2001-06-26 National Governors Association

Testimony – Internet Tax Nondiscrimination Act

Mr. Chairman, on behalf of America’s Governors, I am here to report that to my knowledge, there is no state or local government interested in imposing new access taxes to the Internet. What state and local governments are interested in, however, is tax simplification and tax fairness.

I have worked long and hard to encourage Washington to return power and authority back to the states and local governments. This notion of a new federalism was best represented in welfare reform, which has been an unqualified success. When given the responsibility, states responded with accountability and innovation.

Legislation enacted during the past five years demonstrated that the federal government could build incentives for adaptability and performance and delegate substantial decisionmaking authority to states. Actions include:

  • Welfare Reform – Perhaps the most significant example of devolving program responsibilities from the federal government to state governments is the 1996 welfare reform law. This law resulted from the strong leadership role played by states and the pressure exerted to implement a federal waiver process to develop innovative welfare reforms. The 1996 law repealed the Aid to Families with Dependent Children (AFDC) program, which had existed for more than thirty years, and created a new Temporary Assistance for Needy Families (TANF) block grant. Under AFDC, individuals were entitled to a federal welfare payment under federally prescribed rules. TANF affords Governors the flexibility, within certain federal guidelines, to make decisions about how to run welfare programs in their states and how to distribute assistance to individuals.
  • Health Care – With the passage of the State Children’s Health Insurance Program (S-CHIP) in the Balanced Budget Act of 1997, Congress recognized that the best way to improve health care access and outcomes for children is to empower states. Rather than simply allowing states to expand Medicaid with an enhanced federal match, Congress gave them considerable flexibility to design programs that more closely match private insurance plans, but still meet the goals of improving access and outcomes.

States have always been laboratories of democracy, especially in health care. A potential benefit of S-CHIP is national recognition that devolving responsibility for health care to states can improve health care access and outcomes more effectively than a one-size-fits-all federal approach.

  • Education – Another small step toward devolving authority and flexibility came on April 29, 1999, when the President signed the conference agreement on the Education Flexibility Partnership Act of 1999 to expand the Education Flexibility Demonstration (Ed-Flex) to all states. The new statute allows the U.S. Secretary of Education to waive certain federal statutory or regulatory requirements in exchange for states waiving comparable state regulations. States that are in compliance with Title I and have a comprehensive school improvement plan that has been approved by the secretary may apply for Ed-Flex. The Department of Education has released draft guidance on the expanded program, and several states are developing applications to become Ed-Flex states.

But despite these successes and despite the President’s often-stated commitment to federalism, some in Washington still insist on concentrating power here in the Beltway. This tendency to micromanage from Washington is not healthy for democracy, for it separates people from their government.

Preemption of state regulatory authority and restrictions on state revenue sources is becoming a very serious intrusion into state sovereignty. Some prime examples include:

  • The Estate Tax. The provision in the recent tax bill that phases out the 100 percent state credit for the estate tax was very onerous. It will cost the states upwards of $75 billion over ten years. Other examples of federal intrusion into state tax activity include the Internet Tax Freedom Act as well as other bills that are circulating that would restrict state corporate profits. Since Congress has respected state tax authority for over 225 years, these are serious federalism issues.
  • International Trade. The federal government has adopted comprehensive trade measures that preempt numerous state laws. The North American Free Trade Agreement (NAFTA) and General Agreement on Tariffs and Trade (GATT) are major initiatives that Governors supported. Yet, to accommodate the needs and desires of international trade partners who would rather deal with one uniform policy governing trade than fifty different state laws, NAFTA and GATT supersede many state laws. These agreements downgrade the status of state laws from actions that derive from constitutionally determined powers to trade barriers that international agreements can obviate.
  • Financial Services. The National Securities Markets Improvements Act of 1996 preempted state authority to license nationally traded securities, mutual funds, and large investment advisers. Despite preserving state ability to collect licensing fees, we lost our traditional power to regulate many aspects of securities activities within our boundaries. The Securities Litigation Uniform Standards Act of 1998 has similar adverse implications of states’ rights. In addition to prohibiting class action suits based on the violation of state laws, the act permits viable class action suits to be moved from state courts to federal district courts.
  • Food Inspections. The Food Quality Protection Act of 1995 preempted state regulation of pesticides in the shipping, handling, and production of food.
  • Telecommunications. The Telecommunications Act of 1996 overhauled the regulation of local telecommunications services. The act ostensibly sought to deregulate the local telephone industry, but it effectively re-regulated the industry by stripping state and local regulators of their traditional authority over local telephone service and transferring this power to the Federal Communications Commission (FCC). Consequently, the federal legislation eliminated or seriously impaired states’ ability to control the range, quality, and affordability of telecommunications services available to their citizens.

In addition, the patients’ bill of rights and energy legislation include significant preemption concerns. Moreover, the education bill now in conference – which features many provisions that Governors support – cuts Governors out of the process of writing state education plans. This is classic one-size-fits-all Washington micromanagement at its worst.

I raise this concern because the issue of creating a streamlined sales tax system for the 21st century gives Congress the chance to do right by our states. When dozens of states can work together to solve a problem, Congress should recognize that effort and help make the solution a reality.

Governors understand, as you do, that the Internet is an incredibly powerful tool. It provides a new nexus between customers and businesses, between citizens and their government, and between people. Access to this new public square must continue to be open and unhindered.

What the Internet should not be is a way for buyers and sellers of goods and services to avoid their obligation to pay sales or use tax. That’s why America’s Governors urge Congress to enact legislation giving states the authority to require remote sellers to collect and remit sales and use taxes.

We know that the current sales and use tax collections systems must be dramatically simplified for this proposal to work. Indeed, 13 states have already adopted model legislation to simplify their systems and reduce the complexity and cost of collection.

The simplifications, as recommended by the Streamlined Project include:

  • centralized, one-stop multi-state registration;
  • uniform definitions for goods and services;
  • uniform rules for attributing transactions to particular taxing jurisdictions;
  • uniform and simplified rules for dealing with exempt transactions;
  • procedures for relieving sellers from liability to the state for errors resulting from use of information provided by states;
  • certification of software that sellers may use to determine tax due on transactions;
  • uniform rules for claiming bad debts;
  • uniform formats for returns and remittances, including electronic filing and remittances;
  • state-level administration of all state and local sales and use taxes; and,
  • uniform audit procedures, including the option for a single, multi-state audit.

In Michigan, such legislation has already passed the State Senate and is being considered by the House, and I expect to sign it later this year. When an appropriate number of states do agree to a common approach through an interstate compact, we desire Congress to grant states the authority to impose the duty to collect on remote vendors.

What we are proposing is a partnership between the states and the federal government that achieves our goals of fairness and simplicity. When states adopt a streamlined and technologically efficient tax system for the 21st century, the federal government will require remote sellers to collect current sales tax obligations. The Governors would favor a sales threshold below which remote sellers could not be required to collect use taxes, otherwise known as the de minimis provision.

The Governors recommend that Congress use any extension of the Internet Tax Freedom Act as an important opportunity to enact legislation establishing a procedure that would encourage states and localities to continue their initiative to develop and implement a simplified and streamlined sales tax system.

I should note that America’s Governors support the simplifications contained in H.R. 1410, introduced by Representatives Istook and Delahunt, to reduce the burden of state and local sales tax compliance and to save the nation’s economy millions of dollars by bringing our tax system into the 21stcentury.

The simplifications in the bill are consistent with many of the efforts now being undertaken by the Streamlined Sales Tax Project, including the model statute as well as the accompanying agreement states would enact to implement a much simpler multi-state sales tax system.

Mr. Chairman – four out of every five states are willing to simplify their systems and dramatically reduce the complexity and cost of collection for all sellers. I believe that shows our commitment to adapt to the new economy and to grow with the Internet.

Let me be very clear on one point. I am not talking about a new tax, a tax increase, or a tax on the Internet. Every state that levies sales taxes requires a use tax to be paid if a customer’s purchase is made online or out of state. Under current legal standards, a state may only impose sales and use tax collection requirements on sellers with a physical presence, or nexus, in the state whether the transaction is over the Internet or not. As a result, remote sellers are able to exploit the market in that state – whether by mail, telephone, or the Internet – without being required to collect or remit tax on their sales into the state. Sellers that are physically present in the state are required to collect and remit the tax.

Obviously, not collecting the use tax on electronic transactions is an incentive for merchants to use electronic or Internet transactions. As e-tailing – versus retailing – continues to grow in popularity, the imbalance and the unfairness to Main Street retailers will continue to grow.

It won’t be too long, however, before sophisticated Main Street retailers respond. Consider this example, a customer walks in a downtown department store, picks out a pair of jeans and instead of paying for them at the counter, proceeds to an in-store Internet kiosk. The customer pays over the Internet, a clerk puts the jeans in a bag, and the customer walks out without paying sales tax.

America’s major e-tailers are already partnering with major retailers. The tax-savings for their customers is but one of the many advantages of such partnerships. These strategic unions of e-tail and retail will become commonplace.

The bottom line is that eventually the sales and use tax will be rendered obsolete and inefficient as a source of revenue for state and local governments, especially for public schools. Of course, retailers who continue to collect the tax – and continue to support the United Way and other local charities – will also be rendered obsolete, devastating the backbone of Main Street America.

Consider another example. A business traveler wants to buy an airline ticket from Washington D.C. to Detroit. Instead of calling a travel agent, the traveler simply goes online and buys an e-ticket – which, as Northwest Airlines reports, 65 percent of their passengers use. This committee is well aware that every single passenger who boarded a plane in the United States paid the airline ticket tax. How they paid for their tickets – online or in line from an agent – made no difference.

I should note that federal excise tax on cigarettes, tires, and liquor are collected on Internet purchases as well. I ask this committee: What’s different about a pair of jeans, a sofa, or a computer?

Finally, I must advise the committee that while the National Governors Association does not have a policy on extending the moratorium, there is a concern that the current definition of access is extremely broad.

As this new industry matures and expands, firms will bundle significant amounts of content into one fee, which includes access. Furthermore, telephone calls over the Internet, i.e., telephony, are increasing dramatically. These are both issues of tax fairness since the first principle of tax policy holds that similar goods should be taxed in a similar way regardless of how they are delivered.

Telephone calls, on average, face federal, state, and local telephone taxes in excess of 15 percent. To make some telephone calls taxable and others non-taxable is discriminatory. A similar question is raised regarding content delivered via the Internet. A movie, for example, seen in a local movie theater could be taxed, but one downloaded over the Internet would be exempt. Again, this is inequitable. We would ask that the committee look again at the definition of access in light of these two emerging issues.

Thank you, Mr. Chairman, I would be happy to answer your questions and the questions of the committee.

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