No Internet
Tax
A Proposal
Submitted to the "Policies & Options" Paper Of
the Advisory Commission on Electronic
Commerce
By
Governor James
S. Gilmore, III Commonwealth of Virginia November 8,
1999
Policy Statement
(Proposed for Consensus Adoption and Inclusion In "Policies &
Options" Paper)
The Internet represents a
marvelous tool of empowerment for citizens, consumers and
entrepreneurs all over the world. It is the most transforming
technological development since the industrial revolution. As we
enter the 21st Century, American culture and our economy depend
vitally upon the Internet's full development. Therefore, American
public policy should embrace the Internet to realize all of its
social as well as economic benefits.
Evidence that the Internet is
driving America's economic boom can be found everywhere and was most
recently documented in a study conducted by the University of Texas'
Center for Research in Electronic Commerce. According to the study,
the nation's Internet-based economy grew 68 percent last year to
produce over $507 billion in business revenues. The Internet economy
has created 2.3 million new jobs. The Internet and information
technology sector now accounts for more than half the capital
investment in our country. And of the tens of thousands of new
businesses being created every year, research shows nearly one in
three did not exist prior to 1996. One sector of the Internet
economy – electronic commerce – accounted for nearly 1 million of
the 2.3 million jobs created by the Internet.
It is beyond dispute that the
Internet economy is creating new jobs and new business opportunities
and contributing to the stock market boom. Even in rural areas long
ago ignored by the economic progress in metropolitan areas and the
interstate highway system, small businesses are prospering by
selling products worldwide. VirginiaDiner.com in rural Wakefield,
Virginia, is a perfect example. The nation's huge investment of tax
dollars in the interstate highway system left Rt. 460, a classic
small town "Main Street," virtually abandoned years ago. Those
people who happened through Wakefield could stop into the Virginia
Diner and buy a cup of coffee and a can of Virginia peanuts. But the
Internet economy has empowered VirginiaDiner.com to sell Virginia
peanuts to consumers from Spain to California to Tokyo. The boom in
Internet sales has led the Virginia Diner to increase its employment
in Wakefield from 70 to 120 employees over the last three years and
this year the Diner will invest over $100,000 in new computer
hardware and software.
All of this economic activity
and increased productivity is creating new wealth and increasing tax
collections by governments. Indeed, the Internet economy has local,
state and federal tax coffers fuller and growing faster than ever
through the massive job creation and capital investment occurring in
every state in the Nation. The tax collector's glass is not
half-empty. It is full. In fact, the National Governor's Association
reports that the states collectively took in $11 billion in tax
surpluses in 1998 despite tax cuts totaling $5.3 billion in 1998 and
$4.9 billion in 1997. And end-of-year balances for all states
totaled $36 billion by the end of 1998.
Underlying all the documented
numbers is a profound social and economic transformation. Every
sector of our society is challenged to adapt to the new Internet
economy. Business is being conducted differently. Business models
are changing. Companies are more efficient and productivity per
employee is increasing exponentially. The same transformations are
occurring in education, in the way Americans live, obtain
information and conduct their own lives. Fundamentally, this
technology empowers. It empowers businesses, business leaders,
employees, educators, and mostly it empowers each individual
citizen.
All of this evidence validates
the maxim: The Internet changes everything. More to the point, the
Internet changes everything including government. Old rules do not
work well in this new borderless economy. Sometimes they do not work
at all. Regardless, change is everywhere, and government has to
change as well.
In the Internet economy,
government at all levels must change its policies as well as the way
it operates. The private sector is producing a 15 percent increase
in revenues and productivity per employee as a result of the
Internet according to the University of Texas' Center for Research.
Government must marshal the Internet to become equally as productive
per public employee in the delivery of government services. The
result should be a dividend to American taxpayers through
lower-cost, more efficient government. The savings should be
re-prioritized to other government services so that no city goes
without fire trucks or schools, and taxes should be kept
low.
There is a contrary view. The
contrary view is that the Internet changes everything except
government. That view wishes to impose a depression-era sales tax
based on the locus of a business transaction upon Internet-based
transactions which occur personal computer to personal computer from
any corner of the world. That view was characterized by Ronald
Reagan many years ago when he told a group of small business
leaders: "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." In the new
economy, what's moving is the Internet and the business and wealth
it generates, and many in government want to tax it, and eventually
regulate it, despite tax surpluses being generated by it across the
United States.
By burdening Internet consumers
with new tax burdens, by imposing new tax collection millstones upon
Internet-based entrepreneurs, or reporting all sales transactions to
third-party tax collection agents of the government who would view
the private purchases of each consumer, the evidence is clear that
government would severely inhibit economic growth of the Internet
economy and particularly impact small Internet entrepreneurs and
consumers. University of Chicago Professor Austan Goolsbee presented
to the Commission compelling evidence that the volume of sales over
the Internet would decline 30 percent if sales taxes were imposed on
Internet commerce. That impact is confirmed in survey after survey.
BizRate.com found that 75 percent of on-line customers would buy
less on-line if sales taxes were imposed and a survey by
Fabrizio-McLaughlin & Associates found that 34 percent of
Americans would be less inclined to make purchases over the
Internet. Ernst & Young also presented evidence showing
tremendous costs to Internet-based retailers to collect such taxes
across all states.
Imposition of sales taxes on
remote on-line sales may also significantly reduce the value of
Internet-based retailer stocks. Currently, no major Internet-based
retailer (or "e-tailer") in America is making a profit.
Internet-based retailers are operating at losses to build name
identification, customer base, and market position. Since price
continues to be mentioned as one of the primary concerns of on-line
shoppers, e-tailers are keeping their prices and mark ups as low as
possible to build customer loyalty. Since a sales tax would increase
the bottom line to the customer, most e-tailers would likely reduce
their prices to keep the bottom-line price paid by the customer to a
minimum. Many already do this to absorb the added costs of add
shipping and handling. Sales taxes collection costs would be an
additional overhead cost absorbed by each e-tailer. The upshot is
that most of the extra costs of collection and the actual sales
taxes would be absorbed into the overhead of the businesses,
delaying profitability for at least another 2-3 years for major
e-tailers. Delayed profits mean reduced stock value in the
short-run.
Moreover, the history of
taxation confirms that any new tax burdens on Internet-based
transactions will not stop at the taxation of tangible goods sold
over the Internet. The entire economy is shifting away from tangible
goods to services and information. According to a study conducted by
Ernst & Young, consumer spending for services has exceeded the
growth rate of spending on durable goods by 35 percent and the
growth rate of spending on non-durable goods by 50 percent over the
last decade. Ernst & Young estimates that 63 percent of current
business-to-consumer Internet sales are intangible services. If the
old way of government thinking prevails and the Internet changes
everything except government, then the American people will soon
face taxes on their access to digital goods, financial services,
entertainment and information transmitted from personal computer to
personal computer. Since the Internet's purest application is the
delivery of services, such new tax burdens would inevitably inhibit
the Internet's expansion as well as consumer privacy.
In return for inhibiting the
growth of the Internet economy, governments would increase their
sales taxes by approximately 1 percent of the sales tax base over
the next four to five years. Professor Goolsbee estimates that by
2003, sales taxes on Internet-based sales would amount to no more
than 1.4 percent total sales taxes collected nationally. To the
extent many on-line consumers are switching from catalogues to the
Internet, the 1.4 percent largely reflects a revenue-neutral shift
for state and local tax collectors.
But the costs of impeding the
Internet economy's growth and the public and private benefits
attendant to that growth could be far greater than an addition of
1.4 percent in sales tax collections for governments. Therefore,
government has sound public policy reasons to free the Internet and
the commerce it generates from taxes and the regulatory burdens and
privacy intrusions necessary to enforce a sales tax system at its
inception.
There are those who oppose
tax-freedom for consumers on the Internet because they say it
effects a "tax preference" or a "public subsidy" for Internet
commerce. To the extent tax-free treatment is viewed as a preference
or subsidy of the Internet, American public policy should embrace it
in order to realize the Internet's tremendous social and economic
potential.
Tax preferences and public
subsidies of certain business sectors are precedented, especially
where public benefits as great as those generated by the Internet
can be obtained. Many states and localities award new companies
subsidies of tax dollars to attract them. In the entertainment
industry, cities and counties have subsidized the construction of
multi-million dollar stadiums to attract the social and economic
benefits of professional sports teams. In the retail industry,
throughout the decades of the 1960s, 1970s and 1980s, suburban
counties invested millions of tax dollars to subsidize the
construction of shopping malls, much to the detriment of inner city
"Main Streets." And in the 1980s and 1990s, many states and
localities and the federal government have provided tax preferences
to inner city and rural "Main Streets" – commonly known as
"enterprise zones" – in order to revive business activity. The fact
that certain business sectors and sales transactions (e.g.,
services, the sale of securities, repairs) are not currently subject
to sales taxes is a tax preference or subsidy of sorts. Indeed,
inherent in any tax code are preferences for some behaviors deemed
socially and economically beneficial, whether it be home ownership,
research and development by a company, employing a person from
welfare, or the sale of medical services. Moreover, all local
businesses make use of the public resources like roads, sewers,
police, fire, schools and colleges where they are located, thus
receiving direct and indirect subsidies from their local government.
All of the above represent daily public subsidies or tax preferences
for some business sectors over others. Likewise, the Internet
produces such tremendous social and economic benefits that the
public's interest in keeping it tax-free is justifiable as sound
public policy.
Professor Goolsbee estimates
that a substantial portion of on-line shoppers are new shoppers and
concludes that, at present, research "does not seem to point to
intense competition between retail and online commerce at present –
consistent with the notion of Internet as trade creator." Thus,
there is little evidence that shopping malls and Main Streets will
be put out of business by the Internet in the same way malls put
Main Streets out of business over the last three decades. According
to the evidence, it is just as likely that purchases in stores will
continue to increase. It is equally evident that sales taxes on
purchases in stores will continue to increase and that proposals to
tax Internet commerce represent an effort to tax new commercial
activity (or at least commercial activity shifting from catalogues
to the Internet).
In any event, tax freedom on
Internet-based transactions regardless of where a business has
physical nexus will create an even-playing field for all retailers,
even those national chains that adapt to a "click and mortar" model.
All businesses will compete equally when they compete on the
Internet.
Failure to provide tax-free
trade over the Internet within the United States will necessarily
lead to businesses locating offshore to gain an advantage over
domestic businesses, especially in the service, digital goods and
information sectors. For all worried about discriminatory tax
treatments, Congress should consider the probability that some
Internet merchants, especially those who sell digital goods, would
simply locate off-shore somewhere in a place that doesn't require
them to ask consumers questions about where they live or to collect
sales taxes.
For all of these reasons,
American public policy should embrace the Internet and the
borderless economy it creates rather than impose old ways of
thinking and antiquated locus-based tax structures upon
it.
Policy Proposals (To Be
Included in Policy Options and Proposed for Adoption by
Commission)
Sales Tax Treatment of
Electronic Transactions
1. Congress Should Prohibit All
Sales and Use Taxes on Business-to-Consumer Internet Transactions:
The federal moratorium on Internet taxes should be amended to
prohibit all sales taxes on remote business-to-consumer transactions
facilitated by the Internet. The current moratorium should be
amended to create a tax-free zone for consumers and businesses over
the Internet as follows:
- The Tax Freedom Act should
be amended to prohibit the imposition of any sales tax on all
remote business-to-consumer purchases over the Internet;
- The prohibition should
expressly apply to the sale of tangible or intangible goods and
property, intellectual property, digital goods, services,
securities, information and content, and entertainment;
- The temporary moratorium
contained in the Tax Freedom Act should be extended to a permanent
prohibition against the imposition of tax burdens on electronic
commerce.
Income Taxation & Business
Activity Taxation in a Cyber Economy
2. Congress Should Protect
Companies from Unfair Income & Business Activity Taxes Imposed
Upon Them Due To Their Virtual Presence In States: States
traditionally have imposed their corporate income and related
business activity taxes only upon businesses that physically exist
in their jurisdictions. Traditionally that meant companies could be
taxed only if they maintained an office or employees in the state.
However, the Internet makes companies ubiquitous, and more state tax
collectors have begun to impute physical presence to companies due
to their virtual or electronic presence, or due to their ownership
of equipment needed solely to transfer information in a cyber
economy. The business community's concerns over being subjected to
unfair income or business activity taxes has been heightened by
recent court rulings in several states that "impute" physical
presence in various legal contexts due to their virtual or
electronic presence.
Commissioner Dean Andal, Vice
Chairman of the California State Board of Equalization, proposes
that we amend Public Law 86-272 (codified at 15 U.S.C. §§ 381-384)
to create a single uniform jurisdictional standard for taxing all
companies engaged in interstate commerce – "substantial physical
presence" – and to codify a clear definition of "substantial
physical presence" in a way that protects companies from unfair
taxation due only to Internet-based presence. The Commission should
adopt the Andal proposal to amend P.L. 86-272 as follows:
Extend the protections of P.L.
86-272 to all state and local government taxation;
- Provide express protection
to companies that sell intangibles, services and information in
addition to the current protection for only the sale of tangible
goods;
- A company that owns only
intangible property in a state would not have "substantial
physical presence" in a state and would not be subject to income
or business active taxes in that state;
- A company that uses an
Internet service provider or that places digital data on an
Internet service provider's web server in a state would not have
"substantial physical presence" in that state and would not be
subject to income or business activity taxes in that state;
- A company that uses
communications services in a state would not have "substantial
physical presence" in that state and would not be subject to
income or business activity taxes in that state;
- A company that is
"affiliated" with another company in a state would not have
"substantial physical presence" in that state and would not be
subject to income or business activity taxes in that state.
Taxes on Internet
Access
3. Prohibit All Taxes on
Internet Access: The Tax Freedom Act currently permits states to
impose taxes on consumers' monthly access charges in those states
that already had adopted them before October 1, 1998. The
grandfather clause for access taxes was controversial. The National
Governor's Association lobbied to extend taxes on Internet access
and won the day in Congress. Consequently, the tax on Internet
access has become a bargaining chip for those who want to impose
sales taxes on Internet transactions – a more lucrative tax for
government. But that bargain presents a false choice for the
Internet economy. The grandfather clause should be eliminated and
all states should be prohibited from imposing taxes on the ability
of the American people to log on the Internet and empower their
lives. To effect this amendment, Congress needs simply to eliminate
the grandfather clause contained in the current Act.
Taxes on
Telecommunications
4. Abolish the Federal 3%
Excise Tax on Telephone Service: A tax on a consumer's telephone
is a tax on Internet access because most Americans use their phone
lines to log on the Internet. Aside from its limitations on personal
empowerment, a tax on one's telephone is regressive. Congress first
enacted a federal tax on each consumer's local and long-distance
telephone service as part of the Spanish War Act of 1898 to fund
America's effort in the Spanish-American War. At the time few
American citizens owned telephones and the tax was premised as a
luxury tax. Over the ensuing three decades the tax was repealed and
reenacted several times. Since 1932, the tax has been levied at
varying rates on a continuous basis. The tax was extended to local
telephone services a few months prior to the U.S. entrance into
World War II by the Revenue Act of 1941. Throughout the decades of
the 1960s, 1970s, and 1980s, the tax was reduced and scheduled for
elimination, but that never occurred due to budget deficits in the
early 1980s. In 1987, the tax was made permanent at 3 percent. Today
the tax produces approximately $5 billion for the federal treasury's
general fund, or .3 percent of the total federal budget. The
Congressional Budget Office estimates that figure will double over
the next ten years. At the same time, the federal government expects
budget surpluses over the next ten years.
The Commission has pending
before it a resolution proposed by Commissioner Grover Norquist to
eliminate the federal excise tax on local and long-distance
telephone services. The Commission should adopt Commissioner
Norquist's resolution and the federal excise tax on telephone
service should be eliminated.
However, equally onerous to the
backbone of the Internet is the panoply of tens of thousands of
varying state and local taxes imposed on telephone services. By some
counts telephone companies spend millions of dollars each year to
file tax returns in over 40,000 taxing jurisdictions. Commissioner
Mike Armstrong has spoken eloquently and cogently of this tax and
regulatory burden which costs consumers millions of dollars in the
cost of telephone service.
It would be difficult for
Congress to try to solve this burden due to government dependency on
the existing telephone taxes and the wide variance of state and
local taxing authority. Therefore, I propose that Congress provide
each state an incentive for three years to simplify their complex
systems of multiple tax burdens in the process of eliminating the
federal excise tax according to the following plan:
- The federal government will
immediately eliminate 2% of the 3% federal excise tax. The federal
government would continue the tax at 1% for three additional
years. At the conclusion of three years, the federal excise tax
would be completely abolished at the federal level.
- This tax cut will
immediately save the American people over $3.3 billion this year,
doubling to $6.7 billion ten years from now.
- Each state would be called
upon to voluntarily simplify its system of multiple and
overlapping state and local telecom taxes into one rate per state
and one tax collection point. Internal distribution of telecom
taxes would be handled internally by each state. Each state would
have three years to accomplish this simplification. Each state
that simplifies its system within three years will automatically
be ceded the federal 1% telecom excise tax applicable to phone
services used in that state and the federal government would stop
collecting the 1% tax from phone bills in that state
altogether.
- In return for simplifying
their existing taxes, state and local governments would be ceded a
new revenue stream from the federal government amounting to $1.7
billion this year and doubling to $3.4 billion ten years from now.
Those funds would compensate states and localities for any sales
taxes foregone to Internet-based commerce. Since Ernst & Young
and Professor Goolsbee estimate that interstate Internet-based
sales would have provided states only $170 to $200 million in
sales taxes in 1998, this new revenue stream will create an
immediate tax windfall of $1.5 billion for states and
localities.
- American consumers would
benefit because the cost of telecommunications services could be
reduced in a competitive market to reflect savings in company
overheads. Reduction in telephone costs reduces the cost to log on
the Internet.
- States that do not simplify
state and local telecom taxes would not be ceded the 1% federal
tax and would lose the chance after three years when the federal
tax would automatically be abolished at the federal level.
International Tariff Treatment
of E-Commerce
5. No International Tariffs
on E-Commerce: International taxes and tariffs pose a tremendous
threat to U.S. global competitiveness. The Commission has voted
unanimously to oppose the imposition of any international tariffs on
Internet-based sales and transactions. The Clinton-Gore
Administration should vigorously oppose international tariffs on
transactions conducted electronically.
International Tax Treatment of
E-Commerce
6. No International Taxes on
E-Commerce: The United States should oppose the imposition of
any international taxes on Internet-based sales and transactions
originating in the United States to mirror the United States' own
domestic "tax free zone" over the Internet. The Clinton-Gore
Administration should vigorously oppose taxes by foreign countries
on U.S. sales conducted electronically, including bit and byte
taxes.
Abolish the Digital Divide for
All Consumers
7. Amend Federal Welfare
Guidelines to Permit States to Spend TANF Surpluses to Buy Computers
and Internet Access for Needy Families: Due to the success of
welfare-to-work reforms and the booming economy, welfare rolls have
been reduced dramatically across the United States. Consequently,
many states have accumulated surpluses of federal TANF (Temporary
Assistance to Needy Families) funds. Under federal statutes and
regulations, states arguably could use TANF funds to empower needy
parents and their children with computers and Internet access.
However, there is some doubt regarding the legality of using surplus
TANF funds (unliquidated obligations and unobligated balances) to
put needy families on-line. Therefore, Congress should clarify
federal law to permit states to use TANF surpluses to purchase
computers and Internet access for needy families.
America can abolish the digital
divide and empower needy families in rural America and inner cities
to participate in the Internet economy on an even playing field with
affluent families. Poor families should have the same tax-free
opportunity to purchase clothing and food, to invest in securities,
and to obtain critical information about employment and educational
opportunities as anyone else. TANF surplus funds are a rational and
available source of funds to accomplish this objective without
increasing taxes and without creating all-new entitlement programs.
Once federal law is amended, each state should act quickly to
partner with computer companies and Internet service providers for
the lowest prices for the most up-to-date hardware and software and
swift installation.
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