The Pros and Cons of Internet Taxes

Two sides lay out their cases for whether Internet transactions should be taxed.

The question of how and when the Internet should be taxed has stirred up a firestorm of controversy from the halls of Congress to the homes of Mr. and Ms. America. Among the issues being debated are whether should access be taxed; when does an e-commerce company have enough of a presence in a particular locality to establish nexus; will taxing the Internet stifle growth of this medium; what are the international implications of America's taxing the Internet; and much more.

The issue has been deemed so integral to America's economic future that a temporary ban on new Internet taxes was imposed by Congress in October 1998. Popularly known as the Internet Freedom Act, in addition to preventing new taxes until 2001, Public Law 105-277 established the Advisory Commission on Electronic Commerce to study and make nonbinding recommendations to Congress. This was done in 2000. Among the suggestions in the report were to clarify which factors do not establish a seller's physical presence in a state; to encourage state and local governments to work with the national Conference of Commissioners on Uniform State Laws to draft uniform sales and use taxation policies; and to make permanent the current ban on transaction taxes on the sale of Internet access.

Congressional legislators are currently trying to extend the moratorium through 2006. At the same time, in anticipation that eventually some sort of taxation will be allowed, state and local governments are developing processes that are expected to simplify America's complex system of multiple taxing jurisdictions.

To give entrepreneurs a grass roots understanding of how they are or will be impacted by the issue, Entrepreneur.com talked to people against and in favor of taxing the Internet. Dave McClure, president of the U.S. Internet Industry Association, spoke to us on behalf of those opposed to taxing the Internet, and Larry J. Jones, assistant executive director of the U.S. Conferences of Mayors, represents those supporting a tax. Following is a discussion of the respective camps' positions.

Does Industry Have Incentive to Negotiate?
Larry L. Jones: There's still a lot of incentive for the industry to negotiate with state and local governments. I think many people in the industry, particularly from the e-commerce side, understand what we're talking about is achieving a level playing field and eliminating the unfair advantage dotcoms have over brick-and-mortar retailers. Currently, local retailers are required to collect taxes, but dotcoms selling goods and services over the Internet are not required to do so. That message-the understanding that e-tailers have an unfair competitive advantage over local retailers-is beginning to get through to Congress. What we want, and I think most people will agree, is to have a level playing field. That's the primary reason why the moratorium does not remove incentive to negotiate.

Dave McClure: You're beginning with the premise that there is something that needs to be negotiated, and that is not correct. The Internet Tax Freedom Act only did three things: It prohibited the tax authorities from unfairly targeting Internet businesses with multiple and discriminatory taxes; it prohibited the states from rushing forward to implement new and punitive taxes on e-commerce; and it set up a commission to consider how the obsolete and unworkable tax structure of the 19th century could be updated for the electronic economy of the 21st. What the act specifically did not do was interfere in any way with the ability of the states to collect sales and use taxes. So long as they stay within the law, as defined by the U.S. Supreme Court in the Quill decision [Quill Corp. vs. North Dakota, May 26, 1992] and others, the states are free to tax sales on the Internet in keeping with their own state laws. Unfortunately, the act imposed only a three-year moratorium, and this removed any incentive the states had to work with the industry. They have consistently stalled in an effort to outwait the moratorium and strike at the industry with new and punitive taxes.

Will Taxes Stifle Net Growth?
McClure: No, but it will strangle electronic commerce in its infancy. Remember, we are not talking about standard sales taxes. Those are bad enough--if each state has only one sales tax, small businesses on the Internet would still have to file up to 600 tax returns each year (12 months x 50 states). And that's if there were only one rate, which is not presently true. It is not the tax itself that creates the burden. It is the requirement to have a fully-staffed tax compliance department capable of tracking the tax laws of all 50 states day in and day out. If the same requirement had been imposed on small businesses in the brick-and mortar world, there wouldn't be any small businesses left. But on top of subjecting every Internet business to the whims of 38,000 U.S. taxing authorities, the states also wish to impose new and special taxes on the Internet--on access, on services, on Web hosting, on e-mail and on transactions.

Jones: Taxes do not stifle the growth of the Internet. There is absolutely no evidence that people buy on the Internet to avoid paying taxes. I think they do it for convenience and because it gives them access to a much larger market from which to purchase goods and services. Certainly, in some cases, price comparisons are being done, which is good. But we think the Internet is a medium just like other mediums and should be treated no differently. If you go to the market or mall to purchase a jacket, suit of clothes or shoes, you're required to pay taxes. It should be the same on the Internet. Because local retailers understand and depend on local governments for roads, airports and the basic infrastructure that permits the free flow of commerce, they collect state and local taxes. Without this infrastructure, commerce would definitely be stifled.

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