Testimony – Internet taxation

Mr. Chairman and members of the committee, on behalf of the National Governors’ Association and the people of Michigan, thank you very much for the courtesy that’s been extended to me this morning.

No other innovation — no other way of doing business — has revolutionized our nation’s economy faster than the Internet. It took generations for the Industrial Revolution to play out around the world. The Internet Revolution has unfolded before our eyes, in less than a decade. The speed of this change has been astounding. In the Industrial Age, as change took place, governments were able to react accordingly. In the Internet Age, today’s innovation is tomorrow’s standard. Government simply cannot keep up.

Congress, as well as state and local governments, need to function in this new economy without hindering its continued expansion. I welcome this committee’s thoughtful approach to an important issue, e-commerce, and how it fits into government’s traditional revenue-raising functions.

Any thoughtful discussion on e-commerce must include the following key issues:

  • The proper relationship between the federal government and the states on issues of taxation;
  • The necessity of keeping tax policy neutral so that neither traditional retailers nor remote sellers (catalog, Internet, or similar enterprises) are given an advantage based on tax policy;
  • The need to stop erosion of essential revenue streams that support education and other key public services at the local level.

Governors are vitally concerned about any action that could negatively affect the vast majority of retailers — most of them small businesses, by the way — as well as their employees in our states, and erode the revenue source most important to the provision of education, public safety, and transportation services to the American people and businesses.

So I am grateful you have invited the National Governors’ Association to be represented, and I am honored to be their witness, as well as to be joined by Michigan’s esteemed Senator Spencer Abraham, who so ably represents our state in the Senate.

Collection of Existing Taxes

The central issue between the states and federal government as it relates to e-commerce is not about new taxes on the Internet, but rather how the states will collect taxes already on the books, and whether states will remain sovereign in their right to collect those taxes.

As part of the Internet Tax Freedom Act, Congress imposed a three-year moratorium on new state and local Internet access fees, and multiple and discriminatory taxes on the Internet. The act is silent with regard to federal taxes on the Internet, and it is silent with regard to federal, state, and local sales and use taxes. Today, we will discuss a moratorium that does not expire until October of 2001, more than 18 months from now.

In Michigan and many other states, we strongly oppose any new taxes on the Internet. We should not impose new surcharges or access fees to this emerging technology.

State governments should not seek to enrich themselves with new taxes just because of new technology and new methods of delivering goods.

In Michigan, we have spurred our economy, created new jobs, and strengthened families by cutting taxes, not finding new ones.

The states must, however, act effectively to inform consumers of their obligation under existing law and find ways to help efficiently collect it.

What is this tax obligation for which consumers need to be better informed? It is called the “use tax.” Every state with a sales tax has a companion tax for purchases made outside the state. This remote sales tax — or use tax — applies to any purchase on which the consumer did not pay a state sales tax.

This remote sales tax has an obvious purpose. It would be pointless to require a tax on purchases of furniture in Michigan, but then allow Michigan residents to purchase furniture in Illinois, Indiana, Ohio, or Wisconsin — all bordering states — tax-free. To have no tax on purchases made elsewhere would put each state’s retailers at an obvious disadvantage.

In Michigan, this legal obligation to pay tax on goods purchased outside the state has been on the books since the 1930s. It is equally long-standing in other states. This obligation is well understood by businesses. Unfortunately, most ordinary shoppers do not understand it and it is this misunderstanding that we are beginning to address — from Michigan to Virginia and nationwide.

The New Economy

Electronic commerce is not new. It first began with the invention of the telephone. It continued over the decades and expanded with the invention of the fax machine. Nobody ever suggested that the federal government should begin regulating this industry or that the states should be prohibited from imposing taxes.

Today, however, e-commerce as it relates to the Internet has prompted House Budget Committee Chairman John Kasich and Senate Commerce Committee Chairman John McCain to propose legislation that would have the federal government preempt existing state and local sales and use tax systems. This legislation would be an unprecedented infringement upon the states’ ability to raise the revenues necessary to carry out state functions, much less compel the federal government to provide state tax loopholes.

That could mean, Mr. Chairman, that if you happened to be in a store in Albuquerque and saw a pair of Levis but, instead of pulling them off the rack and paying for them at the counter, you used an Internet kiosk in front of the rack and then went to the counter and picked up exactly the same pair of trousers, there would be no state or local tax. Under such a system, one can imagine just how long it would take for every vendor in America to migrate to a kiosk or other system simply in order to maintain a level playing field.

If you think this sounds far fetched, just talk to the local furniture or computer sales people in your state. They have already experienced this problem.

In the face of the impending transformation of retail shopping, government tax policy must remain neutral. It is not the time to have government tilt competitive forces in favor of either traditional retailers or emerging electronic retailers. Unfortunately, without the states effective enforcement of our current laws — and with the passage of proposals like that proposed by Chairmen Kasich and McCain — such government-sponsored favoritism will result.

Without compliance to both sales and use tax requirements, our traditional main-street retailers will face a significant pricing gap with their remote competitors. In Michigan, this gap would be 6 percent; it is even greater in some other states. In effect, the federal government will be providing this significant price differential to those who don’t support communities, create jobs, pay property taxes, and keep our cities and towns livable. It is both unfair and counterproductive public policy. It is, in essence, a two-tiered system: good for clicks, bad for bricks.

In order to keep the playing field level and to increase compliance, Michigan and other states are stepping up their consumer education and enforcement efforts. In recent years, we included clear directions on how to comply with the use tax obligation in our income tax booklet. This has not been as effective as we had hoped.

This year, modeling the work of other states such as Virginia, Michigan has much more prominently featured information on the use tax and its requirements in the state’s income tax booklet, including a worksheet for taxpayers to figure out use tax owed and a Use Tax Table, for people who owe use tax but did not save their receipts.

Most significantly, the Michigan income tax form now has a new line for residents to pay any use tax obligation. Finally, the state is working closely with the state retailer and education organizations — even tax preparers — in raising public awareness of this very important issue.


The federal government has a constitutional role to prevent interference with interstate commerce. At the same time, the states retain basic sovereignty under the 10th amendment to the constitution. For decades the states have had the authority to enact and modify sales tax laws and their complement use tax laws. Use tax laws have been effectively enforced for decades as it relates to business purchases. For example, when K-Mart Corp., headquartered in Troy, Michigan, purchases furniture for their corporate offices outside of the state, they automatically pay Michigan’s 6 percent use tax on that purchase.

While the rapid growth of Internet sales has heightened interest in this important issue, it is by no means limited to Internet sales. In fact, to the degree that such an artificial boundary is maintained, the absurdity of the policy grows.

Is it possible that the federal government will override long-standing state policy and prevent states from collecting use tax on an Internet purchase from an Eddie Bauer web-site, but continue to allow the collection of tax from catalog sales? Will the federal government tell the states that have been enforcing use tax on furniture shipments into their states that they may no longer do so?

Once successful in this regard, will we see additional actions of the federal government? Will the federal government declare that income taxes can no longer be applied to the software engineers who build the websites involved? Will dot.com firms’ warehouses be exempted from property taxes by action of the federal government?

Such an action would clearly violate the sovereignty of the states to enact and enforce sales and use taxes.

Imagine where that slippery slope leads in the years ahead — congressional tax cuts imposed by eliminating state taxes! The taste of enacting tax cuts that don’t reduce federal revenue could, of course, easily prove to be addictive. What about the elimination of state use tax on equipment necessary to reduce environmental emissions? Why not override states authority to tax diesel fuel that is used to transport goods across state lines? How about an end to income taxes for teachers? Or firemen? The opportunity for mischief is unlimited.

Only with state action to efficiently collect existing taxes will our traditional main-street retailers compete with the new world of e-commerce on a level playing field, and will our funding base for critical services be preserved for the years to come.

There is no question that the federal government has the right to regulate interstate commerce. But it would be virtually unprecedented for the federal government to stomp on the most basic rights of the citizens and taxpayers of each and every state by determining how they may or may not raise revenues.

To reiterate, the states do not seek new taxes. We have been very careful to craft our proposal for a zero-burden collection system to ensure effective enforcement of current tax laws.

The point is this: the federal government has absolutely no authority to override the states sovereign right to administer existing state tax laws.


Let us be clear. No Governor is looking to tax the Internet, any more than any Senator is trying to impose a special, discriminatory tax on the Internet.

The states’ sales and use taxes are existing taxes, not new taxes.

All we are asking is to keep the right we now have as a state to determine our own revenue policies under the laws the people of our state have adopted and we are elected to implement. Most of these sales and use taxes have been in place for at least 50 years.

The largest revenue collections in the nation, even in the income tax states, are through state sales taxes. If Congress overrides states’ tax policies by cutting our tax base, it will fundamentally upset both the states’ and the nation’s capacity to provide critical services to the people. The sales and use tax revenues belong to people and taxpayers of the states, not the federal government.

In Michigan, education is the primary beneficiary of these revenues. We have a long history of support for K-12 education at the state and local levels. Total state and local funding for schools is estimated to exceed $12.5 billion in this coming fiscal year and grow to $14.3 billion by fiscal year 2003.

In fact, since fiscal year 1998, the state has consistently spent more state dollars on K-12 education than is spent in our entire general fund budget.

Nearly 75 percent of Michigan’s sales tax revenue and one-third of our use tax revenue goes to fund K-12 public education alone. The second biggest beneficiary is local units of government, providing fire and police protection, road improvements, and library services.

Other states rely on sales and use taxes to fund other critical priorities, such as health care services for vulnerable citizens, Medicaid, mental health services, public health services, veteran’s homes, and services to seniors.

Finally, if we gravitate towards a tax system that creates a specific loophole for retailers that use the Internet, we risk creation of a federal policy that favors Internet vendors at the expense of Main Street stores and home-town merchants. We cannot adopt a tax policy in America that assists in harming traditional Main Street retailers.

Thank you for the opportunity you’ve given me to testify, Mr. Chairman.