S. Rept. 105-184 - INTERNET TAX FREEDOM ACT105th Congress (1997-1998)
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Calendar No. 357 105th Congress Report SENATE 2d Session 105-184 _______________________________________________________________________ INTERNET TAX FREEDOM ACT _______ May 5, 1998.--Ordered to be printed _______________________________________________________________________ Mr. McCain, from the Committee on Commerce, Science, and Transportation, submitted the following R E P O R T together with MINORITY VIEWS [To accompany S. 442] The Committee on Commerce, Science, and Transportation, to which was referred the bill to establish a national policy against State and local government interference with interstate commerce on the Internet or interactive computer services, and to exercise congressional jurisdiction over interstate commerce by establishing a moratorium on the imposition of exactions that would interfere with the flow of commerce via the Internet, and for other purposes, reports favorably thereon with an amendment in the nature of a substitute and recommends that the bill, as amended, do pass. Purpose of the Bill The purpose of the bill is to foster the growth of electronic commerce and the Internet by facilitating the development of a fair and consistent Internet tax policy. Background and Needs Commerce conducted through use of the Internet is experiencing tremendous growth. According to Forrester Research Inc., a Massachusetts consulting firm, the value of goods and services traded over the Internet could grow to over $300 billion in 2002, a substantial increase from the $8 billion that electronic commerce is estimated to have generated in 1997. This immense growth is expected to boost our nation's economy by creating new jobs and new business opportunities. The Internet also offers advantages such as providing small- and medium-sized companies the opportunity to compete with multinational conglomerates because they can now gain access to consumers globally without having to invest in costly marketing and distribution channels. Moreover, through the Internet, individuals in rural areas will have the same access to goods and services as those located in urban areas, and disabled and elderly persons will be able to purchase products without having to leave their homes. The benefits to be gained by the surge in electronic commerce could be stifled, however, by the haphazard imposition of multiple and confusing State and local taxes that apply only to Internet-related transactions and services. If these taxes are not levied in a consistent and equitable manner, electronic commerce will not continue to develop at its expected pace. In general, there are three types of Internet taxation. Some States tax Internet access charges, which are fees Internet service providers (ISPs) impose on Internet users for access to the Internet and other services like electronic mail. About 12 States subject Internet access charges to a sales, use or other transaction tax while others view Internet access as a tax-exempt service. Another type of Internet-related tax is one that involves sales of goods over the Internet. When a consumer orders a product online, it is often delivered through traditional channels, like the U.S. mail. Such transactions are sometimes compared to mail order catalogue sales. In the latter situation, taxability of a transaction turns on the issue of nexus. Under the United States Supreme Court's Quill decision, a seller cannot be subject to a State's tax jurisdiction unless it has a ``substantial nexus'' with that jurisdiction. Substantial nexus can exist if a seller has a physical presence in the taxing jurisdiction, such as a store, office, or warehouse, or if the seller's agent, such as a sales representative or contractor, is conducting business in a location. These traditional notions of nexus are difficult to apply to the Internet because of the way that Internet transactions occur. For example, a company can be based in State A, have a server located in State B, and receive an order from a consumer in State C who purchases a product from the company and has the product delivered to State D. Under these circumstances, it is unclear which State would have the ability to tax the event. One problem is that State and local taxing authorities may disagree on whether or not maintenance of a server in their location is sufficient to establish nexus. A State or locality also could decide that an ISP which hosts a World Wide Web site on its servers for another company is an agent of that company. In either situation, the same transaction could be subjected to multiple taxes. A third type of Internet tax concerns purchases of software or information through the downloading of the software or information off of the Internet. Most States only tax tangible goods, tangible goods traditionally being those that you can physically see and touch. Many States take different positions on whether downloading software is a transfer of a tangible or intangible good. Currently, approximately 25 States tax the downloading of software or information from the Internet while such transactions are tax exempt in as many as 17 States. Confusing and inconsistent interpretations of these important issues could lead to redundant taxation and uncertainty regarding the tax collection and remittance obligations of Internet-based companies. Such confusion and uncertainty can be enough to discourage companies from doing business on the Internet. In particular, small- and medium- sized companies will be adversely affected. The Internet is a low cost way for these companies to market their products to customers worldwide. While a substantial portion of the country's 30,000 taxing jurisdictions have not adopted Internet taxes, the potential costs of complying with the tax demands of these authorities could make use of the Internet uneconomical for such companies. Most State and local commercial tax codes were enacted prior to the development of the Internet and electronic commerce. Efforts to impose these codes without any adjustment to Internet communications, transactions or services or to impose discriminatory Internet-related taxes will lead to State and local taxes that are imposed in unpredictable and overly burdensome ways. Before States and localities are allowed to take such actions and thereby stunt the growth of electronic commerce, a temporary moratorium on Internet-specific taxes is necessary to facilitate the development of a fair and uniform taxing scheme. Congress has the authority under Article I, section 8, clause 3 of the United States Constitution to establish such a moratorium because communications or transactions using the Internet, online services, and Internet access service are all services or activities that are inherently interstate in nature. Because policymakers must be given an opportunity to develop an equitable, technology-neutral tax policy, this moratorium is intended to prohibit taxes that discriminate against Internet communications or transactions and Internet access and online services. Legislative History introduction S. 442 was introduced on March 13, 1997, by Senator Wyden. may 22, 1997 hearing The full committee held a hearing on S. 442, the Internet Tax Freedom Act, on May 22, 1997. witnesses Panel I Hon. Christopher Cox (R-CA) Hon. Rick White (R-WA) Hon. Lawrence H. Summers, Deputy Secretary, Department of Treasury Panel II Timothy Kaine, Richmond City Councilman, National League of Cities, Richmond, Virginia Wade Anderson, Director of Tax Policy, Office of the State Comptroller, State of Texas Kendall Houghton, General Counsel, Committee on State Taxation Linda Rankin, General Counsel, Bear Creek Corporation James Walton, Association of Online Professionals panel i Congressman Cox testified that it is Congress' responsibility to examine what is necessary to promote the continued development of the Internet. He stated that there are over 30,000 taxing jurisdictions that could tax Internet communications, transactions or services. He asserted that if these jurisdictions do tax the Internet in pursuit of their own interests, the Internet will not continue to grow at its phenomenal rate. Congressman Cox also stated that the moratorium would apply only to taxes that target the Internet and that are applied in a discriminatory way. He also said that it is possible for Congress to work with the States and the special taxing jurisdictions on this issue. He noted that the California State Board of Equalization, the California Franchise Tax Board, and the Governor of the State of California have voted unanimously to endorse S. 442. Congressman White argued that the moratorium in S. 442 applies only to special taxes on the Internet. It does not include nondiscriminatory taxes such as a property tax on a building that houses an Internet server. He also asserted that it is Congress' duty, pursuant to the Commerce Clause of the United States Constitution, to protect the Internet as a national market phenomenon. According to Congressman White, States and localities should not be allowed to harm the Internet by imposing unfair taxes. Lawrence Summers testified that the Treasury wholeheartedly supports the goals and objectives of S. 442. In November of 1996, the Treasury issued a white paper on taxes relating to electronic commerce, and its central principle was that there should be no taxes directed at limiting or scaling back the growth of the Internet. He agreed with the approach of temporarily prohibiting discriminatory taxes while preserving technology-neutral taxes. Summers noted the potential chilling effect of possible future taxes on business activity and stated that it will be much easier to deal with the tax issue at an early stage. He said that S. 442 furthers important public policy objectives because it will help business, make the United States more competitive, and empower American citizens by promoting the growth of Internet technology. panel ii Timothy Kaine testified that an indefinite moratorium on State and local Internet taxes is unnecessary because so few States and localities actually tax the Internet. He stated that the moratorium would harm localities by denying them revenue they now rely on and would promote discriminatory treatment of local businesses. Kaine also said that S. 442 is inconsistent with the Unfunded Mandates Reform Act of 1995. He asserted that State and local governments and business interests can work together to establish a fair tax policy. He also suggested that the bill should be amended to preserve other existing, neutral taxes, such as local property taxes. He expressed concern about the burden of local taxation falling harder on Main Street retailers than on companies who conduct business over the Internet. Wade Anderson expressed concern about the preservation language in S. 442. He said that sales taxes are the primary revenue source in Texas. Anderson also mentioned that Texas does tax Internet access charges because they view it as a local transaction. He stated that electronic commerce and Internet access are 2 distinct areas that can be addressed separately. Anderson also asserted that there is no end date for the moratorium in the bill. Kendall Houghton testified that the moratorium in S. 442 will do three positive things. First, it will send a message to States and localities that electronic commerce is not to be taxed in inconsistent and burdensome ways that will hamper the growth of the Internet. Second, it will facilitate constructive dialogue among the different interests involved. Third, it will help American companies compete on a global basis. Houghton said that Congress can act in this area pursuant to its Commerce Clause authority. She also stated that taxpayers are clearly willing to pay their fair share of taxes on electronic commerce. Linda Rankin stated that the potential of the Internet could be severely impaired if this national and international business medium is subjected to a host of provincial taxes without coordination and consideration of the national interest. She said that while the United States Supreme Court has ruled a number of times that to force national marketers with no presence in a State to collect and remit sales and use taxes would be an undue burden on interstate commerce, States have repeatedly tried to impose these duties on out-of-State marketers. Rankin asserted that under pressure to raise needed revenue, State and local governments will act without regard to national policies or the economy as a whole. James Walton testified that he received opinion letters from the Tennessee Department of Revenue in 1994 and 1996 stating that as an ISP, he did not provide a taxable service, and therefore, he did not have to collect sales tax. In 1996, after his business was audited by the Tennessee Department of Revenue, Walton was told that he should have been collecting sales tax on Internet access charges since January of 1993. This decision caused Walton's business to fail, and Walton ultimately was forced to file for bankruptcy protection. Walton asserted that ISPs already pay taxes on every phone line they use, on every dollar they make, and on the salaries they pay. He said that the Internet industry has become a target for State and local taxing authorities seeking to increase their revenues. november 4, 1997 executive session In open executive session on November 4, 1997, the Committee ordered reported S. 442, the ``Internet Tax Freedom Act,'' by a vote of 14 to 5, with an amendment in the nature of a substitute. Estimated Costs In accordance with paragraph 11(a) of rule XXVI of the Standing Rules of the Senate and section 403 of the Congressional Budget Act of 1974, the Committee provides the following cost estimate, prepared by the Congressional Budget Office: U.S. Congress, Congressional Budget Office, Washington, DC., January 21, 1998. Hon. John McCain, Chairman, Committee on Commerce, Science, and Transportation, U.S. Senate, Washington, DC. Dear Mr. Chairman: The Congressional Budget Office has prepared the enclosed cost estimate and mandates statement for S. 442, the Internet Tax Freedom Act. The bill contains an intergovernmental mandate as defined in the Unfunded Mandates Reform Act of 1995. If you wish further details on this estimate, we will be pleased to provide them. The CBO staff contacts are Rachel Forward (for federal costs), and Pepper Santalucia, (for the state and local impacts). Sincerely, June E. O'Neill, Director. Enclosure. CONGRESSIONAL BUDGET OFFICE COST ESTIMATE S. 442--Internet Tax Freedom Act CBO estimates that enacting S. 442 would result in new discretionary spending of less than $1 million over the 1998- 2003 period, assuming appropriation of the necessary amounts. Because the bill would not affect direct spending, pay-as-you- go procedures would not apply. S. 442 contains no private- sector mandates as defined in the Unfunded Mandates Reform Act of 1995 (UMRA), but it does contain an intergovernmental mandate on state and local governments (see the attachment mandates statement). S. 442 would impose a moratorium on certain state and local taxation of online services, Internet access service, and communications or transactions using the Internet until January 1, 2004. In addition, S. 442 would require the Secretaries of Treasury, Commerce, and State to examine domestic and international taxation of these Internet services and to recommend policies regarding the taxation of such services to the President. Based on information provided by the affected agencies, CBO estimates that the agencies would spend a total of less than $1 million between 1998 and 2000 to complete the studies required by the bill, assuming appropriation of the necessary amounts. The CBO staff contact for this estimate is Rachel Forward. This estimate was approved by Robert A. Sunshine, Deputy Assistant Director for Budget Analysis. CONGRESSIONAL BUDGET OFFICE MANDATES STATEMENT S. 442--Internet Tax Freedom Act Summary: S. 442 contains no private-sector mandates, but by prohibiting the collection of certain types of state an local taxes, the bill would impose an intergovernmental mandate as defined in the Unfunded Mandates Reform Act of 1995 (UMRA). CBO cannot estimate whether the direct costs of this mandate would exceed the statutory threshold established in UMRA ($50 million in 1996, indexed annually for inflation). Intergovernmental mandates contained in bill: S. 442 would place a moratorium until January 1, 2004, on certain state and local taxes on online services, Internet access service, or communications or transactions using the Internet. The moratorium would not affect state and local taxes on these services and transactions as long as the taxes meet certain criteria in the bill. Because existing taxes are not specifically grandfathered by the bill, any current taxes that fail to meet these criteria would be preempted until the year 2004. Estimated direct costs of mandates to State, local, and tribal Governments Is the statutory threshold exceeded? Because it is unclear how the criteria in the bill would apply to the state and local taxes that are currently levied on Internet-related transactions or services, CBO is unable to determinewhether the threshold for intergovernmental mandates ($50 million in 1996, indexed annually for inflation) would be exceeded in any of the first five years of the moratorium. The applicability of many of the criteria and definitions allowing for the collection of certain taxes would likely be litigated, and we cannot predict the outcome of such litigation at this time. If the criteria allowing for the collection of taxes are interpreted narrowly and if, as a result, most or all existing taxes that could be affected by this bill are suspended, the loss of revenues would probably exceed the threshold. Total direct costs of mandates UMRA includes in its definition of the direct costs of a federal intergovernmental mandate the estimated amounts that state, local, and tribal governments would be prohibited from raising in revenues in order to comply with the mandate. The direct costs of the mandate in S. 442 would be the tax revenues that state and local governments would be precluded from collecting because of the moratorium. Because the taxation of Internet-related services and transactions is changing rapidly, it is possible that in the absence of this legislation some state and local governments would impose new taxes or decide to apply existing taxes in this area over the next five years. (UMRA requires CBO to estimate the direct costs of a mandate for the first five years that it is effective.) It is also possible that during this time some state and local governments would repeal existing taxes or administratively limit their application to Internet- related services and transactions. These changes would affect the ultimate cost of the mandate but are extremely difficult to predict. Therefore, for the purposes of preparing this estimate, CBO limited its analysis to those taxes currently collected by state and local governments. S. 442 would temporarily prohibit state and local governments from taxing Internet access service, online services, or communications or transactions using the Internet, unless the tax fell into one of the categories of taxes specifically preserved by the bill. These categories include: taxes imposed on or measured by net or gross income derived from such services; taxes imposed on or measures by value added, net worth, or capital stock; fairly apportioned business license taxes; property taxes; taxes imposed on or collected by common carriers or other providers of telecommunications service; franchise fees imposed on cable services; and sales, use, or other transaction taxes that are also imposed and collected ``in the case of similar sales, uses, or transactions not using the Internet, online services, or Internet access service.'' While many existing taxes would clearly fall within one of these categories and thus would be preserved, some current state and local taxes do not fit neatly in one of the categories. These taxes are sales, use, or other transaction taxes on internet access and online services and on information and data processing services. As described below, however, CBO cannot predict whether these taxes would be temporarily suspended by the bill's moratorium. Basis of estimate: The moratorium in S. 442 could affect some taxes currently collected by state and local governments. For the purpose of preparing an estimate of those potential losses, CBO gathered information from 25 states and from interest groups representing both state governments and the industries that would be affected by the bill. Taxes on Internet Access Service and Online Services. CBO has identified 12 states nationwide that currently impose a sales, use, or other transaction-based tax on the fees charged by providers of Internet access or online services. Some of those states also allow local taxes on these same services. Half of these states tax Internet access as an information or data-processing service. The other half tax Internet access as a telecommunications service. In general, states could not provide definitive estimates of their tax revenues, because many providers of these services also provide other taxable services and typically remit their tax collections to the states as one sum. In addition, the industry is growing so quickly that revenue figures from previous years are not very useful for estimating present collections. Based on the information that states could provide and on national market data, CBO estimates that 1997 revenues for the 12 states and various localities that currently collect these taxes were close to $50 million. Given the rapid growth in use of the Internet, these revenues are likely to grow in coming years as more households and businesses decide to purchase Internet access. It is not clear whether S. 442 would allow states and localities to continue collecting all of these revenues. The question is whether the taxes are also imposed and collected in the case of ``similar sales, uses, or transactions not using the Internet, online services, or Internet access service.'' This question is likely to be the subject of litigation. In the case of a sales/use tax on information and data processing services, a state wishing to preserve its tax could argue that it imposes the tax both on Internet access and on similar services not using the Internet, such as Westlaw or Lexis/Nexis. However, a provider could argue that Internet access is significantly different from access to a single data base, and that sales of Internet access should not be considered ``similar sales'' for taxation purposes. The same arguments could be made concerning taxes imposed on Internet access and online services as telecommunications services. It is not clear whether courts would find these services ``similar'' to other telecommunication services, such as telephone, fax, paging, and voice mail. Taxes on Information and Data Processing Services. CBO also cannot predict exactly how S. 442 would affect sales, use, or other transaction-based taxes on information services or data processing services provided via the Internet or online services. For decades, companies have provided these services by allowing customers to directly connect to the companies' computers via modem. It is increasingly common, however, for firms to also provide these services over the Internet. In some cases, the companies are completely Internet-based. A 1996 survey by the Federation of Tax Administrators identified 15 states that levy a sales, use, or other transaction-based tax on some kinds of information and data processing services. Some of those states also allow localities to levy an additional sales tax on these same services. Of those states and localities, three states and one major city were able to provide estimates of their revenue from these sources. The 1997 revenues for these jurisdictions alone were between $35 million and $45 million annually. As with Internet access, the market for information and data processing services provided over the Internet is growing quickly, and state tax revenues from this market are likely to follow suit. Some portion of future revenues could be interrupted by the bill's moratorium. If S. 442 were enacted, states and localities would have to show that they tax the sales or use of information services provided via the Internet the same way that they tax ``similar'' sales or uses not using the Internet or online services. CBO expects that litigation would be required to determine which state and local taxes pass this test. For example, a state that levies a sales tax on the subscription that a customer pays to access news or financial information at an Internet site could argue that the tax is preserved, because it also applies to computer-based information services that do not utilize the Internet. However, the information provider could argue that its product is more similar to newspapers and magazines, which may not be subject to sales and use tax in the state. Regulatory Impact Statement In accordance with paragraph 11(b) of rule XXVI of the Standing Rules of the Senate, the Committee provides the following evaluation of the regulatory impact of the legislation, as reported: number of persons covered This legislation will impose a moratorium on the imposition, assessment, or collection of State and local taxes that discriminate against communications or transactions using the Internet, and against online services or Internet access service. It will have no effect on the number of individuals regulated. economic impact This legislation establishes a moratorium until January 1, 2004, on State and local taxes that discriminate against the Internet. It would preserve State and local taxing authorities' ability to impose traditional sales and use taxes, excise taxes, and other taxes that are technology-neutral. These taxes make up the vast majority of State and local tax revenues. Therefore, any adverse economic impact that the moratorium would have is minimized. In addition, this measure will allow for growth in electronic commerce and the Internet industry and will thereby create benefits for the economy. privacy This legislation will not have any adverse impact on the personal privacy of the individuals affected. paperwork This bill will require State and local taxing authorities temporarily to stop imposing, assessing or collecting discriminatory Internet taxes. Therefore, the paperwork requirements associated with this measure should be minimal. Section-by-Section Analysis Section 1. Short title Section 1 provides that the bill may be cited as the ``Internet Tax Freedom Act.'' Section 2. Findings Section 2 includes the findings of Congress. Among the findings are: that as a massive global network spanning not only State but international borders, the Internet and the related provision of online services and Internet access service are inherently a matter of interstate and foreign commerce within the jurisdiction of the United States Congress under Article I, section 8, clause 3 of the United States Constitution; that consumers, businesses and others engaging in interstate and foreign commerce through online services and Internet access service could become subject to more than 30,000 separate taxing jurisdictions in the United States alone; and that because the tax laws and regulations of so many jurisdictions were established long before the advent of the Internet, online services, and Internet access service, their application to this new medium and services in unintended and unpredictable ways could prove to be an unacceptable burden on interstate and foreign commerce of the Nation. Section 3. Moratorium on the imposition of taxes on the Internet, online services, or Internet access service Section 3 of the reported bill establishes a moratorium, which expires on January 1, 2004, on State and local taxes that discriminate against communications and transactions using the Internet, and online services and Internet access service. The purpose of the ``time out'' on discriminatory taxes is to allow for a process to examine current policies and practices and to develop policy recommendations with respect to taxation of communications and transactions using the Internet, online services, and Internet access service. Ideally, this process will produce policies on taxation that eliminate any disproportionate burden on interstate commerce conducted electronically and establish a level playing field between electronic commerce using the new media of the Internet and traditional means of commerce, such as in-store sales, mail order and telephone sales. It is expected that participants in electronic commerce will pay their ``fair share'' of State and local taxes. The original verion of the bill provided for an indefinite moratorium on taxes that discriminate against the Internet. The committee substitute establishes an end date for the moratorium. The inclusion of an end date for the moratorium strikes a balance between the interests of State and local authorities in imposing taxes on the Internet, and businesses that believe State and local tax authorities would simply ``wait out'' the moratorium and then tax electronic commerce in whatever manner they desired. The duration of the moratorium is designed to allow the Consultative Group established in Section 4 of the Act sufficient time to develop policy recommendations for the President, for the President to prepare policy recommendations for Congress, and for Congress or the State and local authorities to act upon any legislative policy recommendations made by the President pursuant to the work of the Consultative Group. Section 3(a) provides that except as otherwise provided in this Act, prior to January 1, 2004, no State or political subdivision thereof may impose, assess, or attempt to collect any tax on communications or transactions using the Internet, online services or Internet access service. The moratorium would not affect any State or local tax on communications or transactions using the Internet, online services or Internet access service as long as they are imposed or assessed in a technologically neutral and nondiscriminatory way. The moratorium applies to both existing and new taxes and administrative interpretations that are inconsistent with the provisions of this Act. For example, the moratorium would apply to a tax that a State or local authority imposes and assesses on a subscription to a newspaper accessed online if that State does not also tax a newspaper subscription ordered over the telephone or through the mail. The moratorium would also apply to ``double taxation'' of products or services, such as a tax imposed or assessed on telecommunications services provided by a local phone company to an Internet service provider (ISP) where the ISP has already paid a tax on the telecommunications services. The moratorium applies to online services, Internet access service, or communications or transactions conducted through the Internet, regardless of the technology being used to deliver these services--e.g., the public switched network, cable systems, and wireless networks. However, it applies only to the portion of the medium being used to provide such services. For example, the moratorium would apply to discriminatory taxes imposed on online services via a cable network, but only to the portion of the cable network provider's communications or transactions that employ the Transmission Control Protocol, Internet Protocol, or any predecessor or successor protocols. The moratorium does not allow a cable network, public switched network or wireless network to claim or to seek immunity from taxes--discriminatory or otherwise--for the provision of other products or services, such as cable programming or telephone calls, that do not employ the Transmission Control Protocol/Internet Protocol, or any predecessor or successor protocols. Section 3(b), Preservation of State and Local Taxing Authority, specifically preserves the authority of State and local entities to tax in a nondiscriminatory manner online services, Internet access service, and communications or transactions using the Internet. Existing taxes are specifically grandfathered by the bill provided they are imposed and assessed in a nondiscriminatory and technologically-neutral manner. This subsection specifically preserves sales, use, or other transaction taxes; taxes imposed or measured by gross or net income derived from online services, Internet access service, or communications or transactions using the Internet, or on value added, net worth or capital stock; fairly apportioned business license taxes; taxes paid by a provider or user of online services or Internet access service as a consumer of goods and services; property taxes imposed or assessed on property owned or leased by a provider or user of online services or Internet access service; taxes imposed on or collected by a common carrier acting as a common carrier; taxes imposed on or collected by a provider of telecommunications service (as defined in the Communications Act of 1934 (47 U.S.C. 153)); and franchise fees for the provision of cable services. The bill as reported preserves general forms of State and local taxation, which account for the vast majority of State and local level tax revenues on an annual basis; they will be unaffected bythe bill. These taxes include net income taxes, gross income (e.g., business license) taxes, property taxes and sales and use taxes. The bill as introduced preserved three types of taxes; the committee substitute significantly expands the coverage to preserve the eight most common types of taxes. Subsection (b)(1) would ensure that transactions effected through the Internet or online services which are functionally equivalent to transactions effected through traditional forms of commerce (e.g., mail order or phone sales) remain subject to sales and use tax. Other transaction taxes include taxes on the sale of alcohol, tobacco, and fuel. For example, if a taxable event occurs when a customer orders a computer from a mail order company, using its 1-800 telephone line to place the order, then the transaction should likewise be taxable if that customer goes online to order the computer from the mail order company's Web site. Another example involves software vendors that deliver their product electronically and who have had to analyze the sales tax implications of the mode of delivery of their products. Traditionally, determining whether a software vendor has a sales or use tax obligation involves a 2-step analysis. First, it must be determined whether the electronic delivery of the software is considered tangible personal property subject to tax or whether it should instead be treated as exempt intangible property. As an illustration, Virginia has ruled that software which would otherwise be taxable as the sale of tangible personal property is not subject to tax when delivered electronically because the electronically-delivered software is considered intangible property. Second, if the software is taxable, the seller must have the requisite nexus with the jurisdiction in order to have a sales and use tax collection obligation. Thus, if the seller does not have any physical presence in the jurisdiction, either through employees or property, the seller may not have a tax obligation regardless of the tax classification of the software. States must treat sales of other electronically-delivered items, such as movies and music, in a like manner. Pursuant to the bill as reported, 2 conditions must exist in order to preserve the ability to impose a sales or use tax on an electronic commerce transaction: (1) the tax (including the rate at which it is imposed) is the same as it would have been had the transaction been conducted via telephone (e.g., as a catalogue sale); and (2) the obligation to collect the tax is imposed on the same person or entity as in the case of non- electronic commerce transactions (e.g., the vendor has the duty to collect and remit the tax, in both cases). In other words, as long as the State or local sales tax is imposed on Internet transactions at the same rate and in the same manner as mail order transactions, then the tax is not affected by the bill. As a related matter, the committee substitute directly addresses concerns about the labeling of taxes raised by the State of Hawaii (e.g., that its General Excise Tax will be suspended during the period of the moratorium) and the State of Illinois (e.g., that its Retail Occupation Tax will be suspended during the period of the moratorium). These taxes may have different names or labels, but the purpose they serve is that of a sales tax, and experts widely regard and call them such. The use of the term ``sales or use tax'' in the committee substitute is intended to apply to the many varieties of sales and use taxes, regardless of their label. Subsection (b)(2) would ensure that participants in electronic commerce pay their fair share of State and local income taxes. Because income taxes are typically imposed in a neutral fashion (e.g., without regard to the manner in which the income is earned or derived) and do not create inordinate compliance burdens, income taxes are specifically excluded from the moratorium. The committee substitute removes the word ``net'' so as to preserve both net income taxes and gross income taxes. States' business taxes are typically imposed on or measured by net income, but not every State takes this approach: one example of an alternative business tax is the Washington State Business and Occupation Tax, which is imposed on gross rather than net income. The committee substitute, by eliminating the word ``net,'' broadens the income tax preservation to include net and gross income taxes and clarifies that Washington's State-level income tax is preserved. Similarly, California imposes a ``franchise tax'' that is measured by the net income of corporations subject to the tax; although the tax is not labeled as an ``income tax,'' it clearly operates in the prescribed fashion and is specifically preserved by the committee substitute. Subsection (b)(3) preserves fairly apportioned business license taxes, which are typically imposed on the gross receipts of businesses that have a location within the taxing jurisdiction. Such taxes are a significant source of revenue for localities. The committee substitute provision is consistent with United States Supreme Court precedent by requiring business license taxes to be fairly apportioned. By including the words ``fairly apportioned,'' the committee does not intend to imply that other preserved taxes do not have to be fairly apportioned. Subsection (b)(4) preserves taxes paid by a provider of Internet or online services as a consumer of goods and services not otherwise excluded from taxation pursuant to this legislation. This subsection was added to the original version of the bill to ensure that Internet service providers and other entities providing Internet and online services pay State and local taxes when acting as consumers (e.g., purchasing goods and services) as opposed to providing electronic commerce services. The bill as reported does not excuse Internet sellers and online service providers from paying sales and use taxes on their purchases. Where an Internet or online service provider purchases a good or service that is already subject to a resale exemption, such exemption should continue to apply. Subsection (b)(5) preserves property taxes imposed or assessed on property owned or leased by an Internet or online service provider. Property taxes include real property, personal property, and intangible property taxes assessed on property that is owned or leased. This subsection was added to the original version of the bill to reflect the committee's intent that the moratorium would not apply to property taxes assessed or collected at the State or local level. Subsection (b)(6) preserves taxes imposed on a common carrier acting as a common carrier, and subsection (b)(7) preserves taxes imposed on a provider of telecommunications services to ensure that State and local telecommunications taxes, fees, and regulations are unaffected by the bill. The preservation of this taxing authority, added to the original version of the bill, is intended to apply to entities when they act as telecommunications service providers and not as Internet access or online service providers. For example, a company that provides both telecommunications and Internet access service and uses its lines to provide Internet access does not cause such lines to be exempt from telecommunications taxes. Subsection (b)(8) preserves franchise fees imposed by a State or local franchising authority for the provision of cable services. The preservation of this authority, which parallels the provisions of subsections (b)(6) and (7), ensures that cable providers remain liable for local franchise fees in connection with the provision of cable services, pursuant to section 622 or 653 of the Communications Act of 1934. The broad preservation of State and local taxing authority set forth in section 3(b) is not intended to be an inclusive or exhaustive list of preserved taxes; rather, it is illustrative of the general categories of taxes that State and local authorities impose or assess on businesses and consumers. State and local authorities may continue to impose and assess sales, use, and other transaction taxes on communications and transactions using the Internet, online services or Internet access services provided the tax is the same tax imposed on traditional means of commerce, and the obligation to collect or pay the tax is imposed on the same person as in the case of traditional means of commerce. Sales, use, and other transaction taxes that create a substantively greater burden on electronic commerce or participants in electronic commerce than other means of commerce are not preserved. For example, the preservation authority in this subsection means that if a State generally imposes and collects a sales or use tax on mail order sales, then it may impose and collect a sales or use tax on sales made using the Internet, online services or Internet access service. This subsection does not provide special protection from taxes for communications or transactions using the Internet, online services or Internet access service that are also generally applied to communications or transactions using other means, such as mail order or in-store retail; rather, it seeks to ensure that taxes are imposed and assessed in a technologically neutral way and in a manner that does not discriminate against communications or transactions using the Internet, online services or Internet access service. Section 4. Administration policy recommendations to Congress Section 4 establishes a process by which the Administration, State and local governments, and business and consumer groups will examine current policies and practices, and develop and recommend to Congress policies on taxation of communications and transactions using the Internet, online services, and Internet access service. Section 4(a) directs the Secretaries of the Treasury, Commerce and State, in consultation with appropriate committees of Congress, State and local authorities, and consumer and business groups, to examine United States domestic and international taxation of communications and transactions using the Internet, online services, and Internet access service, and the telecommunications infrastructure used by them, and to jointly transmit within18 months of the date of enactment of S. 442 any recommendations to the President. It is expected that the Consultative Group first will determine whether taxes should be imposed and assessed on communications and transactions using the Internet, online services and Internet access service. Second, if taxation is recommended, it is expected the Consultative Group will examine and recommend policies to ensure such taxation is uniform, fair, and administrable. It is expected the Consultative Group will evaluate current domestic and foreign policies and practices on taxation of communications and transactions using the Internet, online services, and Internet access service, and will develop policy recommendations for the President on taxation of the Internet, online services, and Internet access service. The Consultative Group shall consider any specific proposals from the National Tax Association's Joint Communications and Electronic Commerce Tax Project and the National Conference of Commissioners of Uniform State Laws. The confusion caused by the variety of ways in which different States tax communications and transactions using the Internet, online services, and Internet access service is underscored by the Congressional Budget Office (CBO) in its January 21, 1998 estimate, on S. 442. The CBO states it ``has identified 12 States nationwide that currently impose a sales, use or other transaction-based tax on the fees charged by providers of Internet access or online services. Some of those States also allow local taxes on these same services. Half of these States tax Internet access as an information or data- processing service. The other half tax Internet access as a telecommunications service. In general, States could not provide definitive estimates of their tax revenues because many providers of these services also provide other taxable services and typically remit their tax collections to the States as one sum.'' If communications and transactions using the Internet, online services or Internet access service are to be taxed, then the tax policy should be simple, uniform, and administrable. Section 4(b) directs the President not later than 2 years after the date of enactment of S. 442 to transmit to the appropriate committees of Congress policy recommendations on taxation of online services, Internet access service, and communications and transactions using the Internet. Section 5. Declaration that the Internet should be free of foreign tariffs, trade barriers, and other restrictions Section 5 expresses the sense of the Congress that the President should seek bilateral and multilateral agreements through appropriate international organizations and fora to establish that commercial transactions using the Internet are free from tariff and taxation. This section supports the policy of the Administration to work to create a worldwide ``duty free zone'' on the Internet. Section 6. Definitions Section 6 sets forth the definitions of the ``Internet,'' ``online services,'' ``Internet access service,'' and ``tax'' for purposes of S. 442. The definitions of the ``Internet,'' ``online services,'' and ``Internet access service'' apply only to the terms as used in the reported bill, and are not intended to affect in any way existing law, regulation, or policy. Rollcall Votes in Committee In accordance with paragraph 7(c) of rule XXVI of the Standing Rules of the Senate, the Committee provides the following description of the record votes during its consideration of S. 442: Senator McCain (for himself, Mr. Wyden, Mr. Burns, and Mr. Kerry) offered an amendment in the nature of a substitute to S. 442. By rollcall vote of 14 yeas and 5 nays as follows, the amendment was agreed to: YEAS--14 -- NAYS--5 Mr. McCain- Mr. Gorton Mr. Stevens \1\ Mrs. Hutchison Mr. Burns- - Mr. Ford \1\ Ms. Snowe-- Mr. Bryan \1\ Mr. Ashcroft \1\- Mr. Dorgan Mr. Frist \1\ Mr. Abraham Mr. Brownback Mr. Hollings Mr. Inouye Mr. Rockefeller Mr. Kerry \1\ Mr. Breaux Mr. Wyden \1\ By proxy Changes in Existing Law In compliance with paragraph 12 of rule XXVI of the Standing Rules of the Senate, the Committee states that the bill as reported would make no change to existing law. MINORITY VIEWS OF SENATOR DORGAN I oppose S. 442, the Internet Tax Freedom Act on several grounds, not the least of which is the fact that this legislation constitutes one of the more significant federal assaults on state and local sovereignty in recent memory. In my judgment, this legislation is unwarranted and if enacted, it would significantly erode state and local tax bases and hurt main street businesses. The claims of the bill's sponsors that S. 442 is needed to fend off aggressive tax discrimination by states and to prevent a crippling burden on Internet commerce, as well as the erroneous assertion that Internet traffic constitutes a unique form of interstate commerce, are without foundation and cannot justify this broad reaching assault on state and local sovereignty. I object to the notion that the Congress ought to step in and write state and local tax laws. Until specific tax problems or abuses are identified and supported with evidence, federal legislation of this nature should not be entertained. This legislation violates the Unfunded Mandates Reform Act of 1995 (P.L. 104-4) and I intend to raise a point of order on this legislation should it be considered by the full Senate. Because the billcontains ambiguous language and new definitions which have not been adequately reviewed by the Commerce Committee, the bill's exact impact on state and local revenues is hard to determine at this point. However, it is clear that the impact will be large, the question is how large (in terms of hundreds of millions of dollars). In addition to the unfairness of Congress dictating state and local tax policy, this legislation would create an unfair competitive situation with respect to telecommunications providers and local business by carving out a specific technology from broad based state and local taxation; placing some telecommunications providers and local businesses at an unfair disadvantage because they would remain subject to state and local taxation. This bill creates more than just a tax break--it creates a technology preference policy and a new unregulated, untaxable medium for commerce. What is the justification for singling out Internet commerce for special tax treatment? Why should buying a sweater through an Internet service be exempted from the same tax that is imposed when the identical sweater is purchased at a store on main street or purchased through a mail order catalog? The tax effect of this bill is that Internet commerce will be given favored tax treatment, and that is not fair to other lines of commerce. This should raise concerns with not just state and local governments but the businesses and individuals that are left subject to regulations and taxes. It is my belief that taxes-- whether federal, state, or local--ought to be imposed in a fair and equitable manner and I object to the approach embodied under S. 442 which creates a special tax status for a particular technology and category of users who have not made a public policy case why government should single them out for special tax treatment. The effect of this legislation, if enacted in its present form, would be to create the ``Cayman Islands'' of sales taxes by establishing a tax free haven that will hurt main street businesses and dictate to state and local governments an inequitable application of sales, use, and other taxes that have historically been under state and local jurisdiction. This legislation attempts to create a ``tax free access road'' along the information superhighway that will unfairly hurt local businesses and create an unfair competitive situation with respect to the use of telecommunications services; creating a ``nexus free'' medium for commerce that will circumvent state and local tax laws that all other businesses are obligated to follow. Given the fact that the Internet is a new medium and business activity is just beginning to grow in this area, it is not surprising that there would be issues that need to be resolved. However, these issues should be resolved appropriately--through cooperative discussions between industry and state and local governments. Congress should not dictate a moratorium on state and local governments. In fact, I contend that the moratorium imposed under S. 442 will actually be counter productive to the efforts of those who are attempting to develop uniform taxation of electronic commerce. Further, the ambiguities in terms of what is included in the legislation's moratorium and the vague definition of the so- called exceptions to that moratorium indicate that the bill is certain to create extensive litigation as telecommunications providers and businesses that use electronic commerce vie for the tax breaks provided by this legislation. legislation is unwarranted S. 442 is a solution in search of a problem. The proponents of this legislation have simply failed to make the case that it is necessary to pass federal legislation preempting state and local taxation on electronic commerce. It seems to me that if Congress is to consider taking such drastic action as to tell state and local governments how they can and cannot tax, then those seeking the tax breaks must make a compelling case that such action is necessary. That case has certainly not been made with respect to S. 442. Advocates have claimed that electronic commerce is being subjected to unfair and discriminatory taxation by state and local governments. The fact is that there is no discriminatory taxation occurring that warrants a federal moratorium. Proponents have failed to identify a single enacted state or local law that singles out Internet services or on-line services for punitive or discriminatory taxation. The bill's advocates fail to identify any specific tax in any specific state or local jurisdiction which would justify a federal preemption. The justification cited by the advocates seeking the tax preemption is that state and local governments are discriminating against Internet providers and on-line services in their taxation policies is simply not grounded in fact. Different tax treatment of a newspaper, for example, may be due to the fact that products that are exempt from a sales tax in tangible form may be subject to a sales tax in electronic form because it is available through an online service--which, in general, is subject to a broad based use tax. The reason why it may be taxed in the latter situation is because it is part of a broad based use, sales, or other taxes on ``information services'' regardless of the method of delivery--not because of an Internet-specific tax. Even if there were discriminatory taxation occurring at the state or local levels, there is no need for a federal law to correct that situation for such taxation has long ago been declared unconstitutional. If a state or local government were to impose a discriminatory tax, then those who are subject to such discriminatory taxation have constitutional protection. Each state must, and does, provide ready avenues to aggrieved taxpayers to protest potentially discriminatory taxes through the court system. The U.S. Supreme Court has determined that fairly apportioned state and local taxation that does not discriminate against interstate commerce are constitutional so long as the tax is applied on an activity with a substantial nexus with the taxing state.\1\ Court precedent has made it clear that discriminatory taxation is not constitutional.\2\ --------------------------------------------------------------------------- \1\ Quill v. North Dakota, 504 U.S. 298 (1992). \2\ A variety of types of discrimination in state taxation have been struck down by the state and federal courts. For example, the Pennsylvania courts determined that a statutory exemption from the sales and use tax and corporate taxes that was allowed for broadcasters but not for cable television operators violated the Equal Protection Clause of the U.S. Constitution, in Suburban Cable TV Co. V. Commonwealth, 570 A.2nd 601 (Pa. Cmwlth. 1990), aff'd, 527 Pa. 364, 591 A.2d 1054 (1991), Taxes that discriminated among speakers that were based on content [Arkansas Writers] Project, Inc. v. Ragland, 481 U.S. 221 (1987), City of Cincinnati v. Discovery Network, Inc., 507 U.S. 410 (1993)], or that singled out the press or targeted a small group of speakers [Grosjean v. American Press Co., 460 U.S. 575 (1983)], have been struck down as violations of the First Amendment. And, tax classifications that discriminated against interstate commerce have been determined to be violations of the Commerce Clause, Boston Stock Exchange v. State Tax Commission, 429 U.S. 318 (1977), Armco Inc. v. Hardesty, 467 U.S. 638 (1984). --------------------------------------------------------------------------- I am opposed to discriminatory taxation and I will not defend attempts by state or local governments to single out electronic commerce for punitive or discriminatory taxation. However, no evidence of such discriminatory taxation has been presented to the Congress that would substantiate the claims of the bill's proponents. I believe that there is no policy justification for the moratorium on state and local taxation in this legislation. There is not a signal state or local enacted law, currently in effect, that imposes a specific tax on Internet or on-line services or the use of those services. There are instances where these services are taxed, but where they are taxed, they are subject to broad based taxes that apply generally to sales of goods and services or to telecommunications services or similar business activities. The bill advocates have also claimed that the legislation is necessary to address fears that states and localities will impose taxes on the transmission of Internet traffic. The bill's findings suggest that the future viability of the Internet is threatened because of excessive taxation and that state and local taxes are restricting the growth of this medium. Internet commerce hardly shows any sign of being impeded. The sponsors claim that without federal protection, Internet commerce would be strangled as state and local governments seek to impose taxes on the transmission of Internet traffic, regardless of any nexus determination. Such claims have no foundation. The Supreme Court has ruled that there must be a sufficient connection between the state and the activity seeking to be taxed, and the mere transmission of communications through a state is insufficient to meet this test. No new Federal law is necessary to address this fear.\3\ --------------------------------------------------------------------------- \3\ Cf: Goldberg v. Sweet, 488 U.S. 252 (1989) establishing that a state may tax interstate telephone services only if the origin or destination of the call was within the state AND the billing address for the call was in the state. Moreover, the Court required that there be a mechanism to avoid multiple taxation by two or more states to pass constitutional muster. --------------------------------------------------------------------------- It is important to note that Internet commerce is thriving without the special federal protection that the bill sponsors' claim is urgently needed. In 1997 alone, web-generated revenues exceeded $24 billion, which was an 800 percent increase from the previous year. Web-generated revenues are forecasted to exceed $300 billion by 1999 and over $1 trillion by the year 2001, constituting increases from 1996 of 1130 percent and 3875 percent respectively. The total value of goods traded in 1997 on the Internet was an estimated $8 billion and is expected to reach $327 billion by the year 2002 \4\--absent any special tax protection imposed by the Congress. Compared to other industries, Internet commerce is far from a struggling infant. According to figures from Standard and Poor's, in 1997, the wireless telecommunications industry grew 20%; biotechnology revenues grew 15%; radio advertising 8.2%; national network television advertising 3.1%; and air transportation revenues 0.2% from the previous year. The growth of Internet commerce-- which is growing at an annual rate exceeding 800%--is staggering compared to these other major growth industries. --------------------------------------------------------------------------- \4\ The Forrester Report, Volume One, Number One (July, 1997). --------------------------------------------------------------------------- Finally, there is nothing unique about the ``interstate'' nature of on-line commerce, which is the foundational premise of this legislation, according to the sponsors. The issues surrounding the debate over how to tax Internet commerce are fundamentally no different than the debates over the past 30 years over mail order sales and other matters of interstate commerce. This legislation uses the ``interstate nature'' of Internet commerce as justification to further exacerbate the current inequities for local businesses with respect to their mail order competitors who are often not collecting the same local sales taxes for example. The only unique quality in the debate over Internet commerce taxation viz a viz other forms of commerce is the technological means--not its interstate nature. There is no policy justification to enact a federal tax break that will cost state and local governments millions of dollars simply because a new technology has emerged into commerce. unfunded mandate The preemption imposed under this legislation constitutes an unfunded mandate on state and local governments that could cost them billions of dollars in revenue that is needed for education, welfare services, transportation infrastructure and other state and local needs. I take seriously the new era of federal-state relations that was set when the Congress passed the Unfunded Mandates Reform Act of 1995 (PL 104--4) and I believe that the Congress ought to resist granting special interest tax breaks at the expense of state and local governments. In the past few years, numerous special interests have come running to Congress seeking special tax breaks at the state and local level. In the last Congress, I saw satellite companies, airlines, busing companies, cellular companies, and even the National Weather Service, claiming that they needed a special tax break at the expense of state and local governments. The scenario in each case is similar where special interests claim that state and local governments are unfair and are signaling them out for special taxation. Each special interest makes the same assertion that they are victims of discrimination by unreasonable local and state governments that Congress must take up their cause. But the facts reveal that the necessity of federal preemption are rarely, if ever, warranted. S. 442 places an unfunded mandate on states and local governments and would be subject to a point of order under the Unfunded Mandates Act enacted in the last Congress. Since the bill affects both future and present methods of state and local taxation, the financial impact on state and local governments is likely to be very significant. The basic premise of S. 442 flies in the face of the principle that the Congress ought to return power to the states and I reject the notion that ``Washington knows best.'' It would be unfortunate if the Congress would undermine the important principle of deferring to state and local governments in areas that are traditionally in their jurisdiction such as taxation. According to the CBO analysis required under the Unfunded Mandates Reform Act, (January 21, 1998) the version of S. 442 that was reported by the Senate Commerce Committee ``contains an intergovernment mandate as defined in the Unfunded Mandates Reform Act of 1995'' and that the bill would preempt ``existing taxes.'' Because of the ambiguity of the language in the bill with respect to the preemptions on state and local taxes, the CBO stated that it could not estimate whether or not the bill in its present form would exceed the statutory threshold established in the unfunded mandates law ($50 million annually). CBO predicts that litigation that will likely occur over the ambiguous language in this legislation and, depending on the interpretation provided to the terms in the bill after court battles, the loss of revenues to state and local governments could probably exceed the $50 million threshold test under the Unfunded Mandates Reform Act. The CBO's determination that the scope of the bill's impact on state and local revenues cannot be accurately determined triggers Section 424(a)(3) of the Unfunded Mandates Reform Act which states that: [I]f the Director determines that it is not feasible to make a reasonable estimate that would be required under paragraphs (1) and (2), the Director shall not make an estimate, but shall report in the statement the reasons for that determination in the statement. If such determination is made by the Director, a point of order under this part shall lie only under section 425(a)(1) and as if the requirement of section 425(a)(1) had not been met. Section 425(a)(1) states that: [I]t shall not be in order in the Senate or the House of Representatives to consider any bill or joint resolution that is reported by a committee unless the committee has published a statement of the Director on the direct costs of Federal mandates in accordance with section 423(f) before such consideration * * * Thus, S. 442 is subject to a point of order in the Senate should S. 442 be considered by the full Senate, the first vote on this legislation will be on the point of order raised under the Unfunded Mandates Reform Act. impact of s. 442 S. 442, would, among other things, preempt state and local taxes by imposing a moratorium on state and local taxation on Internet or on-line services until 2004. S. 442 would prohibit state and local taxation on ``communications or transactions using the Internet and online services or Internet access service.'' In addition to the certain litigation that will occur over the scope and meaning of this broad and ambiguous language if this legislation is enacted, there are serious consequences that could be financially devastating for local businesses and the budgets of state and local governments. While the bill sponsors contend that Sec. 3(b) preserves certain state and local taxes from the preemption, I am not convinced. Such a claim cannot be held with much confidence since it is not possible to determine--without extensive litigation--whether or not the specific state and local taxes identified under this subsection will be upheld or preempted. The structure of the bill, which establishes a blanket prohibition followed by several exceptions creates uncertainty and the risk of litigation for states and localities, which will have to prove for every challenge that their taxes fall completely and squarely within one of the exceptions. This legislation takes the approach of establishing a broad preemption of taxation of electronic commerce and then attempts the absurd by authorizing state and local governments to impose only certain types of taxes. If an existing state or local tax does not meet the exact description provided under this legislation, then such tax would be preempted. This approach is fatally flawed and instead of identifying and addressing any particular problem of state or local tax application on Internet commerce, it will launch a new era of litigation that will cost state and local governments and corporations millions in unnecessary court battles. Communications using the Internet would be excluded from state and local taxation under this legislation, which establishes a very broad application of Internet commerce and excludes all communications using the Internet and online services from state and local taxation. Thus, the preemption in the bill would affect any tax applied to e-mail services, web page hosting, advertising, and Internet telephony. This would create a circumstance where communications through other telecommunications mediums would be subject to tax but the same service provided through the Internet would be exempted from that same tax. This legislation is not prospective. Instead, it exempts a certain category of users--i.e., electronic commerce--from existing taxes. The Commerce Committee heard testimony from the Texas Comptroller of Public Accounts who said that the state of Texas alone would lose hundreds of millions of dollars in revenues from existing broad-based taxes that would be preempted under this legislation.\5\ In addition, a survey of some states conducted by the Federation of Tax Administrators calculated that several states would lose between $1 million and $1.5 billion each.\6\ --------------------------------------------------------------------------- \5\ Attachment A. \6\ Attachment B. --------------------------------------------------------------------------- The bill creates more questions about taxation than it resolves. The findings suggest that Internet services are solely a matter of interstate commerce, thereby implying that state and local jurisdictions have no authority to impose a regulation or tax on any aspect of Internet services. What is it that makes Internet services different from other forms of interstate telecommunications services that justifies this privilege status? Long distance phone calls that cross state boundaries are interstate commerce. However, like Internet services, telephone calls have a local origin and a local destination. As a result, telephone services are not shielded from state or local jurisdiction. Internet and on-line communications ought to be treated in similar fashion. Does the assertion that Internet services are solely a matter of interstate commerce mean that no state or local government could impose a state or local regulation of any kind? How does this affect the growing controversy over direct alcohol sales and the attempt of state and local governments to regulate access to Internet pornography, the growing commerce of Internet pornography, and the burgeoning field of Internet gambling? What impact does this policy have on state and local attempts to address problems associated with the Internet being used to lure minors into sexual encounters or the distribution of pornographic material that would otherwisebe banned or prohibited if it were distributed to minors through other mediums? If Internet commerce is solely a matter of interstate commerce, then does that mean state and local laws that require minimum drinking ages would not apply to the distribution of alcohol via Internet commerce? Is this legislation the beginning of a slippery slope agenda designed to make the Internet a tax-free, regulation-free medium that will not only disrupt the fair and non- discriminatory application of state and local taxes but also undermine the ability of local communities to control otherwise illegal activity such as the distribution of alcohol to minors? Under the bill, can electronic commerce be used to conduct tax- free, regulation-free Internet gambling and games of chance? The revised version of S. 442 provides new federal definitions on a broad range of state and local taxes such as sales and use taxes, property taxes, income taxes, franchise taxes, and business license taxes. In analyzing the bill, the question is: what kinds of sales and use taxes, for example, fall within the definition in the bill and what kinds of sales or use taxes fall outside of the definition and therefore would be preempted? Below is a discussion of just a few examples of the problems created by this legislation by the vague language and broad preemption. Income Taxes. The bill attempts to preserve corporate income taxes. However, the bill does not take into account the different ways in which states impose corporate income taxes and how they apportion revenues and assets to determine those taxes. The bill raises questions as to how states are going to have to differentiate between revenues derived from Internet services as opposed to other services. With respect to states that impose corporate income taxes, how will this bill affect the manner in which these states apportion income related to Internet services as opposed to other telecommunications services? Will states have to restructure their income taxes differently for determining income derived from Internet services as a result of this legislation? To my knowledge, the Committee has not obtained an analysis on how this legislation will affect the imposition of income taxes on those states that provide Internet services; neither has the Committee reviewed the corporate income statutes in all the states to determine whether or not there are any states that currently apply income taxes measured by something other than gross or net revenue or on net worth or capital stock. The Committee never conducted an analysis on the various means that States use to determine income taxes to determine which income taxes are not included in this clause so as to provide a means to avoid the determination of income in that particular instance. The beneficiaries of the tax break provided under this legislation will include some very significant telecommunications and computer companies who not only provide Internet services but other telecommunications services as well. I fear that this legislation will create a significant tax loophole for major corporations. In addition, there is the question as to how this legislation affects payroll taxes such as unemployment insurance and workers compensation taxes. Would these taxes--which are paid by corporations that provide Internet services and online services--be preempted? These are not income taxes and there is no mention in the exceptions of this legislation to ensure that the corporations receiving the tax breaks provided under this legislation would have to pay payroll taxes, unemployment taxes, or workers compensation taxes. Fairly apportioned business license taxes. What is the meaning of fairly apportioned business license taxes in this legislation? There is already a constitutional requirement that taxes on interstate commerce be fairly apportioned.\7\ Does the inclusion of this phrase in this legislation suggest a different meaning? The Committee did not determine what state and local governments currently impose business taxes nor did it determine whether or not this phrase refers to all kinds of business license taxes or only certain specific types of business license taxes. --------------------------------------------------------------------------- \7\Cf: Complete Auto Transit v. Brady. --------------------------------------------------------------------------- Because of the way in which the preemption under this legislation is structured (i.e., imposes a broad preemption than identifies exceptions to that broad preemption), a tax that operates like a business tax but is named something else and may not be directly related to the privilege of doing business will be preempted. According to a letter addressed to Senator McCain dated October 3, 1997,\8\ the State of Texas claimed that this legislation would cost the State of Texas about $1.5 billion. My understanding is that the business license taxes supposedly permitted under Sec. 3(b) do not include the Texas franchise tax which is imposed on all telecommunications carriers, including Internet service providers and commerce over that medium. How does this provision relate to the franchise tax on telecommunications services imposed in a state like Texas and why would Texas come to the conclusion that this legislation would cost them $1.5 billion? --------------------------------------------------------------------------- \8\ Cf: Attachment B. --------------------------------------------------------------------------- According to a letter from the Comptroller of the State of Texas, Wade Anderson,\9\ said that the franchise tax imposed by Texas is not a business tax and therefore would be preempted under this legislation. The Committee never conducted an assessment on how the franchise taxes in States like New York and Ohio would be impacted under this provision. What is a business license tax? How is it defined in the bill? What happens if a tax is called a ``privilege tax?'' Who decides whether it will be treated like a ``business license'' tax? Here again, the structure of the bill creates a problem in that if a tax does not fall squarely within the 4-corners of one of the exceptions, it could be prohibited. --------------------------------------------------------------------------- \9\ Cf: Attachment A. --------------------------------------------------------------------------- Sales Taxes. Section 3(b)(6)(A) of the bill states that sales taxes would be exempted from the moratorium if they are imposed on ``similar sales or transactions.'' But, ``similar'' is highly ambiguous. Does this refer to an item-by-item comparison (e.g., electronic newspaper vs. tangible newspaper) or is it a comparison of classifications of taxation (e.g., use taxes on like tangible products or use taxes on electronic services or products?) In addition, the ambiguity creates a whole host of issues and potential litigation as to what constitutes a ``similar sale.'' It is my understanding that in the case of newspapers, some jurisdictions have exempted the tangible versions from sales taxes (based on statutes decades old) but the electronic version is captured under a broader sales or use tax on ``computer services'' or ``information services.'' Would this legislation mean that in those jurisdictions where this situation exists, the broader computer services tax or information services tax would be preempted? If that is the interpretation, would that not then create an incentive for those jurisdictions to remove their sales tax exemptions on tangible versions to avoid a major revenue loss because this new law would strike down their broad based computer services tax or their broad based information services tax? Our understanding is that some states impose sales taxes on computer information services--which is unique to Internet or online commerce in terms of its delivery and distribution in some cases. Computer and information service taxes are unique by their very nature, but the imposition of them may not suggest discrimination. If, in a state or local jurisdiction, sales taxes were imposed on all information services, then does that mean the sales tax on computer and information services is preempted or would it be permissible under this legislation? What is the impact of the bill on sales and use taxes applied to Internet access charges to end consumers? If the sales tax is applied generally to telecommunications, does it meet the ``similar sales'' requirement of Section 3(b)? What if the tax exempts residential service, or applies only to intra- and interstate long-distance calls? Does it still meet the ``similar sales'' requirement? Who will decide? The latest version seems to allow sales taxes on access charges if they meet the requirement of also being applied to ``similar'' sales not involving the Internet. The problem is it just becomes another area for litigation. What is the impact of the bill on sales taxes on electronic information services? In some services, a person can receive news already sorted by specified topics delivered to one's computer daily. A data base of historical news of particular stocks with regular updates and performance for example can be delivered as well. Is this a ``similar sale'' to a newspaper or a library or the services of a stockbroker? Will the bill allow a state or locality to impose a tax on that service since it all takes place using the Internet? Some research and services are available only on-line. In this case, what will determine whether or not there is a similar sale? The point here is the difficulty created by the sales tax preservation language. The ``similar sale'' language will create a great deal of litigation and constrain the ability of states and localities to make reasonable decisions and classifications on what they want to tax and what they do not want to tax. Most importantly, the bill attempts to establish that electronic commerce sales should be compared to mail order or direct marketing sales in determining whether the seller should be required to collect use taxes on the transaction. As we all know, the Supreme Court has held that states may not require a direct marketer without physical presence in the state to collect such taxes.\10\ The bill attempts by fiat to treat all electronic commerce marketers as mail order marketers and to prevent states from requiring them to collect use taxes whether or not they have the requisite presence in the state. The effect is to blow a gaping hole in the revenue base of state and local governments and to further place main street businesses at a competitive disadvantage. --------------------------------------------------------------------------- \10\ Cf: Quill v. North Dakota, 504 U.S. 298 (1992). --------------------------------------------------------------------------- About half of all revenues to state governments are derived from sales taxes. Any preemption of that revenue base could have a dramatic impact on States. According to a recent Federation of Tax Administrators report, 14 states impose sales taxes on computer and information services and 11 states impose sales taxes on computer and data processing services. It is not clear how the sales taxes in these states be impacted under this bill and whether or not the states that impose such sales taxes will satisfy the ``similar'' test under Sec. 3(b)(6)(A). Unfortunately, the Committee has not done a sufficient analysis on what State and local sales taxes would be preempted and which ones would be permissible under this legislation and nobody, including the bill sponsors nor CBO, can explain with confidence the full scope of the impact this legislation will have on State and local sales taxes. Finally, section 3(b)(4) of the bill would exempt ``taxes paid by a provider or user of online service or Internet access service as a consumer of goods and services not otherwise excluded from taxation pursuant to this Act.'' What kinds of taxes are referenced in this subsection? The clause ``not otherwise excluded from taxation pursuant to this Act'' seems to create a negative, canceling out what tax is being referred to in the first part of the sentence. The revised version says that the tax preemption does not apply to common carriers acting in their capacity as common carriers. Does this mean that transnational taxes and access charges would not be preempted when common carriers--such as phone companies--provide Internet service but the same service would be preempted from taxes if it were provided by someone other than a common carrier? Is this an equitable application of a tax? Despite the failed attempts of the legislation to preserve certain types of taxes from the broad preemption imposed, there are a range of taxes on the books in many States and local governments that are clearly not mentioned in Sec. 3(b) and therefore would be preempted under this legislation. Those taxes include: Franchise Taxes. There are at least 3 states that impose franchise taxes: Texas, New York, and Ohio and these taxes would be preempted under S. 442 with respect to Internet services and online services, but would still apply to other telecommunications services. The bill does not specifically mention that franchise taxes are preserved and therefore I can only conclude that these would be preempted with respect to the application of these kinds of taxes on Internet commerce. Information Services Taxes. There are 11 states that have information services taxes which would be preempted. Those states are: South Dakota; Texas; New Mexico; South Carolina; Iowa; Connecticut; Ohio; Pennsylvania; Colorado; New York; and District of Columbia. It appears that under this legislation, Internet services and online services would be exempted from the information services taxed in these States. Internet Access Taxes. The legislation specifically preempts Internet access taxes. I understand that 16 States have laws taxing Internet access: Tennessee; South Dakota; Texas; New Mexico; Utah; South Carolina; Iowa; Connecticut; Ohio; Illinois; North Dakota; Wisconsin; West Virginia; Colorado; Alabama; and the District of Columbia. Tobacco and Alcohol Taxes. Tobacco sales over the Internet are growing fast. Under this legislation, it appears that tobacco sold through Internet commerce or through an online service would be exempted from taxes whereas tobacco purchased at a store remain subject to tax. The same situation exists for alcohol sales--which I understand is a growing problem, not only with respect to taxes but also with respect to minors accessing alcohol through Internet commerce, circumventing state and local laws designed to limit access to alcohol and tobacco. Will this bill allow special excise taxes to be applied to the purchase of cigarettes, cigars, wine and the like over the Internet? In some states, it is possible to purchase certain quantities of these products via mail order or by phone orders and a requirement that state tobacco taxes or liquor taxes be paid. If they are purchased over the Internet under this bill, the sale would seem to be tax exempt because there is no exception for the taxes. Gaming Taxes. Where gaming taxes exist, they would be preempted under this legislation with respect to gaming activity over the Internet. Telecommunications Excise Taxes. The effect of the bill on existing special telecommunication excise taxes on Internet access charges to the end consumer and the purchase of telecommunications services to create the networks that make up the Internet is unclear at best. Only a couple of states impose a special telecommunications excise tax (special in that it applies only to telecommunications and not just Internet access), but a number of others apply such a tax to the purchase of telecommunications services that make up the backbone of the Internet and the corporate intranet. There is no exception for such taxes and therefore these taxes would be preempted. Definitions. The bill introduces new definitions, creating uncertainty about the bill's impact. This legislation would preempt taxation on ``online services'' and on ``Internet access service,'' and it is not clear on how ``on line services,'' as defined in this bill, relates to how these services are defined in the Communications Act. The term ``online services'' is defined as the ``offering or provision of information, information processing, and products or services to a user as part of a package of services that are combined with Internet access service and offered to the user for a single price.'' It appears this includes preempting taxes on the use of Lexis/Nexus, stock quotations, real estate listings, and other on-line data bases that are currently subject to taxation. Our understanding is that several states have statutes taxing ``information services,'' ``computer services,'' and ``data processing'' services and these are interpreted as online services. It appears that these taxes would all be preempted. For the most part, the consumer paying these kinds of taxes are law firms, corporations, and significantly-sized businesses. It is the determination of the bill sponsors that law firms and major companies need a break from these taxes? And have the sponsors determined how much revenue is at stake here and would be shifted to other revenue sources that may have a large impact on individuals? In other words, it appears that the preemption of taxation on online services is largely going to benefit law firms; shifting State and local tax burdens on individuals. Finally, this definition may capture private communications networks set up between the various locations of a single business enterprise. These ``intranet'' networks are becoming increasingly popular and are proliferating. Thus, telecommunications taxes applied to the telecommunications services used for such networks would be preempted. ``Internet access services'' are defined as the ``offering or provision of the storage, computer processing, and transmission of information that enables the user to make use of resources found via the Internet'' i.e., the Internet connection. The definition says that these services include the use of telecommunications services and cable services defined under 602 of the Communications Act. Does this mean that under the legislation, taxes on cable services would be preempted from taxation? Or would a portion of cable services, i.e., Internet services, be immune from taxation while other cable services would remain subject to taxation? I understand that the legislation says that franchise fees for the provision of cable services are specifically excluded from the preemption. However, the definition of Internet access services suggests that any tax imposed on a cable company outside of franchise fees would be preempted. Is that the intent of the legislation: to provide a tax break for cable companies who provide Internet access? Also, what is to keep cable companies (and other telecommunications carriers for that matter) from exploiting this special tax treatment by classifying their other telecommunications services as Internet access services? If Internet access qualifies for tax breaks, what aspects of telecommunications networks would be excluded from this special tax treatment and what would be included? Does this definition mean that sales taxes imposed on cable services would be preempted? Following the logic of the legislation's claim that taxes on ``similar sales or transactions'' would not be preempted, would that mean all sales taxes on cable services would be preempted because of Section 602 of the Telecommunications Act which preempts state and local taxation on direct-to-home satellite services, thereby ensuring that there are no other similar taxes? There is also the concern about this definition undermining universal service. According to the May, 1997 universal service order issued by the Federal Communications Commission (FCC) \11\ Internet service providers are specifically excluded from the requirement to contribute to universal service. Under S. 442, cable services are classified as Internet services, thereby creating a loophole for some providers to avoid the requirement to contribute to universal service. Although Section 7 of this legislation states that nothing in this Act shall affect the implementation of the Telecommunications Act, if this Act defines cable services as Internet services--which the FCC specifically exempted from the Telecommunications Act's requirements to contribute to universal service--this legislation then establishes a new category of telecommunications carriers excluded from the requirement to contribute to universal service. Although this legislation does not change the Telecommunications Act statute--it does expand the exclusion created by the FCC's interpretation of the Telecommunications Act in terms of allowing a new class of telecommunications carriers to avoid contributing into universal service. --------------------------------------------------------------------------- \11\ FCC Report and Order (FCC 97-157), May 7, 1997. --------------------------------------------------------------------------- summary This legislation creates an unfair special interest tax break for a particular category of telecommunications providers based on technological means of commerce, provided on the backs of state and local governments. Why should Congress decide that one specific technology deserves a special tax break over other means of commerce? The moratorium imposed in S. 442 would create an unfair competitive situation by providing on-line providers with a tax break that others not utilizing electronic commerce would not receive. This is a tax break provided solely on the basis of a particular technology, not on the service; creating a technologically-specific preference policy. It is a tax break that is not technologically neutral and therefore, it runs counter to one of the fundamental principles of the Telecommunications Act of 1996 that was designed to create a regulatory environment to promote competition on a technologically neutral basis. S. 442 is the opposite of fairness and equitable tax treatment. The fundamental approach of this legislation is not to level the playing field but to tilt the field in favor of a special class of commerce, namely electronic commerce. This legislation is seriously flawed and ill-conceived and it ought not be considered by the Senate until the Commerce Committee and other appropriate Committees that have jurisdiction over issues of taxation can explore the issues related to taxation of electronic commerce. This legislation would seriously hurt main street businesses, creating a tax-protected avenue for commerce that discriminates against main street businesses and other areas of commerce. Under this bill, transactions and the use of a particular area of commerce--namely, Internet use and online activity--receive special federal tax protection. There are a whole host of business activities which would be exempted from state and local taxation as long as those activities are occurring over the Internet and not from main street or mail order distribution. Non-electronic commerce activity would remain subject to State and local taxation. This legislation will impose unfair taxation circumstances on main street businesses and create a ``tax free'' pricing advantage for those doing business via on-line services. Main street businesses will be disadvantaged because they will have to continue paying taxes that their competitors who use the Internet as their commercial medium will receive special tax treatment. A dozen major state and local government organizations have informed the Committee of their opposition of this legislation: The National Governors Association; The International City/County Management Association; The National Association of Counties; The National Council of State Legislatures; The National League of Cities; The Council of State Governments; The U.S. Conference of Mayors; The National Association of County Treasurers and Finance Officers; The National Association of State Auditors, Comptrollers, and Treasurers; The National Association of Telecommunication Officers and Advisors; The National Association of State Treasurers; and The Government Finance Officers Association.\12\ --------------------------------------------------------------------------- \12\ Attachment C. --------------------------------------------------------------------------- My objective is to advance policies that neither favor nor discriminate against particular types of commerce, electronic or otherwise. In my judgement, electronic commerce ought not to be subject to discriminatory taxation, nor should it receive special tax treatment unless a legitimate public policy reason requires unique tax status. So far, such a case has not been made. This legislation is harmful and counter productive to the discussions currently taking place between industry and state and local government officials that are attempting to develop model legislation for the taxation of Internet services. Discussions have been ongoing between the industry and state and local government officials under the sponsorship of the National Tax Association. NTA, working with industry and state and local officials, is studying methods to address issues related to the appropriate taxation of businesses using the Internet and other issues related to on-line commerce. Although the bill sponsors altered the original bill to limit the moratorium to 6 years, I doubt that once the Internet industry is provided with the special tax status afforded under this legislation, they will never give up their special tax privilege and will have no incentive to participate in those discussions. S. 442 in its present form creates a circumstance in which the industry will have no incentive to negotiate with state and local governments to develop uniform taxation. By installing a permanent tax preemption, the industry will have the incentive to fight any new method of taxation. In contrast to S. 442, we ought to create a level playing field where all sides will have the appropriate pressure and incentive to work cooperatively to develop a uniform method of taxation. The Congress should encourage the industry to work in good faith with state and local governments to address legitimate issues of taxation of on-line services as opposed to granting a special interest tax break. Granting a moratorium will not be productive. Rather, it will be counter productive and will not encourage either side to work for a consensus solution. The Congress needs to be reminded about the serious commitment that state and local governments are making to work cooperatively with the industry to address legitimate concerns. Imposing moratoriums on state and local rights do not move the process forward. Rather, moratoriums will have a chilling affect on these important discussions. The National Governors Association also endorses this approach instead of the legislation. According to a resolution approved by the NGA at their winter meeting,\13\ the Governors will continue to oppose federal action to preempt the sovereign right of the states to determine their own tax policies. The Governors therefore endorse the process undertaken by the National Tax Association with the support of the Federation of Tax Administrators and the Multistate Tax Commission to review existing problems in the taxation of telecommunications and to propose coordinated policies that will help states promote fair competition while ensuring that the telecommunications industry bears it fair share of taxation. --------------------------------------------------------------------------- \13\ Attachment D. --------------------------------------------------------------------------- It seems to me that the objective we should seek to accomplish is to establish a uniform method of taxation of not only Internet services but other telecommunications services and lines of commerce as well. Section 4 of S. 442 is productive in that it calls for a discussion between all levels of government to study taxation issues and develop proposals for a uniform taxation system. However, the process is already taking place and the moratorium imposed under Sec. 3(a) defeats the purpose of ensuring a good faith dialog. Our efforts ought to focus on how to ensure that the existing process succeeds, rather than creating an erosion of state and local tax bases. The fundamental difficulty with S. 442 in its present form is that it preempts existing broad based taxes and creates an un- uniform method of imposing a whole host of state and local taxes on commerce by exempting a specific technology from existing broad-based taxes. I believe that taxes that target a specific technology--such as the Internet--should not be imposed. Broad-based taxes that are fair and reasonable because they apply to all categories of services and on all categories of telecommunications providers should not be carved up through a special interest Federal preemption. Under S. 442, state and local governments could lose hundreds of millions of dollars because their existing broad-based taxes would have certain persons and businesses carved out in an anti-competitive fashion.