Copyright 2000 Federal News Service, Inc.
Federal News Service
April 12, 2000, Wednesday
SECTION: PREPARED TESTIMONY
LENGTH: 2554 words
HEADLINE:
PREPARED TESTIMONY OF JONATHAN ZITTRAIN
BEFORE THE
SENATE COMMITTEE ON COMMERCE, SCIENCE AND TRANSPORTATION
SUBJECT - S. 2255, A BILL TO EXTEND THE INTERNET TAX FREEDOM ACT
THROUGH 2006
BODY:
Chairman McCain, Ranking
Member Hollings, Members of the Committee:
My name is Jonathan Zittrain,
and I am the executive director of the Berkman Center for Internet & Society
at Harvard Law School, where I also teach on Internet-related subjects as a
lecturer on law. Among my research interests is the taxation of Internet
commerce, and last year I wrote an article (attached) for the National Tax
Journal on the subject with Prof. Austan Goolsbee of the University of Chicago.
Today the committee considers S. 2255, which is Chairman McCain's
proposal to extend through 2006 the moratorium on certain kinds of taxes set in
place by the Internet Tax Freedom Act. I will try to touch on the economic
implications of S. 2255 (and thus of the Internet Tax Freedom Act), as well as
on other, more significant forms of "Internet taxation" to which the Act does
not speak. My bottom line: The moratorium of the Internet Tax Freedom Act is not
objectionable, because the moratorium is so limited in scope that it has little
consequence for state tax revenues--it does not apply to
sales tax for physical goods bought over the
Internet. The moratorium may also help the Internet's growth at
an important time. However, the real issues still lie ahead, particularly
because while the Internet Tax Freedom Act is silent on state
sales tax for online commerce, a Supreme Court decision has
itself imposed an essential moratorium on such taxes. It thus falls to Congress
to decide what the boundaries of state taxation power are in this area, and what
research I have done in this area suggests that this more significant moratorium
may be helpful now, but should be lifted later. I will first speak to the
peripheral taxes covered by the ITFA moratorium, then to the more central taxes
covered by the Supreme Court's moratorium, and finally to some guiding
principles that might help sort out what the ultimate policies should be.
Why the Internet Tax Freedom Act's moratorium is not harmful to state
revenue interests--and is helpful to Internet growth
The scope of the
Internet Tax Freedom Act's moratorium is quite modest. It restricts states'
abilities to impose discriminatory or multiple taxes on Internet commerce, and
it prohibits new taxes on Internet access.
One example of a
discriminatory tax might be a surtax on products ordered through the Internet
(for example, a state assessing a 10% tax on books ordered online when it only
demands a 5% tax on books bought in a bookstore). Another would be claims by
multiple states to collect tax for a single transaction with a buyer in one
state and a seller in another, thus doubly taxing. Each of these examples is
hypothetical; I know of no major attempts by states to impose discriminatory or
multiple taxes on Internet commerce, and thus no substantial state money at risk
if this revenue stream were clearly marked off-limits. By its very terms, this
aspect of the moratorium seems at best sensible and at least unobjectionable.
Examples of the prohibition on new taxes on Internet access are taxes on
monthly subscription fees for America Online, mindspring.com, or any other
service that provides Internet access. This moratorium may impact the coffers of
states that wish to tax Internet access but did not have corresponding
legislation on their books before the moratorium came into force. The category
of taxable commerce affected here is small compared to the revenue to be gleaned
from the broad swath of traditional goods typically covered by sales
tax.
While the impact on state coffers may be small, the
subsidy to Internet usage and to all the economic progress that
flows from it could be large. This is because the Internet is subject to
positive "network externalities," which is to say that it becomes more useful to
everyone as more people use it. (This is a general phenomenon of networks;
compare how useful a fax machine might be to someone when only ten others own
one versus when millions of others own one.) Such networks can grow
exponentially once they reach critical mass, and signing more people on at a
given time--thanks to an ability to offer comparatively lower access
rates--amounts to a boost to future economic activity generally, at least to the
extent that new Internet commerce need not simply be drawn from competition with
existing retail stores. Further, any lessening of Internet access fees might
help bridge the "digital divide" by making Internet access that much more
accessible. A 5 or 6% difference might not seem like a lot, but there will be
some group of people on the margin for whom it would make the difference between
signing on and not signing on.
To be sure, once the Internet has reached
a natural saturation point among potential users, there is less reason to treat
its provision any differently from any other transaction subject to sales tax.
Thus the infant industry protection represented by the "no new access taxes"
part of the moratorium may not need to become ensconced as established industry
protection.
The bigger controversy, unaffected by the Internet Tax
Freedom Act: Taxation of Internet commerce
More notable than what the
ITFA moratorium covers is what it doesn't cover. The moratorium does not
preclude the application of state sales tax for physical goods
ordered through the Internet. The meat and potatoes of state
sales tax revenue comes from the sale of
physical goods generally, so this is the source of revenue that states are most
concerned about losing to tax-free sales of
goods over the Internet.
If the moratorium creates no
boundary, why the worry? Because there is another boundary out there: one that
separates in-state from out-of- state merchants. Sales tax is a tax technically
imposed on a consumer--when we buy something we fork over a little extra money
to cover the tax--but it is enforced and collected by the merchant. In its
landmark Quill decision,/1 the Supreme Court made it clear that it was
Congress's province to decide the extent to which one state could force a
merchant located elsewhere to collect a sales tax, even if the buyer, located in
the first state, is clearly subject to the tax. Since Congress has been silent
on the issue, states can only force out-of-state merchants to collect sales tax
on items they sell to people living there if the merchants have other "contacts"
with the state: so-called "nexus." In practice, out-of state merchants can
usually avoid creating that nexus, so many distant merchants (whether they
receive customer orders through the Internet, mail order, or
telephone) cannot be forced to, and do not, collect sales tax.
According to the Census Bureau, sales tax amounted to
$193 billion of state and local tax revenues in 1998. How do
transactions placed through the Internet fit in? The best estimate Prof.
Goolsbee and I could make on state sales tax revenue lost to
out-of-state merchants receiving taxable orders through the
Internet for 1998 is $430 million on total
sales of $7.3 billion, or 0.2% of the
collected tax kitty. Failure to pay tax on
Internet-generated sales is thus not currently
significantly denting state coffers.
What makes sales
tax on goods purchased through the Internet such an
issue then, despite the ITFA moratorium's silence on the subject and the
relatively small revenues currently at stake?
I can offer two reasons.
First, Quill provides its own effective moratorium on sales tax
on most Internet-driven sales unless Congress
rescinds it, and everyone has big expectations for the growth of the proportion
of sales taking place through Internet commerce. The most recent figures from
the Census Bureau estimate $5.3 billion in online commerce
sales for the fourth quarter of 1999, and Forrester Research estimates
$108 billion per year in online retail sales by 2003.
Predictions beyond 2003 are due to be quite speculative; perhaps between 2004
and 2007 revenue loss from online, interstate transactions for which Quill
blocks sales tax collection could amount to ten percent of total sales
tax revenue, if more interstate, sales
tax-exempt trade happens overall thanks to the added ease of
Internet ordering.
A second reason for the current
worry over an inability to apply sales tax to goods purchased across state lines
has to do with a desire not to unduly distort markets with arbitrarily applied
taxes. Tax experts may have differing personal views as to whether taxes should
be raised or lowered generally, but they tend to be in agreement over the idea
that one should tinker with rate rather than scope when seeking to adjust the
public's tax burden. Over the short term, at least, Quills moratorium on
out-of-state tax collection will likely encourage more people to use the
Internet for shopping, just as the ITFA's moratorium on new access charges will
encourage more people to sign up for Internet access in the first instance. But
as the use of the Internet matures and the benefits of the network externalities
I discussed earlier are reaped, distinctions such as "in-state/out-of-state" or
"ordered through Internet/ordered in a store" become truly arbitrary.
Differences in tax rates should be made on the basis of the substance of a sales
transaction, not on where or through what medium it takes place. Local
merchants, themselves in many instances limited to margins of 4 or 5% on their
wares, should not forever pay a sales tax while their online and/or out-of-state
counterparts do not.
Further, the enforcement costs of imposing taxes on
goods ordered and paid for over the Internet could drop over time. Thanks to
authentication and encryption technologies under development in the private
sector--technologies to ensure that when one orders a dozen pizzas through the
Internet, one cannot repudiate the bargain by saying someone else actually
placed the order--it may become quite easy to know who is buying what from whom,
to know where the buyer is, and then to collect the appropriate tax. This raises
serious privacy issues, particularly if the scope of state sales tax varies so
much that one must know and verify the nature of the item purchased in order to
actually assess and account for the tax. But in a simplified scheme where the
various states can agree on common definitions if not rates--something sorely
needed and long overdue--one could actually imagine the collection of sales tax
as second nature in online transactions, far easier than the corresponding
calculation, collection, and remittance by local merchants in a traditional
transaction. Indeed, structured properly, the collection of tax could come
straight from the user, converting "sales tax" collected from the merchant into
a corresponding "use tax" collected from the buyer, and in such a way that the
buyer would not revolt. (Current use taxes, owed by consumers whenever they have
managed to avoid having their merchants collect sales taxes thanks to Quill,
remain largely uncollected, presumably because consumers would not take well to
having to maintain accounts of everything they have purchased and what tax they
might owe on it.)
In the current political climate it seems difficult to
imagine Congress enabling states' collection of sales tax from out-of-state
merchants, so the revenues will only be obtained--if at all--through creative
electronic collection schemes that can manage to only minimally burden both
seller and buyer, or through reciprocal state tax collection agreements, through
which New York, say, could ask a New York merchant to collect and remit New
Jersey sales tax for its New Jersey customers. Neither of these solutions is
particularly appealing, nor are they easy to implement, though they well emerge
as alternatives to Congressional action to allow states to collect sales taxes
across state borders.
Again, over the long run, state boundaries seem
odd and unhelpful lines to draw on sales tax collection, as do boundaries
between electronic and physical means of ordering. The legal and technical
status quo whereby some transactions avoid the tax while others do not should,
in the long run, be traded in for a more comprehensive tax reform that offers
uniform tax relief (perhaps in tax rates) while enabling or maintaining other
revenue streams in as simple and direct a way as possible.
Digital goods
So far I have interpreted "Internet commerce" to cover the purchase of
physical goods ordered via a computer network instead of a telephone call or
visit to a store. I do see this as the core of the Internet tax controversy,
because a lot of money will sooner or later be at stake through such channels,
and because there exist bricks-and-mortar merchants who sell identical products
and for whom differential tax treatment seems, over the long
run, unfair.
But the Internet also enables the
sale of digital goods: e-books and software, for example.
Depending on one's reading of the Internet Tax Freedom Act, these purchases may
not be taxed by the states, whether the purchase is inter-state or intrastate.
Since the distribution of wholly digital goods is especially in its infancy,
even more so than the online purchase of physical goods, this would be an
auspicious time for a moratorium on taxes of such goods.
Indeed, we may
see the creation of new markets where individuals can sell cookie recipes or
bedtime stories one at a time, for 25 or 50 cents each. To insist on collection
and calculation of sales tax on such transactions might produce an
administrative barrier that would preclude the development of such a "small fry"
sellers' market.
It is also important to ensure that other countries to
not impose onerous or discriminatory taxes on digital Internet commerce,
especially as they might perceive that digital merchants on the Internet are
disproportionately American vendors.
Conclusion
The Internet Tax
Freedom Act does not speak to the taxes that really fill state coffers-and hit
consumers' pocketbooks. What few taxes it does preclude deserve to be precluded,
and thus an extension of the Act's moratorium seems perfectly appropriate, if
not particularly efficacious. But in passing this Act, it's important to note
that much more work remains to be done. In particular, the convening of the
commission that the Act chartered has helped focus attention on a long-simmering
issue for which the growth of the Internet is turning up the heat: the fact that
states require Congress's formal assent before they can readily collect most of
the taxes they wish to on goods purchased by instate consumers from out-of-state
merchants. A long-term compromise might be the easing of states' ability to
collect such taxes in exchange for a serious simplification and harmonization of
the substantive scope and administrative burden associated with the respective
state sales tax regimes.
An extension of the moratorium should be
accompanied by efforts to broaden the difficult conversation begun in earnest by
the Advisory Commission on Electronic Commerce and among officials representing
state and local governments, attempting to agree on the fairest and most
practical ways to enjoy economic growth and freedom while paying the piper for
the common services from which we benefit.
FOOTNOTES:
1 See
Quill Corporation v. North Dakota, 504 U.S. 298 (1994).
END
LOAD-DATE: April 13, 2000