{1} Electronic commerce over the Internet is growing at almost an exponential rate. An April 1998 report of the United States Department of Commerce, entitled The Emerging Digital Economy, [2] describes the almost mind-boggling growth of electronic commerce, and of the Internet itself. Some of the more fantastic facts included in the report are:
- By the end of 1997, more than 100 million people were using the Internet and some experts expect that 1 billion people will be connected to the Internet by 2005.
- Traffic on the Internet is doubling every 100 days.
- By 2002, Internet commerce between businesses will likely surpass $300 billion.
- The number of names registered in the domain name system grew from 26,000 in July of 1993 to 1.3 million in July of 1997.
By December 1998, 80 million adults, [adults being] defined as ages 16 years and older, were already online in the United States. Of those, 48 million reported that they had shopped for product information on the World Wide Web, and as many as 16 million people reported that they had purchased a product or service online. A recent Merchants Association survey states that e-commerce is growing 200 percent annually- $13 billion in 1998. Indeed, Internet advertising totaled approximately $1.3 billion for the first three-quarters of 1998, a 127 percent increase over the same time period in 1997. But notwithstanding this growth of "buyers" on the web, this segment represents only 5 percent of visiting consumers. [3]
Recently, William M. Daley, Secretary of the Department of Commerce, stated:
[I]n the history of business there has never been anything like the Internet. E-commerce's potential to change the way we shop, we work, we get our news, we conduct business is enormous. . . . .
. . .
. . . [E]-commerce is still relatively small, compared to the rest of the economy. Last year, business to business transactions accounted for less than a percent of our $9 trillion economy. And even though retail sales on the Internet tripled last year, they still accounted for much less than one percent of all retail trade. It may be small, but it is growing fast. . . [4]
{3} According to a spring 1999 estimate by International Data Corporation, [5] E-commerce is expected to increase to $400 billion by 2002. [6] Noteworthy is the fact that International Data's spring 1999 estimate is $100 billion larger than the Department of Commerce estimate of only one year earlier. [7] International Data further estimates that the number of Web buyers will expand from 18 million in 1997 to 128 million in 2002. [8]
{4} While business to consumer E-commerce is growing at a phenomenal rate and is causing more and more merchants to take to the Internet, even more astounding are the projections for business to business E-commerce. According to Forrester Research, [9] by 2004, business-to-business commerce over the Internet will account for 95 percent of all E-commerce. [10] Forrester also predicts that online business transactions will increasingly infiltrate into all "business supply chains, particularly computers, electronics, aerospace, defense, utilities and motor vehicles." [11] Currently, businesses are already using the Internet to "lower purchasing costs, reduce inventories and cycle times, provide more efficient and effective customer service, lower sales and marketing costs, and realize new sales opportunities." [12] Consumer electronics companies, media giants, phone companies, computer companies, software firms, satellite builders, cell phone businesses, Internet service providers, television and cable companies are all aggressively investing in the Internet. [13]
{5} Additionally, with respect to the broader "Internet economy," [14] of which electronic commerce is only a portion, the Internet "generated an estimated $301 billion in revenue in 1998 and was responsible for over 1.2 million jobs." [15] In order to put these figures into perspective it is important to note that the "Internet economy" is already larger than both the energy industry ($230 billion in revenue in 1998) and the telecommunications industry ($270 billion in revenue in 1998). [16] Furthermore, the "Internet economy" is almost as large are the automobile industry ($350 billion in revenue in 1998). [17] As Federal Trade Commissioner Orson Swindle aptly points out, "[t]he Internet economy is becoming as essential to American life as the automobile." [18]
{6} Undoubtedly by the time you are reading this article the projections of the experts, pundits, politicians and academics will have increased to even more dramatic proportions. The reality of the Internet is that nothing stands still for long, including predictions. Suffice it to say that the Internet and everything associated with the Internet, including electronic commerce, is enjoying a phenomenal rate of growth, which will only continue for the foreseeable future. Even though E-commerce currently represents only a small portion of the United States economy, individuals and businesses are rapidly realizing the potential for business conducted over the Internet. This being the case it is, therefore, only logical to conclude that as the value of electronic commerce continues to grow, both in relative and absolute terms, governments, at all levels, will be tempted to tax electronic commerce. Government motivation to tax electronic commerce will likely have a range of justifications. These justifications will likely vary from the relatively benign purpose of seeking to capture revenue that is escaping from the real world into cyberspace, to the less benign purpose of revenue enhancement, to the malignant purpose of creating tax policies that further social or political agendas in cyberspace, and distort electronic commerce and free trade.
{7} This article will discuss the existing "real world" tax paradigm, why the existing model fails in cyberspace, government initiatives to tax or control taxing cyberspace, and finally, suggest a tax policy for cyberspace.
II. THE EXISTING MODEL OF TAXATION IN THE "REAL WORLD"
A. Sales and Use Taxes
{8} While the term "sales tax" can encompass a variety of slightly different levies, it is most often used to refer to the tax collected directly from consumers on a transaction-by-transaction basis. Although the economic burden of the sales tax falls upon the consumer, it is the seller who bears the statutory burden of collecting the tax and remitting the sums collected to the government entity, usually a State, in charge of collecting taxes within the jurisdictional borders where the business is located. [19] Currently, forty-five states and the District of Columbia impose a general sales tax upon purchases. [20] The only states that do not have a sales tax, or a use tax for that matter, are Alaska, Delaware, Montana, New Hampshire and Oregon. In Alaska, however, municipalities have the statutory authority to impose both sales and use taxes. [21]
{9} A "use tax," which is theoretically related in some respects to a sales tax, taxes the privilege of using, storing or otherwise consuming tangible personal property or services. A use tax is a nonrecurring tax that is paid only once by the owner of the property. For this reason a use tax is generally characterized as a form of excise tax and is not considered to be property tax. A use tax differs from a sales tax in that a sales tax is paid by the purchaser of the property at the time the property is purchased. A use tax, however, is generally not paid incident to sale, but rather is paid by the purchaser at some later time, ostensibly in exchange for the privilege of exercising ownership rights over the property. [22]
{10} A use tax allows the state levying the tax (i.e., the "taxing state") to tax sales of tangible personal property not occurring within its borders. Because the actual sale occurs outside of the taxing state's boundaries no sales tax can be levied. However, when the tangible personal property is purchased out-of-state and is then transported across state lines, the state where the property is ultimately used does have an interest in being able to levy a tax. In other words, a sales tax is levied when transactions occur within the state and a use tax is levied upon articles bought in "foreign" states and subsequently transported into the taxing state. [23]
{11} The purpose of the use tax is to protect state revenues by taking away any advantage residents may have to travel out-of-state to make untaxed purchases. [24] The problem posed by use taxes is that they are normally self assessed. [25] This means that the use tax is either voluntarily paid by the purchaser, or the tax goes unpaid unless the state levying the use tax can require the seller to collect said use tax at the time of sale. Therefore, if a state does impose a use tax it is vitally important to require sellers to be responsible for collecting and remitting use taxes. In order for the seller to be required to collect and remit such use taxes, however, the seller must have some physical connection or "nexus" with the taxing state. [26]
B. Quill Corporation v. North Dakota
{12} A state can impose upon an out-of-state seller the duty to collect use taxes only in certain circumstances. Specifically, both the Due Process Clause of the Fourteenth Amendment and the Commerce Clause represent constitutional hurdles that must be cleared prior to the imposition of a use tax collection duty. It is important to realize, however, that the out-of-state seller does not per se pay the use tax, which is why the question is whether the taxing state can place a duty upon out-of-state sellers to collect use taxes from their residents. While the battleground is semantically over a "collection duty," in reality the out-of-state seller will be paying the tax. This is true because the only time such a case will arise is when the out-of-state seller has not collected a use tax. By not collecting the use tax at the time of purchase the out-of-state seller has lost its only chance to pass these charges along to the purchaser. Therefore, regardless of how the cases characterize the ultimate question, the question in reality is whether the out-of-state seller is going to be forced to pay back use taxes without hope of recovering them from the purchaser. The seminal case addressing this issue is the United States Supreme Court case of Quill Corp. v. North Dakota. [27]
{13} Quill Corporation is a Delaware corporation with offices and warehouses in Illinois, California and Georgia. None of Quill's employees worked or resided in North Dakota and Quill did not have any significant ownership interests in any tangible property within North Dakota. [28] Nevertheless, North Dakota required every "retailer" maintaining a place of business within the state to pay use taxes. [29] In the applicable legislation, North Dakota defined "retailer" to include "every person who engages in regular or systematic solicitation of a consumer market in th[e] state." [30] Therefore, because Quill sold office equipment and supplies by soliciting business through catalogs, flyers, advertisements in national periodicals and telephone calls, the North Dakota Tax Commissioner filed an action to collect unpaid use taxes against Quill. [31]
{14} In addressing the issues presented by Quill, the Supreme Court first pointed out that it is possible for a state to have the authority to levy taxes pursuant to the Due Process Clause of the Fourteenth Amendment while at the same time not have the authority to levy taxes pursuant to the Commerce Clause. [32] Because these two constitutional requirements differ on a fundamental level it is necessary to address each independently.
1. Use Taxes Under the Due Process Clause
{15} Before a state can levy a tax the Due Process Clause requires a definite link between the state and the person, property or transaction it seeks to tax. [33] In National Bellas Hess, Inc. v. Department of Revenue of Ill. [34], the Supreme Court held that physical presence is required under the Due Process Clause in order for the taxing state to have jurisdiction under both the Due Process Clause of the Fourteenth Amendment and the Commerce Clause. [35] In Quill, however, after twenty-five years of due process evolution, the Court revisited the ruling and rationale of Bellas Hess and reversed its previous holding that physical presence is a prerequisite to being subject to the duty to collect use taxes under the Due Process Clause. In so doing, the Court pointed out:
{16} In Burger King Corp. v. Rudzewicz [37] the Supreme Court held that a foreign corporation is subject to in personum jurisdiction simply by purposefully availing itself of the benefits of an economic market in the forum state. [38] In Quill, the Court felt that reasoning comparable to the reasoning found in Burger King required the imposition of a use tax collection duty on mail-order houses engaged in continuous and widespread solicitation of business within a state. The Supreme Court, in reaching this conclusion, stated:Our due process jurisprudence has evolved substantially in the 25 years since Bellas Hess, particularly in the area of judicial jurisdiction. Building on the seminal case of International Shoe Co. v. Washington, we have framed the relevant inquiry as whether a defendant had minimum contacts with the jurisdiction "such that the maintenance of the suit does not offend 'traditional notions of fair play and substantial justice'." In that spirit, we have abandoned more formalistic tests that focused on a defendant's "presence" within a State in favor of a more flexible inquiry into whether a defendant's contacts with the forum made it reasonable, in the context of our federal system of Government, to require it to defend the suit in that State. [36]
In "modern commercial life" it matters little that such solicitation is accomplished by a deluge of catalogs rather than a phalanx of drummers: The requirements of due process are met irrespective of a corporation's lack of physical presence in the taxing State. Thus, to the extent that our decisions have indicated that the Due Process Clause requires physical presence in a State for the imposition of duty to collect a use tax, we overrule those holdings as superseded by developments in the law of due process. [39]
Quill partially overrules Bellas Hess and holds that the Due Process requirements of the Fourteenth Amendment do not require physical presence in a state for the state to be able to require the collection of a use tax. So long as the corporation's contacts with the state are sufficient to require it to defend suit there, the state may impose a duty to collect use taxes without violating Due Process requirements.
2. Use Taxes Under the Commerce Clause
{17} Under the Supreme Court's current Commerce Clause jurisprudence, "with certain restrictions, interstate commerce may be required to pay its fair share of state taxes." [40] The purpose of the Commerce Clause has never been to relieve those engaged in interstate commerce from paying their fair share of state taxes, even though those state taxes necessarily increase the cost of doing business. [41] Nevertheless, the Commerce Clause can act as a barrier that prohibits states from collecting use taxes.
{18} In Complete Auto Transit, Inc. v. Brady [42], the Supreme Court announced a four-part test to determine whether a state tax is constitutionally permissible under the Commerce Clause. A state tax will withstand constitutional challenge under the Commerce Clause if the tax: (1) is applied to an activity with a substantial nexus with the taxing state; (2) is fairly apportioned; (3) does not discriminate against interstate commerce; and (4) is fairly related to the services provided by the state. [43] In Quill, North Dakota did not rely upon Complete Auto, choosing rather to argue that the nexus requirement imposed by the Due Process Clause is equivalent to the nexus requirement of the Commerce Clause. [44] The Supreme Court, however, disagreed with North Dakota, stating:
Despite the similarity in phrasing, the nexus requirements of the Due Process and Commerce Clauses are not identical. The two standards are animated by different constitutional concerns and policies. Due process centrally concerns the fundamental fairness of governmental activity. Thus, at the most general level, the due process nexus analysis requires that we ask whether an individual's connections with a State are substantial enough to legitimate the State's exercise of power over him. . . In contrast, the Commerce Clause and its nexus requirement are informed not so much by concerns about fairness for the individual defendant as by structural concerns about the effects of state regulation on the national economy. . .
. . .
. . [T]he "substantial nexus" requirement is not, like due process' "minimum contacts" requirement . . . but rather a means for limiting state burdens on interstate commerce. Accordingly, contrary to [North Dakota's] suggestion, a corporation may have the "minimum contacts" with a taxing State as required by the Due Process Clause, and yet lack the substantial nexus with that State as required by the Commerce Clause. [45]
{19} Armed with the above understanding of the differences between the Due Process Clause and the Commerce Clause, the Supreme Court declined North Dakota's invitation to overrule the bright line physical presence test of Bellas Hess, in so far as that test relates to the constitutionality of state taxes under the Commerce Clause. The Court recognized that this bright line test does appear artificial, but the artificiality of the test is one of its clearest benefits. The bright line physical presence test "encourages settled expectations and, in doing so, fosters investment by businesses and individuals. Indeed, it is not unlikely that the mail-order industry's dramatic growth over the last quarter century is due in part to the bright-line exemption from state taxation created in Bellas Hess." [46]
{20} Even though North Dakota could properly impose upon Quill Corp. the duty to collect use taxes without offending the concept of Due Process, North Dakota could not impose the duty to collect use taxes, in this case, under the Commerce Clause. Simply stated, because Quill Corp. did not have a physical presence in North Dakota the "substantial nexus" requirements of the Complete Auto test could not be met and, therefore, the Commerce Clause prevented taxation.
C. Development of Case Law After Quill
{21} After Quill several cases have discussed the substantial nexus requirement and attempted to define exactly what physical presence is necessary for a state to impose a use tax collection duty upon an out-of-state vendor.
1. Orvis Co, Inc. v. Tax Appeals Tribunal of the State of New York
{22} In Orvis Co., Inc. v. Tax Appeal Tribunal of the State of New York [47] the Court of Appeals for the State of New York was faced with a consolidated appeal that strongly resembled Quill. The New York State Commission of Taxation and Finance sought to have two Vermont companies held liable for collecting and paying use taxes for products purchased by New Yorkers. [48]
{23} The first Vermont company, Orvis Company, sold retail and wholesale camping, fishing and hunting equipment. Orvis' sales were almost entirely through mail-order catalog purchases that were shipped from Vermont by common carrier or United States mail. Orvis also sold wholesale merchandise to New York retail establishments. Orvis did, however, admit that several of their employees had visited the New York retailers to whom merchandise was sold. [49]
{24} The second Vermont company, Vermont Information Processing, Inc., (VIP) markets computer software and hardware to beverage distributors throughout the United States. In most cases, orders were filled by shipments made by common carrier or United States mail. Employees of VIP did, however, visit customers in New York for the purpose of: (1) giving instruction on how to use their software; and (2) installing software. [50]
{25} The Appellate Division concluded that the "sporadic activities" of Orvis failed to meet the substantial physical presence standard test set forth in Quill. [51] Likewise, the Appellate Division concluded that the activities of VIP were insufficient to constitute the requisite substantial physical presence test set forth in Quill. Therefore, the Appellate Division annulled the determination assessing the use tax.
{26} The Court of Appeals, however, had a very different view of Quill. The Court of Appeals, pointed out that Quill did not adopt a "substantial physical presence" test, but rather only begrudgingly retained the "physical presence" test of Bellas Hess. The Court of Appeals disagreed with the arguments forwarded by Orvis and VIP, which urged that Quill required a blending of the "substantial nexus" requirement and the "physical presence" test to create a "substantial physical presence" test. In discussing this point, the Court of Appeals stated:
[A]cceptance of the thesis urged by Orvis and VIP - that Quill made the substantial nexus prong of the Complete Auto test an in-State substantial physical presence requirement - would destroy the bright-line rule the Supreme Court in Quill thought it was preserving in declining completely to overrule Bellas Hess. Inevitably, a substantial physical presence test would require a "case-by-case evaluation of the actual burdens imposed" on the individual vendor involving a weighing of factors such as number of local visits, size of local sales offices, intensity of direct solicitations, etc., rather than the clear-cut line of demarcation the Supreme Court sought to keep intact by its decision in Quill. [52]
{27} Nevertheless, the Court was forced to decide whether the minimal, or as the Appellate Division stated "sporadic", contacts in New York were enough to support a duty to collect use taxes. The Court of Appeals stated that a physical presence that is "more than a slightest presence" will be enough to support taxation. The Court of Appeals also stated that the required physical presence "may be manifested by the presence in the taxing State of the vendor's property or the conduct of economic activities in the taxing State performed by the vendor's personnel or on its behalf." [53] On the facts in this case, despite what appeared to be truly "sporadic" activity, the Court of Appeals found the minimal contacts to be sufficient to support a duty to collect use taxes. [54]
2. Brown's Furniture, Inc. v. Wagner
{28} In Brown' Furniture, Inc. v. Wagner, [55] the Illinois Supreme Court was faced with a case very similar to Orvis. Brown's Furniture is located in Palmyra, Missouri, which is approximately 15 miles southwest of Quincy, Illinois. Approximately 30% of Brown's Furniture total sales were to residents of Illinois. During a 10 month audit of Brown's Furniture, from January 1, 1989, to October 31, 1989, 942 deliveries were made into Illinois. Despite these 942 deliveries, no Illinois use tax was collected, nor was any Missouri sales tax collected for these sales. [56]
{29} Since 1975 Brown's Furniture had inquired a number of times regarding whether it had a duty to collect Illinois use taxes. As a matter of fact, Brown's Furniture did collect use taxes prior to 1975 and only ceased collecting use taxes after being told by the Illinois Department of Taxation that it had no duty to collect use taxes. [57] In 1985, however, the Illinois use tax statute was amended "to require use tax collection for out-of-state merchants who engage in activities in Illinois which would subject them to use tax collection responsibilities if engaged in within their own state." [58] After this amendment Brown's Furniture did, once again, collect Illinois use taxes.
{30} Subsequently, the Illinois customers of Brown's Furniture complained that Brown's Furniture was the only furniture store to collect such use taxes. Their customers felt they that Brown's Furniture was "pocketing the collected use tax." [59] In 1988, Brown's Furniture once again contact the Department of Revenue and was told that it did not have to collect use taxes. Nevertheless, in 1989 the Department of Revenue audited Brown's Furniture to determine if it was paying the required use taxes. [60]
{31} In determining that Brown's Furniture was liable for the use taxes, the Illinois Supreme Court recognized that Quill established that an out-of-state vendor must be physically present within a state in order to meet the substantial nexus requirement under the Complete Auto test. After Quill, however, the question remains as to exactly what presence will allow the state to impose the tax collection duty. [61] While a "slight" presence will not be enough, a substantial presence will not be required. [62]
{32} The Illinois Supreme Court went on to state that while reasonable minds can surely differ as to the required physical presence required to justify imposing use tax collection duties, the presence of Brown's Furniture in Illinois was enough. [63] The Court stated:
Brown's Furniture made 942 deliveries in Illinois during the 10-month audit period. Testimony at trial indicated that during a typical trip into Illinois, Brown's Furniture might make as many as five or six individual deliveries. Thus, during the audit period, Brown's Furniture was averaging between 15 and 18 trips into Illinois per month, or a minimum of about one every other day. We believe that by physically sending its representatives into Illinois on this regular and frequent basis, Brown's Furniture has established more than an slight physical presence within the State. [64]
Therefore, because Brown's Furniture was "physically present" in Illinois on a regular basis, and because they were competing with Illinois retailers, Brown's Furniture was found to meet the Complete Auto substantial nexus requirement and, therefore, had a duty to collect use taxes for Illinois. [65]
III. THE EXISTING MODEL OF TAXATION FAILS IN CYBERSPACE
{33} Tax policy particularly, tax collection, faces numerous problems when dealing with electronic commerce. Many, if not most, of the commercial transactions a state or local government will wish to tax will be between merchants who are in one jurisdiction and consumers who are in another jurisdiction. In this scenario, as explained earlier, it is the use tax that comes into play. [66] Unless the government seeking to tax the consumer can place upon the merchant a duty to collect the use tax it will be virtually impossible to reliably collect the use tax.
{34} Some states are attempting to combat the use tax collection problem by requiring individual tax payers to swear under pains and penalties of perjury that they have remitted all due use taxes. For example, the State of Connecticut has added a use tax line to the state income tax return. The 1998 Connecticut Resident Income Tax Return Form CT 1040, line 15, requires the tax payer to enter the total use tax that is due. [67] The Connecticut Resident Income Tax Return Instructions [68] provides an "Individual Use Tax Worksheet" for tax payers to complete in order to determine the appropriate amount to enter in line 15. The worksheet instructions state: "If you purchased taxable goods or services for use in Connecticut during the calendar year and a Connecticut or out-of-state merchant failed to collect Connecticut sales tax, you must pay the Connecticut use tax." [69] Furthermore, both Form CT 1040 [70] and the Tax Return Instructions [71] inform the tax payer that an number must be entered at line 15. The instructions say: "You must enter a zero on Line 15 if no Connecticut use tax is due; otherwise you will not have filed a use tax return." [72]
{35} Notwithstanding state efforts to force their citizens to voluntarily remit use taxes, there are still further difficulties states and local governments will face in attempting to collect use taxes due on purchases consummated over the Internet. In remarks to the Georgia Public Policy Forum on August 11, 1999 Federal Trade Commissioner Orson Swindle highlighted a few of the hurdles facing regulators wishing to tax electronic commerce over the Internet. Commissioner Swindle said:
The issue of taxing the Internet is complicated by several factors:
a. First, there are about 30,000 taxing jurisdictions in the country. Need I say more! The Internet is inherently susceptible to multiple and discriminatory taxation in a way that commerce conducted in more traditional ways is not.
b. The Internet commerce is very new. We do not know what the basic business model will look like in a few years. How can we know how to tax it? Many adverse, unintended and unanticipated consequences are lurking in the weeds.
c. How would the taxes be collected? One of the main benefits of Web-based businesses is that the ability to reach such a large potential universe of customers cheaply provides an opportunity for small companies to thrive without a tremendous amount of start-up capital. The cost of compliance and tax collection alone for these small businesses could be enough of a deterrent to keep them from participating in the marketplace.
d. Which state, county, country or countries has tax jurisdiction over income generated by electronic transaction? [73]
{36} In addition to the taxing nightmares identified by Commissioner Swindle, additional, seemingly intractable problems include the potential anonymity of both the buyer and the seller and the difficulty of associating online activities with physically defined locations. Both of these problems are related to what is called IP address swapping. [74]
IV. GOVERNMENT INITIATIVES: AN APPROACH TO TAXATION OF THE INTERNET
A. The Clinton Administration
1. Principles Behind The Framework for Global Electronic Commerce
{37} The first major initiative taken with respect to regulation of the Internet was the White House report entitled Framework for Global Electronic Commerce, which became a "whitepaper" in July 1997. [75] The whitepaper establishes five principles to guide the development of electronic commerce.
{38} Exploration of these five principles is useful in that it sheds light on how the Clinton Administration sees the role of government with respect to the Internet and E-commerce.
i. The Private Sector Should Lead
{39} While it is true that the government has played a unique role in financing and developing the Internet, the private sector has driven the development of its infrastructure and on-going evolution. The report recognizes that the private sector must lead and the economics of electronic commerce must be market driven. A market based E-commerce economy, rather than an economy based on invasive regulations, will result in lower prices and broader participation. The White House sees the role of the government as supportive of industry self-regulation. The report specifically states:
Accordingly, governments should encourage industry self-regulation wherever appropriate and support the efforts of private sector organizations to develop mechanisms to facilitate the successful operation of the Internet. Even where collective agreements or standards are necessary, private entities should, where possible, take the lead in organizing them. Where government action or intergovernmental agreements are necessary, on taxation for example, private sector participation should be a formal part of the policy making process. [76]
ii. Governments Should Avoid Undue Restrictions on ElectronicCommerce
{40} The White House believes that individuals must be able to contract on the Internet to buy and sell products and services with minimal government involvement. Excessive government regulation of the Internet and/or E-commerce will only distort the development of the electronic marketplace by inefficiently reallocating supply and demand, thus increasing cost and fostering inefficiency. Furthermore, because the Internet is evolving at a phenomenal rate, the government regulators will likely be unable to keep pace with technical and market based changes. Given the regulatory and rule-making process, the report quite correctly recognizes that regulations will probably be out dated by the time they are adopted. "Accordingly, governments should refrain from imposing new and unnecessary regulations, bureaucratic procedures, or taxes and tariffs on commercial activities that take place via the Internet." [77]
iii. Governmental Involvement Should be Supportive and Predictable
{41} It is inevitable that the government will become involved, to some extent, with both the Internet and electronic commerce. Specifically, the White House realizes that:
[G]overnment agreements may prove necessary to facilitate electronic commerce and protect consumers. In these cases, governments should establish a predictable and simple legal environment based on a decentralized, contractual model of law rather than one based on top-down regulation. This may involve states as well as national governments. Where government intervention is necessary to facilitate electronic commerce, its goal should be to ensure competition, protect intellectual property and privacy, prevent fraud, foster transparency, support commercial transactions, and facilitate dispute resolution. [78]
iv. Governments Should Recognize the Unique Qualities of the Internet
{42} The report recognizes that the Internet presents a critical challenge to existing regulatory scheme. The government must rethink existing regulatory models, particularly where these models intersect with electronic commerce. It is unlikely that " regulatory frameworks established over the past sixty years for telecommunications, radio and television fit the Internet." [79] The regulation of E-commerce "should be imposed only as a necessary means to achieve an important goal on which there is a broad consensus." [80] Likewise, "[e]xisting laws and regulations may hinder the growth of electronic commerce and, therefore, should be reviewed and appropriately revised or eliminated in order to better reflect the needs of the new electronic age." [81]
v. Electronic Commerce Should be Facilitated on a Global Basis
{43} The White house also quite correctly realizes that the Internet is rapidly emerging as the global marketplace. It will, therefore, be necessary for the legal framework supporting commercial transactions to become global. Predictability of results will be necessary for continued growth. Therefore, electronic commerce transactions should be "governed by consistent principles across state, national, and international borders... regardless of the jurisdiction in which a particular buyer or seller resides." [82]
2. Customs and Taxation on the Internet
{44} With respect to customs and taxation on the Internet, the moder trend for the past 50 years has been a general reduction in tariffs. [83] It is generally accepted that national economies and consumers benefit from free trade. Given these realities, and because the Internet is indeed a global medium, the Clinton White House believes it makes "little sense to introduce tariffs on goods and services delivered over the Internet." [84]
{45} The Internet lacks the clear and fixed geographic lines of transit that historically have characterized the physical trade of goods. For this reason, the Clinton Administration believes that the Internet must be declared a tariff-free environment whenever it is used to deliver products or services. Further, there should be no new international taxes imposed on E-commerce. Tax policy with respect to E-commerce should follow established "principles of international taxation, should avoid inconsistent national tax jurisdictions and double taxation, and should be simple to administer and easy to understand." [85]
B. The Treasury Department's Approach to Electronic Commerce
{46} In November of 1996 the Treasury Department issued a discussion paper entitled Selected Tax Policy Implications of Global Electroni Commerce. [86] This purpose of this paper was to introduce certain federal income tax policy and administration issues that are presented by developments in communications technology and electronic commerce. The paper was not intended to be a statement of policy, but rather a discussion document designed to elicit comment upon the issues presented.
{47} The Treasury Department is of the opinion that the "substantive tax policy... tax administration and compliance issues that arise" with respect to electronic commerce "must be guided by" fundamental taxation principles. [87] The fundamental and guiding principle in the eyes of the Treasury Department is neutrality - neutrality in the sense that the tax system "should treat economically similar income equally, regardless of whether earned through electronic means or through more conventional channels of commerce." [88] "Ideally, tax rules would not affect economic choices" and, thereby "ensure that market forces alone will determine the success or failure" of electronic commerce. [89]
{48} The principle of neutrality annunciated by the Treasury Department will, however require that existing principles of taxation be adapted to electronic commerce, taking into account the borderless world of cyberspace. [90] For example,
The growth of new communications technologies and electronic commerce will likely require that principles of residence-based taxation assume even greater importance. In the world of cyberspace, it is often difficult, if not impossible, to apply traditional source concepts to link an item of income with a specific geographical location. Therefore, source based taxation could lose its rationale and be rendered obsolete by electronic commerce. [91]
{49} One of the potential problem areas that the Treasury Department highlighted was transactions in digitized information. Any type of information that can be digitized can be transferred electronically via the Internet. Let's say, for instance, that this digitized information is a picture. The purchaser of this electronic picture could, among other things, obtain the right to: (1) use a single copy of the image; (2) reproduce multiple copies of the image; (3) distribute the image in a mass circulation; or (4) prepare a derivative work based upon the original picture. [92] Because of the ease of perfectly reproducing and disseminating digitized information it is necessary to reexamine existing taxation principles. As the report aptly points out:
Classifying transactions involving digitized information may require a more complex analysis that disregards the form of transactions without regard to whether tangible property is involved in favor of an analysis of the rights transferred. This is necessary to ensure neutrality between the taxation of transactions in digitized information and transactions in traditional forms of information, such as hard copy books and movies, so that decisions regarding the form in which information is distributed are not affect by tax considerations. [93]
While the Treasury Department speaks of being concerned about the infinitely reproducible nature of such copyrighted works as an "electronic book," what they are really concerned about is the purchase one copy of software and subsequently reproduction of that one copy into any number of identical, indistinguishable copies. In this regard, the Treasury Department states:
Digitized information... presents unique issues because it can be perfectly reproduced, often by the purchaser. Although someone desiring to purchase ten copies of a bound book will generally purchase ten copies from a publisher, someone wishing to purchase ten copies of an electronic book may simply purchase one copy and acquire the right to make nine additional copies. This transaction might literally be considered to create royalty income... since [sic] the right to make reproductions is a right reserved to the copyright holder and by allowing a third party to make reproductions, the payment is, at least in part, in consideration for the use of the copyright. However, this transaction may also be viewed as merely a substitute for the purchase of ten copies from the publisher... Therefore, it is necessary to apply the definition of royalties in a manner that takes into account the unique characteristics of digitized information. [94]
C. The Commerce Department's Approach to Electronic Commerce
{50} In April of 1998 the United States Department of Commerce issued a report entitled The Emerging Digital Economy. [95] In this report the Commerce Department sings the praises of the Internet and electronic commerce in general. For example, in the conclusion to the report, which is entitled Challenges Ahead, the report states:
As with any major societal transformation, the digital economy will foster change and some upheaval. The Industrial Revolution brought great economic and social benefit, but it also brought about massive dislocations of people, increased industrial pollution, unhealthy child labor and unsafe work environments. . . .
. . . . .
. . . The good news is that the net economic growth anticipated by this digital revolution will likely create more jobs than those that are lost. Further, the jobs created are likely to be higher-skilled and higher-paying than those that will be displaced. . . .
. . . .
. . . If . . . public policy issues can be resolved, and electronic commerce is allowed to flourish, the digital economy could accelerate world economic growth well into the next century. [96]
The report clearly, explicitly, and unmistakably compares the "digital revolution" to the American Industrial Revolution. The reader may initially be taken back by such a comparison, but the truth of the matter is the so-called "digital revolution" has the potential to cause societal change on a magnitude that is even greater than that caused by the Industrial Revolution. It is incredibly encouraging to see that the United States government recognizes the awesome potential of electronic commerce.
{51} While the report does clearly demonstrate that those in the federal government appreciate the likely societal and economic impact of electronic commerce, the report does not address many specifics. The report only briefly addresses issues of taxation. Toward this end the report states:
Companies are also concerned about the potential for excessive taxation of the Internet. The U.S. Government believes that no new discriminatory taxes should be imposed on Internet commerce. It also believes that no customs duties should be imposed on electronic transmissions. The application of existing taxation on commerce conducted over the Internet should be consistent with the established principles of international taxation, should be neutral with respect to other forms of commerce, should avoid inconsistent national tax jurisdictions and double taxation, and should be simply to administer and easy to understand. [97]
As far as a policy statement goes, this is very encouraging. How such aspirations will be represented in future legislation and regulations remains to be seen.
D. The Internet Tax Freedom Act
{52} The Internet Tax Freedom Act, which was passed by Congress on October 20, 1998 and signed into law by President Clinton on October 21, 1998, as a part of the Omnibus Appropriations Act of 1998, [98] was a bi-partisan effort to prevent the haphazard implementation of Internet related taxes. As the web site of Representative Christopher Cox [99] states:
The Internet Tax Freedom Act is needed not just to give the Net room and time to grow, but also because the Net is inherently susceptible to multiple and discriminatory taxation in a way that commerce conducted in more traditional ways is not. The very technologies that make the Net so useful and efficient - notably its decentralized, packet-switched architecture - also mean that several States and perhaps dozens of localities could attempt to tax a single Internet transaction. The Internet Tax Freedom Act will protect commerce conducted over the Internet from being singled out and taxed in new and creative ways, and will give Americans the reassurance they need that they will not be hit with unexpected taxes and tax collecting costs from remote governments. [100]
{53} The central provision of the Internet Tax Freedom Act is a three year moratorium, from October 1, 1998 to October 21, 2001, on Internet related taxes. The Act specifically states: "No State or political subdivision thereof shall impose . . . taxes on Internet access . . . and multiple discriminatory taxes on electronic commerce." [101] The Act does not prevent a state or local governments from imposing those taxes that are "otherwise permissible by or under the Constitution of the United States or other Federal law and in effect on the date of enactment of this Act." [102] This provision of the Act allows states to levy income taxes, business license taxes and certain sales and/or use taxes that are currently levied in the "real world." [103] Furthermore, while the Act prohibits new taxes, there are grandfather provisions that would allow a state or local government to levy taxes on Internet access if, but only if, the tax was "generally imposed and actually enforced prior to October 1, 1998." [104]
{54} The Internet Tax Freedom Act was not reported to the House by any committee and, therefore, there is no committee report. [105] Nevertheless, on June 23, 1998, Representative Cox, delivered a speech to the House of Representatives describing the intent of the major provisions of the Act. Most importantly for our purposes here is the statement of Representative Cox with respect to the definition of "discriminatory tax."
{55} Representative Cox explained that the prohibition on any new "discriminatory tax" was:
to prohibit States and localities from using Internet-based contacts as [a] factor in determining whether an out-of-State business has "substantial nexus" with a taxing jurisdiction. This is intended to provide added assurance and certainty that the protections of Quill v. North Dakota, 504 U.S. 298 (1992) - including its requirement that substantial nexus be determined through a "bright line" physical-presence test - will apply to electronic commerce just as they apply to mail-order commerce, unless and until a future Congress decides to alter the current nexus requirements . . .
. . .
. . The promotion of electronic commerce requires faithful adherence to the U.S. Supreme Court's clear statement in Quill that a "bright line" physical presence - not some malleable theory of electronic presence - is required for a State to claim substantial nexus. [106]
If Representative Cox's statement is at all representative of Congressional thinking, it would appear as if the 105th Congress, while placing a moratorium on new Internet taxes, did not want to foreclose the possibility for the collection of sales and/or use taxes.
{56} What Internet tax legislation will ultimately be enacted is anyone's guess. The Internet Tax Freedom Act established an Advisory Commission on Electronic Commerce [107] for the purpose of studying electronic commerce tax issues. [108] The 19 member Commission, which will be chaired by Virginia Governor Jim Gilmore, was to report back to Congress after 18 months and explain whether electronic commerce should be taxed, and if so, how it can be taxed in a manner that will not subject it to multiple or discriminatory taxes.
{57} Almost immediately after the make-up of the Advisory Commission on Electronic Commerce was announced arguments arouse. The Advisory E-commerce Commission was slated to hold its first meeting in December 1998, but this was delayed because associations representing state legislators, governors, mayors and counties objected to the make-up of the Commission. [109] The dispute between the state and local governments and Congressional leaders reached its climax when the National Association of Counties and the U.S. Conference of Mayors sued the Advisory Commission to prevent it from beginning its work. [110] State and local authorities feared that because Congress had overwhelmingly appointed representatives from the business community, the Advisory Committee was virtually assured to recommend no taxes for the Internet generally and electronic commerce specifically. [111] The make-up of the Advisory Commission was particularly troubling to the states and local governments because they are the ones, not the Federal government, that will disproportionately feel the ramifications of a continued, or perhaps permanent moratorium on Internet and electronic commerce taxes.
{58} In order to resolve the dispute between Congressional and state and local leaders, Jim Barksdale, Chief Operating Officer of Netscape, resigned from the Advisory Commission. In his place Senate Majority Leader Trent Lott appointed Delna Jones, a commissioner in Oregon's Washington County. [112] As a result of the appointment of Delna Jones, the National Association of Counties and the U.S. Conference of Mayors have dropped their lawsuit and have claimed victory. [113]
{59} In the midst of such political maneuvering one may not realize exactly what is at stake. Undoubtedly, state and local governments have an interest in tapping into the ever increasing revenues generated by electronic commerce. For example, PC seller Micron Electronics Inc., which was formerly based in Nampa, Idaho, shut down its retail outlet in Midvale, Idaho in January 1999. Micron's intention is to focus more on online sales, but Midvale suddenly lost a projected $180,000 in sales tax revenue, which represents 4 percent of Midvale's sales tax revenue. [114] Micron, however, was not unique in its decision to focus on Internet sales. Software retail giant Egghead, Inc. changed its name to Egghead.com, Inc. and closed all of its outlet stores in February 1998. [115]
{60} While state and local authorities clearly have a vested interest in molding Internet and electronic commerce tax policy, business leaders have equal motivation to prevent widespread taxation on the Internet. Austan Goolsbee, an economics professor at the University of Chicago Graduate School of Business who in 1998 completed a study [116] of the purchasing habits of online consumers said that the study showed that the number of Internet shoppers would drop by 25 percent if sales tax were collected on their purchases. [117] Similarly, the study also showed that the amount of money spent by online shoppers would drop by 30 percent if sales taxes are collect. [118] Clearly, the Advisory Commission has its work cut out.
V. PROPOSED ELECTRONIC TAX POLICIES FOR THE INTERNET
{61} Electronic Commerce, although growing rapidly, is still in its infancy. Prior to enacting any legislation or creating any regulations that will affect electronic commerce, government officials must consider the potential up-side impact that E-commerce will have for the United States economy. In assessing the likely positive effects of widespread national and global growth of the Internet and E-commerce it is crucial to remember that both the Internet and electronic commerce are still young, fragile, underdeveloped and susceptible to destructive exploitation. With this in mind, the following guidelines must be considered and kept in the mind of our nations leaders as they debate the merits of the Internet taxation.
1. Expanding state authority to place upon electronic commerce merchants a duty to collect use taxes will likely harness growth. Therefore, it will be critical for tax policy to be consistent with existing principles and policies of taxation in the "real" world. There is simply no justification for treating E-commerce different.
2. The temptation to reach the ever growing Internet revenues will become increasingly great. As this temptation grows it must be tempered and tax policy must neither distort nor hinder the growth and development of electronic commerce.
3. Tax policy must not discriminate among types of electronic commerce. Such discrimination would undoubtedly lead to needlessly complex laws, rules and regulations.
4. As technology grows business will change. The marketplace should decide the shape, form and nature of commerce in the twenty first century. Tax policy must not create incentives that will change the nature or location of transactions.
5. As our national economy becomes more global, and as economic boundaries are breaking down all over the world, it would be counter productive, and a significant step backward, to have electronic commerce tax policies that are not consistent between all United States jurisdictions.
6. If the United States is going to become the dominant economic powerhouse of the twenty first century tax policy must not favor "real" world economies over the developing Internet economy.
7. As with any economic growth, there will be fair and legitimate avenues for taxation. Any E-commerce tax policy must be capable of capturing appropriate revenues, while at the same time be simple, easy to implement, transparent and minimize burdensome administrative expenses and duties for both government and merchants alike.
{62} The major thrust of all of the abovementioned policy statements is that the Internet and electronic commerce should not be treated any different than real world economies. Simply stated, there must not be discrimination against electronic commerce. Furthermore, while proposed policy statement number 7 does recognize that there will be appropriate means for taxing E-commerce, the question we must ask is whether the present time to initiate a tax is now. To be sure, state and local officials are worried that the Internet and the phenomenal growth of E-commerce will significantly, and negatively, impact on tax revenues.
{63} Regardless of whether state and local governments are losing tax revenue, it is critically important to realize that many individuals are still skeptical about the Internet and about placing orders online. As FTC Commissioner Thompson points out, only 5 percent of those who shop online actually purchase online. [119] Commissioner Thompson states that the reason consumers are currently somewhat reluctant to purchase online due to privacy concerns and the possibility of fraud. [120] If taxes are immediately placed on Internet purchases the growth of electronic commerce will be significantly curtailed due to yet another extraneous outside force. Congress, the Federal Trade Commission and industry leaders are working toward achieve a meaningful solution to consumers privacy and fraud concerns. To consider the implementation of Internet and electronic commerce taxes prior to the evaporation of privacy and fraud concerns seems premature. While state and local governments justifiably do not want to see their tax base drift into cyberspace, if we allow Internet and electronic commerce taxes prior to the maturation and stabilization of the E-commerce industry we risk losing the projected growth and concomitant savings in operating expenses that businesses would otherwise enjoy. In short, we risk failing to realize full potential and benefits of E-commerce.
{64} In a letter to the Secretary of the Federal Trade Commission dated July 1, 1999, Dell Computer Corporation, in commenting on proposed government regulation of the Internet to protect consumers, states that "E-commerce should not be discriminated against merely because it presents a new field for regulation. Only if there is something 'different' about e-commerce that makes necessary additional or new regulatory mandates should action be taken." [121] While these words were meant to deal with a slightly different concern, the word "taxation" could just as easily be inserted for the word "regulation." Just because we can tax the Internet and electronic commerce does not mean that we should; at least not now.
{65} FTC Commissioner Swindle appropriately points out that "[t]omorrow's tax policy will have an enormous impact in shaping the future of this burgeoning new industry of electronic commerce supported by the Internet." [122] Therefore, the immediate question policy makers should ask themselves is not how to tax the Internet and electronic commerce, but rather when to tax. Only after the policy makers have decided when to tax will it be possible to talk about how to tax. To be sure, the decision of when to tax is not all that simple. The Internet and electronic commerce are still in their infancy. There is absolutely no way to predict what the predominate business model will be on the Internet. [123] Without knowing how business will be done on the Internet it is virtually impossible to create a taxation structure that has any hope of surviving more than a few years at best, and more likely a few months.
{66} When the United States entered into the North American Free Trade Agreement earlier this decade a policy decision was made to allow manufacturing jobs to leave America. We became determined to focus America's future economic growth on higher paying high technology jobs. The Internet and electronic commerce in particular offers the United States the opportunity to add the higher paying, high technology jobs that are so sought after. In 1998 alone, 1.2 million jobs were created as a result of the "Internet economy." [124] A hasty decision with regard to taxation could well stifle the incredible growth of the Internet and electronic commerce, with the necessary side effect of slowing the United States economy.
{67} Although electronic commerce currently represents less than one percent (1%) of total retail sales, [125] the recent and rapid success of such companies as Amazon.com, [126] together with the phenomenal rate of growth the Internet is experiencing, forces the conclusion that electronic commerce will become a dominant marketplace in the twenty first century. Inconsistent and ill advised tax policies, regulations and legislation, while perhaps profitable for the short term, will only stifle the development of the "Internet economy." For this reason, the federal government must assume the leadership role, which is bestowed upon it by the Commerce Clause of the United States Constitution, and, when appropriate, promulgate intelligent, simple, fair and uniform tax policies that do not discriminate against E-commerce.
{68} Government officials, working together with industry leaders, have the opportunity to promote electronic commerce and provide our economy with the opportunity for sustained growth. Through the use of sound policies and well thought out regulations and legislation, electronic commerce over the Internet can and will provide growth and expansion far exceeding the growth and expansion experienced during the Industrial Revolution.