The Coming Internet Tax Quid Pro Quo?

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The ongoing debate over the taxation of the Internet-or, morespecifically, the application of sales tax collection obligationsto all interstate vendors-is coming to a head. The Internet TaxFreedom Act of 1997, which didn't deal directly with sales taxesbut imposed a moratorium on taxes on Internet access or "multipleor discriminatory" taxes on electronic commerce, is due to expireon November 1, 2003. The Internet Tax Nondiscrimination Act wasintroduced in the House (H.R. 49) and in the Senate (S. 150) to make the existing ITFA moratoriumpermanent. The measure already has already passed the House and isadvancing through the Senate.

In the other direction, Rep. Ernest Istook (R-Okla.) and severalcosponsors recently introduced H.R. 3184, the Streamlined Sales and Use TaxAct, which would eliminate existing federal barriers to state andlocal taxation of interstate commerce and Internet sales.Specifically, the Istook bill would give congressional blessing tothe Streamlined Sales and Use Tax Agreement (SSUTA), an ongoingeffort by many state and local leaders to enter into a formalcompact that would simplify and harmonize sales tax administrationamong the states to get around constitutional hurdles to taxinginterstate vendors.

Now that the ITFA appears to be sailing toward easy passage,state and local officials are starting to grumble about how itmight cut into their future tax revenues if "Internet access" comesto include some of the old telecom services they tax so heavily.But state and local officials have continued to go along with theITFA extension and kept their eyes squarely focused on the biggerprize: Congressional termination of the 30 years' worth of SupremeCourt jurisprudence that has limited their ability to impose salesand use tax collection obligations on interstate activities andvendors. This is what the Istook bill would accomplish.

Thus, despite some complaints about the ITFA's prohibition onInternet access taxes, SSUTA supporters have long understood thebenefit of allowing the ITFA to exist, and even be extended. Itprovides them with a potential legislative quid pro quothat roughly reads as follows: We gave you the ITFA moratorium onInternet access taxes, now give us your consent on the SSUTAcompact so we can start collecting sales taxes on e-commercetransactions.

By way of background,in a string of Supreme Court decisions over the past 30 years, theCourt held that states could only require firms with a physicalpresence-or "nexus"-in their jurisdictions to collect sales taxeson their behalf. State and local tax officials have worked toeliminate or water down these restrictions on their tax reach butthus far have not been able to get around them or convince Congressto give them the authority to tax interstate vendors. Simplystated, these Supreme Court rulings embodied the timeless principleof "no taxation without representation" and sought to applysensible Commerce Clause protections to interstate activities sinceCongress had been silent on the matter.

Section 3 of the new Istook bill would effectively end theseprotections for interstate vendors by noting, "It is the sense ofthe Congress that the sales and use tax system established by theStreamlined Sales and Use Tax Agreement. . . provides sufficientsimplification and uniformity to warrant Federal authorization toStates that are parties to the Agreement to require remote sellers,subject to the conditions provided in this Act, to collect andremit the sales and use taxes of such States and of local taxingjurisdictions of such States." That language would send a clearmessage to the Courts during future interstate tax policy or nexuscontroversies: Congress now cedes to the States-or, morespecifically, the "Governing Board" of the SSUTA-authority overinterstate commerce for cross-border sales tax collectionactivities.

Will SSUTA supporters now demand that the price of their generalacceptance of the ITFA extension is the Istook bill's congressionalblessing on the creation of a multistate compact and theelimination of existing Supreme Court jurisprudence? That's theproverbial million (or perhaps multibillion) dollar question. Butsuch a quid pro quo is a steep price to pay for the mere extensionof the ITFA's ban on Internet access taxes. Congress would be wiseto think twice before casually disposing of 30 year's worth ofsensible Supreme Court nexus jurisprudence, which not only embodiedand extended the Founding Fathers' "no taxation withoutrepresentation" vision but nurtured a vigorous interstatemarketplace free from extraterritorial tax and regulatory meddlingby state and local officials.

Supporters of the SSUTA are essentially proposing to abandontrue federalism and jurisdictional tax competition in exchange forthe power to potentially recoup a small amount of tax revenue frominterstate sales via a uniform system of third-party taxcollection. Sadly, it appears the many state and local officialswould prefer tax collusion over a "laboratories of democracy" modelof competition between the states. Real federalism, as envisionedby the Founders, is about a friction and tension between competingunits of government, not cooperation and harmonization in the nameof extending tax burdens. That's the European Union modelof federalism, not the U.S. model. Congress should be wary ofcollusionarytax compacts such as the SSUTA that would grant the states suchopen-ended tax authority over the channels of interstate commerce.Preserving or enhancing tax competition should be a guiding themeof this ongoing debate.

Finally, some state leaders will claim that they need to tax theNet and interstate sales to curtail their current fiscal policycrisis. But that crisis is of their own doing, brought on by theirprofligate spending habits particularly at the end of the 1990s.Total state general fund spending grew by 7.7 percent in FY1999,7.2 percent in FY2000, and 8.3 percent in FY01. Even as economicgrowth slowed and budget gaps appeared, state spending stillincreased 1.3 percent in FY02 and will increase further in FY03.And how much money do they really think they're going to squeezeout of the Net sector? Internet business represents a minusculeportion of aggregate retailing activity in the United States.According to the U.S. Department of Commerce, e-commerce activityaccounted for just 1.3 percent of all aggregate retail sales in2002. Some fear the Internet will grow larger, like mail order andcatalog, but in reality those sectors represent breadcrumbscompared to the rest of the economy. Do we really want to justify aburdensome and potentially unconstitutional multistate tax compactand taxes on interstate activities on the grounds that the statesneed more cash in the short term?

After they cut spending, state and local leaders can exploreother tax reform options to solve whatever problems they feel theyare experiencing. But in doing so, they must abide by theconstitutional protections and sensible nexus guidelines that haveprotected the channels of interstate commerce in previous decades.It would be foolish for members of Congress to abdicate theirresponsibility to safeguard the national marketplace by giving thestates carte blanche to tax interstate commercial activities via acollusionary multistate tax compact.