To Tax or Not to Tax
(Originally published in Messaging Magazine, November/December 1998)
To Tax or Not to Tax
(Originally published in Messaging Magazine, November/December 1998)
By Jim Bruce, Wiley, Rein & Fielding
As Messaging Magazine went to print, Congress passed a final version of the Internet Tax Freedom Act with a two-year moratorium on state and local governments’ taxation of Business Conducted over the Internet. This article details the numerous proposals and events which ultimately constituted the Internet Tax Freedom Act.
One of the bills likely to emerge from the 105th Congress as new law is a measure that would create a moratorium on state and local taxation of business conducted over the Internet. Some observers project sales over the Internet to rise from about $8 billion to $300 billion by the year 2002. This type of commerce is a tempting target for states and local government, especially if their sales tax revenues will decline as business shifts from local stores to virtual stores via the Internet. Only a few states so far have attempted to tap this new form of commerce, but Internet advocates want to prevent the taxation before it soars, figuring that it is easier to block new taxes than it is to repeal those on which the nation’s 30,000 taxing jurisdictions have become dependent for revenue. Those states having no income tax rely especially heavily on sales tax receipts. In contrast six states, most recently California, have passed legislation removing most of their taxes from the Internet.
The core issue is not just whether Internet business should be taxed, but how? For example, how much physical presence must a merchant have in a state before the state sales tax attaches to the transaction? Merchants who sell through mail order catalogues cannot charge a state sales tax on out-of-state mail order companies, although Congress could remove this barrier. Yet Internet sales can arguably involve several states in the transaction—the location of the customer, the server, the merchant, and the warehouse from where the product is shipped. (Note that income taxes on Internet-based companies and access providers are untouched by the legislation.) Compounding the difficulty is that the same product could be sold through conventional channels as well as the Internet, with different taxes imposed, resulting in what some call discriminatory taxation. Earlier this year the National Governors Conference proposed to lobby Congress to permit states to tax the Internet and mail order sales even where the merchant had no physical presence in the state.
The purpose of the proposed legislation in both houses is to call a time-out on taxing Internet business and to create a mechanism, such as a blue-ribbon panel, to examine the issue of how Internet taxation should occur, if at all. Congress hopes not only to create a sensible model for this country, but to serve as a responsible example for the rest of the world as well. In September 1998, reports surfaced that the White House is developing a system involving tracking and taxing goods with the use of electronic resident cards and private-sector escrow agents around the world.
There are three proposals pending in Congress as the "Internet Tax Freedom Act", that are quite similar and well along in the legislative process. On June 23, the House passed H.R. 4105, introduced by Rep. Chris Cox (R-Ca) which would establish a three-year moratorium on Internet access taxes, bit taxes, and multiple or discriminatory taxes. Meanwhile, the Senate is poised to take up the companion measure S. 442, sponsored by Sen. Ron Wyden (D-Ore). As this article goes to press, the Senate has taken up and is debating the version of the bill reported out of the Senate Commerce Committee, although the Senate Finance Committee also reported a different version under the same bill number. The Commerce Committee version has a six-year moratorium, while the Senate Finance Committee version contains a two-year moratorium. The Administration is reportedly willing to support some form of the eventual compromise.
Despite the continuing debate over even the basic issue of how long the moratorium should last, the latest reports from the Senate floor are that the measure is very likely to reach the President’s desk and become law. Yet even if a bill passes, the only clear result is the Internet will gain a temporary reprieve from state and local taxation. Whether and how to tax the Internet will still be an issue as policy makers look for a sensible approach for the United States.