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Net tax debate continues

Legislators at the first Internet Summit of the States discuss the issue of whether to impose taxes on the budding e-commerce industry.

COLORADO SPRINGS, Colorado--Under the gun of federal legislation to impose a temporary ban on new Net taxes, a majority of the legislators at the first Internet Summit of the States agreed that skimming money from the budding industry could cripple the future of electronic commerce.

However, when it comes to businesses that sell goods and services solely online, the idea of creating a low uniform sales tax on e-commerce sparked the interest of some, who fear that these booming companies will never collect and remit local and state sales taxes when surfers from all over the country buy online.

Members from 29 state legislatures gathered here late last week to discuss Net taxation and other cyberspace regulation issues during a three-day summit organized by the United States Internet Council, whose members include companies such as Microsoft, AT&T, and America Online. (See related story)

Tired of being left out of the loop by Congress, state lawmakers set out to draft their own Net policy agenda. By Saturday, it became clear that the diverse group of attendees still had a lot to learn about federal export restrictions on technologies that protect digital communication, but gained significant ground on the topic of Net taxes.

After much discussion, most realized that the border-less nature of cyberspace requires statewide cooperation when it comes to passing new laws or enforcing existing ones. Drawing comparisons between the mail-order industry and e-commerce, the taxation issue often took center stage.

Mail-order companies, for example, are not required to collect and remit local and state sales taxes from nationwide buyers unless they have a physical presence in the state, known as having "nexus." Still, the large catalog companies, such as Spiegel, usually voluntarily collect the taxes for all states because they have a presence in many territories.

With e-commerce, the same nexus principles apply. But e-commerce promises to be a bigger, global industry, meaning states aren?t going to sit back and watch potential tax revenue from the online marketplace disappear into cyberspace. Many here expressed concerns about missing out on sales tax revenue if their residents begin buying music, software, books, and research materials online instead of from local merchants, who have to collect and turn over the levies.

Online businesses, such as and the slew of subscription-based databases, can sell products to consumers nationwide. Unlike many of the mail-order companies, however, they often run their entire operations out of one place, so they only have return sales taxes in their home state.

"Companies like that are the states' worst nightmare," said Bob Levering, senior vice president of the Direct Marketing Association (DMA). "States could get away with a tax on Internet-only goods and services if it was simple enough and laid out certain exemptions."

A nationally adopted single levy on products sold online, some argue, would not constitute a new tax; rather, it would make up for lost revenue as exclusively online shops begin giving local brick-and-mortar stores a serious run for their money. However, legal experts say the Supreme Court's 1993 decision in Quill Corporation vs. North Dakota could derail any attempts by states to apply any e-commerce use taxes, which are collected from customers on the "use of tangible personal property."

The court ruled that the Commerce clause of the Constitution prohibits "states from compelling out-of-state mail-order houses to collect use taxes on sales to in-state residents." Based on the ruling, a company such as, which is based in Washington State, would not have to collect from its customers another state's usage tax on books. The Quill ruling also could apply to sales taxes, so an e-commerce flat tax would most likely have to be passed at the federal level.

The DMA is pushing a solution whereby the mail-order and catalog business would adopt a simple "voluntary collection agreement" (VCA) for state sales taxes, which it says could be used by the e-commerce industry as well. Under the VCA, companies agree to remit taxes to all states on a quarterly basis using a standardized form instead of delving into the various, complicated collection processes for each state, city, and county. The DMA argues that the VCA will stave off new laws, ensure that states and localities don?t lose tax revenue, and allow businesses to sell products in any state without the complications of creating nexus.

Despite the tax proposals kicked around by summit attendees, there would be huge legal and logistical problems with setting up a state-by-state adopted flat tax on Net sales. That is why a majority here support a national time-out of passing any taxes specific to Net-related products or services.

The USIC supports the Internet Tax Freedom Act, which calls for placing a moratorium on new state and local Net taxes. Introduced by Sen. Ron Wyden (D-Oregon) and Rep. Chris Cox (R-California), the bill is expected to be voted on by Congress early next year, although it is not yet clear how long the ban would last. The House version of the bill states six years, but the length in the Senate bill is undetermined.

Instead of endorsing the Cox-Wyden bill, the American Legislative Exchange Council, which represented more than half of the legislators at the summit, on Saturday unanimously approved a recommendation that the states adopt their own moratoria.

"We don't know what the federal bill is going to look like yet," said Colorado Sen. Bill Schroeder, who cochaired the summit.

"We're going after this so fast because many states go back into session in January," he said. "The end result may be to support it, but right now we want the states to take action when they can tailor the legislation for their states, especially if Congress doesn't pass this bill."

The voting members of ALEC, which also includes a private-sector membership, did not represent the views of all 29 states present. But the group does give a sense as to which direction the states could go on the Net tax issue and other laws that affect the high-tech industry, such as the Clinton administration's export regulations on strong encryption products and national standards for the use of digital signatures.

At its next meeting in January, ALEC will decide whether to endorse the federal Security and Freedom Through Encryption Act (SAFE). The bill would lift export controls and rejects mandated key recovery systems, which give law enforcement access to the keys that unscramble encrypted email or other digital communications.

In September, California adopted a resolution introduced by Silicon Valley Sen. John Vasconcellos to support SAFE.

When ALEC reconvenes, it also will discuss the issue of digital signatures, which ensure the authenticity of documents sent over the Net. States such as California, Georgia, and Washington already have approved laws that give electronic documents the same legal power as paper contracts. In order for digital signature systems to work across state lines, some states would like to use uniform standards.

The National Conference of Commissioners presented the Uniform Electronic Transactions Act (UETA) for consideration by the states at the summit. The model legislation would give digital contracts and electronic records the legitimate legal standing in every state.