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Internet Tax Moratorium Passes House

May 11, 2000

On May 10, 2000, the House voted 352-75 to extend a moratorium on Internet-specific taxes for five years, until Oct. 1, 2006 (H.R. 3709). Supporters of the bill argued that the moratorium is not about sales taxes. Rather, it would prohibit the imposition of new taxes on access to the Internet and prevent "multiple" or "discriminatory" taxes on Internet use. While technically correct, this is misleading. While states can still impose a sales tax, their ability to enforce an Internet sales tax has been greatly eroded by Supreme Court decisions. Federal legislation is needed to help states create an even playing field between bricks-and-mortar and Internet businesses. Instead, the House bill further discourages states from finding solutions, leaving bricks-and-mortar businesses at a competitive disadvantage and limiting government resources for state and local services.

The House bill is an extension of the 1998 Internet Tax Freedom Act which prohibited taxing access to Internet Service Providers, such as AOL, and prevented certain "discriminatory" and "multiple" state and local taxes until October 1, 2001 -- 17 months from now. The law was linked to creation of a bipartisan national commission to study tax and access issues and make recommendations. However, the commission was unable to reach agreement on how to handle Internet taxes as it lacked the two-thirds required by Congress to make a recommendation. Since the moratorium doesn't expire for another 17 months and the bipartisan commission did not reach agreement on limiting Internet sales tax, there is no need for the House bill to extend the moratorium for five more years.

More importantly, while there is growing consensus that consumers should not be taxed on their connections to Internet Service Providers, the House bill has language that presents several problems in this regard. But the heart of the problem is in the moratorium on the other taxes.

Forty-five states already impose sales tax on goods and some services. For those sales made from a store located in a state, the consumer pays a sales tax and the store forwards the money to the state. For those sales made from a business in another state -- whether through mail order or the Internet -- the state has limited authority to require the seller to remit the sales tax to the state. A 1992 Supreme Court decision (Quill Corp. vs. North Dakota), combined with a 1967 decision (National Bellas Hess vs. Illinois), made clear that states cannot require sellers without a "nexus" to the state (e.g., out of state) to impose a tax. So consumers are supposed to fill out information on their state tax forms about goods they bought from other states and pay a sales tax on those items. But state enforcement of these "use" or "remote" taxes is nearly impossible.

H.R. 3709's limitation on "multiple" or "discriminatory" taxes does a disservice. Instead of offering ways in which states can collect use taxes or encouraging states to develop a streamlined approach to sales tax collections, the House bill discourages states to find solutions until the moratorium is over. In the Internet age, six more years is a life time.

Rep. Bill Delahunt (D-MA) offered a compromise to extend the current moratorium, which expires October 1, 2001, by two years. This would send a message to state and local governments to develop a workable solution for sales and use-tax systems. The compromise was defeated.

A non-binding resolution offered by Rep. Ernest Istook (R-OK) was passed (289-138) that provides a description of what states need to do to impose a sales tax that would not be "multiple" or "discriminatory." The provision identifies 14 characteristics, such as that there should be a centralized, one-step, multi-state registration system for sellers, and there should be uniform definitions for good and services across states.

OMB Watch supports removing the distinction between taxation of goods sold by bricks-and-mortar facilities and those sold through the Internet and mail order mechanisms. However, we believe sales of goods for meeting basic human needs (e.g., food and health related purchases), regardless of the selling vehicle, should not be taxed. We recognize that the sales tax is a highly regressive tax. Accordingly, we encourage that revenues generated through Internet and mail order sales tax be used by states for improved service delivery and community improvements; they should not be used for tax cuts or rebates.

Members of both parties are trying to demonstrate that they are friendly to technology companies, believing that such players represent key swing voters in the November elections. They are in such a rush to help technology companies that they are even skipping the hearing process on a number of bills. In the case of H.R. 3709, Rep. George Gekas (R-PA), chair of the Judiciary Committee's Commercial and Administrative Law Subcommittee, announced that he would hold hearings on May 17 to explore the concerns raised over the bill that passed yesterday.

It remains unclear what will happen in the Senate. A similar five year moratorium extension has been encouraged by Sen. John McCain (R-AZ), but was slowed down when opponents raised concerns. Sen. Byron Dorgan (D-ND) has been developing an approach similar to the Istook amendment that many are eager to see. Many are hopeful that the Dorgan approach will provide a reasonable approach that will help us move in the direction of applying sales tax in a uniform manner regardless of the sales venue.



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