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The Starting Line: Digital commerce sparks tax tango

Who do you want regulating state Internet taxes? Two bills in Congress are dueling over just that.

A new bill being debated by Congress would carve out a special legislative space for purely digital commerce, freeing it from the tangle of regulations and taxes in the 50 states.

The Jurisdictional Certainty Over Digital Commerce Act, sponsored by Rep. Cliff Stearns, R-Fla., would reserve to Congress the right to regulate "commercial transactions of digital goods and services conducted through the Internet," thereby leaving states out of the loop. It would cover purely digital items, such as downloaded software, e-books and music files.

"These types of transactions are inherently interstate in nature and their regulation by state and local entities could significantly increase transaction costs and stymie development of this commerce," Stearns said.

The bill comes as Congress is reviewing a slew of proposals on how to deal with the Internet tax issue, including whether to extend a moratorium on Internet-specific taxes, which is set to expire this October.

Under a Supreme Court ruling, states are currently prohibited from requiring out-of-state companies to collect local taxes unless the companies have a physical presence in the state. That effectively exempts most Internet companies and other mail-order firms from having to charge sales tax.

Critics argue that the current state of affairs puts an undue burden on local stores and unfairly deprives states of revenue. But proponents argue that placing special taxes on e-commerce would hinder its development. And requiring merchants to slog through regulations specific to 50 states and countless other local authorities would be nearly impossible.

"It is not in the public interest to have thousands of disparate and inconsistent regulations, including taxation, apply to transactions in digital goods and digital services carried out entirely online," Stearns said in a news release.

The National Governors' Association and other states' rights groups are backing a bill from Sen. Byron Dorgan, D-N.D., that would extend the moratorium on new taxes and set up a system where Congress and the states would work out a streamlined sales tax system. But some critics contend that a streamlined system wouldn't necessarily be any less complicated, and could set up serious constitutional issues.

The Stearns bill may in fact be a warning signal to the Senate that Dorgan's simplification approach is not necessarily going over well with everyone.

Dorgan's bill would essentially be setting up a "national taxing scheme," said Stearns staffers. That has caused some considerable concern because it sets up a precedent for states to tax vendors who have no nexus with their state.

"There's substantial impact for more penny-ante regulations by states and locales," said one staffer, who asked to be nameless.

Stearns' office said the types of digital goods and services covered under his bill currently make up only 0.8 percent of total online sales. But critics charge that the bill goes too far in an attempt to rein in state regulation.

The digital services aspect of the bill could potentially be interpreted to cover everything from online banking to gambling to buying a car, said Frank Schaffroth, spokesman for the National Governors' Association. If all digital services were covered by Stearns' bill, states wouldn't be allowed to collect many taxes on Internet commerce.

"This is one of the most extraordinary preemptions of state and local authority and existing revenues that I have seen in years," he said. "What its implications are, it's almost beyond perception."

The bill could also cause problems as digital commerce goes offline, said Aram Sinnreich, a Jupiter senior analyst.

"One of the trends we're seeing is a blurring of the lines on what constitutes a digital product as opposed to a physical product," he said.

"Moreover, we increasingly see sales of digital products through offline methods. If (Congress has) the ability to regulate digital music files sold at Barnes&, do they also have the ability to regulate digital music files sold through a kiosk at a Barnes & Noble store?"