Conflict of interest: The taxpayer-funded campaign for Internet taxes

By Ron Nehring
web posted February 7, 2000

The Internet appears to be changing everything. Americans are using the Net to communicate, bank, shop, buy stock, plan their retirement and even buy cars and homes. One thing that never seems to change, however, is the impulse of government to regulate and tax.

Barely seven years have passed since the modern World Wide Web made its debut as a means of exchanging text, graphics, video and audio in ways that finally moved computing out of the realm of hobbyists and programmers. Consumers are no longer limited to the corner grocery store or the local mall. The Internet makes shopping around the country or around the world easy, efficient and money-saving. Conversely, this new medium provides vendors with a low-cost means of reaching a truly global market.

In its infancy, the Internet was barely noticed by the political class in Washington and state capitols, and those hardware and software engineers in Silicon Valley and elsewhere who were building the applications and infrastructure were content to innovate without government interference. Now, however, as the number of Internet users approaches 100 million and online commerce is challenging depression-era tax collection systems, the politicians have begun to take notice.

Congress attempted to step in and regulate online content in 1996 with the Communications Decency Act, which the Supreme Court promptly struck down for imposing an unconstitutional restriction on Internet users' First Amendment rights. The movement to control online content, in the name of children or otherwise, was rendered largely defunct by the Court.

But a new movement to meddle with the Internet is again underway, and this time the politicians are much more determined. The intensity surrounding this new regulatory assault stems from what is now at stake -- rather than protecting children from viewing pornography online, the goal is to impose new tax collection schemes and use the Internet as a cash cow for state and local politicians. When potential tax dollars are concerned, the political class and its nonprofit surrogates show much greater resolve.

Elected officials have enlisted powerful tax-exempt, taxpayer-funded nonprofit organizations in their cause. They are waging an intense lobbying and public relations campaign to enact a risky national sales tax collection system for electronic commerce. Taxpayers are being forced to subsidize a campaign that, if successful, will increase the net tax burden on all Americans while posing a very real threat to the health of the Internet. The politicians who control these associations have chosen to subjugate the interests of the tax payers to the interests of the tax collectors.

Internet Tax Freedom Act

Recognizing what might happen if 6,600 taxing jurisdictions applied their own tax collection regimes to the Internet, Congress passed the Internet Tax Freedom Act (ITFA) in 1998. The ITFA instituted a national, three-year moratorium on any multiple or discriminatory taxes specifically directed at electronic commerce. This meant states and localities could no longer specifically tax Internet access and commercial online transactions unless their laws took effect before the ITFA.

Under the ITFA and Supreme Court precedent, states and localities may only require companies with a "substantial physical presence" or "nexus" in their state to collect sales taxes. For example, a company with facilities in California may be required to collect taxes on sales to Californians. But a New Hampshire company with no "nexus" in California cannot be required to collect taxes on the goods it sells to Californians.

This arrangement creates a virtual "tax free zone" for many purchasers. For instance, 800.Com is an online consumer electronics vendor based in Oregon, which has no sales tax. It has no presence in any other state. As a result, 100 per cent of purchases from 800.Com are free of sales tax collection. Consumers in states with sales taxes are technically responsible for reporting their purchases to their local taxing authority and paying a "use tax." This is, of course, rarely if ever done.

Many state and local politicians detest a system which allows consumers to avoid paying sales taxes by going online or, as is more common, purchasing from a catalog. As a result, nonprofit lobbying groups representing government officials are lobbying Congress and its creation, the Advisory Commission on Electronic Commerce, to change the law and institute a national sales tax collection system for all Internet and catalog remote sales.

The ITFA's sponsors, Rep. Chris Cox (R-CA) and Sen. Ron Wyden (D-OR), originally envisioned a permanent ban on Internet-specific sales and access taxes. During negotiations with the Clinton Administration, however, the ban was reduced to six years, then reduced again to three years. Finally, a provision was added creating an "Advisory Commission on Electronic Commerce" (ACEC) to study the issues surrounding Internet taxation and report its findings to Congress.

Nineteen Commissioners sit on the ACEC: three representatives of the Clinton Administration and 16 representatives from the public and private sectors appointed by the Republican and Democrat Congressional leadership. As of this writing, the Commission has met twice and will meet twice more before issuing its report before the statutory April 21, 2000 deadline.

The proponents of Internet taxation, led by Commissioners Michael O. Leavitt (the Republican governor of Utah) and Ronald Kirk (the Democratic mayor of Dallas), clearly view the ACEC as a forum for advancing their case for a national sales tax collection scheme that will end the Internet's status as a "tax free zone."

By law, the ACEC must accept comments and ideas from the public. Not surprisingly, thus far the Commission has received 27 letters, faxes and e-mails opposing Internet tax collection schemes for every one it receives in support. "I've never seen anything like it," said one Commission staffer.

A poll conducted on the Dick Morris-run Vote.Com web site found that 95 percent of respondents were opposed to new taxes in cyberspace.

Recognizing how amazingly unpopular their tax ideas are with the public, Leavitt, Kirk and others have enlisted their taxpayer-subsidized nonprofit organizations representing elected officials to craft and sell their idea to the Commission, members of Congress and the public.

"Big Seven" Campaign

Seven nonprofit organizations are at the center of the campaign to impose a national sales tax collection scheme on the Internet: the National Governors Association (chaired by Leavitt), the Council of State Governments, the National Conference of State Legislatures, the National Association of Counties, the National League of Cities, the International City/County Management Association and the U.S. Conference of Mayors.

These groups are tax-exempt, nonprofit membership organizations for state and local officials and their staffs incorporated under Section 501(c)(3) of the Internal Revenue Code, or with a 501(c)(3) adjunct. Each group receives a substantial portion, if not the majority, of its operating revenue from "dues" levied on state and local treasuries. There is no question that the endeavors undertaken by these groups are ultimately financed by the taxpayer.

For example, the National Governors Association (NGA) receives more than one-third of its budget from federal grants and contracts, and another third from state appropriations. Corporations, along with corporate and private foundations, fund roughly 20 percent of the NGA's operations, often using their sponsorship as a backdoor way to get close to influential state executives.

Each of the Big Seven groups faces a critical conflict of interest: represent the interest of the taxpayers who ultimately finance the group, or represent the interests of the politicians, to whom the privilege of membership is solely reserved? Unfortunately, the needs of taxpayers are subordinated to the needs of politicians.

At the September ACEC meeting, Commissioner Grover Norquist -- president of Americans for Tax Reform and the official "consumer/taxpayer representative" on the panel -- suggested to Leavitt that the interests of governors as tax collectors naturally conflicted with the interests of taxpayers. Leavitt bristled at the suggestion.

"I don't know how many voters aren't taxpayers," Leavitt said. "I don't know exactly who it is I represent if it isn't taxpayers. That's who pays my salary. That's who I work for every day. That's who all 50 Governors work for. In terms of who represents taxpayers at this table…."

Bypassing Congress

Under Leavitt's command, the NGA has opposed any efforts in Congress to block states from exporting their tax collection schemes beyond their borders. Incredibly, a news release issued by the NGA last November 16 declared Leavitt's support for a three-year "stand still on any federal legislative changes to states' ability to require businesses outside their borders to collect sales tax on their behalf." Of course, states do not have the power to "require businesses outside their borders to collect sales tax on their behalf." Because they cannot convince Congress to pass legislation giving them expanded taxing authority, the "stand still" is designed to give Leavitt and the other Big Seven groups time to mount a direct, frontal assault in the courts.

In 1992, the U.S. Supreme Court affirmed in Quill v. North Dakota that companies with no physical presence in a state cannot be compelled to collect sales taxes for that state. The Court argued that to require a seller to collect and remit sales taxes for up to 6,600 state and local taxing jurisdictions would pose too great a burden and would unduly interfere with interstate commerce. The Constitution's Commerce Clause grants Congress sole authority over matters of interstate commerce.

To address the Court's reasoning in Quill, Leavitt's NGA staff developed a plan in concert with the Big Seven. It would impose taxes on Internet sales, providing the much-desired sales tax revenue to government, while shifting the burden of collecting and remitting sales taxes from vendors to "Trusted Third Parties." They call this the "zero burden" approach. The Big Seven plan would clear the way for a new round of litigation to enact a national sales tax collection scheme without Congressional approval.

The National Conference of State Legislatures, another Big Seven group, endorsed these ideas in a resolution passed at its July 1999 annual meeting in Indianapolis.

Although the Big Seven often advocate "federalism," their plan for a national, uniform sales tax collection mechanism is out of touch with the federalist view of competition between states, which allows citizens of one state to move or do their business in another state when their liberty is compromised. The Big Seven instead propose a national system that forces citizens to pay sales taxes wherever they are, wherever they shop. This bizarre view of federalism is consistent with the groups' views on other issues, such as Goals 2000, the Kyoto Protocol and the Endangered Species Act. As Sarah Foster of the Western Journalism Center points out, "instead of resisting such government intrusions, the Big Seven offer ‘strategies' for implementation and ‘partnerships' between feds and locals to solve society's problems." The Big Seven consistently twist the meaning of "federalism" to support their goals of bigger, more intrusive, inescapable government.

Taxpayer-funded P.R.

Of course, selling this idea to the public is far more challenging than convincing fellow politicians of the need for more tax revenue. Elected officials get their political power by controlling how government acquires and dispenses wealth. The more wealth a state or local government acquires and redistributes, the more favor it can curry with special interests or constituents. The taxpaying public, of course, sees things differently. So Leavitt and his colleagues must redefine the issue away from the Internet and taxes. This is where the nonprofit groups come in.

Last November 10, 25 free-market, taxpayer and consumer groups came together to form the "e-Freedom Coalition," which presented a taxpayer-friendly proposal to the ACEC at its December meeting. Representatives of the Coalition were joined by Rep. John Kasich (R-OH) and Rep. John Boehner (R-OH), who unveiled their bill, the Internet Tax Elimination Act, to make permanent the moratorium on Internet sales taxes and extend the ban to cover sales that are not interstate transactions.

The NGA immediately responded with a news release: "Kasich Proposal Would Discriminate Against Main Street Businesses," the headline blared. Incredibly, the release went on to claim that any proposal to make the Internet tax-free would "mean fewer teachers, less law enforcement protection around the country," "hurt low income taxpayers," be "unconstitutional," and, again for emphasis, "discriminate against main street businesses."

Six days later, on November 16, Leavitt and NGA Executive Director Ray Scheppach were featured speakers at a forum hosted by the U.S. Conference of Mayors (USCM), another Big Seven group, where "collecting sales taxes on electronic commerce" topped the agenda. The USCM made no attempt to appear unbiased on the issue. It would "hear expert testimony and engage in a discussion on effectively applying sales taxes to commercial transactions that occur on the Internet," and it invited only supporters of the Big Seven plan to participate.

The Big Seven's public relations campaign is not only directed at the public and the media – it's aimed at the Commission and Congress. While Leavitt carries water for the Big Seven within the Commission, he and his allies arrange for other Big Seven representatives to testify and lobby members of the Commission personally. At the ACEC's New York meeting, state Rep. Matthew Kisber of Tennessee and state Sen. Steven Rauschenberger of Illinois urged the Commission to grant states broader tax collection authority in exchange for lower administrative burdens and easier paperwork requirements for vendors. Kisber and Rauschenberger were backed up by the NCSL staff, which issued a national news release and promoted their testimony.

Twelve days after Rep. Kasich and the e-Freedom Coalition unveiled their low-tax proposal to the Commission, the National League of Cities (NLC) fired off a letter to members of Congress expressing "strong opposition to any legislation that would bar the collection of sales and use taxes on Internet transactions." The group employed alarmist rhetoric, claiming that "education, transportation, health services" and even "solid waste collection and environmental quality" are threatened unless states are permitted to expand their tax collection regimes beyond their borders. No mention was made that the NLC's position would ultimately mean higher taxes for the constituents who elect the League's member councilmen and mayors.

Clintonian Doublespeak

Leavitt and his colleagues quickly change the subject when it's revealed that their plans increase the net burden on taxpayers,. At the September ACEC meeting, Leavitt proposed the Commission solicit public proposals outlining what an Internet sales tax plan would look like. Among his criteria was that proposals contain "no new taxes."

Sensing the use of Clintonian doublespeak, Commissioner Norquist asked Leavitt, "Does that mean no net tax increase on citizens?" Leavitt's response: "No, what it means is no new taxes being imposed on sales over the Internet."

Aaron Lukas of the Cato Institute observes that Leavitt's "notion of ‘no new taxes' leaves plenty of room for, well, new taxes. The key is a dubious distinction between ‘new' and ‘higher' taxes. In Leavitt-speak no ‘new' taxes doesn't mean the state won't take more of your money; it will just do the job with additional ‘old' taxes. In either case the result is the same: more money for the state, less for taxpayers."

Rather than face directly the issue of new Internet taxes, the NGA has recast the issue as one of "fairness," and its press releases and USCM events are a deliberate public relations strategy to disparage clearly pro-taxpayer proposals as anti-taxpayer. The Big Seven, which commonly support new taxes and burdens on businesses, purport to be the defenders of "Main Street" vendors, and they claim that exempting out of state vendors from sales tax collection is unfair. "Internet vendors should not receive preferential tax treatment at the expense of local ‘main street' merchants," cries the NCSL.

But those claims miss a critical point. As Adam Thierer of The Heritage Foundation explains, "remote vendors do not use or deplete state or local resources which state or local taxes support. It would be patently unfair to force out-of-state companies to pay taxes for government services or programs they do not use or benefit from. State and local businesses pay or collect such taxes because they can take advantage of the programs or services provided with those funds. Remote vendors engaging in interstate electronic transactions do not benefit in a similar way from these taxes, and shipping companies already pay taxes to cover their use of public goods and services."

Moreover, Internet vendors are tangible "bricks and mortar" businesses that will continue to pay routine income taxes where they reside. A permanent Internet tax moratorium would only exclude states and localities from taxing remote vendors of electronic commerce.

Similarly flawed is the argument that a low-tax Internet threatens future state and local tax revenues. State and local governments continue to enjoy budget surpluses of historic proportions, just as they have for most of the decade. Rather than face imminent layoffs of teachers and police officers, as the Big Seven suggest, many states are finding the "politics of surpluses" -- deciding how to spend unanticipated revenue -- to be as difficult as the "politics of deficits."

Economic Consequences

Despite the NGA's claim that a low-tax Internet would "hurt low-income taxpayers," the Big Seven's vision of the Internet would clearly be less friendly to all consumers. A New Yorker purchasing a Hitachi VCR from 800.Com would pay $129.95 today. If the Big Seven have their way, that same consumer would pay more than $141. The difference consists of sales tax, plus processing fees and incentives necessary to install the new tax collection system. Lower costs for consumer goods are "pro," not "anti," taxpayer.

Although the Big Seven's Internet tax scheme would drive up costs for many individual consumer purchases, the overall economic impact would be far more noticeable. The current economic boom is largely attributable to phenomenal growth in the high-technology sector. The Commerce Department reported in June that "over the past four years, [Information Technology] industries' output has contributed more than one-third to the growth of real output for the overall [U.S.] economy."

Hardware, software and telecommunications companies are growing so quickly that a national shortage of technology workers is expected to persist for years to come. Moreover, the average job in high-tech pays more than $60,000 per year. Strong personal income growth is driving more Americans into higher tax brackets, producing enormous windfalls for state and local government coffers.

The Internet is at the center of this surge in high-tech. America is the undisputed world leader in producing software and the high-end servers and routers that carry all Internet traffic. As competition drives price-to-performance ratios in consumers' favor, technology enables businesses of all kinds to reach a global market instantly.

What will happen if existing sales tax regimes are applied to electronic commerce, as the Big Seven propose?

Austan Goolsbee, Associate Professor of Business at the University of Chicago, studied this question. His analysis of 25,000 people with online access found that "local taxation plays an influential role in online commerce." More specifically, his research demonstrated that people living in places with high tax rates are "significantly more likely" to purchase goods online. Goolsbee concludes that applying a national sales tax collection system to the Internet would force a contraction of the e-commerce market by 24 percent or more.

Such a contraction would deal a crippling blow to many online ventures, including traditional retailers as they make the transition from "bricks and mortar" to "clicks and mortar." Chris Wysocki, President of the Small Business Survival Committee, said such a result would be "a nightmare for small business owners and entrepreneurs. Profits for online retailers and traditional retailers' online ventures, most of which operate on very tight margins, would slump and push many into the red and force others to close up shop entirely."

The NCSL's July 1999 resolution echoes the Big Seven view that the Internet is a threat, not the opportunity most Americans see. "[T]he projected growth of electronic commerce transactions will have a substantial negative impact on state sales and use tax revenues." This is, of course, Cro-Magnon economics, as state and local government coffers continue to overflow with tax revenue generated by our technology-driven economy.

Slashing the emerging e-commerce market would have obvious macroeconomic implications. Fewer buyers means less demand for Internet-capable hardware (PCs, routers, servers), software (browsers, server software, web sites, databases, graphics) and telecommunications infrastructure. Diminished job growth, employment and investment would be certain to follow. The only question is, how bad will the damage be to the overall economy?

Ron Nehring is Director of National Campaigns for Americans for Tax Reform. Reprinted with the kind permission of the Capitol Research Center.

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