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The Pros and Cons of Internet Taxes

Two sides lay out their cases for whether Internet transactions should be taxed.
March 23, 2001
URL: http://www.entrepreneur.com/article/38912

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.

Is Local Tax Enough?

Jones: We do have the authority to collect sales and use taxes. But having the authority and the ability are two different things. State and local governments rely on the seller to collect sales and use taxes from customers at the point of purchase. We know of no other effective way of achieving this. So we think it's only fair to require Internet companies to collect sales and use taxes, provided we make collecting such taxes easy and simple. We concur with those who say the current tax system is overly complicated and burdensome. To require business owners who sell to customers in multiple states to keep up with thousands of taxing jurisdictions, different tax rates, rules and administrative procedures is just too much.

However, we do believe that technology is available today that will enable us to come up with software all sellers can use that will provide them all of the information they need at the point of sale. State and local governments are in the process of working together to create such software, so it can be made available to all sellers.

McClure: The concept of "enough" doesn't fit well in this discussion. Who gets to decide what is "enough" vs. too little or too much? Generally, the state legislatures make that call. And in virtually every state where the matter has come before the legislature, those bodies have ruled not only that sales taxes are enough but are too much. From the perspective of the taxing authority, whose job it is to maximize the amount of tax revenue, the opposite is true-not only can there never be too much, there can never be "enough."

Should the Internet Be Taxed at All?
McClure: Of course Internet businesses should be subject to taxes--according to the same rules as other, similar businesses. As a nation, we have decided that it is counter-productive to tax access to the Internet if our goal is to have every home, business, school and library connected. That only makes it more difficult financially to reach our goal. But note that the U.S. Supreme Court, again in the decision in Quill vs. North Dakota, ruled that sales and use taxes are payments for services rendered to a business--fire and police protection, well-managed roads that lead to the business, and similar services provided by the state. Businesses that use these services should pay for them. Conversely, businesses that do not use these services should not have to pay for them. Thus was created the concept of nexus. If a business has nexus, it is making use of services from the local state and should pay for them. Those that do not have nexus are not using the services and should not be coerced into paying for them.

As for the lost revenue. . .well, what lost revenue? So far, other than a host of "Chicken Little" projections, most of the evidence seems to point to the opposite. To claim that revenue is being lost would infer that every transaction on the Internet would otherwise be conducted in a local store. In point of fact, there is no credible evidence that the sales of local stores are--or ever will--be threatened by Internet sales. Rather, the Internet competes more directly with catalog and telephone sales, where taxes are also not collected. Even if revenues did someday decline, that would simply reduce the number of businesses using state services--meaning less traffic on the roads, fewer fires, etc. That means the state could make a commensurate reduction in the services it provides, since those services would not be as greatly needed. Fewer cars on the road, for example, translates to less wear and fewer re-pavings.

Jones: We believe most state and local officials would agree that the Internet itself should be taxed. They don't believe a person should be taxed to access the Internet. But they do believe that if a person goes onto the Internet and orders goods and service, those goods and services should be taxed just as if they were purchased over the counter. We don't think customers should be taxed every time they access the Internet, just as they aren't taxed each time they walk into a shopping mall.

Should Dotcom and Brick-and-Mortars Be Taxed Equally?
Jones: The whole idea of having companies collect taxes is based on the nexus concept. If a company is located within the borders of a state, the state and its local governments have the authority to require the company to collect their taxes. We think state and local governments should be given authority to require dot coms to collect their taxes, when they sell to customers residing in their areas. That's what we will ask Congress to do. When a person walks into a store and purchases a suit, that local retailer is responsible for collecting the state and local sales taxes. Again, dot com companies should be required to do the same, as long as the process for obtaining tax information is simple and easy. Businesses shouldn't have to figure out the different tax rates for this state or that locality or what is exempt and what is not exempt. They should have all of that information provided to them in a simple way. Again, through use of technology, we think this could be provided in software.

McClure: The discussion is simpler if you view taxes as payment for government services rather than government-sponsored extortion. Though taxing authorities favor the "give us your wallet" approach, the courts have consistently held that they must actually provide something in return for the money they collect. So consider the dotcom vs. the brick-and-mortar business. Are both using the services of the state? Those that use the services should pay. Those that do not should not pay. The continuing attack on the Internet tax moratorium is an admission by the states that they wish to collect taxes without providing a service in return.

Is It Fair Not to Tax an e-Business?

McClure: What's "fair" about being forced to pay for services that are never rendered? We used to call such schemes a "protection racket" and prosecute those who operated them. Go back to the Supreme Court decision: The brick-and-mortar businesses collect and remit sales taxes as a payment for the services they receive that enable them to operate more efficiently and profitably. The sales tax is not based on where the customer is located-it's based on what services the business uses in its physical location. And to the extent that an Internet company uses services in its physical location, it should pay as well. The "use tax" was conceived as a way to make consumers pay for the services the businesses do not receive. That is, since there is no legal authority to charge a sales tax, the states implemented a "use tax" dedicated to the idea that somehow the state is entitled to the money anyway. Such taxes are almost never collected, since to do so would bring taxpayers to ask what the money is for.

Jones: It certainly is unfair to allow dotcoms to sell goods and services tax free when local retailers are required to collect taxes. It gives dotcoms an unfair competitive advantage. When you talk about big ticket items such as a computer that may cost $3,000 or $4000 and a resident of, say, New York purchases it in Oregon or Delaware-where there is no sales tax-he or she could save as much 8.5 percent. This could be a significant savings. That kind of thing would be unfair to local retailers.

It is also unfair, because most often when such goods as computers are sold over the Internet, they depend on local infrastructure supported by the sales tax. These goods must be transported over highways or streets, or use local airports, and receive protection from state or local police. All kinds of services kick in. How is it fair for a local retailer to partner with government by collecting taxes, and not have dotcoms do the same? All businesses would be required to do is collect what is rightly owed to state and local governments. It's not like they're paying money out of their budgets. This is not too much to ask of businesses, which depend heavily on the local infrastructure for the free flow of commerce.

Without a Tax, Will More Businesses Flock to the Net?
Jones: I would answer this way. It may not encourage them to eschew brick-and-mortar businesses, but they could set up a separate company for Internet sales, which might enable them to achieve the same effect. Instead of getting out of bricks and mortar, they could sell everything over the Internet and thereby avoid the responsibility of collecting taxes. For example, a company with stores in multiple states might set up kiosks in all its stores so anything can be purchased over the Internet. Customers in each store could use the kiosks to make purchases over the Internet [from the separate Internet company located in a different state], then go over to a counter [in the store] and pick it up. Under such circumstances, many believe the company would be under no obligation to collect state and local taxes.

McClure: It might, though what is their incentive? It's not as if the firms can just put that tax money in their pockets. It does mean less paperwork, less bureaucracy and more time for the business owners to focus on running their businesses. But remember that only a very few businesses can conduct their transactions over the Internet. We're still sorting it all out, but we're finding that things best purchased in a physical store are still best purchased in a physical store. In some cases, use of the Internet allows businesses to conduct transactions more efficiently, at a lower cost, and these efficiencies can be passed along to consumers. That's a good thing-for the businesses and for their customers. And that happens regardless of whether the transaction is subject to tax.

Should We Create One Taxing Body?
McClure: You mean, shouldn't we create yet another humongous federal bureaucracy so consumers could pay more and higher taxes to fund it? Call me crazy, but that doesn't strike me as a good idea. Consider the other possibility: There is a set of services that we, as business people, have determined are good for us and that we wish to see continue. We also wish to have these paid for on a fair basis, so that companies who use more of the services pay more, and vice versa. We know that the old models of sales, in which people shopped in their local neighborhood stores or went to town on Saturday to do their week's buying, don't apply anymore. And since that concept of sales is the basis for the sales tax, the whole notion of a sales tax is pretty obsolete. Some sales are local, some are not. If we accept the fact that we have to come up with some way of paying for the services and that sales taxes as presently structured won't do the job in the global economy of the 21st century, then we need to begin work on a replacement to the sales tax. Not a slap-on-any-old-tax approach. Not a band-aid. But meaningful reform of the tax structure that will result in a new and better way to fund government services fairly and honestly. That was the intent of Congress in passing the Internet Tax Freedom Act-to begin work on that new way. But as long as the states believe they can simply out-wait the moratorium and slap any old tax on the Internet, that badly needed reform will never take place. That is why an extension to the moratorium was introduced on April 7 [in 2000] in the House and Senate.

Jones: We're really strongly opposed to the idea of single taxing body. Our nation is not a nation of one but of many people and many units of government. Many states, counties and cities have different needs. People have different desires. One of the beauties of our country is the fact we have widely diverse groups of cities and counties that make their own laws rules, regulations and taxes based on what the citizens believe is best for them. It would be a sad day in this country, if legislation were adopted that eliminated the taxing authority of states and local governments. This would not only be contrary to our nation's constitution, but would stifle the creativity and innovations that so often come out of cities in response to the need to solve all types of public problems. Good ideas, many times, flow from the bottom up.