Testimony of Erick Gustafson Director of Technology and Communications Policy Citizens for a Sound Economy Foundation Before the

Mr. Chairman, and members of the Committee, thank you for the opportunity to share my views on the work of the Advisory Commission on Electronic Commerce (ACEC), Internet and communications taxes, and the effect they have on the digital divide. My name is Erick Gustafson, and I present these views on behalf of the members of Citizens for a Sound Economy Foundation (CSE Foundation), a consumer education organization that promotes free market solutions to public policy problems. At CSE Foundation, I am the director for technology and communications policy.1

More than a quarter-million strong, CSE Foundation’s members are in every congressional district of America. Our members distinguish themselves as policy activists. They constantly remind us that decisions made in Washington, D.C., are felt in places far away from here; and that is where CSE Foundation is found. We at CSE Foundation believe that individual liberty and the freedom to compete expands consumer choice and provides individuals with the greatest control over what they own and earn.

The topic of today’s hearing has long been an interest for CSE Foundation. Our activists were a force pressing for passage of the Internet Tax Freedom Act and CSE Foundation staff and members have either attended or participated in every meeting of the Advisory Commission over the past year. We were both pleased by the substance of the Commission’s full report and frustrated by those Commissioners whose abstention from several key votes limited the report’s formal recommendations.2 Despite differing with the Commission on a few key points, we believe that Governor Gilmore and his colleagues have provided Congress with a valuable prescription for addressing a number of issues confronting consumers and our nation’s growing technology sector.

In part, Congress has already acted on the substance of the Commission’s report by passing The Internet Nondiscrimination Act (H.R. 3709). This legislation would extend the current moratorium for five years and terminate a communications service tax currently being charged to some consumers for Internet access.

When we at CSE Foundation examine the topic of Internet, communications taxes, and the digital divide, we begin with two tenets that are central to our mission:

Governments already collect far too much money, and individuals are taxed far too much; and,

Excessive government taxation and regulation of communication services is the greatest impediment to access of technology and further compounds the digital divide.

Consider the following facts: Every state in America began the year with a budget surplus, the collective total of which exceeded $35 billion. State tax revenues have doubled in the last 10 years. Last year alone, state taxes increased by 11 percent. State government spending in 1999 was up 8 percent.3

At a time like this, the tax debate should be focused on cutting tax rates for consumers and small businesses, not adding new taxes on the Internet. Rather than exploring new ways to tax the engine of our economic growth, government should be looking for ways to end outdated taxes and open the doors of the Internet to everyone. Following the Commission’s advice would be a solid step in that direction. In fact, adopting just three of the suggestions in the Commission’s report will save American consumers billions of dollars.

Repeal the 3-percent federal excise tax on telecommunications services. The 3-percent federal excise tax on telecommunications services was introduced to fund the Spanish-American War. This tax costs Americans nearly $6 billion each year simply for the “luxury” of keeping a phone in the house.4 The fact that this tax is still on our monthly phone bills 102 years after the Spanish-American War ended demonstrates just how difficult it is to remove a tax. Regrettably, this is just one of the many taxes and outdated regulations that make it more expensive for Americans to go online. We won the Spanish-American War more than 100 years ago; yet, the wartime levy still exists – it is time we win the war against taxes that expand the so-called digital divide.

Extend the current moratorium on multiple and discriminatory taxation of electronic commerce for a minimum of five years. When the Internet Tax Freedom Act was passed, the Internet itself was in its infancy and e-commerce was virtually non-existent. Today the specter of bit taxes on emails, right-of-way taxes on the transfer of information, and other onerous tax schemes are little more than a figment of overactive imaginations. Had any of these plans been allowed to take hold or had the Internet been treated differently from other types of remote sales it is extremely unlikely that we would have the economy we know today. The Senate should, without delay, follow the lead of the House and act to extend the current moratorium so that discriminatory taxes do not threaten electronic commerce. To preserve our rapidly expanding economy we must continue to allow consumers, small businesses, and students to browse, shop, and learn online without facing unique and harmful taxes.

Make permanent the current moratorium on Internet access taxes. Taxes at the on-ramp to the Information super highway raise the cost of going online and keep too many Americans offline every year. Consumers pay between 20 percent and 30 percent in taxes on communications services – tax rates similar to those on “sin” taxes.5 By imposing regressive rates of taxation while simultaneously proclaiming the need to rapidly expand technology to all regions and income levels, government officials only ensure that taxes will hit hardest those who can least afford it. Policymakers must understand, as they look for ways to bridge the digital divide, the best way to give consumers the full benefits of high technology is by removing the high taxes and obsolete government regulations that are barriers to competition and innovation.

CSE Foundation has long asserted, and a study by the Stanford Institute for the Quantitative Study of Society (SIQSS) has found, that eliminating taxes and regulations is the best approach the government can take to bridge the digital divide. The Stanford study found that demographics only account for 20 percent of the digital divide. Unfortunately, government efforts at bridging the digital divide have traditionally been designed to target specific demographic groups. This study indicates that these types of programs will not solve the problem. If government truly wants to get more people online the best solution is to lower the cost of going online. There are numerous free Internet Service Providers (ISPs), but Internet access fees and highly taxed phone lines are barriers to these ISPs. By eliminating discriminatory taxes on communications, the government could lower the cost of going online and take a huge leap forward in eliminating the digital divide. Now is the time for Congress to act and ensure that taxes will not keep Americans offline.

Each recommendation is a step in the right direction, but undoubtedly someone will tell you that America cannot move forward. You may hear that states and cities will lose too much revenue, that small Mom-and-Pop retailers are unable to take on a global electronic market, or that no retailer can compete against an Internet tax advantage. Know that those who tell you such things either seek to increase tax revenue or to protect existing business models from competition.

In the fourth quarter of 1999, the most recent holiday season, total retail sales exceeded $526 billion. Of that total, online retail sales constituted just $5.3 billion or 0.64 percent.6 To claim that states and cities will not be able to fund schools or law enforcement because of revenue lost to Internet sales is an outright lie. The fact is, in spite of all the media attention lavished on e-commerce, an overwhelming number of retail sales still take place at bricks and mortar retailers. Moreover, Internet sales are subject to sales taxes in many instances – the same as catalogue sales have been for decades.

Researchers at the University of Chicago and Harvard University recently calculated the impact of Internet transactions on sales tax revenue. They found that online transactions reduce state and local revenues by only $430 million annually – less than one-quarter of 1 percent of total sales tax revenues. Industry watchers expect online sales to grow by 70 percent per year over the next few years, but even then, the revenue lost will represent less than 2 percent of sales tax revenue in 2003. 7

Small businesses have embraced the Internet in droves despite facing unfamiliar technologies and unproven ways of reaching customers. A newly released survey shows that small businesses outspent consumers by more than $5 billion last year as they made travel reservations and purchased office and computer equipment in record numbers.8 Those small businesses that do venture online find that, far from being a threat, the Internet actually adds to their profitability.

The Internet economy accounts for nearly one-third of our nation’s economic growth. It is estimated that if taxes were applied to online sales, growth in the technology sector would be slowed by 24 percent. Intervention in the high-tech marketplace creates fear and uncertainty among investors and threatens to destroy our economy. The government must be stopped from taxing to death the goose that laid the golden egg.

At the start of the 21st century we have the opportunity and the ability to give consumers the full benefits of high technology without harming Main Street or state governments. The Advisory Commission on Electronic Commerce has pointed us in that direction, I urge Congress to heed their advice and send a strong message that the Internet will remain free from the heavy hand of government taxation.

1CSE Foundation does not receive any funds from the U.S. Government.

2More than seven members of the Advisory Commission on Electronic Commerce abstained on 10 key votes during the Dallas Meeting on March 20-21, 2000

3Background for these tax statistics is available upon request

4Mark Zuckerman, “from ‘Remember the Maine’ to ‘No New Taxes’: A History of the Telecommunications Excise Tax” Citizens for a Sound Economy Foundation, July 29, 1999

5Jeffery Eisenach, “The High Cost of Taxing Telecom,” study prepared for presentation to the Advisory Commission on Electronic Commerce, September 14, 1999

6″Retail E-commerce Sales for the Fourth Quarter 1999 Reach $5.3 Billion, Census Bureau Reports,” U.S. Department of Commerce News, March 2, 2000

7Austan Goolsbee and Jonathan Zittrain, “Evaluating the Costs and Benefits of Taxing Internet Commerce” (Manuscript, May 20, 1999)

8Access Markets International Partners Survey, Released May 15, 2000