use

Taxes

1998

Sales

Taxes as

% of

State

Personal

Income

1998

Sales

Taxes as

% of

State

Personal

Outlays

Final

Consumption

State

Sales and

Use Tax

Rate

Final

Consumption

State

Rate as

% of Current

State

Rate [1] [2] [3] [4] [5] [6]

[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%

22

4Line 30 of Michigan’s personal income tax return, MI–1040, asks the taxpayer to report use

tax due from a worksheet. 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.

Table 2: State Sales and Use Tax Rates, Household’s Share, and Estimated Final Consumption Sales and Use

Tax Rates—Continued

State

January,

2000

State

Sales &

Use Tax

Rates

Household

Fraction

Of Sales

& Use

Taxes

NonHousehold

Fraction

of Sales

& Use

Taxes

1998

Sales

Taxes as % of

State

Personal

Income

1998

Sales

Taxes as % of

State

Personal

Outlays

Final

Consumption

State

Sales and

Use Tax

Rate

Final

Consumption

State

Rate as

% of Cur- rent

State

Rate [1] [2] [3] [4] [5] [6]

[7]

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?

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

23

6Periodically 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.

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.

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 .

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, espeVerDate 20-JUL-2000 16:42 Jan 08, 2001 Jkt 061710 PO 00000 Frm 00027 Fmt 6633 Sfmt 6602 K:\HEARINGS\67448.TXT WAYS3 PsN: WAYS3
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7Third 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. 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).

cially 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.

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

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, cooperaVerDate 20-JUL-2000 16:42 Jan 08, 2001 Jkt 061710 PO 00000 Frm 00028 Fmt 6633 Sfmt 6602 K:\HEARINGS\67448.TXT WAYS3 PsN: WAYS3
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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.

tive 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.

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

26

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

27

10Lists 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.

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.

I would be happy to respond to any questions you may have about this testimony

Mr. Coyne for questions.

or issues related to it.

Chairman HOUGHTON. I am going to turn over the microphone to

f

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

28

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 imposVerDate 20-JUL-2000 16:42 Jan 08, 2001 Jkt 061710 PO 00000 Frm 00032 Fmt 6633 Sfmt 6602 K:\HEARINGS\67448.TXT WAYS3 PsN: WAYS3
29

ing 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

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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

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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

32

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 selfassess 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

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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.

f

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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.

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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

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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.

37

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?

38

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

39

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

40

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

41

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.

42

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 competi- tors 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

43

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.

44

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

45

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 H

I think we should turn to Mr. Honaker.

OUGHTON. Thank you very much, Mr. Ledger.

f

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 fulltime 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

46

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 beautyrelated 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 frontend and back-end taxes. The front-end are the ones being paid on

the profits made by the businesses using the Internet. The backend 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.

47

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.

48

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 H

Would you like to say something, Mrs. Honaker?

OUGHTON. Thank you very much.

f

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.

49

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 taxfree. 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 taxfree 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,

50

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

51

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.

f

52

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

53

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 MilwauVerDate 20-JUL-2000 16:42 Jan 08, 2001 Jkt 061710 PO 00000 Frm 00057 Fmt 6633 Sfmt 6602 K:\HEARINGS\67448.TXT WAYS3 PsN: WAYS3
54

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. 2Quill 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). 3This includes sales of both digital products and, more importantly, tangible goods via electronic means.

kee, 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.

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 outof-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.

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

55

4Some 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. 5For 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.

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.

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-ofstate 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

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 longterm 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.

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

56

6See, 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. 7Donald 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.]

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.

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 uncol- lected 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 ecommerce 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

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8Sellers 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.

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

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

58

9The Commission’s report was presented to Congress in April 2000. It is available at the Commission Web site www.ecommercecommission.org. 10See testimony of Gov. Michael O. Leavitt before the Committee on Commerce, U.S. Senate,

April 12, 2000.

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

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.

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

59

11Tax is imposed only on amounts over $25 per month. 12 Certain cities in Colorado and Arizona also apply their tax to such charges.

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.

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 Wiscon- sin, 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 outof-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

60

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

1998 1999 2000

(est.)

Federal Highway Administration—Development and Presentation of Training Courses on Motor Fuel Tax Evasion and

Investigation ............................................................................ $20,000 $25,000 $25,000

Federal Highway Administration—Contract to develop and

implement an Internet-based electronic filing application

of International Fuel Tax Agreement returns ...................... $185,000 $51,000

f ¥0-

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 afterVerDate 20-JUL-2000 16:42 Jan 08, 2001 Jkt 061710 PO 00000 Frm 00064 Fmt 6633 Sfmt 6602 K:\HEARINGS\67448.TXT WAYS3 PsN: WAYS3
61

noon 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

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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

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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.

64

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

65

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 instate 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.

That was great.

Chairman HOUGHTON. Well, thanks very much, Mr. Nebergall.

f

Now, Mr. LoGalbo?

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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 valueadded 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

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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

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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 fiveyear 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, highbandwidth 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 businessoriented 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

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1 Committee on State Taxation’s Fifty State Study and Report on Telecommunications Taxation, p. 5 (September 7, 1999). 2Karl Freiden, Cybertaxation: The Taxation of E-Commerce (Chicago: Arthur Andersen LLP,

2000), p. 82.

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

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 valueadded tax rules or rates to be complied with.2

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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 H

Ms. Dunn, would you like to ask some questions?

OUGHTON. Thanks very much, Mr. LoGalbo.

f

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.

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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.

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Mr. MCDERMOTT. Is that correct?

Mr. DUNCAN. That’s right, sir. The sales tax is a destinationbased 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

73

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.

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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

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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

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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 cerVerDate 20-JUL-2000 16:42 Jan 08, 2001 Jkt 061710 PO 00000 Frm 00080 Fmt 6621 Sfmt 6602 K:\HEARINGS\67448.TXT WAYS3 PsN: WAYS3
77

tainly 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

78

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.

79

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 H

Mr. Wilkes?

OUGHTON. Thanks very much.

f

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:]

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81

82

83

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

84

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 H

Now, Mr. Martin.

OUGHTON. Thanks very much.

f

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

85

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

86

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 

f

made permanent in 1990.

Chairman HOUGHTON. Thanks very much, Mr. Martin.

Mr. Coyne?

Mr. COYNE. Thank you, Mr. Chairman.

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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

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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 customerfriendly, 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 SpanishAmerican 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.

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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 hightech 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

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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

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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—shutins, 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 threeyear ban, ending September 30, 2001, on any new state and local taxes on Internet

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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.

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

gress to take swift and effective action.

Statement of Dan R. Mastromarco, Argus Group, Alexandria, VA, on behalf

of Americans for Fair Taxation

f

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

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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.

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 broadbased 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.

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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

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2For 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. 3See, for example, Financial Action Task Force on Money Laundering (Released February 3,

2000) at http://www.oecd.org/fatf/pdf/2000typ-en.pdf</SPAN></SPAN> and http://www.oecd.org//

publications/pol—brief/9701—POL.HTM#14.

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 online 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

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 intergovernmental 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

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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

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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.

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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.

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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 localVerDate 20-JUL-2000 16:42 Jan 08, 2001 Jkt 061710 PO 00000 Frm 00103 Fmt 6621 Sfmt 6602 K:\HEARINGS\67448.TXT WAYS3 PsN: WAYS3
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ities.’’ 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.

Mr. Chairman and Members of the Subcommittee:

Statement of Deloitte & Touche LLP

f

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.

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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 busiVerDate 20-JUL-2000 16:42 Jan 08, 2001 Jkt 061710 PO 00000 Frm 00105 Fmt 6621 Sfmt 6602 K:\HEARINGS\67448.TXT WAYS3 PsN: WAYS3
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nesses. 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?

103

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:

mmcclintock@dttus.com) or Richard Prem, Partner, National E-Business Tax Services Group at 415.783.4518 (e-mail: rprem@dttus.com).

Statement of Frank G. Julian, Operating Vice President and Tax Counsel,

Federated Department Stores, Inc., Cincinnati, OH

f

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.

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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

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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 opporf

tunity 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

106

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

107

‘‘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 shortterm 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.

SUMMARY OF

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

APPROACHES FOR

f

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 .

Approach/Criteria

Simplifies

compliance over

multiple

jurisdictions

Provides

an effective

mechanism for

collection

of tax on

purchases

from remote vendors

Provides

for consistent

application of

sales and

use taxes

for all

types of

commerce

Allows

state and

local governments

to set

their own

tax system

Does not

discriminate

against

any type

of commerce

A. Allow the Internet Tax Freedom Act’s

moratorium to expire in October 2001 .... o o o + +

B. Extend the current federal moratorium

on new taxes permanently ....................... o o o ¥ ¥

C. Legislatively define nexus (taxable

presence) at the federal level for sales

and use tax purposes ................................ + ¥ +o+

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Approach/Criteria

Simplifies

compliance over

multiple

jurisdictions

Provides

an effective

mechanism for

collection

of tax on

purchases

from remote vendors

Provides

for consistent

application of

sales and

use taxes

for all

types of

commerce

Allows

state and

local governments

to set

their own

tax system

Does not

discriminate

against

any type

of commerce

D. Allow states to collect sales and use tax

from remote vendors (reverse Quill) ....... ¥ o+++

E. Have a third party serve as the collector of sales and use taxes ......................... + o + o +

F. Exempt all or a portion of e-commerce

from sales and use taxation ..................... o o ¥¥¥

G. Create federal level tax for remote ecommerce and mail order sales ............... o o + ¥ +

H. Apply the origin basis (vendor location)

to all sales and use taxes ......................... o + + + o

I. Simplify existing sales and use tax systems ........................................................... + o o o +

J. Educate consumers about the use tax

and encourage states to collect it from

residents who buy from remote vendors + o + + +

K. Resolve issues of applying sales and use

taxes to e-commerce in the broader context of improving existing sales and use

tax systems ............................................... + + + o +

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:

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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.

110

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 nonprofit 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.

111

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

Revenue Source

Typical

Share of

All Revenues

Range, Various 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

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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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