June 28, 2012

The Honorable Lamar S. Smith
Chairman
Committee on the Judiciary
U.S. House of Representatives
Washington, D.C. 20515

The Honorable John Conyers, Jr.
Ranking Member
Committee on the Judiciary
U.S. House of Representatives
Washington, D.C. 20515

Dear Chairman Smith and Representative Conyers:

The National Governors Association opposes H.R. 1860, The Digital Goods and Services Tax Fairness Act, because it would violate the basic tenets of federalism, erode state tax bases, reduce state revenues, generate excessive litigation and give special treatment to goods and services delivered through digital technology. Governors have been willing to work with industry to address concerns related to digital commerce, but the underlying bill would create far more problems than it solves.

During a recent congressional hearing, Professor Walter Hellerstein observed that when considering proposals for federal legislation that affect state taxation, “Congress should keep in mind the admonition of the Hippocratic Oath – first, do no harm.”  H.R. 1860 falls short of this admonition because as drafted it will confuse, not clarify, the law and lead states to lose revenue. 

The model for states and industry working together to solve complex state tax issues is the Mobile Telecommunications Sourcing Act. That law was written together by states and industry to resolve the questions of when and how states could tax mobile phone service. The emergence of the digital economy provides us with the same opportunity. 

Unfortunately, states were not consulted in the development of H.R. 1860. That is why state tax administrators provided the committee and industry proponents with a detailed list of concerns last August.  It is also why – after states heard nothing in response for more than six months – NGA recently initiated talks with industry representatives to try and resolve differences.  NGA consulted with state tax administrators to develop an alternative that would address state concerns while still accomplishing what proponents say they need. Talks to discuss the alternative were ongoing when the committee markup was announced.

Governors are committed to sound tax policy that honors state sovereignty while providing certainty for taxpayers.  Unfortunately, H.R. 1860 does not meet either criteria. For example, the bill establishes a clear roadmap to “nowhere” taxation through its elective sourcing and bundling provisions that effectively allow companies to select where to source a particular sale and the tax treatment of that sale.  The situation is made worse by the bill’s failure to grant states jurisdiction over the seller or to provide any ability to correct errors in how a sale is sourced.  Together these provisions will result in states losing existing revenues and an erosion of the states’ tax bases for goods and services.

The bill will also require lengthy and costly litigation as states try to administer and enforce the bill’s many undefined, vague and ambiguous terms and provisions.  For instance the bill does not define what constitutes “receipt” of a digital good.  In the age of cloud computing, these types of definitions are critical to effective tax administration and certainty for taxpayers. While governors appreciate that the chairman’s mark reportedly makes some improvements, such as removing federal court jurisdiction over state tax issues, without clearer terms and definitions the bill will not create certainty or provide necessary guidance for states to effectively administer the law.

Finally, in the guise of preventing discrimination, the bill would actually codify special treatment for items and services sold in digital form to the detriment of other forms of commerce.  States are already working to correct the imbalance created by the U.S. Supreme Court’s decision in Quill v. North Dakota that gives remote electronic retailers a significant competitive advantage over local brick-and-mortar stores.  The Digital Goods and Services Tax Fairness Act should be designed to provide a framework for taxation that does not favor one form of commerce over another, not enshrine favored tax status for goods and services that can be delivered electronically.  

Congress should avoid laws that limit state authority to determine their own tax systems, and it must work closely with states when enacting laws that tread on that authority. NGA will continue to work to find a solution that is suitable to states and taxpayers, but until an agreement can be reached, governors encourage the committee not to pass H.R. 1860.

Sincerely,

Dan Crippen