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POLICY BRIEF FROM AMERICANS FOR TAX REFORM

The E-Freedom Coalition Proposal to the Advisory Commission on Electronic Commerce

November 10, 1999

In this Brief:

Electronic commerce has grown rapidly over the past several years. The Internet is changing the way the world does business. From the perspective of the online consumer, it does not matter if a purchase is made from a Web site in San Francisco, Boston, or Beijing - it only matters who offers the best product at the best price. Everyone - including government - gains from such increasing economic integration.

Unfortunately, the benefits of electronic commerce are threatened by the impulses of some elected officials to regulate and tax. Electronic commerce is changing daily in scope and scale: in the way the industry is structured, the ways information is formatted and transmitted, the ways in which exchanges are created and financed, and the ways in which privacy is protected. Every aspect of electronic commerce is in flux. We believe any effort to assert political control is an assault on this emerging medium. We believe taxes on remote sales will inevitably entail vast and invasive monitoring - Who would levy the tax; what level of tax and of record-keeping would be imposed; how would compliance and sales be monitored. Furthermore, tax proposals pose severe threats to the evolving privacy protections on the Internet such as encryption and anonymous digital money. The emergence of these technologies could be profoundly hampered by new tax collection schemes.

Those are reasons enough for caution. But the problems with e-commerce taxation go far beyond its invasiveness. Indeed, allowing state and local governments to tax across borders is fundamentally unjust. Remote taxation is, quite simply,Taxation without Representation on an unprecedented scale; a practice that cannot be tolerated in democratic society. The proper role of taxation is to support those functions carried out within a governing jurisdiction. Such taxes cannot be levied on or collected from people who have no say in how the funds are used. Imposing tax collection responsibilities on remote firms violates those important principles by staking claim on economic activity largely unrelated to the benefits provided by the taxing jurisdiction.

The advocates of new tax collection schemes rely on an increasingly irrelevant distinction between so-called "Main Street" businesses and online business. But the Internet is open to everyone. Even as the Commission deliberates, Main Street businesses are embracing the Internet in droves, through individual Web sites, online auctions, and such emerging forums as Amazon's zShops and Iconomy.com's automated storefronts. In the name of the small number of Main Street businesses that would stifle rather than embrace the opportunities presented by the Internet, the proponents of new tax collection schemes are willing to sacrifice the ability of future Main Streeters to reach the world via the information highway. If the advocates of expanded taxation prevail, many main Street businesses will stay precisely that - never reaching their full potential in the increasingly global marketplace.

Proposals to apply "efficient" or "uniform" taxes to remote sales are especially distressing. A uniform tax is easily raised and high tax rates, even when administered on a neutral basis, are detrimental to economic growth and development. Electronic commerce empowers consumers to take advantage of competitive tax rates in other jurisdictions and thus serves as a necessary constraint on excessive government. The flexibility in moving capital and economic activities around the globe offered by the Internet at last makes it possible to sharpen those disciplining influences.
For those officials concerned about "leakage" from state and local taxes due to Internet commerce, the solution is a re-examination of their own tax-and-spending policies. The first priority should be to cut unnecessary expenditures and streamline tax collection systems. Indeed, it is abundantly clear in this time of unprecedented federal, state and local budget surpluses that the last thing politicians need are new revenues.

Rather than impose new and onerous tax collection schemes, we take a more open approach that respects the sovereignty of both taxpayers and local jurisdictions.

Recognizing that a citizen's ability to take advantage of all the Internet offers, including e-commerce, completely depends on the Internet's accessibility, we begin this proposal with five recommendations to tear down and prevent the re-emergence of government-imposed taxes and regulations that serve only to drive up costs for consumers and retard the investments needed to strengthen and maintain the national information infrastructure. Specifically, we have identified five tax-related barriers to Internet access:

Specifically, we have identified five tax-related barriers to Internet access

  1. The federal 3% excise tax on telecommunications. The tax is an anachronism and should be repealed immediately.
  2. Discriminatory ad valorem taxation of interstate telecommunications. Fifteen states tax telecommunications business property at rates higher than other property, driving up costs for consumers. Federal protections against such taxes - already in effect for railroads, airlines and trucking -- should be extended to telecommunications.
  3. Internet tolls - new taxes and fees levied on telecommunications providers and their customers when cable is installed along highways and roads. These new taxes, which can run up to 5% of gross receipts, drive up costs for consumers, and should be abolished. Congress should make clear that the 1996 Telecommunications Act intended only for state and local governments to be reimbursed for actual costs incurred for managing public rights of way.
  4. High state and local telecommunications taxes, complicated auditing and filing procedures. Many governments are using consumer telephone bills as cash cows, imposing multiple and high taxes on services. Such taxes should be slashed to a single tax per state and locality, and filing/auditing procedures streamlined.
  5. Internet access taxes. The temporary federal ban on Internet access taxes should be made permanent. States and localities that imposed such taxes before the ban took effect should repeal any taxes on access to keep costs down for consumers.


Next, we propose that if sales taxes are to continue to be collected online, a pro-growth system for the collection of sales and use taxes by companies with a substantial physical presence within the taxing jurisdiction is appropriate. The system would affirm, update and clarify existing constitutional law by setting clear jurisdictional standards that are relevant and easily understood in "new economy." Originally proposed by Commissioner Dean Andal, this proposal will encourage tax collection by minimizing the compliance burden while at the same time encourage expansion of e-commerce by improving the certainty of state and local tax responsibilities.

In short, our proposal hinges on many of the principles that have prevailed in fostering the Internet's own phenomenal growth: openness, fairness, accessibility, freedom, and the minimal involvement of political institutions. We now propose taking the Internet into the next century by increasing its accessibility, encouraging the growth of e-commerce, and enabling tax collection within proper constitutional guidelines.

A Clear, Constitutional Approach to e-Commerce Taxation

Recommendation #1

(a) Permanently ban taxes on Internet access. State and local governments that imposed taxes on Internet access prior federal moratorium should repeal those taxes, and no new taxes on access (service) should be imposed.
(b) Amend the Internet Tax Freedom Act to make permanent the moratorium on discriminatory sales and use taxes.

Section 1101(a)(1) of the Internet Tax Freedom Act placed a three-year moratorium on any new Internet access service taxes that were not in place as of October 1, 1998. "Internet access service" is defined under the ITFA as, "a service that enables users to access content, information, electronic mail, or other services offered over the Internet and may also include access to proprietary content, information, and other services as part of a package of services offered to consumers. Such term does not include telecommunications services." In addition, the ITFA grandfathered certain existing Internet access taxes for those states that had come to rely on them as a source of revenue before the passage of the moratorium.

Section 1101(a)(2) of the ITFA also placed a three-year moratorium on multiple or discriminatory taxes on electronic commerce, which includes state and local sales or use taxes. The combined effect of these two clauses of the ITFA is the temporary creation of a "tax-free zone" for Internet access and certain types of electronic commerce. The E-Freedom Coalition is proposing that this temporary tax-free zone arrangement be made permanent for both access taxes and sales or use taxes on electronic commerce. Moreover, the Advisory Commission should recommend that any existing state or local taxes that were grandfathered under the ITFA be phased out or repealed outright.

The Importance of Making the Ban Permanent

It is vital that the Advisory Commission understands why the current ban on Internet access, sales, or use taxes must be made permanent. The case against taxing the Internet and electronic commerce can be made on both economic and legal grounds:

The economic arguments against taxing electronic commerce are strong. First, such taxation is inefficient. Imposing multiple, overlapping or discriminatory access or sales taxes on the Internet or electronic commerce in general would be extremely difficult and inefficient in practice. Having 30,000 or even just 50 tax jurisdictions and policies would create a confusing and counter-productive domestic tax regime. Imposing such a tax regime on the Internet or electronic commerce would also have an extremely deleterious effect on the Internet sector just as it is beginning to grow and expand. Industry output and entrepreneurialism would likely be greatly curtailed as a result.

The negative effects of a new Internet tax regime would reverberate throughout the national economy. Almost every American industry is now engaged in some form of electronic commerce or has initiated Internet-based services. Imposing burdensome taxes on Internet access or sales would discourage further efforts in this regard and likely retard innovation, job creation, and economic growth in general.

The creation of such a tax regime or regimes would likely require a significant increase in government tax oversight and enforcement efforts. Tax collection agencies at all levels of government would grow larger and more intrusive as efforts to tax electronic commerce proliferated. The resulting expansion in the overall size of government would likely lead to more government meddling in the private sector in general and the high-tech sector in particular.

Just as the economic arguments against Internet taxation are strong, so are the legal and constitutional arguments. The Supreme Court has long held that attempts by a state or local government to tax or regulate out-of-state activity or "remote commerce" are unconstitutional. State and local governments can only tax those parties that have a "nexus" or "substantial physical presence" within their jurisdictions. Establishing a tax system that grants state and local governments the right to impose multiple and over-lapping taxes would reverse two centuries worth of sound Supreme Court case law and create a disturbing precedent for the taxation of other forms of interstate commerce.

Beyond upsetting legal precedent, taxing electronic commerce represents a direct affront to constitutional first principles and a threat to America's federalist structure of government in general. The Founding Fathers included language in Article 1, Section 8 of the Constitution to allow Congress to "regulate interstate commerce" in an attempt to remedy the problems the colonies experienced when they operated under the Articles of Confederation. Excessive parochialism and perpetual interference with the free flow interstate commerce forced the Founders to abandon the Articles and instead adopt our modern Constitution to alleviate these ills. The federal republic they created allowed for extensive state and local experimentation and autonomy, but also placed firm limits on the ability of state and local governments when interstate commerce was at stake. An important part of America's federalist system of government, therefore, is an understanding and appreciation of the limits of state sovereignty. In order for each state to preserve an autonomous sphere for itself, there must necessarily be limits on its jurisdictional authority. Simply put, a state's jurisdictional authority ends at its own borders. Allowing state or local taxation of the Internet would betray this constitutional first principle by allowing governments to impose their will on consumers and companies outside their jurisdictional boundaries.

For these economic and legal reasons, it is vital that the Advisory Commission propose a permanent ban on access taxes or any form of discriminatory sales or use taxes on electronic commerce.

Addressing and Debunking the "Fairness" Arguments

Despite these arguments, some members of the Advisory Commission may still resist the adoption of a permanent ban on Internet access and sales taxes because of certain "fairness" arguments they have heard repeatedly voiced by critics of the Internet Tax Freedom Act. These fairness arguments typically come in two varieties:

  • Fairness Argument #1: It is not fair to exempt remote Internet vendors from access or sales taxes when "bricks and mortar" or "Main Street" businesses within a state are required to pay them.
  • Fairness Argument #2: It is not fair to deprive state and local governments of the revenues that could be collected by taxing Internet access or electronic sales.

These arguments represent legitimate concerns that are being raised by a host of state and local government officials and some Main Street businesses. Therefore, it is important that the members of the Advisory Commission address and debunk these fairness arguments to ensure that taxes are not imposed on electronic commerce.

The first argument regarding the fairness of exempting remote vendors from access or sales taxes misses an important point: remote vendors do not use or deplete state or local resources which state or local taxes support. In fact, it would be patently unfair to force out-of-state companies to pay taxes for government services or programs they do not use or benefit from. State and local businesses pay or collect such taxes because they can take advantage of the programs or services provided with those funds. Remote vendors engaging in interstate electronic transactions do not benefit in a similar way from these taxes, and shipping companies already pay taxes to cover their use of public goods and services.

Moreover, Internet vendors are tangible "bricks and mortar" businesses that will continue to pay routine income taxes where they reside. A permanent Internet tax moratorium would only exclude states and localities from taxing remote vendors of electronic commerce.

The second fairness argument regarding the threat a Net tax moratorium would pose for future state and local tax revenues is equally flawed. The remarkable and explosive rise of the Internet and electronic commerce is creating a virtually unprecedented level of entrepreneurialism and innovation in America. Moreover, this remarkable technological renaissance has been the driving engine behind America's recent strong and sustained economic growth.

This has presented policymakers with a paradoxical situation. The rise of this new unregulated and, for the most part, untaxed industry sector, has helped fuel the sustained growth of not only economic activity, but government tax revenues as well. For the first time in decades, Americans now live in an "Age of Surplus," where federal, state, and local governments are taking in record tax revenues. How can this be if critics are correct in their contention that a tax-free Internet represents a serious drain on governmental tax collections?

Simple economics explains the apparent paradox. First, the rise of the Internet and the Information Economy has created new jobs and new business opportunities that did not exist previously. In turn, this increased economic activity and output increased individual income and business profits, which, consequently, provided new tax sources and higher revenues overall for all governments. And, again, it is important to reiterate that simply because interstate Internet transactions have been exempted from taxes, that does not mean companies engaging in electronic commerce are completely tax-free. Electronic vendors are still responsible for paying routine corporate income taxes and are treated like any other business within their home states. A permanent moratorium on Net taxes would not upset this balance in any way.

Internet commerce -- whether the provision of on-line access or the transactions undertaken once on-line -- is an unambiguous example of interstate commerce deserving of protection by Congress from unjust parochial tax schemes. While the definition of what constitutes "interstate commerce" has been much maligned throughout America's history, never before has there existed such an unequivocal example of interstate commerce in action. And never before has an industry or a technology so radically revolutionized and energized the American economy like the Internet. Imposing a balkanized and Byzantine tax system on this wonderful new technology would represent a betrayal of time-tested constitutional priorities and sound economic principles.

Therefore, the Advisory Commission should whole-heartedly recommend the adoption of a comprehensive and permanent moratorium on access and sales taxes for the Internet and remote commerce in general.

Tearing Down Tax-Related Barriers to Internet Access

Recommendation #2: Repeal the federal 3% excise tax on telecommunications

The federal 3% excise tax on telecommunications is an anachronism that should be repealed immediately and in its entirety.

The FET was first established in 1898 as a temporary tax to help finance the Spanish-American War, and then continued as a "luxury" tax to help pay for World War I. Today, the FET is third behind alcohol and tobacco as the largest general fund excise tax in the Federal budget, raising nearly $5 billion in FY 1998. When state and local taxes are taken into account, the average tax rate on telecommunications services in the U.S. is over 18 percent.

Taxes on telecommunications are, inevitably, taxes on the Internet. Whether through dial-up access or Digital Subscriber Lines (DSL), over cable modems or wireless ones, access to the Internet takes place over the telecommunications network. Indeed, over 50 percent of the traffic on the public switched telephone network is now comprised of data rather than voice. Thus, high telecommunications taxes slow the spread of Internet access and discourage deployment of the broadband networks needed for the next generation of Internet growth. They raise the costs of electronic commerce for every business, big or small, and raise the price of Internet access for every household, rich or poor.

Studies by the Joint Committee on Taxation, the Congressional Budget Office and the Treasury Department's Office of Tax Analysis have all concluded that the FET is the most regressive of all federal taxes. A recent study by The Progress & Freedom Foundation estimates that at least 165,000 U.S. households are priced out of the market for fast Internet access due to high telecom taxes, with the impact falling disproportionately on low-income and rural households.

The FET also discriminates against the very sector of the U.S. economy that is driving economic growth. While the information technology sector of the economy accounts for less than 10 percent of Gross Domestic Product, it has produced over 40 percent of GDP growth in recent years. Jobs created by the IT sector are among the highest paying jobs in the U.S. economy, with average annual wages in excess of $52,000, as compared with an economy-wide average of less than $37,000.


Recommendation #3: Prohibit the discriminatory ad valorem taxation of interstate telecommunications

This proposal will encourage investment in Internet infrastructure by prohibiting discriminatory state ad valorem property taxation of interstate telecommunications. It extends the same protection against discrimination that federal law currently provides to railroads, airlines and other industries critical to interstate commerce.

As Internet access is highly dependent on the telecommunications backbone, any excessive taxes on telecommunications restricts access to the Internet, either through higher costs to users or under-investment in capital expansion in telecommunications infrastructure. Available and affordable Internet access to Americans requires a nondiscriminatory tax burden on telecommunications service providers.

Other interstate industries faced with the same inequitable tax treatment have sought and received federal legislation prohibiting state and local government from applying property taxes to them in a manner different than to other business property generally. The first of these was the railroad industry, which in 1976 received property tax protection in the Railroad Revitalization and Regulatory Reform Act (the "4R Act"). This proposal adopts a similar approach for telecommunications, one that has proven to be effective at halting discrimination and encouraging investment while respecting state taxing prerogatives to the maximum extent possible.

State property tax discrimination against interstate telecommunications

Discriminatory property taxation usually takes two forms. First, as part of the concept of unit valuation, many states tax the intangible assets of public utilities while not taxing the same assets held by other businesses. These intangible assets, which include assets as diverse as federal operating licenses to an assembled work force, are often the most valuable portion of the utility's business. Second, states often apply a higher tax rate to the tangible personal property held by utility companies than that held by other business taxpayers generally. A recent study by the Committee On State Taxation (COST) illustrates this fact. Committee On State Taxation, 50-State Study and Report on Telecommunications Taxation, September 7, 1999.

The COST study found 15 states tax telecommunications' tangible personal property at a higher rate than other business property, and 14 states levy an ad valorem tax on telecommunications intangible property at a higher rate than other business intangibles. Please note the following chart:

States that tax telecommunications companies' tangible personal property at a higher rate: Alabama, Arizona, Arkansas, Colorado, Florida, Kansas, Maryland, Mississippi, Missouri, New Mexico, South Dakota, Tennessee, Texas, Virginia, and Washington.

States that tax telecommunications companies' intangible property at a higher rate: Colorado, Kentucky, Louisiana, Michigan, Mississippi, Montana, North Carolina, Nebraska, Oregon, South Carolina, South Dakota, Utah, West Virginia, and Wyoming.

The Impact of Discriminatory Property Taxation

  • Exporting Tax Costs to Non-Resident Consumers. Non-resident customers are the unwitting victims of discriminatory property tax practices. Since long distance rates are typically set nationwide, the tax burden is spread out across the country, regardless of the tax burdens imposed in the customers' local jurisdiction.
  • Discriminatory Taxes Result in Rate Increases, Furthering Digital Divide. The poor spend a higher portion of their incomes on utilities than wealthier Americans do. To the degree that discriminatory property taxes are wholly or partially passed on to customers in the form of higher utility rates, they constitute a regressive tax aimed at the nation's less fortunate citizens. Discriminatory property taxes increase telephone rates on the poor and exacerbate the digital divide.
  • Competition is Hindered. Telecommunications service providers that are subject to property tax discrimination are not able to compete on a level playing field with those that are not. In this rapidly evolving industry, different types of companies are now providing an array of telecommunications services.
  • Existing Remedies Inadequate. Even if a strong case against a discriminatory property tax could be made, current federal law severely curtails such challenges being heard in federal court unless an extremely high showing is made that the taxpayer has no "plain, speedy and efficient remedy" available. As a result, these taxpayers must file an appeal in the state court system and perhaps multiple local administrative agencies often composed of the same people who assess the property, thus making it more difficult to gain a fair hearing. Without federal protections, telecommunications companies are forced to pay the discriminatory taxes before seeking judicial review.
  • Inadequate Investment in Internet "Backbone" Infrastructure. The net result of all of these factors is a danger that telecommunications companies will make inadequate investment in the infrastructure backbone that is essential to the development of the Internet. Discriminatory taxation of telecommunications property reduces return on such property and investment in the Internet backbone is diminished as a result. Improved customer access to the Internet, the World Wide Web and electronic commerce will only come through lower costs associated with increased competition and adequate investment. Discriminatory property taxation of telecommunications companies stands squarely in the way.

A federal legislative proposal to extend 4-R property tax treatment to telecommunications carriers engaged in interstate commerce is sorely needed to protect investment in the Internet backbone. This proposal affords telecommunications companies the same tax treatment as their competitors for property tax purposes. Tax discrimination will be eliminated and increased investment encouraged. Ultimately, this policy will result in expansion of the Internet and improved access for all Americans.


Recommendation #4:
Prohibit government from erecting Internet tolls in the form of above-cost fees for the installation of telecommunications cable along right-of-ways.

 

State and local governments are using strained interpretations of the 1996 Telecommunications Act to impose "Internet tolls" in the form of new "franchise taxes" of up to 5% on business and consumer telecommunications use. With an average 18.2% transaction tax burden already imposed,22 Committee on State Taxation, 50-State Study and Report on Telecommunications Taxation, Testimony before the Advisory Commission on Electronic Commerce, September 14, 1999. these new taxes and related special "fees" could easily make telecommunications the most highly taxed product or service in the United States. Given the critical role these services play in accessing the Internet, such new taxes are a true impediment to the growth of widespread access to and use of the Internet. The Advisory Commission on Electronic Commerce must urge Congress to take remedial action immediately to clarify the Telecommunications Act of 1996 and to ensure state and local government tax policy is not a major contributor to the digital divide evident today.

The problem lies in the language of Section 253(c) of the Telecommunications Act of 1996. This provision states that: "[n]othing in this section affects the authority of a State or local government to manage the public rights-of-way or to require fair and reasonable compensation from telecommunications providers, on a competitively neutral and nondiscriminatory basis, for use of public rights-of-way on a nondiscriminatory basis, if the compensation required is publicly disclosed by such government." Unfortunately, state and local governments are routinely interpreting this language as granting them authority to impose a whole new regime of taxation on facilities-based telecommunications providers and their customers.

The most common of these new taxes imposed by state and local governments equate "fair and reasonable compensation . . . for use of public rights-of-way" with a "franchise fee" of 3%, 4% or even 5% of gross revenues attributable to customers physically located in the jurisdiction. Clearly, as found in a number of recent federal district court cases,2
-- Respectfully submitted by the members of the e-Freedom Coalition. www.e-freedom.org



Congress intended this term "compensation" to bear a direct relationship to the actual costs incurred by state and local jurisdictions in managing telecommunications facilities located in the public rights-of-way. Clarification by Congress of what is meant by "fair and reasonable compensation" is critical lest telecommunications providers will continue to incur years of costly litigation as state and local governments repeatedly attempt to impose new taxes never intended by Congress in adopting Section 253(c).

Specifically, Section 253(c) should be amended to make clear that state and local governments should be reimbursed only for their actual and direct incremental expenses incurred in managing the telecommunications providers' presence in the public rights-of-way. Clearly, telecommunications providers and their customers should be responsible for those expenses state and local governments incur in managing the placement of facilities in the public rights-of-way. And, just as clearly, Congress never intended state and local government to create a new tax regime that creates barriers to entry, discourages the development of facilities-based competitors and makes it much more expensive for both businesses and consumers to enjoy the benefits of advanced telecommunications services and access to the Internet. Accordingly, this new and detrimental form of taxation must be halted - this type of costly taxation can only have the effect of slowing the growth of high-speed access to the Internet.

Local governments have also misinterpreted Section 253(c)'s language regarding "authority . . . to manage the public rights-of-way" as providing them with authority to introduce a third tier of regulatory oversight. These attempts at local level regulatory oversight of telecommunications services always result in the telecommunications provider bearing significant and unnecessary costs. Local governments have repeatedly attempted to impose regulatory/management requirements on telecommunications providers that translate into increased costs of doing business in the local jurisdictions. Of course, these increased costs are passed along to business and consumer users of telecommunications in the form of increased rates - a hidden tax. These new local regulatory/management requirements, e.g. mapping requirements, facilities planning reports, provision of in-kind services, undergrounding of facilities, do not constitute "manag[ing]. . . the public rights-of-way" as envisioned by Section 253(c). Instead, as with new "franchise" taxes, these new local regulatory/management requirements have the effect of creating additional barriers to entry, discouraging the development of facilities-based competitors and making telecommunications services artificially more expensive. Congress must clarify Section 253(c) to bar this third tier of regulatory oversight.

Suggested new language for this subsection is presented below:

Nothing in this section affects the authority of a state or local government to manage the public rights-of-way or to require reimbursement of its fair and reasonable incremental costs from providers of telecommunications services. Such reimbursement shall be imposed on a competitively neutral and nondiscriminatory basis for use of public rights-of-way on a nondiscriminatory basis. Fair and reasonable incremental costs shall be limited to actual direct costs incurred by the state or local government in its management of the public rights-of-way and shall be publicly disclosed by such government.

No state or local government may require any provider of telecommunications services to provide in-kind services or to produce, deliver, or otherwise disclose any proprietary information in connection with such state or local government's management of the rights-of-way.

Section 253(c) of the Telecommunications Act was never intended to be the vehicle for erecting tolls on the information superhighway. The Commission should urge Congress to clarify the law to ensure that this abuse of telecommunications consumers is ended.

Recommendation #5:
Simplify state and local telecommunications taxes, filing and auditing procedures.

State and local telecommunications taxes are too high, too complicated, and too numerous. Consumers are burdened by multiple and often regressive taxes on their telephone service - often used to access the Internet - while providers must cope with complex filing and auditing procedures while passing compliance costs along to consumers.

The Commission should consider the following ideas to reduce and simplify state and local taxes on telecommunications:

  • Allow one statewide telecommunications transaction tax with one rate and tax base applying across the state.
  • Allow local jurisdictions currently imposing a transaction tax on telecommunications to continue the tax, however, each local jurisdiction should not impose more than one tax on telecommunications.
  • Require only one return per reporting period per state.
  • Allow only one audit per state for any taxable period.
  • Adopting a nationwide uniform set of rules for determining the proper state to source a transaction for tax purposes.
  • Adopting nationwide uniform definitions of terms representing common components of taxable and exempt telecommunications.
  • Provide adequate time to implement changes to the tax base or tax rates.
  • Provide a vendor compensation allowance to offset the cost of complying with local taxes.
  • Require any state and local transaction tax to follow a uniform tax base within the state.
  • Apply the same rules at the state and local levels for exempt transactions and customers.
  • Require only one return, filed at the state level, per reporting period with state distribution of funds to localities.
  • Follow a nationwide uniform set of rules for determining the proper state to source a telecommunications transaction for tax purposes.
  • Follow nationwide uniform definitions of terms representing common components of taxable and exempt telecommunications.

 

Enacting a Constitutional, Uniform Jurisdictional Standard


Recommendation #6:

Establish a clear nexus standard and definitions to determine when companies have sufficient physical presence that they can be required by a state to collect sales taxes.

The mission of the Advisory Commission on Electronic Commerce is to "conduct a thorough study of Federal, State and local, and international taxation and tariff treatment of transactions using the Internet and Internet access and other comparable intrastate, interstate, and international sales activities." The Commission has been directed to report its findings to Congress, along with "such legislative recommendations as required to address the findings."

A recommendation presumes a goal toward which our efforts are directed. This recommendation for your study and consideration is directed at a simple goal: promoting the expansion of economic activity through electronic commerce. Achieving that goal does not require abandoning state and local taxing authority, only better defining it. By placing clear parameters on state and local authority to tax interstate commerce, Congress can reduce the threat of taxation in jurisdictions in which a business does not have a substantial physical presence. The U.S. Supreme Court has long recognized that the Commerce Clause requires a physical connection between the taxing jurisdiction and the taxpayer. See Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). A substantial physical presence provides an identifiable standard that ensures a state's power to tax is limited to taxpayers within its borders. Nothing will do more harm to the growth of electronic commerce than expanding state and local taxing authority beyond their borders.

The threat of taxation is as much an issue as the obligation of taxation itself. The Supreme Court's decisions in National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967), and Quill Corp. v. North Dakota, 504 U.S. 298 (1992), have not been uniformly adhered to or interpreted. States continually litigate new theories in the hope of expanding their jurisdiction beyond their borders, not just for use taxes but other excise and business activity taxes. The cost to taxpayers in money and time is substantial. All the while, predictable jurisdictional standards are being eroded. This lack of certainty is the biggest threat to business on the Internet.

Encouraging Expansion of E-commerce by Improving Certainty of State and Local Tax Responsibilities

One of the biggest hurdles facing businesses engaged in interstate commerce is simply knowing which tax agencies are involved. For the on-line business, the uncertainty is positively mind-boggling because the technology itself poses new questions in jurisdictional standards. Can an ISP that facilitates the processing of data cause its customers to have tax obligations in the state, county and city of the ISP? Does the mere fact that a customer can order via your web page subject your company to taxation in the state of the consumer? What about the in-state use of a license or copyrighted material?

With the exception of PL 86-272, which relates strictly to state income taxes and to sellers of tangible personal property, Congress has left the question of the limits of state taxing authority to the courts. The courts, however, have failed to solve the problem. Each decision is the subject of subsequent dispute and argument over its proper application. New theories are developed and more time and energy spent litigating for certainty and predictability.

The definition of "substantial nexus" is most often the subject of dispute. Some decisions suggest that it applies differently depending on the type of tax. While the Supreme Court in Quill reiterated the standard of a "substantial physical presence" articulated in the 1967 decision of National Bellas Hess, 386 U.S. 753, some states argue their standard only applies to the collection obligation under the use tax, and not, for example, to income taxes. See Geoffrey, Inc. v. South Carolina Tax Commission, 437 S.E.2d 13 (S.C. 1993), cert. den., 510 U.S. 992 (1993) (foreign corporation's licensing of its Toys 'R Us trademark in the taxing state and the royalties generated from it established nexus even without a physical presence).

The indirect establishment of a substantial presence on the part of the out-of-state person is another fruitful ground of controversy. Over the last decade, the states have attempted to expand the theory of "attributional nexus," which attributes the substantial physical presence of one person to that of another either by way of agency or corporate affiliation. Does advertising by an out-of-state company on a web page that happens to be on a server located in the taxing state suffice? What about a logo on a web page "hot-linked" to an out-of-state vendor? What about the in-state presence of a telecommunications service provider's equipment used by an in-state resident to order from an out-of-state vendor with whom the telecommunications company contracts for services? For example, Texas has asserted that a web site on a Texas server creates nexus for an ISP's out-of-state customer.

Even if one assumes that jurisdiction to tax exists, the next layer of uncertainty is what is subject to tax (tax base) and the appropriate rate to apply. Computing the proper tax liability is the most intrusive aspect of taxation and in many cases the most burdensome aspect of taxation. The more tax agencies involved, the more burdensome compliance becomes.

Unlike the bricks and mortar business that state and local governments so often argue are being discriminated against, the out-of-state retailer is asked to do that which the in-state retailer is not: determine the place of use for each of its customers. For example, the brick and mortar retailer doesn't ask if I'm taking my purchase and going back to my home which is in a different taxing jurisdiction. They don't care. The sales tax treats the place of purchase as the place of consumption. However, if the same transaction occurred online via the company's web page, different standards would apply. If the store is in my home state, most likely the sales tax would once again apply but the seller would first have to determine the destination of the sale. If the seller was in a different state, the use tax applies and the seller would have to identify the destination of the sale and collect and remit based on the rules and rates for that local jurisdiction assuming the company has nexus (reliance on zip codes is not legally sufficient as many zip codes cross taxing jurisdictions). In the purely digital world, where both the consummation of the agreement and the exchange of the product or service occur on-line, location is not just irrelevant; it can be impossible to determine. The use tax is not a surrogate consumption tax, as some would suggest. It was a device conceived to protect in-state merchants.

The physical presence standard not only ensures ease of administration, it properly respects state borders. The basic purpose of taxation is to raise money for government services and programs. Why should a business, having no physical presence in a state, be obligated to contribute to the programs and services in that state? The argument of a "maintenance of a market" for the out-of-state business mistakes the nature of that market. The market exists because of the people, not the government (while such might be true in a centrally planned economy, it is not the case in America). And clearly, out of their own self-interest, the people who live in the jurisdiction properly pay the taxes necessary to support the roads, education and other infrastructure to meet the needs of that market.

Subjecting taxpayers to the intricacies of the tax codes of the jurisdiction in which they are physically present is not an insignificant burden, but subjecting taxpayers to all the tax codes in all the jurisdictions of their customers would create an insurmountable burden to all but the largest businesses.


Recommendation #7:
Protect consumer privacy by prohibiting government from collecting data on individual consumer transactions. Allow consumers and companies to make arrangements to share information.

Extending the moratorium on Internet taxes is the best way to protect consumer privacy in the face of an ever-encroaching government collection of information. If online tax legislation is to be considered at all, provisions regarding consumer privacy are critical.

It is clear that any new, expansive tax collection scheme for e-commerce is undesirable. We do find, however, that while taxes continue to be collected within the constitutional framework discussed herein, the privacy of the consumer should be protected as well as or better than in the analog world, which currently protects consumer privacy by allowing for cash transactions, which are essentially anonymous. Developments in privacy protection in the digital world, such as encryption, should not be stifled by elaborate new tax schemes.

With the expected rise of anonymous e-cash systems, the only information from the transaction that needs be collected is the home state of the consumer. In a sale of physical goods, this information can be taken from the delivery address given by the consumer. If a purchase is made of electronic goods, e.g. downloadable software, the vendor need only collect the home state of the consumer if there exists, in that state, a physical nexus of the vendor. Any further information the vendor wishes to collect would be a decision made between consumer and merchant. Even in the case of a credit or debit transaction personally identifying information available to the vendor is not required by the taxing authority, that is to say that the identity of the consumer is not revealed to the tax-collecting entity.

In the analog world, the merchant is the party responsible for the collection and settlement of the tax bill. Merchants are required, therefore, to keep records of the merchandise sold to prove actual transactions of some volume of business, but they are not required to keep records of the purchaser. This principle should carry over to the digital world. The only records the merchant must keep for tax collection purposes is the amount of goods and services sold in each state where the merchant has a physical presence that satisfies nexus requirements.

We further find that any proposed sales tax system can be administered without the necessity of personally identifiable information being delivered in any way to the taxing authority -- nor should any so-called independent third-parties be formed to collect taxes and transaction information, as proposed by some analysts. Such schemes leave open the threat of government collection of personal shopping habits.

In addition, we recognize a fundamental difference between government collecting information on its citizens and two private parties entering into a voluntary agreement. Clearly, a merchant knowing your purchasing behavior for the purpose of making sales recommendations stands distinct from the government building a profile, for whatever reason, of your purchases and activities. So, the Coalition does not recommend any action regarding a company and an individual entering into a voluntary agreement where a company may openly collect information regarding its customers.

We also acknowledge that in an instance where tax is not to be remitted that no collection of information regarding the transaction is necessary. In other words, we emphasize that transaction information (as compared to personally identifiable information, which is never necessary) is only relevant to taxation when an identifiable nexus exists (such as under the Quill standard, or an expanded Andal-like standard outlined above). If the vendor has no nexus in the customer's state, then no tax is paid, and therefore, the merchant has no need to collect any data on the purchase for the government.

There are four principles to which policymakers should strongly and faithfully adhere

  • No requirement for the collection of personally identifying information beyond which may be necessary to collect a tax, with the recognition that in substantially all cases the collection of sales tax does not require the collection of any personally identifying information.
  • No requirement for the collection of more information in the electronic world than in the analog world, with the recognition that in substantially all cases the collection of sales tax does not require the collection of any personally identifying information.
  • Recognition that the collection of information by private enterprise, where the consumer has knowledge of its collection and use, is fundamentally different than governmental collection of information.
  • No requirement for any collection of consumer information by or regarding any merchant that does not have nexus in the customer's state, as no tax would be remitted.

Again, no particular legislative action is needed to adhere to these privacy recommendations. However, if legislative action becomes necessary or desired the above listed principles of fundamental privacy must be kept in mind.