In this giddy era of Internet success where multimillionaires are made over night and company valuations triple every 5 days, no one is more giddier than Jeff Bezos, the founder and CEO of Amazon.com. In it’s fifth year of existence, Seattle-based Amazon.
com has become the model by which other e-commerce companies model themselves after. Amazon.com now serves over 17 million customers in over 150 countries. As “the leading e-commerce platform,” last year sales grew from $610 million to $1.64 billion - a stunning 169 percent increase. The juggernaut that is Amazon.com is a stunning example of how fast and how far a company can perform in the Internet economy.
Amazon.com is not alone. Market researcher Internet Data Corporation predicts that nearly 100 million worldwide today, and growing to 320 million by 2002, will shop online. Forrester Research estimates that shoppers will spend over $184 billion by 2004 – 7 percent of all U. S. retail spending.
Some people think it’s an example of the unfair protections we place on Internet companies. Amazon.com, like many other Internet companies, is not required to pay taxes on the billions of dollars that they sell to customers outside of their state.
The History of Sales Tax
over the Internet
Among standard brick-and-mortar retailers, sales taxes are an unpopular – but common – cost of doing business. Most states charge sales taxes which merchants collect from customers and then pass along to the government. The advent of e-commerce over the Internet seemingly opened up a brand new revenue stream for states and local municipalities. But in 1998, Congress, backed by industry leaders AT&T, Time Warner, American Online, MCI WorldCom and UUNET passed the Internet Tax Freedom Act, which put a 3-year moratorium on any new Internet taxes until 2001. The Act regards Internet transactions in the same way as catalogue and mail order sales. Mail order and catalogue sales, a $100 billion-dollar industry, are exempt from state and local taxes by the Supreme Court unless the merchant has a physical presence or “nexus” within the state’s borders. This means that although an Internet merchant like Amazon.com has customers in every state, it can only be required to collect sales tax from customers in its home state of Washington and a handful of other states in which it has built warehouses or stationed personnel.
If the state does not charge and remit the tax, laws require customers of Internet and mail order companies to pay the state and local sales tax directly to their home states. However, compliance with this self-remittance requirement is non-existent in the case of individual consumers and is spotty in the case of businesses that make purchases from Internet, mail order, catalogue, and other “remote” sellers.
The requirement that a business be physically present in a state before it is obligated to collect and remit sales tax stems from a 1967 Supreme Court ruling. At the time, the Court expressed concern that collecting sales tax on behalf of 45 states and several thousand localities that impose such taxes would be excessively burdensome for remote sellers under the diverse sales tax rules then in effect. The Court wished to carve out a “safe harbor” from these burdens for companies that were willing to avoid establishing a physical presence in states where their customers were located. Nonetheless, in its 1992 Quill decision, the Court made clear that Congress could authorize states to require remote sellers to charge sales taxes just as Main Street businesses are obligated to do. The Court held that it would be entirely fair for a state to require remote sellers to charge sales taxes provided that Congress first set ground rules aimed at reducing the burdens of sales tax collection. Technically, consumers, not companies, are responsible for paying tax for products purchased on the Internet.
I’ll pause until the laughter stops.
Not surprisingly, few, if any, pay the taxes. As we learned recently, if people can get products over the Internet for free, does anyone think that they will pay taxes for Internet purchases if they are not forced to do so? For all practical purposes, the government does not try to go after people who don’t.
As the moratorium nears an end, the Advisory on Electronic Commerce appointed by Congress has been conducting meetings in order to draft recommend actions on a course of action for Internet taxation. On May 11 the House voted 352-75 on a bill that would extend for five more years the Internet’s “tax-free” status. The bill is part of a Republican “E-Contract 2000” agenda intended to underscore their support for the high-tech sector, a prime campaign contribution battleground for both parties this election year.
Additionally, the bill would repeal a grandfather clause enacted in 1998 that allowed the states of Connecticut, Montana, New Mexico, North Dakota, Ohio, South Dakota, Tennessee, Texas, Washington and Wisconsin and 16 cities to keep taxes they had in place at the time.
Supporters say the emerging Internet is too important an economic engine to permit it to be held back by local taxation. Worse, they say, is the chance that multiple governments will “double-dip” and try to tax the same transaction two or three times.
Most opponents of Internet taxation have only to “look across the pond, mate,” to see a text-book example of how not to nurture an Internet economy. One of the main reasons that the European Internet model has lagged behind the robust American Internet economy is, in part, because of heavy taxation by governmental agencies, the high price of access, and slow access speeds. Any one of these would put a serious strangle hold on any emerging Internet e-commerce initiatives. When you have all three of them to contend with, it puts the Internet in a mortal death grip.
Rep. Christopher Cox, R-California, spoke for many Internet industry supporters when he was quoted recently as saying that without the moratorium extension and repeal of the grandfather clause, thousands of state, county and local taxing bureaucrats could slow down Internet growth and “drown the whole thing in a sea of red tape.” Dorothy Coleman, Vice President of the National Association of Manufacturers believes that “. . .e-commerce is barely in it’s infancy, and a rush to impose government levies could stifle its growth and development.”
Governors and local city officials like Moline Mayor Stan Leach are perplexed when no-tax proponents use the words “Internet” and “infancy” in the same sentence. “It is not our intention to eliminate or try and stop e-commerce. What we’re after is a more equal playing field for the bricks-and-mortar businesses. Right now, a brick-and-mortar business pays sales tax to the city of Moline and to the state. In fact, 38% of the state’s budget is sales tax. If e-commerce is going to grow – and it’s predicted to grow into the trillions of dollars – it will put a dent in not only our local tax, but in the state tax. Where is the state going to make it up? By raising it’s income tax, and larger real estate taxes,” explains Leach.
Asked how local residents would be affected, Mayor Leach continued. “Right now, we offer a lot of services to the citizens of Moline that other cities don't. For example - leaf pick-up. We have six crews that go out and vacuum leaves up. We don’t have a utility tax, which East Moline and Rock Island do. The reason we don’t have this tax and can do the things that we do is that we have $11.5 million in sales taxes coming into our coffers.”
In a publication entitled “High Stakes in Cyberspace: Ensuring Tax Fairness in the Electronic Marketplace,” the National League of Cities make it clear that the coddling companies who have built dynamic Internet businesses has got to end. The publication pointed to a recent University of Texas study estimating states could lose $20 billion in sales tax revenue by 2003 if Internet ecommerce is not taxed. These sales taxes account for one quarter of all tax revenues raised by states to fund education, public safety, health, and many other essential services. A no-tax position could have other effects as well. In a Los Angeles Times article on the effects of Internet competition to local retailers, analyst Sally Gordon of Moody’s Investors Service is quoted as saying that if U.S. retailers lose only 7 percent of their sales to the Internet, their profitability can decline as much as 50 percent. This could force retailers to shut down many under-performing locations, leaving residents out of work, and stores and warehouses empty.
Follow the Money
With the potential impact that a no-tax position could have on state and local governments, why hasn’t Congress – particularly the Republican leadership – responded to the National League of Cities? The cynics who walk among us would say that money has a bit to do with it. After all, this is an election year and in an election year, money talks. A quick check at the Internet site www.opensecrets.com tells us that AT&T and Microsoft were in the top five of all corporations who gave soft money contributions. Clearly there is not as much incentive, from a political contribution perspective, to listen to the NLC.
The Tax Plans
The National Governors Association, in partnership with state and local public interests groups, submitted a proposal to the Commission that outlines a plan for a streamlined tax system. The plan called for:
· Simplification of existing tax systems to respond to business concerns about wide variations among state tax laws and multiple audits
· Use of a third party to serve as tax collectors
· Use of a technology-driven solution that would rely on the creation of new tax software
· A 3-year period where states and businesses would voluntarily work together and during which Congress would take no action to limit the state’s ability to collect legally due sales taxes on Internet transactions.
Virginia Governor James Gillmore, chairman of the ACEC, submitted a proposal that, in part, calls for:
· The elimination of all sales taxes for anything sold over the Internet,
· Opposition to international taxes on U.S. e-commerce
· The use of federal welfare dollars to purchase computers and Internet access for needy families – thereby eliminating the “digital divide”.
To Tax or Not to Tax – That is the Question
Should the Internet remain a sales tax haven? Probably not. Not to protect the viability of dinosaur businesses who need the government to step in because they are unable or unwilling to compete in the new economy. But because the municipal responsibilities of cities and states are so great that they depend upon a rich tax base comprised of vibrant, healthy companies. And there is not a healthier, more vibrant business sector than e-commerce companies. However, because of the nature of the Internet, current tax formulas won’t work. Since the House has passed the bill that will extend the moratorium – and the Senate will surely follow suit - there’s time to come up with a formula that will work. Until then, many people will continue to shop locally – and buy over the Internet.