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The promise shown by the emergence of electronic commerce has attracted some undesirable attention - taxes. States and localities have recently been examining an extension of their tax authority to Internet related activities. The result could be a maze of multiple taxation that stymies emerging commercial activity.
Potential help has shown up in the unlikeliest of places - Congress. This week a Senate Commerce Committee hearing will address legislation proposed by Rep. Chris Cox (R-CA) and Sen. Ron Wyden (D-OR). The Internet Tax Freedom Act (H.R. 1054 and S. 442) would impose a moratorium on new Internet taxation, allowing time to analyze commerce on the Internet.
Taking 'just a little.' With an untapped source of revenue in sight, the temptation to 'take just a little' is sometimes overwhelming for governments suffering from tight budgetary constraints. Additionally, the political risk associated with a new tax is minimal when the revenue comes from a distant or mysterious source. Such is the case today as local governments eye commerce on the Internet.
These taxes are taking a variety of forms, including sales, use and flow-through taxes. They are an immediate threat to the viability of electronic commerce because they constitute a complex array of confusing laws as well as the threat of multiple taxation.
Some jurisdictions are applying broad-based sales and use taxes to online content. The District of Columbia, New York and Ohio tax online services that transmit content.1 The same is true in Chicago where the electronic transmission of information is considered a lease of tangible personal property. In other jurisdictions, like Texas, the local categorization of specific commercial activity as an information, telecommunications or data-processing service imparts a variety of obligations.
Muddle of taxes. The muddle of taxing ill-defined goods and services is illustrated with software products. In California, Maryland, Massachusetts, Missouri, South Carolina and Utah, electronic software sales are not taxed because they represent the sale of intangible property. However, consumer purchases in the same states involving a tape, disc, card or chip generate a sales tax. In Illinois, regardless of the medium of transfer, software that is not specifically tailored to a single consumer is subject to sales taxes. There also is evidence that improvement of the tax system requires more than clear definitions. New York and Massachusetts have identical definitions of a "sale" and yet New York taxes electronic transmissions while Massachusetts does not.
There are several problems with these taxes. Each individual tax inhibits electronic commerce, and a maze of tax jurisdictions creates unforeseen and unintended barriers to economic activity. This is in large part due to the nature of the Internet itself.
Multiple taxation. Unlike commercial activity that travels over rail or road, a high-speed data transmission utilizes many independent paths simultaneously. As a result, local governments see an opportunity to tax commercial activity that travels, whole or in part, through their jurisdiction. And because of the potential to tax a data transmission in each jurisdiction, one transaction may be subject to multiple taxation.
But the Internet emerged as an interconnected, distributed and global network, capable of transporting select goods and services at the speed of light. Its distributed structure makes it impossible to pinpoint the exact paths used by a data transmission. It simply is not compatible with geographically-based tax jurisdictions.
The Cox-Wyden proposal addresses these and other issues. It is a neutral policy that calls a time-out on new efforts to tax electronic commerce. Cox-Wyden includes:
Moratorium on state and local taxation of commercial activity. Income taxes, business license taxes and sales taxes that are parallel to those applied to mail order, telephone and other remote sales are excepted.
Two-year study. Within two years the President, on the advice of the secretaries of Treasury, Commerce and State, is required to make long term policy recommendations to Congress.
Regulatory ban. The Federal Communications Commission is prohibited from regulating the prices of interactive computer services or information services transmitted over the Internet.
The Internet can provide consumers with lower prices, improved convenience and reliability, as well as more choice. This requires clear legal parameters, and sound tax policy is the first step. The effort to create a legal system adapted to a digital world is a slow process. As consumers embrace electronic commerce with increasing vigor, Cox-Wyden is right on track.
1 Frieden, Karl A. and Porter, Michael E., State Tax Notes, November 11, 1996, p. 1371. For this paper, Frieden and Porter, pp. 1363-98, is the source of each specific reference to state tax laws.