Internet: Locals' Appetite for Taxes is Genuine Cause for Concern

By Greg Turner

There is legitimate concern about the impacts of state and local taxation of electronic commerce in California. This state is not just home to the high-tech and entertainment industries and the largest users per capita of the Internet, it also has some of the most aggressive cities and local jurisdictions in the nation when it comes to ferreting out new sources of revenue for taxation.

California stands as the example of both what can be gained and what can be lost if state and local taxing authority over electronic commerce is left unchecked.

While no one wants to be "anti-Internet," neither do governments want to jeopardize their potential take on what they see as a tidal wave of economic activity surrounding the Internet. Many have mistakenly characterized this issue as whether or not to tax "the Internet" as if that were even possible. For all intents and purposes, the Internet as a "place" or a "thing" doesn't really exist.

The Net is merely a protocol to facilitate communications between networks of computers. Goods and services sold via the Internet are already subject to taxation or not under the same laws as the sale of other goods or services. The income produced and gains realized by companies venturing into Internet businesses are taxed just like that of any other company venturing into new markets. And certainly, the transport of Internet communications is already subject to tax or not under the same laws that govern the transport of voice communication.

It has been routinely misreported that the federal Cox-Wyden Internet Tax Freedom Act and the California version (AB 1614 by Assemblyman Ted Lempert) are intended to, or in fact will, exclude transactions or services from taxation simply because they are conducted via electronic means. It simply is not true. Two issues at the heart of this debate are the reach of state and local taxing jurisdictions to out-of-jurisdiction merchants and taxes that are pernicious to Internet communications (such as "bit" taxes, taxes on access or usage, and the like).

As the old saying goes, what happens in California is usually what happens in the nation. If California is indeed the trendsetter, indications are that electronic commerce is in for a bumpy road unless the state and/or the Congress step in to curb the appetites of local taxing jurisdictions.

According to U.S. Census Bureau data, California local governments outpaced their counterparts in other states in tax collections during the 1980s and early 1990s. Even with Proposition 13 in place, local revenues grew significantly faster than economic growth and markedly faster than local government revenues in other states.

The growth in local taxes per $1,000 of personal income was 38 percent faster in California than the average of other states. Utility taxes, of particular concern to electronic commerce, grew 167 percent faster than in other states. Because these figures are based on growth per $1,000 of personal income, they are implicitly adjusted for differences between the states in economic, population and inflation growth.

It is a cliché to say that the Internet has no borders, that there is no locality on the Internet. But it bears repeating because so many still don't comprehend the implications of this medium on tax policy. Taxation is a decidedly local event. Some activity or some benefit must be local to the jurisdiction before a taxable event is triggered. With the Internet, there is no concept of location. One is either "on" the network or "off." There is no here or there.

Consequently, local government tax policies can have far-reaching implications. The burdens of a single jurisdiction's action can have far-reaching consequences. It is the concept of extraterritorial reach that many government officials just don't understand. If the appetites for alternative revenue sources of California's local governments are any indication, the absence of restraints through legislation could signal a real, near-term threat to electronic commerce.

- Greg Turner is Cal-Tax's general counsel.