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Should Internet Commerce Be Subject to Tax?

Gary Chapman is director of the 21st Century Project at the University of Texas at Austin. He can be reached at gary.chapman@mail.utexas.edu

City officials here were very familiar with Ted Kircher when he joined the Austin Telecommunications Commission, a citizens advisory group, last year. Kircher, a retired IBM engineer, had for years been attending nearly every public meeting dealing with Austin’s telecommunications future.

But the officials weren’t at all prepared for the revolt Kircher sparked over the city’s proposal to charge telecommunications carriers 5% of their gross revenues for the right to use city rights-of-way for wires, cables and switches.

Kircher objected to the proposed fee, and he went online and catalyzed an alarmed constituency of Internet activists, multimedia entrepreneurs, small businessmen and tax protesters. Suddenly, the city’s planners are in a jam, facing an aroused opposition that didn’t exist two months ago.

What Kircher and his allies have tapped into is an issue that communities all over the country are beginning to grapple with: how the new information sector might be taxed. The chief characteristic of Internet-based commerce--its disconnect from geography--makes this controversy one of the most complicated and vexing issues confronting both policy-makers and businesses.

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On the one hand, communities throughout the country are facing a rapidly changing tax environment. Federal revenues shared with cities have plummeted over the last 10 years, making most communities increasingly dependent on property, business and sales taxes.

Government officials are aware that new information-based businesses are the wave of the future, and they hope that these enterprises will be a new source of revenue for public coffers. Indeed, most cities use tax abatements to attract such companies, in the hope that increased employment will lead to growth in sales and property taxes.

On the other hand, taxing electronic commerce is complicated to the point of absurdity. Internet tax experts point out that there are more than 30,000 tax jurisdictions in the United States--sales taxes, for example, vary from one town to the next. And Supreme Court decisions have forbidden interstate sales taxes for mail-order commerce unless the mail-order business has a “presence,” such as a retail store, in the jurisdiction in which the customer lives.

Electronic commerce doesn’t yet represent a large slice of the economy--only about $500 million in sales nationally in 1995. But projections by the Interactive Services Assn., an industry group, indicate that by 2000 that figure could be up to $7 billion.

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The U.S. Advisory Commission on Intergovernmental Relations estimates that states currently lose more than $3 billion in sales tax revenue because of mail-order sales; California lost an estimated $483 million in 1994. If such losses are multiplied by expanding electronic commerce on the Internet, argue public officials, government resources will be severely affected.

Tacoma, Wash., became the first city to attempt to tax electronic transactions last year when city managers imposed a 6% tax on the gross revenues of electronic transactions within city limits.

This tax was unique in that it attempted to impose taxes on all businesses with customers in Tacoma, which meant that America Online, CompuServe or even electronic vendors in Texas or Maine would be subject to the tax. The plan produced a howl of protest in Tacoma and other parts of Washington state, and the whole idea was scrapped.

Confusion over how electronic commerce might be taxed has led Rep. Chris Cox (R-Calif.) and Sen. Ron Wyden (D-Ore.) to draft a bill, which they expect to introduce the first week of March, that would impose a moratorium on all “new” taxes on Internet commerce. The bill gives the Clinton administration two years to produce a workable plan for taxing electronic commerce; in the meantime, new tax schemes, such as usage fees or taxing the routing of data through servers, would be banned.

Partly because of the problems of taxing electronic commerce, and partly because of persistent national resistance to property taxes, cities have adopted what’s called an asset-management strategy, based on their chief economic asset: rights-of-way, mainly along city streets.

Officials in Austin, for example, believe it is their responsibility to leverage the city’s rights-of-way for economic benefit, primarily to reduce the property tax burdens of citizens. Fees for use of rights-of-way have been part of cities’ revenues since the beginning of this century.

Entrepreneurs and Internet activists here don’t see it in the same terms. Because the revenue generated by a fee for telecommunications carriers would go into the city’s general revenue fund, the protesters call this fee--which they expect to be passed on to consumers--a tax on a specific segment of the population, meaning those who use telecommunications.

They argue that this is unfair, that it will stifle the very businesses that are making Austin a high-tech center, and that any fee should be targeted at improving telecommunications in the city and not be used for general revenue. City officials believe that if the city’s revenue streams don’t adapt to changing economic conditions, they’ll be stuck taxing “sunset,” or fading, industries, or be forced to raise property taxes, which in turn would deter new businesses.

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What’s emerging is a curious and portentous nexus: Just as the public sector is turning to the information industry for revenues, grass-roots, libertarian and anti-tax sentiment on the Internet is hitting its peak. And just as cities are facing a new range of responsibilities, because of federal “devolution,” or the return of public-sector authority to local and state levels, the Internet is decoupling entrepreneurs from local or even state commerce.

How this will unfold is anyone’s guess, but it is clear that the collision of geographically bound politics with the geographically unbound Internet is going to produce significant friction for some time to come.


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