Net taxes may be inevitable

After years of largely unregulated commerce, Internet retailers and consumers are hearing a dreaded message: Beware the tax man.

7 min read
Economic, political shifts revive calls for e-tail levies

By Troy Wolverton
Staff Writer, CNET News.com
October 30, 2001, 4:00 a.m. PT

After years of largely unregulated commerce, Internet retailers and consumers are hearing a dreaded message: Beware the tax man.

Now that the U.S. federal government's three-year tax ban has expired, the days of the Internet as a practically duty-free zone may be numbered. Although Congress could still reinstate the moratorium, the door to tariffs is starting to open.

"I think in the short run, the expiration of the moratorium is a non-event," said Tom Steele, co-chairman of the state and local tax group for If you are a state and you want more money, Internet access is a very juicy target. -Grover Norquist, president, Americans for Tax Reform San Francisco-based law firm Morrison & Foerster. "The real import here is a political one. The expiration of the old act changes the political dynamic of the new one."

The reasons for the change in the wind are many and diverse.

First, the economic slowdown has drained tax revenues from state, county and city coffers. Second, local governments have become less concerned about thwarting the burgeoning Net industry since the dot-com bust. Third, the line between traditional retailers and online companies has continued to blur with wider acceptance of the Internet to buy and sell goods. Finally, some believe that the Sept. 11 terrorist attacks distracted Congress from routinely extending the 1998 Internet Tax Freedom Act and allowed tax supporters to gather momentum.

For the moment, consumers need not worry that online taxes will cut into their holiday shopping budgets. Even if state and local governments win the right to impose new Internet taxes, they would be unlikely to do so for at least several months because it is such a massively complicated issue. But recent actions involving the federal moratorium suggest that some form of Net taxation is inevitable.

After the House passed a two-year extension of the moratorium Oct. 16, several Senate measures that would have extended the ban were blocked by last-minute legislative maneuvering. Both sides appear unwilling to concede, and the possibility of an extension remains in doubt as Congress winds down its current session.

Instead of discussing how long the ban should be extended, the debate has changed to whether it should be extended at all and, if so, at what price.

An abrupt reversal
"It's very likely that this thing expires and stays expired," said Stan Sokul, legislative consultant for The Direct Marketing Association, which is pushing for an extension of the moratorium without it being linked to the sales tax issue. "There's at least a 50-50 chance."

It's very likely that this thing expires and stays expired. -Stan Sokul, legislative consultant, Direct Marketing Association That would be an abrupt reversal of a hands-off policy that has been in place since the Internet became a mainstream avenue for retail sales. Tax proposals have been shut out of the Internet because of two key legal protections, one by the courts and one by Congress.

In general, e-tailers have been covered by the 1992 Supreme Court case of Quill Corp. v. North Dakota. The court barred state and local governments from collecting taxes on most "remote" sales in that case, ruling that it would be unreasonable to force mail-order and catalog sellers to collect sales taxes in the thousands of jurisdictions around the country where they don't have a substantial presence.

Many state and local governments have opposed the Quill decision as a usurpation of their taxation rights under the Constitution. The matter might have been laid to rest, except the court gave Congress the option to write a law that would permit states to tax remote sales.

The Internet was further shielded from any such moves in 1998 when Congress approved the Internet Tax Freedom Act, which expired Oct. 21. The act barred for three years taxes on Internet access and special "discriminatory" taxes on e-commerce.

The federal law left open the possibility for Net taxes at a later date and created the Advisory Commission on Electronic Commerce to study the issue. But deep divisions on the panel prevented it from making any formal recommendations when it concluded work last year.

To be sure, the Internet is not entirely tax-free. States can charge sales tax on e-commerce transactions between companies and consumers within their borders. Seattle-based Amazon.com's Washington state customers, for instance, must pay Washington's sales tax.

States also can charge a "use" tax--the flip side of a sales tax--for goods bought from out-of-state Why should people in San Francisco be told that they can raise taxes on their cable bills and their utility bills, but their AOL bill can't be subject to the same fee or tax? -Frank Shafroth, director of state and federal relations, National Governors Associationretailers. Although most have encountered obstacles to imposing that tax, states such as Ohio in recent years have added a line to their state income tax forms requiring citizens to calculate and pay such levies.

In addition, the Internet Tax Freedom Act did not affect laws enacted previously by several state and local governments to tax Internet access. Still, the majority of local jurisdictions do not impose Net taxes, and fiscal concerns have increased as the economy has headed south.

Budget shortfalls
An ongoing survey by the National Conference of State Legislatures estimates that at least nine states face budget shortfalls this fall. With every state required to balance its budget, many will be forced to find new sources of revenue or to cut services.

"If you are a state and you want more money, Internet access is a very juicy target," said Grover Norquist, president of the anti-tax group Americans for Tax Reform. "It's been protected for three years."

On top of the economic downturn has been the rapid growth and evolution of the Internet. Tax proponents believe that the medium should be treated more like its predecessors in retailing and entertainment as its uses expand in the mainstream public, where more than 50 percent of Americans now have Internet access in their homes.

Amazon, the epitome of the e-tail start-up, has deals with offline stalwarts such as Toys "R" Us, Circuit City and Borders and is expected to gross more than $1 billion in sales this quarter. America Online, meanwhile, has gone from being the nation's largest Internet service provider to the world's largest entertainment company after its merger with Time Warner.

Gartner analysts French Caldwell and Bill Keller say that with the U.S. Congress' extension of the moratorium on Internet taxes in doubt, businesses should prepare to collect and remit online sales and use taxes.

see commentary

Such developments have weakened some of the arguments about needing to nurture a nascent industry. Similarly, technological advances have increasingly muddied the distinction between Internet and traditional businesses.

Some state and local officials, for instance, have begun to question why they can tax cable television services but not Internet access, even when they are both distributed over the same cable wires. Likewise, they say, telephone calls made using a telephone are taxable but those made over a computer are not.

"Why should people in San Francisco be told that they can raise taxes on their cable bills and their utility bills, but their AOL bill can't be subject to the same fee or tax?" Frank Shafroth, director of state and federal relations for the National Governors Association, asked rhetorically.

Despite all these objections, many industry and political observers believe Congress would have passed an extension of the moratorium if not for the terrorist attacks last month. As the government was dealing with emergency issues such as airline-industry relief and anti-terrorist legislation, sources on Capitol Hill say the delay of action on the tax issue created an important window of opportunity for opponents to the moratorium.

That momentum may persist even if the Senate manages to pass an extension that matches the House's action. Those close to the issue believe that another ban would only delay the issue for another two years, at which time state and local governments would be able to make an even stronger case to tax Internet sales.

Some e-commerce-only companies such as Amazon.com say they would have no problem collecting sales taxes--as long as the sales tax system is simplified. In today's unwieldy system, Amazon and other companies note that there are thousands of tax jurisdictions nationwide, each with its own definition of taxable goods and its own rate schedule.

"Our model is not predicated on the non-collection of these taxes," said Paul Misener, Amazon's vice president in charge of global public policy. "I like to say that if true simplification occurs, companies will be able to handle it, address it and observe it." 


Richard Sullivan, chairman of the e-Fairness Coalition, discusses how the expiration of the Net tax moratorium affects his pro-Internet tax group. (8:10)

Play clip


1967 The U.S. Supreme Court rules in National Bellas Hess, Inc. v. Dept. of Revenue of the State of Illinois that states cannot require catalog and mail-order companies to collect sales and use taxes if they don't have a substantial presence in the state.

1992 In Quill Corp. v. North Dakota, the U.S. Supreme Court upholds its ruling in Bellas Hess but opens the door for Congress to rewrite the law and allow states to tax remote sales.

1995 Amazon.com opens its virtual doors, becoming one of the first e-tailers.

October 1998 Congress passes the Internet Tax Freedom Act. For the next three years, the law bars taxes on Internet access and special taxes targeted solely at e-commerce. The act also creates the Advisory Commission on Electronic Commerce to study, discuss and make recommendations to Congress on Internet tax and policy issues.

June 1999 The commission meets for the first time in Virginia.

March 2000 The commission concludes without making a formal recommendation to Congress.

Holiday season 2000 Retail e-commerce sales climb to $8.9 billion, about 1.1 percent of total retail sales, according to the U.S. Commerce Department.

Sept. 11, 2001 Terrorist attacks in the U.S. destroy the World Trade Center and damage the Pentagon. After the attacks, Congress puts most normal business on hold, including whether to extend the Net tax moratorium.

Oct. 21, 2001 Internet Tax Freedom Act expires.



Senate passes Net tax act

Net firms concede need for taxes

Leading policy-maker proposes end to Net taxes

Anti-tax groups offer e-commerce plan

Net tax panel punts

Analyst predicts extension of e-commerce tax ban

Division defines Internet tax panel

E-commerce panel leaves tax issue unresolved

Net tax measure may pave way for fees

Digital commerce sparks tax tango

Senate shifts renew interest in Net taxes

Senate won't extend Net-tax moratorium


Editors: Noel Wilson, Mike Yamamoto, Jennifer Balderama
Design: Jeff Quan
Production: Ben Helm