Political Odd Couple Back Internet Tax Ban

You log onto the Internet from Los Angeles, and through a Virginia-based provider you reach an Atlanta Web page for the Natural Essence fragrance store in Oregon. Then you order perfume for your aunt in Iowa.

Here’s the simmering question: Who gets to tax that purchase?

The issue has triggered a sharp divide between Gov. Pete Wilson and most of his fellow governors. And oddly, it has joined Wilson with President Clinton in an argument against the National Governors’ Assn., the National League of Cities and the U.S. Conference of Mayors.

At stake are the tax claims to a booming electronic marketplace that is expected to grow from about $500 million last year to something between $70 billion and $600 billion in five years.

“California is the home of many new Internet-based businesses, but their markets are spread throughout the world,” Wilson wrote in a recent letter to Congress. “It would be California businesses that would be hardest hit if local governments attempt to adapt their existing tax structures to cover Internet activities.”

Congress is considering a controversial but bipartisan bill that would bar state and local governments from applying new taxes to Internet activities. The Internet Tax Freedom Act--co-sponsored by Rep. Christopher Cox (R-Newport Beach) and Sen. Ron Wyden (D-Ore.)--is backed by Clinton and Wilson.

The measure would allow sales taxes and other existing assessments to remain as long as they are applied to the Internet in the same way they are used for companies that market through the mail or telephone.

The Cox-Wyden bill seeks to prevent the anticipated development of a new breed of taxes designed to tap an increasingly rich pool of revenue. The authors fear that it will create a national patchwork of regulations and taxation for businesses to navigate.

Some states, for example, have applied user taxes to companies that provide access to the Internet. There also is discussion of computer software at each business Web site to record the sources and value of commercial transactions.

Proponents of the Cox-Wyden bill also warn about a “bit tax” that was considered and rejected in Europe. It would have measured and assessed electronic information as if it were electricity or water.

“Some are tempted to view the Internet as a source of new tax revenues,” Deputy Treasury Secretary Lawrence H. Summers said in congressional testimony last week for the White House. “We believe this strategy will be counterproductive in the long term. . . . Instead of seeking to impose new taxes on the Internet, we should encourage the growth and use of the Internet, which will result in a growing economy and greater revenues from existing taxes.”

No place has more to gain or lose in taxing the Internet than California. A Pacific Bell study this year said California is host to 25% of the nation’s commercial sites on the Internet’s World Wide Web.

But instead of targets for taxation, California’s leadership has issued a bipartisan and powerful call for government to clear out of the Internet so it can grow as rapidly as possible.

The three Democrats and two Republicans on California’s Board of Equalization--which oversees the collection of business taxes--voted unanimously in March to support the federal Internet tax ban. Their vote came after an endorsement of the ban by Democratic State Controller Kathleen Connell and was followed by an endorsement by Wilson.

Nationally, however, California has found itself a lonely advocate. Only one other governor, William Weld in Massachusetts, has written Congress to endorse the Internet Tax Freedom Act.

Elsewhere, the organized voice of state and local leaders has been nearly unanimous in opposition to the proposal.

Last January, the National Governors’ Assn. issued a resolution opposed to federal preemption of a state’s right to tax electronic commerce. And when the Cox-Wyden bill was heard in a Senate committee last week, the governors from Kentucky and North Dakota wrote a letter for the governors association in opposition.

In both cases, the governors said they recognize the danger to commercial growth posed by a haphazard patchwork of Internet taxes. They also endorsed steps to develop uniform guidelines for states and local governments to follow. But they bristled at federal intervention.

“The governors continue to oppose federal action to preempt the sovereign right of the states to determine their own tax policies,” said the governors’ resolution adopted last January. “The governors support state review of existing state tax policies to determine their effect on telecommunications and the future growth of the industry and to ensure that outdated and inconsistent tax treatment does not hinder growth of competition.”

So far, state and local authorities have conceded that Congress probably has the constitutional authority to impose the Internet tax ban.

Federal officials contend that the Internet’s borderless nature makes it a prime example of the activity intended for federal intervention under the Constitution’s interstate commerce clause.

“The Internet is the quintessential marketplace of interstate and global commerce,” Cox said. “This is right down the center lane of what Congress should look after.”

In making their case, local officials harken back to the clarion call of federal devolution that dominated political rhetoric just an election ago. And they argue that the high threshold for such federal meddling has not been demonstrated.

“I think this is of incredible significance,” said Timothy Kaine, a city councilman from Richmond, Va., who represented the League of Cities and U.S. Conference of Mayors in testimony to Congress last week. “When you take what may be the most vibrant sector of the economy and you say to states and localities you are not allowed to apply the same rules you do to other sectors of the economy, then you create a terrible budgeting problem.”

Kaine complains that there is insufficient evidence to suggest that a nationwide patchwork of taxes might develop to the extent that it would threaten expansion of the Internet. But Cox says the legislation is needed before such a problem develops.

“Once these tax laws are passed it would be very, very hard--even through an act of Congress--to repeal all of them,” he said. “It is relatively easy and painless now to prevent these things from happening.”

The Cox-Wyden bill would allow for a review of the ban on taxes after two years. In the meantime, it would direct the executive branch to conduct a study of the Internet and report back to Congress on suggestions for the regulation--and possible taxation--of cyberspace commerce.

That built-in reevaluation is expected to placate many lawmakers who might be uncomfortable about siding against their local and state allies. The conflict could also be significantly defused if the bill is amended to address concerns about its language.

Critics complain that the current language could inadvertently prevent states from collecting taxes on property, unemployment and other traditional taxes from computer-related businesses within their jurisdictions. They hope the bill would be more specific in stating its target of new and specialized Internet taxes.

“That is a philosophical kind of issue irrespective of the details,” said Val Oveson, chairman of the state tax commission in Utah. “To have Congress preempt the state’s ability to tax is taking away the state’s ability to deal with their own problems.”