For Whom the I-Way Tolls

By Ray Wyman Jr.

Appeared in "Query" 15 February, 1996
and San Jose, CA and San Antonio, TX "Business Journal"

An old business adage says you know youíre onto a good thing when Uncle Sam wants to tax it. It may be a bit early to say our famous Uncle has found a way to tax the Internet, however, thatís not so with several of his cousins.

Paying the Zookeeper

The first volley was launched on Jan. 15 from Spokane, Wash. Intended as an extension of an existing sales tax regulation, the Spokane city council proposed a 6 percent tax on gross receipts of Internet access providers.

Strong reaction from angry Internet users and businesses forced city officials to shelve their Net tax scheme for now, but the issue is far from dead.

These days, state and municipal governments are finding it more and more difficult to make an honest living. Everything from ambulance services to zoo keeping is on the budget cut list, and cash-strapped governments feel like theyíre running out of options. 

Since 1980, the federal government has cut funding to states forcing them to cover many public services from locally generated revenues. The most popular tax instrument and easiest to carry out is the sales tax.

All but five states are now using a sales tax to cover an average of 25 percent of their total cash flow. However, market trends have not been kind to the tax collector.

Tax Revenues Shrunken by Mail Order

Since the late 1960s, interstate mail order sales have skyrocketed from $2.4 billion to more than $237 billion in 1993. Governments attempting to apply sales tax on these transactions have been turned away by recent Supreme Court decisions based on constitutional rules of interstate commerce.

As the demand for mail order business has grown, tax revenues have gradually shrunk. According to UC Berkeleyís Center for Community Economic Research (CCER), states are now losing about $3.3 billion in potential sales tax revenue to untaxable mail order sales revenue.Nine statesóCalifornia, Florida, Illinois, Michigan, New Jersey, New York, Ohio, Pennsylvania, and Texasóall are losing $100 million or more per year.

California tops the chart with $482 million, Illinois and Texas are next with about $235 million apiece. Washington is on the high end of a list with 15 other states, each losing between $40 and $72 million or more per year. 

The Internet Tax Debate

The raw figures donít tell the whole story. The real exposure to risk depends on local revenue structure.

Since most large counties and major cities rely heavily on sales tax revenue, it is easy to see that the problems are deep rooted and therefore likely to trigger a new round of fiscal chaos. 

Wally Dean, mayor of Cupertino, Calif., summed it up like this: "The thing that scares us is that cities are run on local sales tax; if stuff is sold on the Internet, thereís no sales tax. Itís a house of cards for government finances. This could be the Achilles heel for state and local government." 

Dean and many others see that the Internet is a new conduit for mail order marketing, but one that presents a greater threat to city coffers.

The most optimistic figures say that the Internet generated only $300 million in sales in 1995 (up by $100 million from 1994). However, long-term growth may produce such a dramatic change that additional and significant tax losses could happen literally overnight. 

Internet Taxation Schemes

So, whatís a state government to do?

Youíd think that the word would get out that the sales tax is a bad idea. Even the popular trend to decentralize revenue collection has its problems. But, being that a politician is what a politician does, nationwide Internet taxes are as likely as sunrise. 

Most Internet tax schemes are merely extensions of existing telecom regulations. The most popular idea is to assess new excise taxes on phone lines, especially second lines in single-family dwellings. 

Meanwhile, the Multistate Tax Commission (MTC), an advisory group of tax experts, is drafting recommendations for state and municipal lawmakers.

In a recent issue of Business Week magazine, MTC General Counsel Paul Mines said, "Itís too significant a part of the economy to suggest there should be a long-term exemption from taxation."

Curiously, California, the state with the greatest risk, has no official word on an Internet tax. While lawmakers in Colorado, Florida, Massachusetts, Texas, and Washington have already begun debates on this issue, few in California will admit awareness of the looming crisis. Even California counties havenít come to grips with this issue, says Dave Oppenheim, senior legislative analyst for the California State Association of Counties (CSAC).

"A few have started studies, but as commerce increases Iím certain that more of them will recognize the change thatís underway."

As we wait for the nation to see the change, Nathan Newman, CCER co-director, sees irony in the movement toward local control and decentralization.

"The increased dependence on local taxes is pushing governments toward burdensome taxes on businesses or more intrusive ones on the individual communities," says Newman.

"As large counties teeter on the brink of bankruptcy," Newman adds, "policy makers need to rethink the current political fads. In an age of national and international commerce, itís now impossible for local governments to design fair and efficient systems of taxation that serve rational economic development."

The Net Reaction

Back in Spokane, Wash., Chris Anderson, the lone city council member who led the fight against the Internet tax there, has a few words of advice.

"Weíre way ahead of the issue," says Anderson. "This was a knee-jerk reaction to grab some quick cash from an emerging industry."

Anderson, who is also a free speech Internet advocate, contends that there is a need for fundamental redefinition of both the telecommunications technology and available taxing methodologies before any new taxes are introduced.

Anderson comments, "Neither municipalities nor other agencies should be too eager to simply jump on this bandwagon just because itís budging."

Jeanne Dietsch, a lead researcher for ActivMedia, questions the fairness of any tax scheme on Internet businesses. "Business, not the consumer, is the primary market on the Internet," she contends. "Most medium-to-large businesses see savings of about 25 to 30 percent.

So, while a nominal sales tax would not be a killing blow, any sales tax will likely hurt smaller businesses."

Given the fast reaction of users and businesses in Spokane, one thing is certain, the Net wonít be taking this issue laying down.

Net users are on average a very well-connected and well-read group. Quintessentially grassroots, they are also very jealous of the freedoms they have enjoyed until now. In Spokane, there wasnít enough bandwidth to express the outrage against the tax. Anderson and a few friends were able to raise an effective opposition in a matter of days. Itís this kind of push-button advocacy that will make it difficult on governments.

"The Internet community is very capable for quick political response," warns Dietsch.

"If they try to tax the Internet in a state like California where Net activity is high, they can be sure to get a very strong and negative reaction." The dynamics between political trends, fiscal realities, and popular opinion will no doubt make this an interesting fight.

Whether itís the right move or not, one thing is certain, Uncle Sam and his pals are logging on.

Ray Wyman is a freelance writer and content creator based in California.