A bare majority of the Advisory Commission on Electronic Commerce (ACEC) submitted a report to Congressional leaders on April 12 that says much more about ideologies of taxation than about electronic commerce. Recommendations in the report would seriously undermine local and state taxes, and even some federal taxes, and call for federal legislation to exempt many sales transactions -- whether electronic commerce or not -- from local and state taxes. Instead of grappling with hard issues to produce a win-win for both electronic commerce and state and local government, the Commission turned itself into the mouthpiece for companies that want tax breaks at the expense of their competitors.

In establishing the Commission, the Congress tried to avoid this one-sided result. The enabling legislation for the Commission requires that the final recommendations be "tax and technology neutral." The law also requires that the Commission obtain a two-thirds majority vote for any report that the Commission submits to the Congress. The purpose of these requirements was to assure that the Chair of the Commission and any majority would try to achieve a fair consensus on the difficult issues before them. Instead, the Chair and a bare majority refused even to publish a minority report that might have provided some balance. The Commission has failed to meet its mandate and it is time to build a constructive solution in its place.

The U.S. Conference of Mayors has prepared this report on behalf of its member cities and the many businesses and individuals in their communities who would be disadvantaged by new tax exemptions and tax avoidance on out-of-state sales that would be possible under the Commission’s bare majority recommendations. We wish to make five points:

• Sales taxes are an essential part of the tax base for many cities.

• Localities and states have chosen different tax systems that reflect local traditions and needs. Therefore, it is important to preserve the local option sales tax on electronic commerce and remote sales.

• The report makes recommendations that would harm American communities by eroding their ability to collect sales taxes that are essential (1) for tax fairness and (2) to pay for essential public services.

• The report makes recommendations that would dramatically reduce state and local taxes on telecommunications providers at the expense of taxpayers.

• Working together, local and state governments, businesses involved in electronic commerce, traditional retailers, other concerned parties and individuals can create a win-win system of fair and minimally burdensome taxation of electronic commerce and remote sales that leaves local and state tax systems intact.

1. Sales taxes are an essential part of the tax base for many cities.

   The Commission's majority report itself admits that sales taxes are important to many localities. It points out that sales taxes have been historically important and that thirty-three states currently authorize local sales taxes. As the majority report concedes:

   "State and local governments that levy sales taxes rely on them as a major source of revenue for their general funds. According to the U.S. Census Bureau, state and local governments collected approximately a total of $237 billion in sales and use taxes in 1999, comprising 24.8% of all revenues generated that year."

   For many local governments, sales taxes are an essential source of revenue. Of the 25 largest cities that collect general sales taxes, four cities (Albuquerque, Denver, Oklahoma City, and Tucson) rely on them for over half of all tax revenues. Another seven cities (Austin, El Paso, Nashville-Davidson Metro area, New Orleans, Phoenix, San Antonio, and San Diego) rely on them for between thirty and fifty percent of tax revenues. (U.S. Census, Statistical Abstract of the United States: 1999, p. 334, "City Governments--Revenue for Largest Cities: 1996").

   These are huge numbers. For most of these cities (Albuquerque, Austin, Denver, Nashville-Davidson Metro area, New Orleans, New York, Oklahoma City, San Diego, and Tucson), the amount collected in general sales taxes exceeds the amount that they spend on police protection. (U.S. Census, Statistical Abstract of the United States: 1999, compare p. 334, "City Governments--Revenue for Largest Cities: 1996" to p. 335, "City Governments -- Expenditure and Debt for Largest Cities: 1996).

   Sales taxes also are an important source of a city's local bonding capacity. Local governments use sales taxes to back bonds for many different purposes: local school district capital needs in Iowa and Louisiana, infrastructure in Texas and California, transportation in New York City, a jail in New Mexico, and municipal parking in Phoenix, for example. (Standard & Poor's CreditWeek Municipal, August 16, 1999, p. 10).

    

2. Localities and states have chosen different tax systems that reflect local traditions and needs.

The American federal system reflects democracy at its best. Localities and states choose the mix of taxes, and the level of taxes that best suits their preferences, traditions, and needs. Thousands of localities levy sales taxes while many others do not. In addition to general sales taxes, some localities and states may tax special items, such as tobacco or alcohol products, at special rates.

Two recent examples are of special interest because they show how high-technology companies themselves support increased local sales taxes to meet new local needs. In Silicon Valley and in the high-tech corridor of Northern Virginia, technology companies have played a major role in calling for increased local sales taxes to pay for transportation projects, to alleviate traffic congestion. (See, "Region Coalition Presents Comprehensive 'Infrastructure Investment Platform,'" http://www.region-va.org/, release dated August 23, 1999; Northern Virginia Technology Council, http://www.nvtc.org/, "The Voice of Technology -- September 1999; and Carl Guardino, "Self-Help Counties -- California's Transportation Success Story," Cal-Tax Digest, July 1999, http://www.caltax.org/).

It is remarkable that, just when their representatives on the Advisory Commission were calling for an erosion of local taxes, these technology companies also were urging an increase in the level of sales taxes in their own localities. If the Commission's bare majority recommendations ever become law, these companies would be able to place all of that local sales tax burden on consumers who shop at local retail stores, rather than over the Internet.

Cities and states have local traditions and concerns about tax equity that they build into their tax systems. A major concern about the Commission recommendations is the way that high-income taxpayers would be favored by the proposed tax exemptions on Internet and catalogue sales. Experts point out that households with incomes over

$ 75,000 are over eight times as likely to have home Internet access as households with incomes between $ 10,000 and $ 15,000. While households with incomes below $25,000 make 25 percent of all retail purchases, they make only six percent of on-line purchases.

The same disparity exists with catalogue sales that the Commission also would favor. Households with incomes above $ 80,000 are more than twice as likely to shop from catalogues as households with incomes of $ 25,000 and below. (Testimony of Iris J. Lav, Deputy Director, Center on Budget Priorities, before the Senate Budget Committee, February 2, 2000; Michael Mazerov, Center on Budget Priorities, "Should the Internet Remain a Sales Tax Haven," December 23, 1999).

Federal preemption of local and state tax systems, as urged by the Commission majority, is especially noxious when it favors the well-to-do over lower income consumers who have a greater need for tax relief.

The majority report recommends sweeping federal preemption of the authority of local and state governments to collect sales taxes. The recommendations hit at many different levels. Some of the most egregious recommendations call for:

1. Exemption of many Internet transactions from sales taxes;
2. Reduced taxation of property taxes paid by telecommunication companies;
3. Expansion of the exemptions to include transactions that currently would subject a company to responsibility for collecting sales taxes (the so-called "nexus" rules that currently subject sales by out-of-state companies to local and state taxes);
4. Creation of a single rate per state for all remote sales; and
5. Expansion of sales tax exemptions to include ordinary goods that today are sold in local stores such as CDs, newspapers, books, software, movies and other products that are deemed to be "functionally equivalent" to so-called "digitized" products and services.

Consider each of these in turn:

Exemption of many Internet transactions from sales taxes: The Commission majority would impose a five-year prohibition on taxing sales of so-called digitized goods and products. The preemption would apply to a broad and undefined number of goods, including software, subscriptions to online databases and information services, online publications, and probably tangible products such as music and software CDs and diskettes. The exemption of such goods and services would add significant complexity to the variety of sales tax rates and exemptions that the Commission itself complains about. More important, local and state governments would need to compensate for the lost revenue by increasing other taxes.

Reduced taxation of property taxes paid by telecommunication companies: This item is egregious because it shows that there are few limits to the desire of the Commission to preempt local tax systems. Under our constitutional system, the property tax is not a suitable subject for federal legislation.

Moreover, telecommunications companies have flourished in recent years, despite the current property tax. This is an example of the fallacy of the Commission's fundamental logic. On the one hand the Commission argues that it must prevent taxation of Internet transactions to assure that they will continue to grow; on the other hand, the Commission is quite happy to urge preemption of telecommunications property taxes even when the companies have thrived despite the current tax levels.

Expansion of the exemptions to include transactions that currently would subject a company to responsibility for collecting sales taxes (the so-called "nexus" rules that currently subject sales by out-of-state companies to local and state taxes): Under the guise of "clarifying" court cases relating to "nexus," the Commission proposes legislation that would create major sales tax loopholes for out-of-state companies that engage in business activities within multiple states. The result would be to place even greater competitive pressure on local merchants who are unable to take advantage of those loopholes. The Commission simply fails to recognize the value of local communities that include local businesses as a mainstay. The Commission seems instead to prefer to subsidize out-of-state sellers with tax exemptions, even if these result in a weakening of local merchants and the local tax base.

Creation of a single rate per state for remote sales: Disregarding the great variations in each state, among urban, suburban and rural localities, and among local traditions and community needs, the Commission imperiously prescribes that there should be only "one sales and use tax rate per state." The Commission justifies this sweeping change to two hundred years of American tradition by complaining about the administrative burden that is involved in paying different sales taxes to different localities.

The Commission should know better. Software now exists that can provide an immediate calculation of the appropriate sales tax, based upon the zip code of the purchaser. Technology provides an answer to the problem of tax administration, without disrupting local and state tax systems.

The one-rate-per state requirement poses serious problems for state and local governments. First it preempts local control, particularly in home rule cities and counties that have varying local rates. In these areas the sales tax is controlled locally and it only applies to local residents. The single rate, on the other hand, is controlled at the state level and it applies to all residents of the state. This will create different tax rates for purchases at local retail outlets and purchases over the Internet from remote sellers. Local retail outlets will still be required to collect the current state and local tax rates on goods purchased over-the-counter, while out-of-state merchants will be required to collect the single rate on Internet transactions. The single rate in all likelihood will be lower than the combined state and local rates because it will be a blended or average rate of the state=s rate and all local rates.

The local option sales tax provides local governments the ability to raise their own revenues to support projects that are important to local residents. The advantage of the local option tax is that local communities are free to use it or not. For example, they can use it to support a new mass transit system or a new library. The local rate allows people in local communities to pay for their projects without imposing the cost on other residents of the state. The single rate does not. This rate is applied to all residents of the state, in areas that use the local option and in those that do not.

Expansion of sales tax exemptions to include ordinary goods that today are sold in local stores such as CDs, newspapers, books, software, movies and other products that are deemed to be "functionally equivalent" to so-called "digitized" products and services: Having decided to grant multiple tax exemptions to out-of-state vendors, the Commission then takes the final step to disrupt local and state tax systems. In the name of tax fairness, the Commission proposes to preempt local and state taxation of sales of goods and products that are sold locally that are "functionally equivalent" to digitized products.

This is a fiscal time bomb. Goods and services are turning digital at an exponential rate. The Commission is proposing that once a product becomes digitized in some form (recently photo developing, for example) both the digitized product and the nondigital equivalent immediately would obtain a mandatory sales tax exemption. Nowhere does the Commission propose how local and state governments are supposed to fill the fiscal void left by this federal preemption.

It is little wonder that the Chair of the Commission praised the majority for sending "a strong anti-tax report" to the Congress. Unfortunately, that was not the mandate that the Congress set for the Commission.

The Commission attempts to justify its recommended preemption of local and state sales taxes by noting that many localities and states are in sound fiscal condition. This is true but shortsighted. The United States is entering the ninth year of an unprecedented period of economic prosperity. However, even the longest business cycles turn downward at some point. When the business cycle does turn down, localities will be called upon --as always -- to provide increased public services on the basis of a revenue base that will shrink as consumers become more cautious and limited in the amount of disposable income that they can spend. Today's welcome period of prosperity provides no excuse for the Commission majority to try to impair local and state sales tax revenues for years or even permanently.

Providing preferential tax exemptions for Internet sales is unfair as well as unwise. If localities and states collect taxes from people who shop at local merchants, but not from people that shop over the Internet, then they will help to drive some of those local merchants out of business. Chief Justice John Marshall long ago stated that "the power to tax is the power to destroy." If the Commission's recommendations were enacted, they would help to destroy local businesses at the expense of out-of-state sales.

The Constitution protects local communities and states from such unfair consequences by leaving to the states (and, by extension, localities) the power to decide on the proper level and type of tax that best suits each community. It is not the place of an unelected Commission that violates the rules of its own enabling act to upset this careful constitutional balance. Indeed, if the Commission had followed the rules, it might have reached a win-win position rather than its one-sided position. That is the purpose of democratic freedom and the principle of taxation with representation.

1. The report makes recommendations that would dramatically reduce state and local taxes on telecommunications providers at the expense of taxpayers

   Failing to reach broad-based consensus on the more dominant issue of applying state and local taxes to electronic commerce and remote sales, the commission turned its attention to creating special tax subsidies for the telecommunications industry.

   Mayors are intimately familiar with the lobbying efforts of powerful telecommunications utilities and providers. Nevertheless, we were stunned to see their efforts appear in the final report of the Commission. We thought the Commission was examining tax policies for Internet activities, not developing special national policy directing unfunded federal mandates to essentially force local taxpayers to subsidize the Bell Operating Companies and other telecommunications providers.

   Since the bare majority of Commission members felt compelled to wander into this territory, we would like to provide a brief analysis of the destructive nature of these recommendations.

   The Proposal. Confusing tax simplification with tax fairness, the report recommends a series of proposals that will dramatically reduce the tax responsibilities of telecommunications providers. At the same time, it fails to address how to replace those lost tax revenues. Further, the report endorses tax policies that will greatly increase the day-to-day destruction and burden on public rights-of-way and the problems all citizens are experiencing with inappropriate use of this precious public property.

   Local Governments Support Reasonable Management and Compensation for Use of Public Rights-of-Way. The first, striking error in the report is its confusion of tax policy with fair payment for use of public property. Rent for use of public rights-of-way is sound economic policy. Public rights-of-way are the most precious property interests held by local governments. Of course the telecommunications providers want free use of our streets and highways. Similarly the oil companies want free oil leases on federal lands. But free use means over-use. And the daily commuter, the abutting shop-owner, and water system user will pay dearly if the rights-of-way they all depend on are not managed to achieve the highest and best use for all. Every business should pay the fair costs of its impact on others: inspection and oversight fees; adverse impacts on other rights-of-way users; shortened road life due to cuts to road surfaces; and fair-market value for the public resource permanently occupied.

   Local Governments Support Tax Fairness for Telecommunications Providers. The second striking error in the report is suggesting that the only appropriate tax reform is "simplification" and reduction in taxes paid by the largest corporations in our communities. Local governments instead call for tax "fairness" which asks each business to pay for its share of local government services in a manner that does not bias the competitive marketplace.

   The report speaks of "excess tax burdens on telecommunication real, tangible and intangible property." In fact, the proposal eliminates the taxes currently paid by telecommunications providers. It also ignores the real common ground among thoughtful observers of telecommunications taxation and instead seeks to force both reductions in, and in some instances elimination of, existing telecommunications taxes.

   Local governments support a tax system at all levels of government that treats competitors the same when they engage in the same activity. It is true that current utility taxes often apply to the Bell Operating Companies and other traditional telephone and cable television companies in ways that do not apply to new telecommunications providers. This needs to be fixed. We should make sure that taxes apply to all the competitors.

   Specifically, a broad-based attack on "unit valuation" property tax assessments is wrongheaded. "Unit valuation" actually makes eminently good public policy. It is a reasonable response to other problems associated with tax equity as the changing nature of the telecommunications business requires accelerated depreciation and dispersed networks based on leasing and resale of various facilities. Further, it is wrongheaded to assert that the tax rate for telecommunications providers must necessarily be same as the tax rate for other industries. This is a unique, community by community question. It is common, and appropriate, to ask that individual industries pay taxes that are related to the burden they place on the community’s infrastructure and services. A software development company does not place the same demands on the sewers, roads, or police as a major heavy manufacturing facility. It is fallacious public policy to suggest that all businesses, necessarily, should have exactly the same tax burden.

   Local Governments Support Efficient Tax Administration—NOT Tax Eradication. The report calls for a wide range of tax administration changes. Some of these may be helpful. Others will be destructive. Local governments are firmly committed to finding more efficient and fair ways to administer their taxes. This is NOT the same as adopting a single tax-rate statewide, or adopting uniformity, which ignores necessary local differences.

   It is self-evident that the business opportunity presented by access to mid-town Manhattan is different than by access to Sarasota Springs, NY. The tax rates in those two locations will—and must--be different. The cost of necessary municipal services in Manhattan is greater, just as the business opportunity is greater, than in Sarasota Springs. The tax system must produce the revenues needed to sustain the required LOCAL public services. Similarly, the difficulties of enforcement and auditing compliance are different in the two communities. One tax form will not fit all businesses and all circumstances.

2. Working together, local and state governments, businesses engaged in electronic commerce, traditional retailers, and other concerned parties and individuals can create a win-win system of fair and minimally burdensome taxation of electronic commerce that leaves local and state tax systems intact.

Now that the Commission has failed, The United States Conference of Mayors calls for an open process of cooperation to achieve a win-win approach to the difficult issues concerning the impact of Internet transactions on local and state tax bases. The U.S. Conference of Mayors and other Big-Seven state and local groups have developed a proposal for a "Streamlined Sales Tax System for the 21^st Century" that we believe provides a good starting point for constructive dialogue. Attached is the Task Force Recommendation that provides details of the proposal.

In summary, the proposal has two parts:

1. First, use the benefits of electronic technology to create a sales tax collection system that alleviates the administrative burden on all sellers, including local retailers, mail order catalogue companies, and Internet retailers. This could be accomplished without federal legislation or multistate agreements.
2. Second, enact state legislation and multistate agreements to create a more uniform tax system, including a classification system for products, a single definition of exemptions, and a one-stop audit process for local and state governments.

The first part of the proposal builds on the ability of information-based technologies to tailor transactions to each individual customer. While legal responsibility to pay local and state sales taxes would remain with the seller, the burden of collecting the taxes would be alleviated through use of new software and other modern techniques that the states would fund to help process such transactions. Localities and states also would begin to simplify sales and use tax laws to help facilitate the collection process.

The first part of the proposal is completely voluntary on the part of sellers. Of course, as is indicated by the Commission's efforts to weaken the current standards for "nexus," many out-of-state companies may face legal liability if they attempt to combine in-state retail sites with out-of-state sales. Localities and states urge the Congress to leave the law alone in this area, to provide sellers with an incentive to live up to their legal responsibilities to assure the collection of sales taxes.

The second part of the proposal will require localities and states to harmonize their sales and use tax systems. While localities and states would retain the authority to change tax rates, this would be done only through a uniform system. For example, localities and states would be limited in the number of changes that they could make, and the timing of those changes. The system of automated transaction processing would become more formal, and rules would be developed for operating in a harmonized system.

The proposed "Streamlined Sales Tax System for the 21^st Century" has three important advantages. First, it creates parity among all classes of seller, including local retailers, catalogue companies and Internet vendors. Second, it builds upon available technologies to create a simpler and less burdensome process of tax administration. Third, it allows localities and states to retain their tax systems and the flexibility to change those systems in response to community needs.

The United States Conference of Mayors invites all parties to engage in a constructive dialogue to help improve, develop, and implement a proposal that contains all three of these features.

Summary. The report is a disappointment. The Commission chose to attack the fundamental financial underpinnings of local governments. Their recommendations would deny us the necessary revenues to support the local services our citizens require. And the report uncritically adopts the preferential tax proposals we observe the large telecommunications companies pushing in various state legislatures. We had hoped for more from this Commission.