LEXIS-NEXIS® Congressional Universe-Document

Search Terms: internet W/10 sales W/10 tax, House or Senate or Joint

Document 45 of 142.

May 16, 2000, Tuesday

SECTION: PREPARED TESTIMONY

LENGTH: 1835 words

HEADLINE: PREPARED TESTIMONY OF J. WILLIAM HARDEN ASSISTANT PROFESSOR OF ACCOUNTING BRYAN SCHOOL OF BUSINESS AND ECONOMICS UNIVERSITY OF NORTH CAROLINA AT GREENSBORO

BEFORE THE HOUSE COMMITTEE ON WAYS AND MEANS SUBCOMMITTEE ON OVERSIGHT

SUBJECT - INTERNET TAX ISSUES

BODY:
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 mail-order 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 markets. 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 mail-order 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).

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.

FOOTNOTES:

1 "Tax Internet Sales.* The Issue Is Not So Black and White." Tax Notes. Volume 87, Number 5, May 1, 2000, 705-710.

END

LOAD-DATE: May 18, 2000

Document 45 of 142.


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