Fact Behind Fiction A number of you have probably been rolling your eyes for at least the past decade at the notion of any number of e-mail alerts, warning of proposed surcharges on the use of modems on telephone networks and per-minute long-distance charges on Internet connections ("proposed" by a Congressman who has never existed, using bill nomenclature that does not even come close to following that of any chamber of Congress). Both of these have been and continue to be false, according to longstanding consumer education efforts by the Federal Communications Commission. Who knows from whence the modem tax story came. We do know that it is has resulted in periodic floods of grassroots e-mail to the FCC-- which has repeatedly asserted it has never even considered such a proposed rule to issue a fee on all phone lines connected to computer modems. At least the "long distance charge" rumor actually was grounded in a bit of reality, namely the reciprocal compensation arrangements and universal service access fees actually in place. The former is the method by which the small phone companies and competitive local exchange carriers (CLECs) are paid by larger regional phone companies (like BellSouth, Qwest, SBC, Verizon) to move Internet traffic through connections involving Internet service providers. In April 2001, after years of wrangling, the FCC set limits on the fees that could be charged among the phone companies for those long-distance calls, but again these are fees among companies, not presented to consumers in their phone bills. The universal service fee, outlined under the 1996 Telecommunications Act, helps provide, and increase the access to, quality telecommunications services-- in urban areas-- at reasonable and affordable rates to all consumers, especially those in low income, rural, hard-to-reach areas. The 1996 Act also called for every telecommunications service providers to contribute-- in an "equitable and nondiscriminatory manner"-- to a federal universal service fund to help underwrite services that would particularly help address the needs of schools, libraries, and health care providers. The universal service fund, however, features an exemption for Internet service providers-- something that has not set well with the telephone companies. Telecommunications should include ISPs, the phone companies argue-- especially since ISPs use phone networks. Those exemptions are often challenged in the courts. One would have thought that simply having the means to access the actual information on the fees would have effectively stopped the stories from circulating, but, as Will Rogers supposedly said, "rumor travels faster, but it don't stay put as long as truth." On 5/16/00, the U.S. House of Representatives voted on a bill sponsored by Rep. Fred Upton (R-MI), that was posited as a way to prevent expansion of the universal service fees charged, while ensuring that ISPs would continue to stay exempt from the fee. There was great uncertainty as to whether the Upton bill would prevent all access fees related to the Internet that are collected for things outside of universal service. Arguably the catchiest summary of opinion regarding the bill came courtesy of Rep. John Dingell (D-MI): "What we are considering today is a fabricated solution to an imaginary problem." We also once heard, supposedly, that American poet Richard Armour once stated that a rumor " ...is one thing that gets thicker instead of thinner as it is spread." Well, lo and behold, that darned rumor even made its way into a debate between then-candidate Hillary Rodham Clinton and then-Rep. Rick Lazio during the race for the vacant U.S. Senate seat from New York. Towards the end of the 10/8/00 debate, the moderator asked both candidates about their position on the bill before Congress, under which " the U.S. Postal Service will bill e-mail users 5 cents for each e-mail they send even though the post office provides no service."-- even citing the phony bill's number-- 602P, according to the Washington Post account. Clinton, at first, said she had no idea what the bill was, and then, after an explanation of it, said she wouldn't vote for it. Lazio, then a member of Congress, not only failed to pick up on the bogus bill numbering, but also went so far as to call it an example of government greed with respect to taxpayers. In fairness to the moderator, that question, like the others for the debate, were submitted... via e-mail(!). To be fair, the FCC actually does have the power to levy the fees about which speculation has circulated for years, if they indeed ever seriously have considered doing so. In addition, the Upton bill was part of a larger set of deliberations around Internet taxation in general. Congress, as well as the states, faced significant constitutional barriers in their attempts to craft legal and workable solution to the issue of Internet tax Resources Modem Tax Hoax http://www.urbanlegends.com/classic/modem%5Ftax.html Internet Long-Distance Hoax http://urbanlegends.about.com/science/urbanlegends/library/weekly/aa012099.htm FCC on Reciprocal Compensation Limits http://www.fcc.gov/Bureaus/Common_Carrier/News_Releases/2001/nrcc0114.html Universal Service fees http://www.fcc.gov/ccb/universal_service Rep. Upton bill http://thomas.loc.gov/cgi-bin/bdquery/z?d106:h.r.01291: Rep. Dingell's comments http://www.usatoday.com/life/cyber/tech/cth918.htm Washington Post October 2000 Lazio/Clinton Debate account http://washingtonpost.com/wp%2Ddyn/articles/A34390%2D2000Oct8.html Legal Barriers to Legislation Attempts by Congress and the states to craft approaches to collecting taxes on online commercial activity have been shaped by a significant set of Supreme Court rulings, resting in large part upon the "due process" clauses of the 5th and 14th Amendments to the U.S. Constitution. [For useful background information, we will draw upon University of Pittsburgh Law School Professor Ronald Brand's 2/98 essay on the due process clauses' limitations on the jurisdiction of U.S. courts]. Due Process and Jurisdiction The 5th Amendment states, in part, that "[n]o person shall be... deprived of life, liberty, or property, without due process of law." The 14th Amendment states, in part, that "...[n]o State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any State deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws."]. These are important because, at a minimum, they lay out limits on what states can do to inhibit the activities of its citizens, but also how far the states (in particular its courts) can go in terms of establishing jurisdiction over defendants in cases. If a case before a court turns on federal laws, the 5th Amendment clause is applicable; in matters involving state statutes, the 14th Amendment clause comes into play. This is relatively easy to determine when the defendant is a person, and when the activity at issue before a court takes place within the boundaries of a state where both the plaintiff and defendant reside. One example of an activity over which jurisdiction might be an issue is a defendant's payment of taxes, because in order to make a case for collection of those taxes, the residency of the defendant would need to be established. If residency can be proved, then it is easier for the court to establish jurisdiction over the matter, and it can weigh the obligations of the defendant with respect to their residency. Corporate Defendants Things get complicated if the plaintiff is a state, and the defendant is a company. Companies have obligations that differ, in some ways, from those of individuals. In most states one of these includes collection of taxes on things sold, in addition to taxes paid in order to conduct business and commercial transactions. Some types of companies are exempt from taxes on their income, while required to collect taxes from their customers for the state (and vice versa). In some instances taxes only apply to goods, and not services (and vice versa). To make things more interesting, most every U.S. state has a "use tax," placed on goods within the state in which they are used (most likely the purchaser's state of residence), and not the one in which they may be sold. Some entities-- including nonprofits, schools, and libraries-- are exempt from taxes in states altogether. Let's make things more complicated: consider a company that conducts business within a state (or states) in which it has no clearly defined physical presence. It might conduct its business over the phone or through the mail, and it may also undertake marketing activities towards residents of that state. But it may also lack, within that state, a mailing address (including a post office box), a phone number, a place where goods are sold and distributed, or agents who actually reside within that state (especially tricky if it has a traveling sales force). Establishing Jurisdiction and Obligations Can the state in question, then, require that company to collect taxes on sales? That question was the issue behind an important 1992 Supreme Court decision, Quill Corporation v. North Dakota, in which North Dakota tried to make a national mail-order office supplies vendor, which had no physical store or outlet in the state, collect a state sales tax on goods sold. We're not going to cheat and tell you what the Court decided, without giving you a legal framework for what led to it. In its Quill decision, the Court first revisited a rule it articulated in its 1945 ruling on International Shoe Co. v. Washington, known as the "minimum contact" rule. Under the "minimum contact" test, when a company is involved as a defendant, the determination as to whether a state has jurisdiction over the company rests on the scope and degree of the defendant's activities (like advertising and outreach to new customers) in the state in question, and the relationship between those activities and the action at issue before the court. This holds that there is a "nexus" between a defendant and the state under which the activity takes place, thereby enabling a jurisdiction to be established. Prior to this decision, the Court had relied on a standard-- stretching back to the days when the U.S. consisted of nothing but territories, and interstate (much less international) commerce was limited-- which placed emphasis on the physical location of a defendant within the boundaries of a state where a transaction took place. Subsequent Supreme Court decisions eventually established that jurisdiction over legal action against a corporate defendant had to rest on activity that was "significant" enough to warrant attention-- as opposed to everything that an individual or business did in a state. Otherwise, a defendant would be potentially inconvenienced by legal action for every activity it conducted-- placing a burden on its ability to conduct business, and therefore depriving the corporate "person" of its "life, liberty, and property" under... yup, you guessed it: "due process." The Court, over time, established that if a corporate defendant's activities in a state consists of something that is ongoing and part of the company's course of business (like shipping and delivery of products), a "general jurisdiction" is in play, which means that a court can address a state's grievance on certain expected obligations at issue-- even if it is not tied in anyway to the "minimum contact" activity. If the activity is a one-time only kind of thing (like a special outreach tour of a state to selected venues), a "specific jurisdiction" can be established, which means that there has to be proof of the corporate defendant's obligation to the state at issue resulting from the "minimum contact" between the defendant and the state. Why distinguish between the two jurisdictions? Because if the activity by a defendant in one state generates enough business in another state, that other state is going to want to make that defendant subject to its rules-- such as collecting and paying taxes. The problem, however, is figuring out how much of what activity crosses the boundary between a general and specific jurisdiction, especially given the reliance on mail and telephone systems to extend a the reach of operations of companies, and the ability of defendants to give testimony and appear in courts much more easily than they could 47 years ago, when the time it took to travel back and forth to court might have proved burdensome. In both anticipation of (and response to) this, the Court also added considerations to its "minimal contact" test, such as:

• the "stream of commerce" through which a corporate defendant channels its goods and services that derives benefit to the defendant, versus the means through which a customer receives access to benefits from a good or service
• the "relevant contacts" involved in the defendant's actions
• whether it is both "reasonable" and "fair" to consider jurisdiction on the defendant
• a track record of "substantial connection" of activity directed towards a particular state and its residents
• the ability to determine in advance that the activity would lead to the ability of a jurisdiction to be established
• whether the defendant took advantage of the legal protections offered by the state in which activity took place
• the overall interest of the state and parties involved in the legal action

All of the above outlines a court's jurisdiction over a defendant (especially a business) with respect to one state. There is something missing, however: interstate commerce. The Interstate Commerce Clause of the U.S. Constitution (Article 1, Section 8, Clause 3) states, in part, that Congress has the power "...[t]o regulate Commerce with foreign Nations, and among the several States..." So state actions, like state taxes, cannot block commercial activities among entities across different states. If it does, say hello to some serious potential constitutional problems. Recognizing this, the Court developed an additional test-- the "substantial nexus" test. Substantial Presence + Significant Activity = Nexus The Court's 1967 ruling in National Bellas Hess vs. Illinois held that the state of Illinois could not require a company that did business through mail-order catalogs to collect a tax from customers in Illinois. Why? Using both a due process and commerce clause test, the Court found that the company did not have a significant physical presence in the state, because its only contact was through the U.S. mail and the state's phone network; a substantial nexus among the state, the company, and the activity at issue could not be established. Further refined in its 1977 decision in Complete Auto Transit, Inc. v. Brady, the Court found that a state tax has to be: (1) tied to activities that have "sufficient presence" in a state, (2) applied fairly, (3) related to services that state provides, and (4) able to play nice with interstate commerce requirements. Now, back to the 1992 Quill decision. The Court found that Quill, through its advertising and other actions, did willfully and knowingly engage in activity to attract business within North Dakota, and that if a due process test were used, there would be enough grounds for a jurisdiction to be established, such that North Dakota could make Quill collect state sales tax for its orders in North Dakota. (Note: In doing so, that establishment of jurisdiction might also have opened up the door for the state to tax Quill, as an entity under its jurisdiction.] But the Court also found that the tax could not be charged and collected in a manner that interfered with the Interstate Commerce Clause. Since the defendant was a company, there had to be a finding that there was a substantial nexus involving it, the activity at issue (taxation) and the state in which the activity was at issue (North Dakota). The Court couldn't find one under an Interstate Commerce Clause test. The Court also reached back to its set of pre-1945 precedents to support a "physical presence" requirement for a state to require a seller to collect taxes. This means that seller, whose only tie to the state wishing to collect taxes is through US telephone network or mail system, has to have a significant physical presence in the state-- whether it be "a small sales force, plant, or office." So using both a due process and commerce clause test, the Court held that a company can have minimum contact without having a substantial nexus, but that in order to establish a substantial nexus, there had to be significant physical presence. In short, North Dakota could not compel Quill to collect or pay taxes on its mail order sales, and a legal limitation, in effect, was placed on states to collect taxes from commercial activity conducted within their borders on non-resident businesses. Interestingly, we should add the Court, in Quill, actually encouraged Congress to find a way to lay requiring retailers outside of a state to collect and distribute use taxes to a buyer's state of residence-- something it can do under... the Interstate Commerce Clause. In the absence of firm federal legislation that spells out how to collecting taxes on online commercial activity across states, while outlining how to meet judicial concerns, there are efforts underway aimed at removing the jumble of tax obstacles across the more than 7500 taxing jurisdictions in the U.S. Resources Professor Ronald Brand's 2/98 essay on due process clauses http://www.state.gov/www/global/legal_affairs/brand.html Quill Corporation v. North Dakota http://supct.law.cornell.edu/supct/html/91-0194.ZO.html International Shoe Co. v. Washington http://caselaw.lp.findlaw.com/scripts/getcase.pl?navby=search&court=US&case=/us/326/310.html National Bellas Hess vs. Illinois http://caselaw.lp.findlaw.com/scripts/getcase.pl?court=US&vol=386&invol=753 Complete Auto Transit, Inc. v. Brady http://laws.findlaw.com/US/430/274.html Internet Taxation: Congress and State Attempts Internet Gets a Tax Break Back in 1998, the Congress passed the Internet Tax Freedom Act, originally introduced by Rep. Christopher Cox (R-CA) and Sen. Ron Wyden (D-OR) in March 1997. Its passage did five basic things:

• imposed a national three-year moratorium on taxes specific to the Internet, including taxes on monthly fees paid to ISPs, except for those states that were looking at ways to levy such fees prior to 10/1/98 (Connecticut, Iowa, New Mexico, North Dakota, Ohio, South Carolina, South Dakota, Tennessee, Texas, and Wisconsin)
• imposed a three-year moratorium on "multiple and discriminatory" taxes on electronic commerce. It barred state and local governments from (1) enforcing taxes on buyers and sellers in electronic commerce transactions involving more than one state; (2) imposing taxes on goods and services offered exclusively over the Internet; and (3) implementing new taxes on out-of-state businesses involved in e-commerce transactions;
• declared the Internet a "tariff-free zone", and called for the U.S. Department of Commerce to be vigilant in those policies, practices, and developments that hamper U.S. commercial activity through the medium-- especially with respect to foreign competitors;
• stated that no federal tax would be placed on the Internet;
• created a temporary advisory commission to review e-commerce tax issues, and make recommendations by Spring 2000 on whether, and how, e-commerce should be taxed in a non-discriminatory manner;

The Advisory Commission on Electronic Commerce, called for under the Act, delivered its report to Congress on 4/12/00. Congress required the Commission (which included governors, mayors, corporate leaders) to achieve a 2/3 vote among its members in order for it to have the authority to make a formal recommendation. Needless to say, this did not happen especially on the Internet sales tax issue. (We should add that there was a pretty clear "no-Internet tax" majority on the Commission, and a minority report was not allowed to be included.) The majority of members, in the report, did recommend that:

1. the moratorium on international tariffs be extended,
2. more study be devoted to e-commerce's impact on privacy,
3. more ways be developed for local public-private partnerships to help address the digital divide,
4. the 102 year-old 3% excise tax on telephone service-- originally enacted to help pay for the Spanish-American War- be eliminated (since it produced revenues that have were not earmarked for a specific purpose)
5. states come up with a simpler system of sales taxes
6. there be more clarification on when businesses need to collect sales taxes

On 5/10/00, the U.S. House of Representatives passed a bill (352 to 75) to extend the federal moratorium on Internet-related taxes until 10/1/06. The vote was conducted without any prior hearings, and well in advance of the moratorium's original deadline of 10/1/01. While the House rushed its extension of the moratorium, a five-year moratorium extension proposed by Sen. John McCain (R-AZ) met significant resistance in the U.S. Senate, and a compromise measure offered by Rep. Bill Delahunt (D-MA) to extend the current moratorium by only two years was defeated. The House bill, and moratorium, do not exempt goods and services sold online from use and sales taxes (among others) at the state level. But it also did not give the states either guidance for doing so, or a legal basis for collections that could pass the Supreme Court's tests outlined above muster-- especially while the moratorium is in effect. Here's a little secret: even though they are not currently barred from doing so, many states have simply chosen not to aggressively collect taxes on online commercial activity within their borders, for reasons that include logistical hurdles, technological barriers, and concerns over nebulous legal limits for doing so. When was the last time you filled out all those forms about every product you bought from another state, and did you pay taxes in your state for each of those items? A non-binding resolution, offered by Rep. Ernest Istook, passed on the same day as the House bill to extend the moratorium by a 289 to 138 vote. It outlined 14 principles for an Internet sales tax that could be incorporated and applied by states in a uniform manner, consistent with interstate commerce principles. Senator Byron Dorgan (D-ND) proposed an approach, similar to Rep. Istook's, which included:

• a five-year extension of the Internet Tax Freedom Act's moratorium (the one currently in place)
• a nonbinding resolution for states and localities to work jointly through the National Conference of Commissioners on Uniform State Laws to craft a streamlined sales and use tax system. [Note: this is a 110 year-old body consisting of some 300+ lawyers, judges, and legal scholars-- appointed by the 50 states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands-- that provides a means for drafting model legislation on issues requiring consistency and uniformity. These drafts can then be taken to legislatures and tailored to meet their needs.]
• a compact incorporating the streamlined system that would receive Congress' assent if at least 20 states agreed to it by 1/1/05, unless Congress voted its disapproval within 90 days of the agreement deadline
• proposed ways for states to meet the bar established under the Quill decision

On 5/10/00, the House of Representatives, voted 352-75 to extend the moratorium on Internet-specific taxes until 10/1/06. The argument was that it would prohibit new taxes on an economic medium still emerging in importance-- and the users who were trying to make that medium viable. Contrary to popular belief, the bill did not exempt goods and services sold online (that could also be sold off-line) from sales taxes at the state level. Most states have, among other things, a myriad of taxing mechanisms for sales and use of products. One main difference between the two is that use taxes are usually placed on products within the state in which they are used (most likely the purchaser's state of residence), and not the one in which they may be sold. Many of the 45 states that have traditional sales taxes have simply not chosen to enforce sales taxes online because of the logistical and technical difficulties they face in doing so. Sales within "bricks-and-mortar" are collected by businesses and passed on to a state treasury. If, however, sales are made by a business in another state (think mail-order, for example) the state from which the purchaser makes his payment is limited in how they can collect the tax from the seller. While the 2000 legislation did not provide a direct barrier on state online taxes, it also did not provide a legal framework (or incentive) for states to simplify the jumble of interstate tax collection approaches already in place. Moreover, questions arise with respect to Internet-based vs. Internet-related products, especially those that entail a combination of telephone, cable, or other telecommunications mechanisms that are taxed (while some online services are not). Next, factor in potential advantages online retailers have in a tax-free environment compared to offline competitors. Shifting Public Attitudes on Online Taxes We've heard the rumors for years, but have usually assumed that if the prospects for actually implementing taxes on any online activity ever went through, there would be immense public backlash on what has been a tax-free medium for communications and commercial transactions for years. Well, a March 2001 Jupiter Media Metrix consumer survey sure proved us wrong. The survey found that any pending sales tax on goods purchased online would not change the buying habits of consumers. In fact, 74% of respondents said they don't plan on avoiding sales taxes on products under US$50 by choosing one vendor over another, compared with 21% who did. The attendant Media Metrix ratings for the survey adds that 6 out of 10 of the top online retail entities already collect taxes in certain areas. Back to Some Basics Citizens are required to pay taxes, a government's key revenue source. Taxes are categorized in terms of what they are targeted towards. Direct taxes (including income taxes) are generally focused on people, and their burden cannot be passed onto others. Indirect taxes (such as sales taxes) are generally oriented towards products and services, and their burden is generally redistributed among other actors. Taxes are also considered in terms such as progressive, proportional, and regressive. With a progressive tax (think income tax), the more you make, the higher your tax rate. With a proportional tax, the same burden is relatively assigned across all income levels. A progressive tax is characterized by a more With a regressive tax (think sales, snack, and per-unit "sin" taxes on beer), the less money you make, the more you will pay. The concern with regressive taxes is that the same tax rate has an amplified effect on persons in lower income brackets, particular if they have less disposable income, fewer alternatives to fulfill certain basic needs, and consume a greater amount of products and services than those at higher incomes. Leaving pure economics aside, it's not simply a question of who pays what proportion of their income for the same goods in differing quantities. Consideration also needs to be paid to what type of goods and services are being purchased. Two families may each pay for phone service, but if a quarter of one families' income is spent each month on phone services, compared to one-tenth of another's-- and the latter has access to phone services not available to the former, you might see where disparities exist. At the other end of the spectrum, let's say a rebate is given to all taxpayers. Even if the percentage of that rebate is the same for everyone, those who pay the most in taxes will get the higher dollar amount of refunds. None of this, however, includes other factors, such as shifts in income over a period of time, and costs (and efficiency) to the taxing authority of collecting revenue. The first questions, in fact, which usually arise around tax policy are not whether to collect, or to what end the revenue is used. Instead it is simply who to tax and at what amount. Underlying those deliberations are values and beliefs about which groups of people should bear the burden of payment, the wealthier (who owe more under progressive tax structures), or the non-wealthy (who owe the most under regressive tax structures). So okay, why all of this fuss about taxes? One interesting quirk to consider is that cuts in taxes collected sometimes have the ripple effect of shifting the tax burden to other parties. Thus, cutting federal taxes might entail a higher portion of state funds used for key services. Consider estimates pegging total amount spent online as high as US$100 billion over the next two years. Now consider that states and localities are projected to lose tax revenues to tax-free online sales ranging from:

$2.5-20 billion (U.S. Congressional Budget Office)

$7.7 billion by 2005 (Jupiter Media Metrix)

$25-30 billion (National Governor's Association) There is a whole range of arguments for and against different forms of taxes, much less the notion of taxation itself. The main point we'll stress here is that taxes, at whatever level they are levied, can generate revenue used for a range of services from which citizens directly or indirectly benefit-- in ways not often acknowledged or always easily witnessed. By way of full disclosure, OMB Watch (our) parent organization-- has advocated for eliminating the line between taxation on goods sold by "bricks-and-mortars," and through online and mail order systems, yet has advocated against taxes on goods that meet basic human needs (including food and health services). It has also supported any vehicles through which revenue from Internet and mail-order sales tax can be earmarked for both improved delivery of state-provided services and investment in community needs, and not rebates or tax cuts. What's a State To Do? Recall the National Conference of Commissioners on Uniform State Laws cited above. It is considered a rigorous, thorough approach, given the nature of the membership, which studies the existing laws of each state in an area. The drafting process can, however, take quite a number of years, and even more years as each state deliberates whether to adopt the language with or without modification. Each state, however, must ultimately pass some form of the draft legislation in order for it to be binding. In order to expedite the quest for draft legislation, nearly 30 states formed a coalition in December 1999, consisting of state revenue/treasury department directors, as a response to the Advisory Commission on Electronic Commerce, also cited above. Under the moniker of the Streamlined Sales and Use Tax Project (SSUTP), they have been working to bring draft legislation to their respective state lawmaking bodies. In late December 2000, some 27 states approved draft legislation addressing the collection of use and sales taxes on Internet and mail-order sales, according to Brian Krebs' 12/21/01 Newsbytes article. The SSUTP draft language, utilizing definitions developed in common with each participating state, allows states to identify which items are to be taxed, but also sets limits on the tax rates with respect to those items, and how the revenues are distributed to the treasuries of more than one state. This is determined, in large part, on the destination of the good sold and/or taxes under the authority of the state where the item is being shipped. Additionally, the draft language provides a number of models for states to follow with respect to technology utilized for tax collection. This includes the designation of certified online service providers that could conduct the collection, distribution and auditing functions required under a state law, and the ability for business to use certified software tools to facilitate the tax collection. The National Conference of State Legislatures and the National Governor's Associationreviewed the draft language in an attempt to harmonize their efforts in this area as well. NCSL, however, stated its concern with the Streamlined Sales Tax Project's proposal for a voting entity, made up of the first five states to ratify the draft language, which would oversee the continued efforts of the Project. NCSL was worried that those states would have more influence in the ratification process for other states. Nevertheless, NSCL and NGA, along with the Federation of Tax Administrators-- representing the state tax collection agencies-- and the Multistate Tax Commission-- a state government agency compact of 44 states and the District of Columbia that works to protect state fiscal authority, as well as interstate/international commerce-- have been encouraging the states to support efforts to simplify tax collections in this area. Given its work to date, the Streamlined Sales Tax Project is widely viewed as the best attempt at the state level to enact a simple, uniform approach to sales tax collection online-- especially since about 11 states have joined as observers, and a number of non-online retailers also support its attempts to eliminate the perceived advantage online retailers enjoy. If enough states can enact legislation, there will most likely be an attempt by these actors to help Congress draft legislation that would make online and mail-order retailers follow the tax collection guidelines nationally. Happiness is an Unfunded Mandate? President Bush has promised the high-tech industry that he will support a permanent moratorium on Internet use and sales tax, as recently as 5/8/01-- and through Vice President Dick Cheney as recently as 4/18/01. NCSL took strong exception to this pledge, in a 4/23/01 letter, to the Administration. It argued that it had initially supported a moratorium in order to foster growth in a still-nascent e-commerce economy. NCSL also pointed out the Congressional Budget Office reported that a moratorium extension, " would impose an intergovernmental mandate as defined in the Unfunded Mandates Reform Act (UMRA)." UMRA is a law passed on 3/15/01-- ironically due in large part to significant pressure from the NGA (especially then-Texas Governor Bush). It sets up a framework to ensure that Congress cannot impose measures at a cost to the states without attendant federal funding. Under UMRA, all bills that are expected to cost a state, local, or tribal government over $50 million (or the private sector over $100 million) have to be analyzed by the Congressional Budget Office. Any House or Senate bill reported out of committee containing such a mandate has to be shown as having been analyzed by CBO. For those mandates on state, local, and tribal government over $100 million, House and Senate committees also have to point to the related authorization for appropriating (funding) that item-- even if it falls outside of the committee jurisdiction-- to offset the cost of that mandate to the public sector. If the committee reporting the bill offers no proof, a point of order to block the bill's consideration can be raised on the House or Senate floor-- overridden only by a majority vote of that chamber. UMRA also forces federal agencies-- before a public notice or comment period is issued for a rulemaking-- to consult with state, local and tribal governments if a proposed rule contains an unfounded mandate, and conduct cost assessments for both proposed and final rules. If no assessment is done, the rules can be subject to judicial review. So, the argument goes, by mandating that the states not collect taxes on online sales or Internet services without federal funding offsets, there is a potential violation of UMRA. Not that the states, again, don't have enough obstacles confronting them on the logistics of collecting taxes on online activity as it is. Recall the discussion regarding nexus creation under the body of Supreme Court decisions on due process. If a nexus, or relationship, can be established that links an entity with practices directed towards a state that result in some activity that falls under the authority of the state in which the activity occurs, the state has jurisdiction over that entity in legal actions. In other words-- according to David Hardesty, who has been providing useful ongoing commentary on this subject through Ecommercetax.com-- those retailers who currently may only have a sales tax relationship with a state are fearful that they may also be subject to business income tax from that state as well. Others are concerned that not spelling out any relationship would allow intangible, or exempt property in one state to serve as a "tax-free" haven for out of state commercial entities (Hardesty mentions, for example, public information kiosks, operated in a shopping mall, that are supported by corporate advertisers). Andy Oram, in a 9/22/00 WebReview.com column on Internet taxation noted, however, that some states, such as California, were already beginning to get more aggressive in targeting retailers that attempt to distinguish their online and offline entities in order to avoid taxation on online sales. Congress' Next Steps To better explain what Congress is currently considering, we wanted to draw your attention to arguably one of the best summaries on this subject to date, Nonna Noto's November 2000 Congressional Research Service Report on Internet Tax Legislation. Such reports are usually only available to members of Congress and their staffs, so a big set of kudos goes to the National Council for Science and the Environment for making this resource available to the public. According to Noto, there are basically four approaches Congress has been considering with regards to online taxes:

1. Extending the current national three-year moratorium on new and/or "multiple and discriminatory" taxes specific to the Internet, including corporate income taxes, and taxes on monthly fees paid to ISPs-- either temporarily or permanently. Those who support the moratorium believe the Internet should not be taxed, are concerned about existing commercial interests, or support such a move only if Congress promises to address related issues of interstate commerce. The main argument in opposition to extending the moratorium is simple: since the current moratorium doesn't end until 10/21/01, Congress did not need to act preemptively in October 2000, which had the additional effect of removing the drive of states to craft solutions for collecting online taxes.
2. Considering an extension or repeal on the protection to allow state and local online taxation-- particularly use and access taxes on Internet service providers-- in those jurisdictions that enacted such measures prior to 10/1/98. Those who argue for repealing this "grandfathering" clause are concerned that Internet services will be subjected to multiple taxation. With some exceptions, for example, ISPs pay taxes for use of the telecommunications backbone supporting their services, which are passed along to subscribers. It is argued that allowing more taxes for access to (versus mere use of) that backbone results in a "double tax" on the service. Those who argue for extending the protection stress the importance of the fiscal authority of all states. They add that since taxes are already collected on other telecommunications services-- like phone and cable-- this is a good opportunity to discuss how to "unbundle" those services such that they can be taxed in a more equitable manner, without granting the Internet an unfair advantage. This would still leave open potential opportunities for Internet service providers to argue for exemptions they already enjoy. This includes "sale-for-resale" services (those sold to ISPs that are, in turn, sold/rented/leased to subscribers, like dedicate Internet access lines), or on services that benefit the public interest, but would not allow for a system of tax-free telephone services through which ISPs to carry Internet traffic. There is one additional argument for extending the protection, persuasively articulated by Michael Mazerov and Iris J. Lav in a 5/11/98 Center on Budget and Policy Priorities analysis: that the moratorium, in effect, shifts the tax burden to lower-income households while hampering the ability of states and localities to generate much-needed tax revenue. How? Because higher-income households, with disposable income available for purchasing things like computer equipment, would be able to buy items tax-free online, while those without Internet-access might still have to purchase those same goods at a physical store. States, in response to lost revenue, might decide to bump up the tax on all sales or telecommunications services. Since those taxes would most likely be regressive, per the discussion above, low-income households are more likely to bear the burden. Additionally, if there is a fiscal shortfall, services directed at lower-income populations stand the best chance of getting cut or eliminated.
3. Initiating federal (legislative) activity in the collection of local and state sales tax, and state use tax on online goods and services. There is generally agreement that there needs to be both simplification and harmonizing among states regarding existing state use taxes and sales taxes at the state and local level, so that online, telephone, mail order, and bricks-and-mortar sales are not treated differently. There are differences of opinion as to whether voluntary or legislated encouragement is the best means for ensuring this gets done, and if the same force put into collection of state taxes by online retailers would also extend to collection of local taxes as well.
4. Expanding the moratorium to also protect digitized products and services from both sales and use taxes. The issue here is that state authority to collect taxes might be preempted by federal action, as the bans would apply to both in-state and interstate commerce on those goods.

Believe it or not, there were about a dozen bills introduced in the 106th Congress during 2000, around state and local taxation of the Internet. The House did pass one of them, the Internet Nondiscrimination Act of 2000 sponsored by Rep. Christopher Cox (R-CA), which extended the federal moratorium on Internet-related taxes until 10/1/06. The vote was conducted without any prior hearings, well in advance of the moratorium's original deadline of 10/1/01. The Senate, however, failed to take action on it before the 106th Congress concluded its business, leaving the 107th Congress with an interesting issue on its hands. As of this writing, in 107th Congress, Sens. Byron Dorgan (D-ND) and Ron Wyden (D-OR) have each introduced proposals that have garnered a good chunk of media and lobbyist attention:

• Sen. Dorgan's bill, Internet Tax Moratorium and Equity Act (S. 512), would stretch the moratorium out until 10/1/05, and would give authority to the states to force online retailers and similar entities to collect taxes, if the states can coordinate their interstate collection mechanisms. Offline retailers and state/local government advocates like this bill, online commercial entitles do not.
• Sen. Wyden bill, the Internet Tax Nondiscrimination Act (S. 288), would stretch the moratorium out until 10/1/06, extend a permanent ban to cover access taxes on the Internet, and eliminate the "grandfather" clause on state and municipal taxation. While online retailers like it, it has drawn particular fire from traditional offline retailers, including the eFairness Coaltion, which oppose its exemption on digital goods.

Coincidentally, Rep. Billy Tauzin, chair of the House Energy and Commerce Committee, announced that his committee would look at a bill by Rep. Cliff Stearns (R-FL) (currently in the draft stages), during July 2001, exempting digital goods downloaded from online sources from state and local taxes, even if Congress allows those jurisdictions to levy taxes on other items sold, according to a 6/27/01 Reuters wire story. Given the increasingly digitized nature of online content, this type of legislative interest will be of importance, for its potential to complicate deliberations about what to tax. Oram's column sketches, for example, two scenarios for comparison. Think about a researcher who has to pay taxes to download content (and presumably pay a subscriber fee potentially accompanied by its own tax), from an online service which, itself, is required to pay taxes in order to conduct business. Then think about a tax-exemption on content that is downloaded online. Is one more fair than the other, and who stands to be burdened, especially if that content belongs to a proprietary service, or is inaccessible to those without (costly?) high-speed Internet connections, among numerous considerations. Since it's not clear that either Senate bill, or other measures will pass this year, we have a situation in which, if the moratorium runs out in October 2001 without any legislation passed by Congress, that leaves the states free to impose their own tax schemes. On 6/20/01, however, House Majority Leader Dick Armey (R-TX) expressed his desire to see a 3-5 year ban on Internet sales taxes, while continuing a push for a permanent ban on Internet-specific taxes, including access and use. Even with a good number of states working through the SSTUP draft language process, without federal legislation, the state efforts would have to rely on the kindness of online and mail-order entities to collect taxes. Why? Without federal limitations, online retailers are fearful of being exposed to collecting taxes on sales *and* paying taxes on income within states in which they are not physically located, posits Hardesty. This would bring us back to the problems raised by the Supreme Court's Quill decision-- which, again, strongly hinted that Congress should do something to fix that type of scenario. Resources Internet Tax Freedom Act http://www.house.gov/chriscox/nettax/lawsums.html Advisory Commission on Electronic Commerce http://www.ecommercecommission.org Rep. Ernest Istook non-binding resolution /files/budget/2000/HR3709am.html National Conference of Commissionerson Uniform State Laws http://www.nccusl.org 5/10/00 House of Representatives Vote http://thomas.loc.gov/cgi-bin/bdquery/z?d106:HR03709:|/bss/d106query.html| March 2001 Jupiter Media Metrix consumer survey http://www.jup.com/company/pressrelease.jsp?doc=pr010501 Streamlined Sales and Use Tax Project (SSUTP) http://www.geocities.com/streamlined2000 12/21/01 Newsbytes article Brian Krebs http://www.newsbytes.com/news/00/159742.html SSUTP draft language http://www.geocities.com/streamlined2000/fnlact1222.html National Conference of State Legislatures http://www.ncsl.org National Governor's Association http://www.nga.org Federation of Tax Administrators http://www.taxadmin.org Multistate Tax Commission http://www.mtc.gov President Bush 5/8/01 comments http://news.cnet.com/news/0-1007-200-5866854.html Vice President Cheney 4/18/01 comments http://news.excite.com/news/r/010418/22/net-tech-cheney-dc NCSL 4/23/01 letter http://www.ncsl.org/programs/press/2001/Bush_letter_4-19b.htm defined in the Unfunded Mandates Reform Act (UMRA)." Unfunded Mandates Reform Act (UMRA) OMB Watch analysis /node/215 Congressional Budget Office http://www.cbo.gov Ecommercetax.com http://www.ecommercetax.com 9/22/00 WebReview.com column Andy Oram http://www.webreview.com/pi/2000/09_22_00.shtml November 2000 Congressional Research Service Report Nonna Noto (courtesy National Council forScience and the Environment) http://www.cnie.org/nle/econ-84.html Michael Mazerov and Iris J. Lav 5/11/98 analysis on Internet Taxation Center on Budget and Policy Priorities http://www.cbpp.org/512webtax.htm Internet Nondiscrimination Act of 2000 http://thomas.loc.gov/cgi-bin/bdquery/z?d106:HR03709:@@@L&summ2=m& Internet Tax Moratorium and Equity Act (S. 512) http://thomas.loc.gov/cgi-bin/bdquery/z?d107:s.00512: Internet Tax Nondiscrimination Act (S. 288) http://thomas.loc.gov/cgi-bin/bdquery/z?d107:s.00288: 6/27/01 Reuters wire story quoting Rep. Billy Tauzin http://news.findlaw.com/legalnews/s/20010627/holdtechtaxesonline.html House Majority Leader Dick Armey (R-TX) Comments on Internet sales tax ban http://news.cnet.com/news/0-1007-200-6336011.html?tag=rltdnws