IP: Tax issues in cyberspace

[Dave Farber <farber@central.cis.upenn.edu>]

Date: Thu, 15 Feb 96 02:02:47 EST
From: "Stewart Baker" <sbaker@mail.steptoe.com>


     Regarding the loss of local sales tax 
     income from cybercommerce, I thought 
     you'd like to see something I wrote not 
     long ago for the LA Times.  If you want 
     more law on this, I also have an outline 
     on www.us.net/~steptoe/welcome.htm
     
     Stewart
     
     INFORMATION SUPERHIGHWAY TRUST FUND
     by
     Stewart A. Baker
     
                If you spend a lot of time 
     on-line, you've already learned to cope 
     with pornographers, scam artists, and 
     pedophiles.  But the next time you log 
     on, you could encounter a minority that 
     scares even the most hardened denizen of 
     cyberspace.
     
                Tax collectors.
     
                State tax collectors, to be 
     precise.  Unlike the federal government, 
     states get a large portion of their 
     total revenue 
     
     from sales taxes, and they will soon be 
     fighting to collect taxes on every sale 
     that's made in cyberspace.
     
                Just ask the inhabitants of 
     postalspace.  A few years ago, the 
     Supreme Court confirmed a long-standing 
     ruling:  Mail-order companies don't have 
     to collect a state's sales taxes unless 
     the companies do something more in that 
     state than just take orders by mail or 
     telephone.  Only Congress could do away 
     with this "something more" requirement, 
     the Court declared.
     
                So the states asked Congress 
     for help against the mail-order 
     industry.  They got nothing.  Other than 
     a modern Washington lesson:  Never get 
     in a lobbying fight with people who send 
     out direct mail for a living.
     
                Especially not a fight about 
     taxes.  As one state tax official put it 
     to me, "Congress will never vote to 
     raise taxes that it can't spend."
     
                But the states aren't about 
     to give up.  The "something more" rule 
     costs state and local governments more 
     than $3 billion a year.  It also hurts 
     Main Street stores that sell in physical 
     space -- and that can't afford to 
     compete with mail order companies 
     charging no sales tax.
     
                So every year the states pass 
     new laws that stretch the definition of 
     "something more."  Every year they 
     launch new audits of catalog companies, 
     trying to catch them doing "something 
     more."  And every year, they doggedly 
     litigate about how to apply the 
     "something more" requirement.  With 
     considerable success.  Indeed, some 
     catalog companies have found that it's 
     easier just to collect the taxes than to 
     keep fighting.
     
     ***
      
                How does cybercommerce fit 
     into all this?  Like Bambi on the 
     opening day of hunting season.  Applying 
     the lessons of the mail-order wars, 
     state governments are already gunning 
     for on-line merchants who don't collect 
     state taxes.  Services like CompuServe 
     and Prodigy face state tax audits and 
     litigation.  Next the states will set 
     their sights on companies that use the 
     Internet and World Wide Web.
                In short, merchants planning 
     to sell things on-line can either 
     collect taxes for all fifty states (and 
     thousands of local governments) or put 
     their lawyers and accountants on 
     permanent standby to handle an endless 
     series of audits and tax claims. 
      
                Win or lose, it's hard to 
     imagine anything worse for electronic 
     commerce than years of litigation about 
     what kind of on-line contacts with a 
     state constitute the "something more" 
     that gives that state jurisdiction over 
     the seller.  As soon as the rules have 
     been laboriously worked out for one 
     technology, another will emerge.  The 
     courts may never catch up. Meanwhile, 
     uncertainty will mean fewer new 
     businesses on the Net, and that in turn 
     will mean less revenue to improve the 
     Net's performance.
     
     ***
     
                Is there a way out of this 
     fix?  
     
                Well, maybe.  Surprisingly, 
     there are at least two reasons why 
     on-line sellers might want to accept 
     federal legislation that lets the states 
     tax all on-line sales.  
     
                First, unlike the mail-order 
     industry, on-line merchants don't have 
     the resources for an endless war with 
     the states.  
     
                Second, relying on litigation 
     could split the on-line industry.  
     Services like America On Line or 
     CompuServe have local phone lines and 
     servers in every state. That gives the 
     states a pretty strong "something more" 
     claim against both the commercial 
     services themselves and against everyone 
     who sells through them.  The Internet 
     and World Wide Web, in contrast, have 
     much less in the way of local contacts 
     and corporate identity.  Like the Main 
     Street merchants, commercial services 
     like CompuServe can't afford to get 
     stuck collecting state taxes while their 
     competitors on the Web do not.
     
                Congress, of course, still 
     may wonder why it should help raise 
     taxes that someone else will spend.  One 
     answer is for the states to earmark the 
     money for something that national 
     leaders of both parties want -- but 
     can't afford.
     
                Vice President Gore has 
     worried publicly that educational 
     institutions and rural and poor 
     Americans will be left behind -- will 
     become information "have nots" -- when 
     the information infrastructure is built. 
      And Speaker Gingrich has famously toyed 
     with the idea of giving poor people 
     laptops as a way of democratizing the 
     information age.
     
                Well, suppose the states 
     agree that half the revenue raised from 
     on-line taxes will be spent improving 
     access to the information 
     infrastructure?  Some states might 
     decide to spend the money underwriting 
     Internet accounts for schools and 
     libraries; others might fund fiber optic 
     lines in rural areas.  Let the states 
     set their own priorities; Congress can 
     take credit for the overall policy. 
     
                Of course, you can't make an 
     omelet without breaking eggs, and some 
     will suffer as a result of such a bill.  
     I don't mean the consumers who will pay 
     the taxes -- or the on-line companies 
     that will collect them -- since both of 
     these groups will benefit from the 
     network improvements the taxes fund.
     
                No, the real losers will be 
     those lovers of the English language who 
     cringe at every new "information 
     superhighway" metaphor.  Because, if the 
     bill does pass, no force on Earth can 
     keep Congress from designating the 
     earmarked state revenues as the 
     "Information Superhighway Trust Fund."
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
                            
     
     Stewart Baker, a former General Counsel 
     of the National Security Agency, has an 
     international and technology law 
     practice at Steptoe & Johnson in 
     Washington, D.C.