Speeches and Testimony

 

 

October 15, 1999

 

Taxation of E-Commerce

It is a pleasure to be with you this morning. As is always the case for Federal Trade Commissioners, it is important for me to note that my comments today are my own and in no way represent the views of the Commission or of any other Commissioner.

Before addressing the topic of Taxation In Cyberspace, it might be helpful to share with you some personal thoughts gained from my years of experience as a federal official. First and foremost, our Founding Fathers had it right: government should play only a minimal role in our lives. I believe it was Will Rogers who once observed: "All government programs have three things in common: a beginning, a middle, and no end."

I mention this because the promises of electronic commerce have those in government excited: the politicians see something to tax and more money to spend, and the regulators see something with endless possibilities to regulate. In their emotion, I fear they will forget some basic rules of a society built upon private enterprise.

Given the tremendous benefits that typically flow from private markets, government intervention in these markets should be undertaken only when it is clearly necessary. We in government, responsible for regulation and for economic and tax policy, should be ever mindful of the Hippocratic Oath -- "First, do no harm." Before embarking on any type of government activity, asking ourselves, "Does this make sense?" might serve us all well.

Taxation is a form of regulation. The history of taxation seems to be that every time a new product, a new industry, a new form of social organization, or even a new economic concept of income or wealth has arisen, governments have moved to tax it. As President Reagan said, "The government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it."

The Internet Economy

Earlier this year, the University of Texas, backed by Cisco Systems, introduced a study of the current status of electronic commerce -- one of the very first attempts to measure the Internet economy. According to the UT/Cisco study, the Internet economy generated an estimated $301 billion in revenue in 1998 and was responsible for over 1.2 million jobs. (These estimates are based on worldwide sales of Internet-related products and services by U.S.- based companies.)

The study divided the Internet economy into four layers: the infrastructure layer that includes companies like MCI Worldcom, AOL, and Cisco; the applications layer that includes companies like Netscape, Microsoft, and Sun; the intermediary layer that includes companies like Schwab.com, Yahoo, and TravelWeb.com; and the commerce layer that includes companies like Amazon.com, IBM, and WSJ.com. It is important to note that many companies are players at multiple layers. Each layer produced a range of revenues from $56 billion to $115 billion and created from 230,000 to 482,000 jobs in 1998.

Let me put those figures in perspective. The Internet economy already is bigger than the energy industry ($230 billion) or the telecommunications industry ($270 billion) and is almost as big as the automobile industry ($350 billion). The Internet economy is becoming as essential to American life as the automobile.

As impressive as this is, realize that the Internet is still in its infancy. Recall that the browser programs, such as Netscape, which make the Internet so consumer-friendly did not arrive on the scene until 1993.

The Question To Consider

As you may know, I spoke before the inaugural meeting of the Advisory Commission on Electronic Commerce this past summer. The question I posed that day is worth repeating today. "Should policymakers apply a Depression-era tax system to the economy of the 21st Century"? The answer to that question will have an enormous impact on economic growth -- the creation of wealth, jobs and prosperity -- throughout our country and the world. The question of imposing new taxes on the Internet is more than just an ideological debate. The economic consequences of government actions in e-commerce will be profound and serious. Any missteps will injure our country gravely, and diminish our position as the leading world economy.

The Internet is a competitive advantage for the United States: more than one-third of all current Internet usage is by Americans. The Internet advances the causes of free trade and improvement of living standards by creating a comparative advantage for people and firms that produce competitive, high-quality services and goods. Internet-specific taxes and taxes on Internet access threaten to choke the Internet at a critical early stage of its development. Unwarranted taxes and regulation at a time when the technology is still rapidly evolving threaten to lock in or limit the Internet to specific technologies and modes of service that fall far short of its likely potential. Tomorrow's tax policy will have an enormous impact in shaping the future of this burgeoning new industry of electronic commerce supported by the Internet.

The Complications of Taxing Internet Commerce

The issue of taxing the Internet is complicated by several factors:

• A. With approximately 30,000 taxing jurisdictions, compliance becomes a significant obstacle. The Internet is inherently susceptible to multiple and discriminatory taxation in a way that commerce conducted in more traditional ways is not. Double taxation would be inevitable because the borderless nature of the Internet makes taxation very tricky. If we simply required that merchants collect the relevant tax for the jurisdiction into which the product is being delivered, such legislation would produce a world that is anything but "simple." Can you imagine the confusion that would arise in the case where a small business owner from New Hampshire (a state without sales tax) is required to collect the tax on a purchase made by a consumer living in the Dallas area-- a metropolitan area with numerous suburbs, several of which have different local sales tax rates, in addition to Texas' state tax? Or even more bizarre, consider Internet sales of shoes-- a product that is tax exempt in some states but not others, depending on such factors as whether the footwear in question is tennis shoes, "sneakers," or cleated athletic shoes.
• B. Since Internet commerce is so new, we do not know what the basic business model will look like in a few years. How can we know how to tax it? There are likely many adverse unintended and unanticipated consequences lurking in the future.
• C. How would the taxes be collected? One of the main benefits of Web-based businesses is that the ability to reach such a large potential universe of customers cheaply provides an opportunity for small one- and two-person companies to thrive without a tremendous amount of start-up capital. The cost of compliance and tax collection alone for these small businesses could be enough of a deterrent to keep them from participating in the marketplace.

Clearly, compelling retailers to collect tax under the current jurisdictional regime would place a significant burden on merchants; and such a burden would likely not be uniformly felt across all retailers. If a recent study by the Washington State Department of Revenue is any indication of things to come, small businesses would be hit hardest with respect to the costs of compliance with multi-jurisdiction tax rates. More specifically, a recent study by one of the Big 5 accounting firms, Ernst and Young, has estimated the costs of compliance of small businesses to be close to 87 percent of the sales tax they collect--a far greater percentage than the 14 percent of the tax collected that it would cost large businesses to comply.

While these costs might be eased by employing various software packages, such software can cost well over $ 20,000. In a time where technology finally makes it possible for virtually anyone to realize the American Dream by starting out on his or her own and creating a business from scratch, do we really want to place one more barrier to entry in the form of heavy compliance costs in front of these potential entrepreneurs that might otherwise fuel our economy?

• D. Another major enforcement issue is identifying the state, country or countries that have tax jurisdiction over income generated by electronic transactions. Electronic commerce permits a foreign person to engage in multiple business transactions with customers in the United States without ever having entered the country.

Furthermore, do we want to enact a taxation scheme that, to be effectively implemented, systematically undermines our privacy by amassing a comprehensive database on our online purchases so that some government agency can be certain that we paid our relevant taxes? What guarantees do we, as consumers, have that such an agency, upon learning of our buying habits, will not either sell that valuable information to third parties or use it in a way that undermines our personal security?

The Lost Revenue Argument

Throughout this debate, the argument has often focused on the claim that failing to create a suitable Internet commerce tax will lead to the steady decline of state revenues, perhaps as much as $20 billion a year, significantly hindering the development of state infrastructure. While such arguments conjure up a frightening vision of what could occur, are such predictions accurate? Another recent study by Ernst and Young has shown that less than $170 million of sales and use tax were not collected in 1998 on Internet sales -- only 1/10 of one percent of total state and local tax revenues. This small effect is due to a number of factors, two of which should be noted. First, an estimated 80 percent of current e-commerce is business-to-business sales that are not subject to sales and use taxes. Second, an estimated 63 percent of current e-commerce business-to-consumer sales are services such as travel and financial services that are not subject to state and local sales and use taxes. These estimates are similar to another study by scholars at the University of Chicago and Harvard who have estimated the loss to be close to 1/4 of one percent. Considering the future growth of electronic commerce, these scholars have predicted that even after five years, the average loss in sales tax revenue to states will amount to only two percent of potential tax revenues--a mere fraction of the $20 billion loss that has been predicted by the proponents of Internet taxation. Is retaining this minor loss in tax revenue worth crippling potential entrepreneurs as they strive to find a place for themselves in this dynamic new marketplace?

Those advocating taxation of the electronic marketplace are also operating on the basis of expectations: they are hungrily anticipating revenue to spend as a result of taxes collected on new products or services. What they may lose sight of, however, is that inappropriate government intrusion in the form of regulation and taxation may in fact chill the development and marketing of new products and services.

Recommendation

Let me offer a proposal, that I favor, for your consideration. Senator John McCain has introduced legislation to permanently ban Internet sales taxes by specifically outlawing any future attempts to impose a sales tax structure on Internet sales. In addition, Senator McCain's bill calls for WTO adoption of a global moratorium on Internet taxes. As Senator McCain said on the Senate floor, "This bill would make permanent the moratorium on sales and use taxes for e-commerce, and would encourage the Administration to urge our world trading partners to do the same."

I could not agree more with Senator McCain. While the Advisory Commission on Electronic Commerce seems more focused on how to tax the Internet, only Congress can authorize one state to compel sellers in another state to collect Internet taxes. It is important to move forward to ensure that the default position is not to lift the moratorium on Internet taxation, but to place the burden of proof on those advocating taxation of e-commerce.

Thank you.