Testimony of California State Senator Ray Haynes

Before the House Judiciary Subcommittee on Commercial and Administrative Law

On Behalf of the American Legislative Exchange Council

 Summary

            Taxation of e-commerce is a policy issue that is plagued by dubious assumptions, misguided fears, and alarmist rhetoric.  Many state lawmakers are acting on unsubstantiated claims that untaxed e-commerce will result in a significant drain on state coffers and that it will ultimately force traditional retailers out of business.  Proponents of plans to tax e-commerce argue that state and local governments are facing an impending crisis unless they are given greater authority over Internet transactions.  They make these claims despite the fact that most state governments are enjoying unprecedented budget surpluses.  Estimates about the size of “lost revenue” appear even more dubious when you take into consideration the meager size of e-commerce relative to the entire domestic retail market.  According to figures from the U.S. Commerce Department, e-commerce accounts for less than one percent of total retail sales.  Furthermore, there is no evidence that e-commerce presents an eminent threat to traditional “main street” merchants.  According to the limited survey research that is available, small businessmen view the Internet as an opportunity to expand their market share, not as a danger to their livelihood.   Although advocates of e-commerce taxation like to couch their arguments in the rhetoric of states rights and local control, they are missing an important point.  The e-commerce debate, stripped of its technical and legal jargon, is essentially an interstate commerce question and as such it falls under the unambiguous purview of the federal government.  States and localities have a stake in e-commerce and they should be an active partner in whatever policy is developed, but the American Legislative Exchange Council does not believe that the states can address this issue absent federal advice. Undoubtedly, the Internet poses a challenge for policy makers in the new millennium and we are aware that sales tax revenue will continue to be an issue that crops up, but the concern right now is out of proportion to the perceived problem.  At ALEC we take seriously the adage “the power to tax is the power to destroy.”  We continue to hope that Congress will take the lead and explore issues raised by e-commerce and the Internet, but that it will not make bad policy based on unsubstantiated claims and misplaced fears.

 

Testimony of California State Senator Ray Haynes

Before the House Judiciary Subcommittee on Commercial and Administrative Law

On Behalf of the American Legislative Exchange Council

 Introduction

            Thank you Chairman Gekas and members of the Judiciary Subcommittee on Commercial and Administrative Law for extending this gracious invitation to speak before you today on an issue that has broad ranging implications for state policy in the 21st century.  I would especially like to commend you for soliciting ALEC’s opinion with respect to e-commerce taxation.  There is, I believe, an unfortunate misconception among casual observers of the debate that all state and local officials are eager to tax e-commerce.  This is clearly not the case and we at ALEC are happy to dispel the myth

             Speaking of myths, it seems as though the Internet has spawned as many policy myths and half-truths as it has dot.com addresses.  The taxation of e-commerce is one area in particular that is plagued by dubious assumptions, misguided fears, and alarmist rhetoric.  Many state lawmakers are acting on unsubstantiated claims that untaxed e-commerce will result in a significant drain on state coffers and that it will ultimately force traditional retailers out of business.  There are a host of half-baked notions about e-commerce and I would like to use my time to discuss some of the worst of the lot.

 Myth #1:  State and local governments are facing an eminent fiscal crisis unless they are allowed to tax e-commerce. 

In their zeal to tax e-commerce some policy makers have taken hyperbole to new heights by claiming that police, fire, and sanitation service, not to mention school budgets, are all in jeopardy because of the growth of e-commerce. This claim is not justified by the facts.  Over the past five years state and local governments, collectively speaking, have seen a dramatic growth in revenue collection that, in many cases, far exceeds the estimates used to craft budgets.  Despite a series of tax cuts and significant and sustained increases in government spending, state governments have still been able to amass significant budget surpluses. It seems contradictory that while governors and legislators are looking for ways to get rid of extra revenue, they should simultaneously attempt to broaden their tax authority.  In my home state of California, for example, policy makers face the difficult task of what to do with a $12 billion surplus – the largest in state history.   Unfortunately, at the same time they spent that surplus without significant tax relief the Assembly has passed a bill that will make it easier for the state to collect sales tax from out of state vendors who sell on-line.  I can’t help but wonder why politicians are looking for a new source of revenue when the established sources seem to be doing the job?

I am aware that the current economic good fortune is not a permanent condition, but it is specious to assert that state and local government finances in general are in immediate peril unless they are given greater power to tax e-commerce.  The dubiousness of these claims is further illustrated when you take into consideration how meager e-commerce is with respect to the whole domestic retail market.  According to figures from the U.S. Commerce Department, for the last two quarters total e-commerce amounted to $5.2 billion and $5.3 billion respectively.  Yet these numbers only account for less than one percent of total retail sales for the same periods.  Taxable sales on-line would be even lower since a large portion of e-commerce is not subject to state and local taxation.  Airline tickets and financial services – two of the most popular e-commerce items – are exempt from state and local sales tax.  Given these facts, the question I have to ask proponents of taxing e-commerce is -- where is the fire?

 Myth #2: E-commerce represents a direct threat to the economic health and viability of “main street” retailers.

With the exception of some anecdotal stories, there is no evidence that proves e-commerce is harming main street businesses.  In fact, what little data we have seems to point in the opposite direction.  According to surveys conducted by the Small Business Administration and the National Trust for Historic Preservation among others, small business owners see the Internet as an opportunity for, not a threat to, their livelihood. 

At a meeting last May I heard a compelling story from Todd Mogren with Coastal Tool & Supply, a small independent hardware retailer from Connecticut.  In the mid 1990s the store came under severe pressure from a large national hardware chain and it appeared unlikely that they would survive.  Then they discovered the Internet and created a web site to sell their goods.  During the next several years business grew by leaps and bounds until they finally needed to relocate to a larger venue to accommodate the increased demand.  Last year they opened a new store directly across the street from the national competitor that threatened to put them out of business a few years earlier.  That modern day success story, however, is also a cautionary tale.  The retailer assured me that his company would not have moved to the web if it had been liable to collect sales tax from every customer’s jurisdiction.  It is clear, from a small business perspective, that the greatest impediment to future use of the Internet is the possibility of more regulation and a higher tax burden.

I think policy makers also need to remember that the larger dot.com firms and etailers are not invincible juggernauts that are capable of always beating their traditional brick-and-mortar competitors.  For every Amazon.com success story there are a hundred companies that fail.  Some stock analysts assume that over half of these dot.com companies – most of which have never turned a profit – will go belly up in the next few years.  This is not to suggest that etailers need special government protection.  The market is doing a fine job of winnowing the field down to the strongest, most viable businesses.  What it does suggest, however, is that these companies do not possess some insurmountable advantage over traditional retailers

 Myth #3: States are capable of simplifying and unifying their own sales tax systems without federal guidance.    

During the past year the National Conference of State Legislatures (NCSL) and the National Governors Association (NGA) have been promoting their answer to the e-commerce dilemma.  They have drafted model legislation that would enable state governments to enter into negotiations to simplify state sales tax systems as a preliminary step toward taxing remote sales.  I applaud any serious effort to simplify state and local sales tax .  In most states the sales tax code is rife with questionable exemptions that favor certain kinds of business and distort the proper functions of the market.  Yet it seems unrealistic, not to mention a sharp departure from the historical record, to expect that states can get together and settle this matter on their own. It is a common and accepted practice in state legislatures to draft tax exemptions that benefit local industries and merchants.  In fact, some observers would argue that it is an intrinsic part of the legislative process.  The old habits die-hard and remain entrenched even among states that seem willing to simplify the sales tax.  Since January, 15 states have adopted the NCSL model bill entitled “A Streamlined Sales Tax for the 21st Century.”  During the same period in the same states, over 150 bills were introduced that carved exemptions for items ranging from gumballs and bee keeping equipment to nicotine patches and car wax.  Of these bills, 25 were enacted into law.  So while the states are claiming to be working toward a simpler, unified tax structure, they are simultaneously complicating the existing code.  That is not the kind of behavior that inspires trust among on-line vendors.

 Conclusion

The reason why I have devoted my time to some of the key misconceptions in the e-commerce debate is to illustrate that the states are not in a crisis that demands an immediate response – particularly one that could threaten the continued growth of e-commerce. ALEC believes that current efforts to institute a tax plan to capture supposed “lost revenue” due to Internet sales are misguided. The obvious question is do we need to extend the hand of the tax man into the web?  We believe the answer, for the moment, is no.  On the contrary, we encourage policy makers to take it slow with respect to e-commerce. In the absence of an obvious fiscal crisis or evidence that e-commerce is damaging traditional retail sales, there is no pressing need to implement a new, radical tax scheme.  Undoubtedly, the Internet poses a challenge for policy makers in the new millennium and we are aware that sales tax revenue will continue to be an issue that crops up, but the concern right now is out of proportion to the perceived problem.  At ALEC we take seriously the adage “the power to tax is the power to destroy.”  We continue to hope that Congress will continue to explore issues raised by e-commerce and the Internet, but that it will not make bad policy based on unsubstantiated claims and misplaced fears.  

 In the end, a free market, and a proper respect for the principles of Federalism, contained in the Constitution, will solve the issue of Internet taxation.  Congress is important to ensure that the states respect the Constitution, and to promote a free market.  As long as it accomplishes those two tasks, the sales tax issue will resolve itself.