A Taxing Question

To tax. or not to tax. That is the Internet question. By late April a panel of experts, the year-old Advisory Commission on Electronic Commerce chaired by Virginia Gov. James S. Gilmore III, is slated to give its answer to the U.S. Congress. However, unless the commissioners find so-far-elusive consensus during the their final meeting in Dallas this week, the group's response could be a virtual disappointment. Rather than present a single, strong tax recommendation, the panel may merely list a few options for the federal lawmakers to consider. Indeed, listing two or three options -- along with their pluses and minuses -- would confirm the deep tax policy divisions that exist both within the commission and outside it. Frankly, it's difficult to find anyone who is neutral on the issue. A commission working document, for example, summarizes seven policy options but shows no areas of potential agreement. One option is to extend the 1998 Internet Tax Freedom Act for five years and prohibit all state sales taxes on business-to-consumer (B2C) transactions. Another would strip states and local governments of the power to tax e-commerce and impose a single-rate federal levy, with proceeds to be shared with states and localities. A third would require state and local governments to simplify their sales and use tax systems while meeting federal standards designed to sustain and promote "the information highway to electronic communication." A proposal from the Washington-based National Governors' Assn. (NGA) envisions "no new taxes" on Internet sales. But it sanctions a new and broad-based "trusted third parties" tax-collection system, an administrative change that raises the ire of Adam D. Thierer, an economic policy analyst at the Heritage Foundation, a conservative Washington-based think tank. Thierer claims NGA's plan "encourages the states to collude in devising a system for the extraterritorial collection of taxes on Internet sales and, eventually, all forms of retail commerce." Thierer's preference is to keep the 'Net completely free of taxes. However, if Congress opts to lift the current three-year moratorium on new Internet access levies and "multiple and discriminatory taxes," states and localities should be allowed to tax only those companies with a brick-and-mortar presence in their jurisdictions, he says. Commission chairman Gilmore, a Republican, is backing creation of a tax-free "zone" for e-commerce. But not many other members of the 19-person advisory group are likely to go along, indicates Kent Johnson, KPMG LLP's Seattle-based national partner in charge of e-tax solutions within the state and local tax services practice. "It's too fraught with problems . . . and that [proposal] actually lost ground at the last round of [commission] hearings," he says. In contrast, a level-playing-field approach -- which would tax catalog sales, Internet transactions, and other sales to consumers alike -- seems to be gaining ground within the commission. Overall commission dynamics may be changing as well. Although it's widely assumed the panel won't be able to muster the two-thirds majority necessary to endorse a single tax plan for e-commerce sales, the possibility can't be completely dismissed. "Over the last several weeks, there's been a lot of action behind the scenes," says Johnson. Some commissioners, facing the embarrassing prospect of issuing a weak report, "are looking to find some compromises," he reports. Meanwhile, business on the 'Net is booming. Business-to-consumer sales, the primary focus of the e-commerce tax debate, will reach $184.5 billion in 2004, nine times last year's $20.2 billion mark, predicts Forrester Research Inc., Cambridge, Mass. But this B2C prospect pales when compared with projected 'Net sales between businesses. These so-called B2B deals are expected to soar to a stratospheric $2.7 trillion in 2004. Much of that phenomenal growth remains to be seen within manufacturing. A survey of 2,500 companies by the National Assn. of Manufacturers, Washington, shows a surprising 68% of those responding are not utilizing the 'Net for B2B transactions. What's more, the level of sophistication among those firms now doing business online is low. While 23% of manufacturers use the 'Net to introduce new products, only 5% are employing it to strengthen links in their supply chains.