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Some Policy
Perspectives on the Taxation of Cyberspace by Orson Swindle on 11/19/99 of
Federal Trade
Commission Topic:
Taxation |
I
Address to the
Federalist Society Silicon
Valley Lawyers Chapter and Corporations Practice
Group Palo Alto,
CA
November 2,
1999
It is a pleasure to be with you this
evening. As is always the case for Federal Trade Commissioners, it
is important for me to note that my comments today are my own and in
no way represent the views of the Commission or of any other
Commissioner.
Before
addressing the topic of
"Some Policy Perspectives On The
Taxation Of Cyberspace," it might be helpful to share with you some
personal thoughts gained from my years of experience as a federal
official. First and foremost, our Founding Fathers had it right:
government should play only a minimal role in our lives. I believe
it was Will Rogers who once observed: All government programs have
three things in common: a beginning, a middle, and no end."
I mention this because the
promises of electronic commerce have those in government excited:
the politicians see something to tax and more money to spend, and
the regulators see something with endless possibilities to regulate.
In their emotion, I fear they will forget some basic rules of a
society built upon private enterprise.
Given the tremendous benefits that typically flow
from private markets, government intervention in these markets
should be undertaken only when it is clearly necessary. We in
government, responsible for regulation and for economic and tax
policy, should be ever mindful of the Hippocratic Oath -- "First, do
no harm." Before embarking on any type of government activity,
asking ourselves, "Does this make sense?" might serve us all
well.
Taxation is a form of
regulation. The history of taxation seems to be that every time a
new product, a new industry, a new form of social organization, or
even a new economic concept of income or wealth has arisen,
governments have moved to tax it. As President Reagan said, "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."
The Internet Economy
Earlier this year, the University of Texas, backed by Cisco
Systems, introduced a study of the current status of electronic
commerce -- one of the very first attempts to measure the Internet
economy. According to the UT/Cisco study, the Internet economy
generated an estimated $301 billion in revenue in 1998 and was
responsible for over 1.2 million jobs. Last week the authors of the
study projected that the Internet Economy will grow to $507 billion
this year and produce over 2.3 million jobs. That's a projected 67%
and 46% increase respectively in one year my friends. (These
estimates are based on worldwide sales of Internet-related products
and services by U.S.- based companies.)
Let me put those figures in perspective. In 1998,
it meant that the Internet economy was the second largest industry
in the United States, second only to the automobile industry at $350
billion. For 1999, if the projections hold, it means the Internet
Economy has become the largest industry in our country. And what is
even more impressive is that the Internet is still in its infancy.
Recall that the browser programs, such as Netscape, which make the
Internet so consumer-friendly did not arrive on the scene until
1993.
The Question To
Consider
As you may know, I
spoke before the inaugural meeting of the Advisory Commission on
Electronic Commerce this past summer. The question I posed that day
is worth repeating today. "Should
policymakers apply a Depression-era tax system to the economy of the
21st Century"? The answer to that
question will have an enormous impact on economic growth -- the
creation of wealth, jobs and prosperity -- throughout our country
and the world. The question of imposing new taxes on the Internet is
more than just an ideological debate. The economic consequences of
government actions in e-commerce will be profound and serious. Any
missteps will injure our country gravely, and diminish our position
as the leading world economy.
The Internet is a competitive advantage for the United
States: more than one-third of all current Internet usage is by
Americans. The Internet advances the causes of free trade and
improvement of living standards by creating a comparative advantage
for people and firms that produce competitive, high-quality services
and goods. Internet-specific taxes and taxes on Internet access
threaten to choke the Internet at a critical early stage of its
development. Unwarranted taxes and regulation at a time when the
technology is still rapidly evolving threaten to lock in or limit
the Internet to specific technologies and modes of service that fall
far short of its likely potential. Tomorrow's tax policy will have
an enormous impact in shaping the future of this burgeoning new
industry of electronic commerce supported by the Internet.
The Complications of Taxing
Internet Commerce
The issue of
taxing the Internet is complicated by several factors:
The Internet is inherently
susceptible to multiple and discriminatory taxation in a way that
commerce conducted in more traditional ways is not. With approximately 30,000 taxing jurisdictions,
compliance becomes a significant obstacle. Double taxation would be
inevitable because the borderless nature of the Internet makes
taxation very tricky. If we simply required that merchants collect
the relevant tax for the jurisdiction into which the product is
being delivered, such legislation would produce a world that is
anything but "simple."
Can you
imagine the confusion that would arise in the case where a small
business owner from New Hampshire (a state without sales tax) is
required to collect the tax on a purchase made by a consumer living
in the Dallas area-- a metropolitan area with numerous suburbs,
several of which have different local sales tax rates, in addition
to Texas state tax? Or even more bizarre, consider Internet sales of
shoes-- a product that is tax exempt in some states but not others,
depending on such factors as whether the footwear in question is
tennis shoes, sneakers, or cleated athletic shoes.(1)
How can we know how to tax it? Since Internet commerce is so new, we do not know what the
basic business model will look like in a few years. There are likely
many adverse unintended and unanticipated consequences lurking in
the future.
How would the
taxes be collected? One of the
main benefits of Web-based businesses is that the ability to reach
such a large potential universe of customers cheaply provides an
opportunity for small one- and two-person companies to thrive
without a tremendous amount of start-up capital. The cost of
compliance and tax collection alone for these small businesses could
be enough of a deterrent to keep them from participating in the
marketplace.
Clearly,
compelling retailers to collect tax under the current jurisdictional
regime would place a significant burden on merchants; and such a
burden would likely not be uniformly felt across all retailers. If a
recent study by the Washington State Department of Revenue is any
indication of things to come, small businesses would be hit hardest
with respect to the costs of compliance with multi-jurisdiction tax
rates. More specifically, a recent study by one of the Big 5
accounting firms, Ernst and Young, has estimated the costs of
compliance of small businesses to be close to 87 percent of the
sales tax they collect--a far greater percentage than the 14 percent
of the tax collected that it would cost large businesses to comply.
While these costs might be eased by employing various software
packages, such software can cost well over $ 20,000.(2)
In a time
where technology finally makes it possible for virtually anyone to
realize the American Dream by starting out on his or her own and
creating a business from scratch, do we really want to place one
more barrier to entry in the form of heavy compliance costs in front
of these potential entrepreneurs that might otherwise fuel our
economy?
Who has taxing
and regulatory jurisdiction?
Identifying the state, country or countries that have tax
jurisdiction over income generated by electronic transactions may be
a problem with no solution. Electronic commerce permits a foreign
person to engage in multiple business transactions with customers in
the United States without ever having entered the
country.
And lastly, what
about personal privacy? Do we
want to enact a taxation scheme that, to be effectively implemented,
will likely have to systematically undermine our privacy by amassing
a comprehensive database of our online purchases so that some
government agency can be certain that we paid our relevant taxes?
What guarantees do we, as consumers, have that such an agency, upon
learning of our buying habits, will not either sell that valuable
information to third parties or use it in a way that undermines our
personal security?
The Lost
Revenue Argument
Throughout
this debate on taxing Internet use and commerce, the argument has
often focused on the claim that failing to create a suitable
Internet commerce tax will lead to the steady decline of state
revenues, perhaps as much as $20 billion a year, significantly
hindering the development of state infrastructure.(3) While such arguments conjure up a frightening
vision of what could occur, are such predictions accurate? Another
recent study by Ernst and Young has shown that less than $170
million of sales and use tax were not collected in 1998 on Internet
sales -- only 1/10 of one percent of total state and local tax
revenues. This small effect is due to a number of factors, two of
which should be noted. First, an estimated 80 percent of current
e-commerce is business-to-business sales that are not subject to
sales and use taxes. Second, an estimated 63 percent of current
e-commerce business-to-consumer sales are services such as travel
and financial services that are not subject to state and local sales
and use taxes.
These
estimates are similar to another study by scholars at the University
of Chicago and Harvard who have estimated the loss to be close to
1/4 of one percent.(4) Considering the future growth of electronic
commerce, these scholars have predicted that even after five years,
the average loss in sales tax revenue to states will amount to only
two percent of potential tax revenues. This is a mere fraction of
the $20 billion loss that has been predicted by the proponents of
Internet taxation.(5) Is retaining this minor loss in tax revenue worth
crippling potential entrepreneurs as they strive to find a place for
themselves in this dynamic new marketplace?
Those advocating taxation of the electronic
marketplace are also operating on the basis of expectations: they
are hungrily anticipating revenue to spend as a result of taxes
collected on new products or services. What they may lose sight of,
however, is that inappropriate government intrusion in the form of
regulation and taxation may in fact chill the development and
marketing of new products and services.
Recommendation
Let me offer a proposal that I favor for your consideration.
Senator John McCain has introduced legislation to permanently ban
Internet sales taxes by specifically outlawing any future attempts
to impose a sales tax structure on Internet sales. In addition,
Senator McCain's bill calls for WTO adoption of a global moratorium
on Internet taxes. As Senator McCain said on the Senate floor, "This
bill would make permanent the moratorium on sales and use taxes for
e-commerce, and would encourage the Administration to urge our world
trading partners to do the same."
I could not agree more with Senator McCain. While some
Members of the Advisory Commission on Electronic Commerce seem more
focused on how to tax the Internet, only Congress can authorize one
state to compel sellers in another state to collect Internet taxes.
It is important to move forward to ensure that the default position
is not to lift the moratorium on Internet taxation, but to place the
burden of proof on those advocating taxation of e-commerce that new
taxes are a good idea.
Thank
you.
Endnotes:
1. Both
of these examples were taken from Cline, Robert J., and Thomas S.
Neubig. "Masters of Complexity and Bearers of Great Burden: The
Sales Tax System and Compliance Costs for Multistate Retailers,"
Ernst and Young Economics Consulting and Quantitative Analysis,
September 8, 1999.
2. Harry
Tennant and Associates, (1997), "Sales tax, use tax and Internet
Transactions" cited in Lukas, Aaron, "Tax Bytes: A Primer on the
Taxation of Electronic Commerce" (CATO Institute, typescript,
1999).
3. The estimate of $20
billion has been offered by the National Governors' Association.
"Governors fear tax loss from Internet; States' surpluses treated
cautiously," Boston Globe, December 31, 1998.
4. Cline, Robert J. and Thomas S. Neubig, AThe Sky
is Not Falling: Why State and Local Revenues Were Not Significantly
Impacted by the Internet in 1998," Ernst and Young Economics
Consulting and Quantitative Analysis, June 18, 1999 Cline and Neubig
have offered the figure of 1/10 of one percent loss. (Goolsbee,
Austin and Jonathan Zittrain, "Evaluating the Costs and Benefits of
Taxing Internet Commerce"( University of Chicago Graduate School of
Business, typescript 1999.) have estimated the loss to be closer to
1/4 of one percent.
5.
Goolsbee and Zittrain, supra n. 4. | |
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