Vol. 8, No. 6 • June 2000
E-Commerce and Internet Taxation: Issues, Organizations, and Findings
by Laura Gordon-Murnane
Knowledge Net Unlimited

When Tim Berners-Lee and Vice President Al Gore (right!) dreamed up the Internet, little did they envision the explosion of Internet commerce and dotcom mania. To prove the point, the Commerce Department reported in the fourth quarter of 1999 that consumers spent more than $5.3 billion in online sales and this accounted for 0.64 percent of the total retail sales for that quarter1. Add to this figure the exploding growth of business-to-business e-commerce and you have a pretty heady mix of economic prosperity and entrepreneurial activity. A report released by Stamford, Connecticut-based Gartner Group, stated that business-to-business e-commerce is not only changing traditional business models, but predicts that “B2B” e-commerce will exceed $7 trillion by 20042.

Internet commerce has touched all aspects of business — technology infrastructure, business-to-business commerce, business-to-consumer commerce, business portals, new business models, the growth (and decline) of tech stocks, new marketing and advertising strategies, and interesting strategic alliances and partnerships. Look for the arrival of new models, new strategies, and new relationships not even under consideration at present.

The economic furnace generated by Internet sales has, not surprisingly, caught the attention of business executives as well as local, state, and federal political leaders. The most pressing question, as one might assume with politicians, is, “Should the Internet be taxed?” Existing tax laws were not developed to face the significant changes that continue to take place with the emergence of the Internet or “New” economy. The Internet allows anyone with Net access to make purchases from anywhere in the world. How do you tax goods purchased online from consumers who do not reside in the state or country where the vendor has set up shop? Existing laws governing state and local taxation are being challenged in ways no one anticipated. If the answer is, “Yes — Internet sales should be taxed,” then how do you develop a system that will make it easy, painless, and fair to all groups involved? How can you police compliance, while continuing to support the growth of the Net? One thing is certain: This will not be easy.

Forrester Research recently reported that online sales will grow to more than $184 billion by 2004. Potential tax revenues from Internet commerce are huge. We are talking about billions and billions of dollars. And it should come as no surprise that state governments want to tap into this new source of revenue to pay for schools, roads, and critical infrastructure. Taxation of anything is a constant political hot potato, and taxation of Internet commerce has proved no exception. Likewise, it should come as no surprise that an important group of politicians (both at the federal and state levels) and cyber- and technology business leaders oppose taxation of the Internet.

To tax or not to tax — that is the $64 question. To address this question, Congress passed the Internet Tax Freedom Act and established the Advisory Commission on Economic Commerce to study the different positions and to offer recommendations to Congress on how to proceed. The Commission was scheduled to report its findings to Congress in April 2000. Although the Commission did report, it could not achieve enough of a consensus to make recommendations. This article will examine the pro- and anti-tax positions, the key players and organizations that support or reject Internet taxation, and the findings of the Advisory Committee on Economic Commerce. I think it is safe to say that the issue of Internet taxation will generate a great deal of passion and interest, and that any solution or recommendation will not make anyone really happy or satisfied.

The Pro-Tax/E-Fairness Position
State and local governments as well as a coalition of brick-and-mortar and Main Street business groups support the pro-tax/e-fairness position. Organizations such as the National Governors Association and the National Retail Federation support finding ways to collect sales taxes or at least make it fair for brick-and-mortar merchants to compete successfully with their dotcom counterparts. Two important issues make up the pro-tax or tax fairness position. The first issue centers on a fundamental constitutional right guaranteed by the U.S. Constitution. State governments have the right to collect tax revenues. The second issue is tax fairness for both cyberbusinesses and brick-and-mortar establishments.

The Right to Tax
It is a given that few Americans like taxes. To dredge up an old cliché, the fountainhead of American political culture rests on the phrase “no taxation without representation.” We Americans are tax allergic, but taxes do serve a useful purpose. They provide revenues for federal, state, and local governments to support services, infrastructure, and resources for the public good. And the states have a right to levy and collect taxes on goods and services sold within the state. State leaders base their states’ right position to tax the intercourse between buyers and sellers on the landmark decision by Chief Justice John Marshall in McCulloch vs. Maryland. Justice Marshall ruled that “[T]he power of taxing the people and their property is essential to the very existence of government and may be legitimately exercised on the objects to which it is applicable, to the utmost extent to which the government may chuse [sic] to carry it. The only security against the abuse of this power, is found in the structure of the government itself. In imposing a tax the legislature acts upon its constituents. This is in general a sufficient security against erroneous and oppressive taxation.”

The leaders of the pro-tax/e-fairness coalition passionately believe that taxation of Internet sales falls within the jurisdiction of states’ constitutional rights. Furthermore, they believe that the federal government does not have the constitutional authority to ban taxation of Internet sales. The Supreme Court may weigh in on this issue if Congress moves to exempt state taxation of Internet sales.

State Revenues
State governments derive their revenues from a variety of sources — property taxes, corporate income taxes, individual income taxes, and sales and gross receipts taxes. Of this mix of tax options, sales and use taxes account for some 48 percent of state revenues. No small chunk. Currently 45 of the 50 states have implemented sales and use taxes. The consumer pays the sales tax on goods and services in his or her state. Consumers who make purchases from out of state are also required, though few do, to pay a use tax. The states have, until now, failed to pursue the collection of these legal tax revenues aggressively.

Some states are finally realizing just how important the use taxes are to state revenues. The state of Michigan recently asked its taxpayers to pay the use taxes that are legal for the state to collect but so rarely do. Line 30 on the state tax form requires taxpayers to add up all of the tax-free purchases they made last year — that is, Internet and mail-order sales — multiply by 6 percent, and send it to your nearest tax collector. Unlikely to happen. The point, however, is not so much to collect the taxes, as to prepare taxpayers to the reality of use taxation, to acquaint the people that the state of Michigan, like the other 49 states, has the legal right to collect this tax3.

According to a study conducted by Forrester Research, state and local governments lost more than $525 million in sales taxes in 1999 because of consumer purchases over the Internet. The study reports that $13 billion in taxable goods was sold online in 1999, but only 20 percent of that commerce was taxed4. The E-Fairness Coalition, a coalition of brick-and-mortar trade associations and state government leaders, contends that state and local governments “stand to lose more than $10 billion in revenues by 2003,” while a report from the University of Tennessee claims that states will lose more than $20 billion in revenues by 20035.

Sales and use taxes are charged to the consumer, but it’s the merchant who is required to collect the tax and send it to the consumer’s state. This works when the consumer is located in the same state as the vendor or merchant. The merchant collects the sales tax and remits it to the state tax authorities. However, this scenario changes when a consumer purchases something from an out-of-state merchant or vendor — like in the case of mail order or Internet vendors. The merchant is required to collect the use tax and send it to the consumer’s state, but only if the merchant has a “physical presence” or “nexus” in the consumer’s state. A physical presence can be a store, a distribution center, or a sales force. States, therefore, cannot require remote sellers without a physical presence to collect sales tax on sales that occur in that state.

The physical presence/nexus requirement is based on two important Supreme Court Decisions — the 1967 National Bellas Hess decision (
<%LINKURL%>&graphurl=<%GRPHURL%>&court=US&case=/us/386/753.html) and the 1992 Quill decision ( The National Bellas Hess company, a mail-order business located in North Kansas, Missouri, was sued by the Illinois Department of Revenue for failing to collect and pay use taxes to the state of Illinois. The Supreme Court ruled that a state could collect sales and use taxes if the business has a physical presence in the state. Physical presence can include any office, distribution house, sales office, warehouse, or any other place of business, as well as an agent, salesman, or representative to take orders. If the business did not meet that requirement, then the state could not require the business to collect sales taxes because of the complexity of the different state and local sales taxes. This complexity was seen as a barrier to interstate commerce.

Consumers are required to remit the use tax to the appropriate state, but most consumers rarely do.

The Quill decision upheld the physical presence “nexus” requirement described in the earlier decision, but the court also held that Congress could introduce legislation that could require remote sellers to charge sales taxes as Main Street businesses must. The Court held that Congress must establish some ground rules aimed at reducing the burden of sales tax collection. Once those ground rules have been established, then the states could begin to require out-of-state sellers to charge sales taxes6.

To further complicate the issue, in 1998, Congress passed and President Clinton signed into law the Internet Tax Freedom Act (ITFA). This law imposes a 3-year moratorium on new Internet taxation (text of law available at Christopher Cox’s site, So states are prohibited from imposing any new taxes on Internet sales exactly at the time when Internet sales are heating up.

The bottom line is that states have two problems: ITFA and the nexus/physical presence rulings prevent state and local jurisdictions from collecting sales and use taxes on out-of-state vendors. Sales and use taxes have generated more than $150 billion per year and pay for schools, police, hospitals, roads, and social services. Not surprisingly, state government leaders are less than pleased with these developments.

E-Commerce Taxation — Fairness for Both Brick-and-Mortar Stores and Cyberbusinesses
Brick-and-mortar and Main Street business owners feel that they compete at a disadvantage with Internet businesses. The brick-and-mortar stores are required to collect sales taxes. However, if Internet businesses are not required to collect sales taxes (except in the case of Internet business conducted with consumers in its own state), consumers and businesses will opt to make their purchases online, rather than at the brick-and-mortar stores. The brick-and-mortar stores fear that consumers will migrate away from making purchases at local stores and make most of their purchasing decisions online. So the brick-and-mortar operations lose and so do the states, which cannot collect the sales taxes. The National Retail Federation argued recently that to exempt taxation of Internet sales amounts to an unfair subsidy that places a harsh burden on brick-and-mortar merchants.

States also have to contend with another problem — the click-and-mortar trend. Many large retail establishments — including Wal-Mart and K-Mart — have created Internet businesses that are separate and distinct from their brick-and-mortar counterparts. Barnes and Noble has done the same thing. These Internet companies have nothing to do with the brick-and-mortar operations of the same name. Consequently,,, and have a single location and, therefore, can take advantage of the Quill decision and avoid sales and use taxes. Another blow to state tax revenues.

The Big Seven associations, led by the National Governors Association, are leading the way for a completely revised tax system in which state and local governments collect sales and use taxes on e-commerce transactions. The National Governors Association believes that a new model of sales and use taxation must be implemented in order to take advantage of the burgeoning Internet economy. It is also politically expedient, on the part of state governments, to seek alternative tax policies and models that reduce the complexity and economic burden on Internet vendors. The problem is that the current system is too cumbersome, too complex, and too burdensome to merchants and consumers. To further complicate the problem, no two states classify products the same way for tax purposes. When is a shoe not a shoe? It depends on how the state and local tax jurisdictions classify this product. Multiply these complications by thousands of tax jurisdictions that have the authority to impose sales taxes. To ask an Internet merchant in the state of Washington to know and understand the complexities of the state sales tax in Wisconsin is asking a lot of the merchant. Let’s face it: Existing tax laws were not written with the Internet in mind. Failure on the part of the states to act will most likely result in Congress imposing a longer moratorium on the taxation of Internet commerce or some form of a national sales tax.

The states, led by Utah Governor Mike Leavitt, have proposed a “Streamlined Sales Tax System for the 21st Century” that utilizes technology solutions to overhaul completely the way state and local governments collect sales and use taxes. State leaders admit that the current sales tax system is burdensome and unwieldy. The goal of the proposal is to “develop a more simple, uniform, and fair system of state sales and use taxation that significantly reduces the burden imposed on retailers, preserves state and local sovereignty, and enhances the ability of U.S. firms to compete in the global and information economy.”7

State leaders believe that a technology solution can be found to make the tax system more balanced and fair. The key provision of this proposal centers on using tax software to calculate and charge sales taxes from around the country and hiring third-party vendors to make the system work. States would rely on tax software that could calculate all the different state and local tax rates.

Once the software is in place, the governors would make banks and credit-card companies responsible for collecting the taxes. Banks and credit-card companies would become third-party service providers that would embed the tax collection software into the Web sites of dotcom vendors. Whenever a transaction occurred, the third-party provider would automatically calculate the sales tax, charge the sales tax to the consumer, and send the revenue to the correct tax jurisdiction. The states would pay to have the system set up by charging a small fee for each transaction. The system is completely voluntary and any jurisdiction, as well as any vendor, could choose whether to participate.

The states want to find a technology solution because it would also get around the problems posed by the Supreme Court Quill decision. The court used the criterion of overly burdensome operational difficulties to rule in favor of remote vendors. A technology solution would get around this problem.

Will it work? Will it be implemented? There are some major problems with this proposal. First, getting all of the state and local tax jurisdictions to agree to a more unified tax system is a daunting challenge. Local jurisdictions rely heavily on sales taxes to fund all types of civic projects and they may be reluctant to give up control over tax rates and tax collection procedures. Another problem centers on the use of third-party vendors to calculate, collect, and distribute the taxes. The Heritage Foundation, the bastion of conservative thinking, questions whether the states want to allow third-party vendors to assume one of the most basic functions of state government — collecting taxes. Lastly, since the system is voluntary, why would any dotcom vendor agree to participate?

Having said that, I think the states should be applauded for at least trying to come up with solutions to streamline the confusing tax system currently in place. Internet commerce is here to stay, and a solution or solutions will have to be found to deal with it. It is in the interest of the states to come up with a viable plan, otherwise, Congress and the federal courts will take over the issue and make decisions that states might not appreciate or deem to be in their best interest.

The Anti-Tax Position
Many federal, state, and business leaders support the ban on Internet taxation. Congressman Christopher Cox of California, senators Ron Wyden and John McCain, and Governor Jim Gilmore of Virginia all endorse making the Internet a tax-free zone. Not surprisingly, business leaders Ted Waitt of Gateway, AT&T’s Michael Armstrong, and John Sidgmore, vice-chairman of MCI WorldCom, also support a moratorium on Internet taxation. The anti-tax position addresses three issues:

The Internet Economy — Grow! Grow! Grow!
Few leaders, whether supporting taxation of Internet sales or not, would dispute the importance the Internet has begun to play and promises to play in the future growth of domestic and world economies. The unprecedented growth in the American economy is due in part to the explosive growth in large and small dotcom companies. Market research firms such as Forrester Research and the Gartner Group frequently track, report, and predict the continued impact of the Internet on American economic prosperity. No one doubts that the Internet is here to stay and will continue to generate billions if not trillions of dollars in sales, profits, and revenues. The anti-tax crowd would like to continue to make it as easy as possible for Internet companies to grow, to hire more and more people, and to continue to tap into the entrepreneurial creativity unleashed by keeping it easy to set up a virtual business.

Anti-tax business and government leaders fear that taxation of Internet sales would not only threaten e-commerce, but choke off the growth of the e-commerce engine and have serious economic consequences for the economy. Christopher Cox has argued in an editorial that the pro-tax coalition has not taken into account the fact that the Internet has opened up new markets for Main Street businesses, generated new jobs and high-paying wages, and built a stronger economy — all of which contributes to state tax receipts8. The anti-tax group argues that rather than trying to find ways to tax Internet sales, states should find ways to make it easier for dotcoms to prosper.

Furthermore, the anti-tax crowd disputes the argument that state and local governments will be severely hampered if sales taxes from Internet sales cannot be collected. Aaron Lilly of Citizens for a Sound Economy argues that state revenues will not be adversely affected. He reports that the lost tax revenue amounts to “not quite one-tenth of 1 percent of state and local government sales and use tax collections.”9 Bolstering his argument, state governments are experiencing tax revenue surpluses that challenge the opposition’s argument that states and local government will lack the revenues to pay for schools, police, roads, and other support services. (Maybe state government leaders need to plan for a rainy day, for when the economy declines, and state coffers have no surplus to fall back on — assuming rainy-day planning is what leadership is all about.).

Current Tax System — Too Complex, Too Burdensome
The Internet has created a world without borders. Consumers can purchase goods and services from around the world. As a consumer, I can go online, comparison shop for whatever I want — a computer, a car, a book, or whatever — and make my purchases, all tax-free (unless the vendor has a physical presence in my state). The current tax system recognizes over 30,000 tax jurisdictions (this only includes the United States. If you make a purchase outside the borders of the United States, you have to factor international tax jurisdictions into the mix.) Within the 30,000 tax jurisdictions, there are more than 7,000 separate state and local tax rates that cover all goods and services.

The sales tax burden from multiple tax jurisdictions could be very costly. Taxation of online transactions “would require that the vendor identify all relevant taxing jurisdictions, calculate how much to charge, file forms, and remit payments to hundreds or even thousands of different taxing authorities10.” Trying to establish a tax system that takes into account the different jurisdictions, tax rates, the different product definitions, and which products are subject to taxation is a great challenge that could significantly impair the ability of large and small dotcoms to make money or even to operate.

No Decision — Findings of the Advisory Commission on Electronic Commerce
The Advisory Commission on Electronic Commerce (ACEC) met for the final time in March 2000 and, not surprisingly, failed to reach the broad consensus required by Congress. Congress mandated that the Commission’s recommendations be supported by 13 of the 19 voting members of the Commission. This did not happen. Two groups, bitterly divided over the taxation issue, emerged from the Advisory Commission — the anti-tax group, led by Jim Gilmore, and the pro-tax group, led by Mike Leavitt. A simple majority of the group (11 of the 19) voted to support a report written by the caucus of business leaders who sat on the Commission. [The report is available at]

Recommendations of the report not adopted by ACEC include the following:

Not surprisingly, the business leaders on the Advisory Commission want to continue to make the Internet a tax-free zone. And they have some very powerful political allies, from both Republicans and Democrats, in Jim Gilmore, Christopher Cox, Ron Wyden, and Dick Gephardt. Taxation supporters were disappointed with the report and felt that it did not reflect the concerns of the states and brick-and-mortar businesses that stand to lose if Congress accepts the recommendations of the Commission. Clinton administration officials were also unhappy with the report. It appears that this was an opportunity missed.

Where Do We Go from Here?
It is unlikely that the issue of Internet taxation will have been resolved by the time you read this article. This is a presidential election year and Congress has shown itself incapable, or unwilling, to enact meaningful legislation in an election year (or, for that matter… no, let’s not go there). The evidence that sales taxes would choke off the growth of the Internet is contradictory and unproven. Furthermore, the American public believes that fairness for both online businesses and brick-and-mortar businesses should be found. Streamlining state sales and use taxes seems like a good idea, but with so many tax jurisdictions, it would seem that a voluntary agreement to charge a single tax rate nationwide is as likely to happen as national healthcare reform.

Congress, state government leaders, and the next president need to deal with some tough questions and to offer thoughtful ways of addressing the nexus/physical presence issue. Without resolving this issue, no meaningful changes can be made without costly litigation and delay.

OK, let’s cut to the chase. Why should we information professionals, librarians, and independent researchers care about Internet taxation? There are several reasons: We are members of a growing and increasingly important segment of the Internet and information economies. We did not get our own NAICS code for no good reason. Information means money, a lot of money, and you can bet that this fact has not gone unnoticed by state political leaders.

How many of us use the Internet to conduct business? Probably all of us. We do research on the Net, we buy and sell our services and expertise on the Net, we conduct business with other information vendors over the Internet, and that is precisely why we need to pay attention. Business-to-business commerce on the Net is growing, and state political leaders will try to find creative ways to tax business-to-business e-commerce and I-commerce (information commerce). We fall into this category.

Can we be taxed? What could be subject to taxation? Literature searches? Patent research? Document retrieval? Marketing research? Web site design and maintenance? Think about it. How could Internet taxation affect your operation or your client’s? We need to pay attention, decide how we feel about the issue, and instruct our legislative lobbyists at SLA, AIIP, ALA, and SCIP to represent our views before federal, state, and local political leaders.

What do you want the Internet to be? Call your political leaders and tell them what you want and stay tuned.

By the way, does your state impose Internet taxes? If you don’t know, check out Vertax Tax Cybrary (

1. “Retail E-Commerce Sales for the Fourth Quarter 1999 Reach $5.3 Billion, Census Bureau Reports.” United States Department of Commerce News, March 2, 2000 (
2. Linda Rosencrance, “Report: Biz-to-Biz E-Commerce Exploding.” InfoWorld, March 24, 2000 (
3. Christopher Swope, “With Congress’ Internet Tax Commission deadlocked, governors and mayors are desperately seeking solutions to their e-commerce sales-tax dilemma” (
4. National Governors Association Online, “Overview of Sales and Use Taxes and Electronic Commerce: Quick Facts” (
5. E-Fairness Coalition: Myths & Facts ( National Governors Association Online, “Overview of Sales and Use Taxes and Electronic Commerce: Quick Facts” (
6. Michael Mazerov, “Should the Internet Remain a Sales Tax Haven?” Center on Budget and Policy Priorities. December 23, 1999 (
7. Streamlined Sales Tax System for the 21st Century, National Governors Association (
8. Christopher Cox, “Internet Tax Freedom at One: No Net Taxes, More Sales Tax Revenue” (
9. Aaron Lilly, “No Internet Tax: Why Internet Sales Taxes Aren’t Necessary” (
10. The Internet Tax Fairness Coalition, “Facts about Electronic Commerce and Taxation” (

The Internet Tax Freedom Act and the Advisory Commission
The growth of the Internet and the taxation issues led Congress to pass the Internet Tax Freedom Act. Representative Christopher Cox of California and Senator Ron Wyden of Oregon began working on an Internet Tax Freedom Act in 1996. The bill became Public Law 105-277 and went into effect in October 1998. The law contains several important provisions (Summary of Law,
  • Three-year moratorium on special taxation of the Internet. This section of the law prohibits state or local governments from taxing Internet access. States may not tax your Internet Service Provider, i.e., AOL or Mindspring, unless the state can demonstrate that these taxes had already been “generally imposed and actually enforced” on Internet access providers prior to October 1, 1998.
  • Three-year moratorium on multiple and discriminatory taxes on electronic commerce. Bars state or local governments from imposing taxes that would subject buyers and sellers of electronic commerce to taxation in multiple states. Also protects against the imposition of new tax liability for consumers and vendors involved in commercial transactions over the Internet, including the application of discriminatory tax collection requirements imposed on out-of-state businesses through strained interpretations of “nexus.” It also protects from taxation, for the duration of the moratorium, goods or services sold exclusively over the Internet with no comparable offline equivalent.
  • Establish commission to study question of remote sales. The Advisory Commission on Electronic Commerce will study the issue of e-commerce taxation and report to back to Congress by April 2000. 
  • No federal taxes. 
  • Internet commerce should be tariff-free. The Clinton Administration should work with the European Union and the World Trade Organization to ensure that electronic commerce will continue to be free of tariffs and other taxes imposed by international tax jurisdictions. The law also asks the Commerce Department to report to Congress on barriers that impact the competitiveness of U.S. businesses that are involved in e-commerce abroad. 
  • The Advisory Commission had to submit its report to Congress by April 2000. The Commission’s membership includes 19 members. Here’s how this breaks down: 
    • three representatives from the Federal Government — the Secretary of Commerce, the Secretary of the Treasury, and the United States Trade Representative (or their respective delegates)
    • eight representatives from state and local governments (one such representative shall be from a state or local government that does not impose a sales tax and one representative shall be from a state that does not impose an income tax)
    • eight representatives of the electronic commerce industry (including small business), telecommunications carriers, local retail businesses, and consumer groups.

The Players
Anti-Tax Organizations

Netfairness (
American for Tax Reform ( (
U.S. Chamber of Commerce (
Citizens for a Sound Economy (
Cato Institute’s Center for Trade Policy Studies (

Pro-Tax Positions
Big Seven 

National Governors Association (
National League of Cities (
National Conference of State Legislatures (
The National Association of Counties (
The U.S. Conference of Mayors (
Council of State Governments (
The Multi-Tax Commission (
Center for Budget and Policy Priorities (
E-Fairness Coalition (

Government or Government-Sponsored Organizations

United States Economic Commerce Policy (
Advisory Commission on Electronic Commerce (

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