Question: Internet Taxation On May 10, 2000, the House of Representatives passed H.R. 3709, the "Internet Non-Discrimination Act," by a resounding majority of 352-75. The bill provided a 5-year extension of an existing moratorium on new Internet taxes that was due to expire in 2001.42 The bill had been embraced by a diverse coalition of consumer groups, Internet users, and high-tech companies that argued that the imposition of taxes on electronic commerce would slow both the development of the Internet and the growth in the U.S. economy. In the Senate intense lobbying by a diverse set of interests caused Senator John McCain (R-AZ), chairman of the Commerce Committee, to cancel a hearing on a bill to make the tax moratorium permanent. When questioned about the cancellation, McCain said the topic of Internet taxes was "incredibly complex [and had] not been nearly fleshed out enough."43 At the same time the legislation stalled in the Senate, the solidarity of the high-tech community on the Internet taxation issue began to slip. In a June hearing before the Joint Economic Committee, Intel Chairman Andy Grove argued for applying sales taxes to transactions on the Web, saying that he felt there was no "justification" for the online tax advantage.
At the same hearing, Hewlett-Packard CEO Carly Fiorina warned that "to apply the current system of taxation to the online world would be disastrous." She, however, criticized those opposed to any Internet taxes, saying that such a stance was "unrealistic."44 A new report by the General Accounting Office (GAO) estimated that state and local governments stood to lose anywhere between $300 million and $3.8 billion in sales tax revenue in 2000.45 Precedents and Mail-Order Sales The controversy surrounding Internet taxation resulted from court decisions that exempted from taxes mail-order sales to out-of-state residents. In two landmark court cases, National Bellas Hess v. Department of Revenue of the State of Illinois (386 U.S. 753, 1967) and Quill v. North Dakota (504 U.S. 298, 1992), the U.S. Supreme Court concluded that requiring mail-order merchants to calculate, collect, and remit the appropriate tax to the appropriate authorities would constitute an undue burden because of the approximately 35,000 state and local tax rates in effect. The Court decided that merchants were only required to collect sales taxes from customers that 42The existing moratorium prohibited the imposition of "multiple and discriminatory" taxes on electronic commerce.
These taxes included those that subjected buyers and sellers to taxation in multiple states and localities, as well as taxes on goods specifically sold over the Internet by companies that did not have brick-and-mortar counterparts in the state. Discriminatory taxes included taxes imposed on Internet sales but not on catalog sales. The moratorium also prohibited the federal government from imposing taxes on Internet access or electronic commerce generally. 43Wall Street Journal, June 22, 2000. 44Atlanta Journal and Constitution, June 8, 2000. 45Report to Congressional Requesters, "Sales Taxes: Electronic Commerce Growth Presents Challenges; Revenue Losses Are Uncertain," United States General Accounting Office, June 2000. resided in a state where the merchant had a "nexus." A nexus, loosely defined, was a physical presence, such as an office or retail outlet. The Supreme Court decisions effectively absolved merchants of their responsibility for tax collection on out-of-state sales, but responsibility for the remittance of the tax remained for consumers. Most states required the remittance of "use" taxes for goods bought from out-of-state vendors. The rate of these use taxes was usually identical to the state sales tax rates for goods sold within the state.
It was the responsibility of individual consumers to report to their state government how much tax they owed and pay accordingly. Use taxes provided governments with a legal basis to collect revenue on out-of-state purchases, but such collection rarely occurred. Compliance was very low, as most consumers were unaware that they were required to pay the use tax. Few states attempted to collect from individual consumers.46 Although the inability to collect use taxes on catalog sales had not led to new tax legislation, the rise of the Internet significantly changed perceptions about the scale of purchases potentially free from state and local taxes. As more transactions migrated to the Web, state and local governments feared a substantial erosion of their tax bases.47 Fears of dwindling revenues were accompanied by the concerns of offline Main Street merchants who felt that the tax advantage of online stores gave them a significant advantage. These issues led to the introduction of bills in several state legislatures, all of which were aimed at providing some form of tax collection on online sales, at least from their own residents. Online merchants, however, argued that they had to bear delivery costs, which, as with catalog sales, offset the tax exclusion.
The online merchants also argued that they did not use state resources other than for delivery and hence should not be required to fund state services. While state and local governments were clamoring for action, the federal government was effectively putting on the brakes. The Internet Tax Freedom Act (ITFA), introduced in Congress by Representative Christopher Cox (R-CA) and Senator Ron Wyden (D-OR), was passed as part of the Omnibus Appropriations Act of 1998. Placing a 3-year moratorium on new Internet taxes, the ITFA also created the Advisory Commission on Electronic Commerce to study issues related to the taxation of the Internet and to recommend to Congress by April 2000 an appropriate tax policy. The Advisory Commission consisted of 19 members, 8 from industry and consumer groups, 8 from state and local Borders.com, however, directed customers to a Borders store if they wanted to return a book. Although proponents of the bill hailed it as a "fair and square measure," other parties, such as the American Electronics Association, argued that California was trying to "shoehorn e-commerce business into an old tax system that doesn't make any sense."59 As the legislation arrived on Governor Gray Davis's desk, observers wondered what its enactment might mean for the future of electronic commerce and state tax autonomy.
International Activity International developments were also complicating U.S. attempts to resolve the Internet taxation issue. The 1999 Human Development Report of the United Nations made a formal recommendation to impose a $0.01 "bit tax" for every 100 e-mails sent between users. The tax would raise an estimated $70 billion a year for underdeveloped countries. Both the Clinton administration and Congress urged the WTO to impose bans on the bit tax and similar Internet-specific taxes. Embracing the sentiments of the Clinton administration, at its Seattle meeting in December 1999 the WTO decided to extend for 2 years an existing moratorium on Internet taxes, effectively striking down the bit tax proposal. Other international organizations were also weighing in on the tax question. In October 1998 the 29-nation Organization for Economic Cooperation and Development (OECD) proposed the Ottawa Taxation Framework Conditions. In the hope of developing a uniform taxation scheme for online commerce, the Ottawa Conditions envisioned a tax plan that was economically neutral, efficient, simple, fair, and flexible.60 The conferees agreed that any taxation scheme should levy taxes on goods based on where they were consumed rather than where they were produced. The flexible nature of Internet commerce, however, raised difficult questions about how to determine where, precisely, goods purchased online were consumed.61
The OECD established several industry and government working groups to examine these issues in more detail. The United States and the European Union (EU) used the OECD as a forum for their negotiations on Internet taxation. Most EU member states imposed a value-added tax (VAT) on electronically delivered goods and services supplied by EU companies to EU residents. In June 2000 the EU Commission proposed extending the VAT to non-EU companies, despite the existing WTO moratorium. Specifically, the proposal required any firm selling more than €100,000 worth of electronic goods into the European Union to be registered with one of the 15 member states' tax authorities and charge that state's rate. The VAT rates of the EU member states variedfrom 15 percent in Luxembourg to 25 percent in Denmark and Sweden. The VAT accounted for approximately 40 percent of the tax revenue of the EU member states and financed the entire EU budget.62 The Commission was heavily criticized by the United States for acting unilaterally despite continued negotiations within the OECD. Stuart Eizenstat, Undersecretary of the Treasury Department, argued that the proposal "if implemented, could well hinder the development of [the] global medium of [electronic] commerce."
Similarly, Andy Grove came out against the VAT, calling it "e-protectionism."63 Implementation issues also arose as to how such taxes would be collected, as well as whether the necessary unanimous endorsement of all member states of the European Union could be expected. Mark Bohannon of the U.S.-based Software and Information Industry Association called the Commission report "fatally flawed" because it was impossible to determine where a customer in cyberspace resided.64 Companies A variety of companies would be directly affected by an Internet tax, and others would be indirectly affected. A tax would have a major impact on Amazon.com, the largest online retailer. A sale to a customer in California saved the customer the sales tax of approximately 8 percent, and a sale to a Texas customer saved 8.5 percent.65 The tax savings helped compensate for delivery costs, which were paid by the customer. Despite not facing sales taxes, Amazon.com lost $207 million before special equity arrangements on sales of $578 million in the quarter ending June 20, 2000. Amazon.com had worked behind the scenes to oppose any Internet taxes. Its perspective was revealed in its commentary on the California bill to impose taxes on sales by those online companies that claimed that their Internet companies were separate from their brick-and-mortar stores.
"Paul Misener, vice president for global public policy at Amazon. com, said he does not see any need to tax Internet sales in general since so many state and local governments are running surpluses right now. ‘We really have to see the problem first,' he said. ‘This is almost a solution in search of a problem.' Misener added that if online sales are taxed, it should be at a lower rate than off-line transactions because sales made over the Internet ‘use fewer state and local resources.' Amazon opposes the... bill because it does not recognize this principle, even though the bill would affect one of the company's biggest competitors: Barnesandnoble.com."66 Cisco Systems, the leading supplier of servers for the Internet, supported the Internet Non-Discrimination Act because state governments were running surpluses and "the often-confusing tax rules of 7,500 separate jurisdictions could severely impede development of this rapidly expanding medium for global trade, investment, and communication. State and local governments should use an extended moratorium period to simplify their existing, complex tax structures."67 Cisco worked on the Internet taxation issue primarily through the Internet Tax Fairness Coalition and the American Electronics Association. Katrina Doerfler of Cisco, testifying on behalf of the American Electronics Association, articulated five principles for any legislation on Internet taxation. "One, impose no greater tax burden on electronic commerce than other traditional means of commerce. Two, support simplicity in administration. Three, retain and clarify nexus standards. Four, avoid new access taxes on the Internet. And, five, consider tax issues in a global context."68
www.cisco.com/warp/public.
68Hearings, House Committee on the Judiciary, Subcommittee on Commercial and Administrative Law, June 29, 2000.
1. How would the market strategy of Amazon.com be affected by the application of state and local sales taxes to online sales?
2. How would the market strategy of Cisco Systems be affected by the application of state and local sales taxes to online sales?
3. How much influence are the various interests identified in the case likely to have on the issue of Internet taxation?
4. Are there any interests not identified in the case that are likely to be active on this issue? Will they be able to overcome the free-rider problem?
5. What is likely to be the outcome of the Internet Non-Discrimination Act?