Executive Summary

The Commission met December 14 and 15, 1999, at the St. Francis Hotel, 335 Powell St., San Francisco. All members were present except for Messrs. Armstrong and Pittman.

The Commission took up International Tax and Tariff issues and heard presentations from the Organization for Economic Cooperation and Development (OECD), European Union (EU) and the Competitive Enterprise Institute. Commissioner Novick briefed the Commission on the recently concluded World Trade Organization meeting, and Commissioner Guttentag spoke concerning the Administration’s involvement with the OECD. Commissioners conducted extensive discussions and questioned the speakers about European Value Added Taxes, the EU’s adaptation to eCommerce, and taxation of digital goods and services, among other issues.

The Commission then heard presentations from the Small Business Survival Committee, the Heritage Foundation/E-Freedom Coalition, a coalition of telecommunications firms, Global Crossing, Ltd., and Commissioner Andal, who spoke about proposals related to nexus issues and state taxation of telecommunications companies. Commissioners discussed the viability of sales taxes in the next century and the consequences of in-store Internet ordering on sales tax bases along with other issues. The Digital Divide was also discussed along with the potential of using surplus Temporary Assistance to Needy Families funding to address it.

The Commission heard the presentations from the following related to sales taxation and the Internet: National Governors Association; Carnegie-Mellon University; Taxware International; Hoover Institution; North American Retail Dealers Association; PricewaterhouseCoopers; Committee on State Taxation; and Ernst and Young. Extensive discussions and questions and answers followed concerning issues such as simplification, extending the Internet Tax Freedom Act’s moratorium, hardware and software issues, audits and nexus standards.

The Commission then heard from representatives of Westfield America, Inc., Wal-Mart, Federated Department Stores, ValueAmerica, Dell Computer, CISCO Systems, Inc. and Hewlett Packard. They spoke about their positions on remote taxation and the impact of various sales taxing options on their businesses. Commissioners questioned them extensively.

Lastly, the Commission took up a lengthy discussion of its Issues and Policy Options Paper. Areas of potential consensus were discussed regarding state tax simplification, taxes on Internet access and digital goods, the telecommunications excise tax, tariffs and the digital divide. The Commission elected to consider these issues further at its Dallas meeting along with the major issue of sales taxes on remote/Internet purchases.

Mr. Norquist discussed four resolutions (attached) and called for a vote on Resolutions 3 and 4. By a vote of 10-15, the Commission elected to table them. A revised budget was presented by Commissioner Jones and approved. The Chairman outlined the preparations needed for the Commission’s final meeting, March 20-21, in Dallas, during which the Commission is expected to vote on options and approve the bulk of its report to Congress, which is due by April 21, 2000.

The following members were present: The Honorable James S. Gilmore, III (Chairman); Mr. Dean F. Andal; Mr. Joseph H. Guttentag; The Honorable Paul C. Harris; Ms. Delna Jones; The Honorable Ron Kirk; The Honorable Michael O. Leavitt; The Honorable Gary Locke; Mr. Gene N. Lebrun; Mr. Grover Norquist; Mr. Robert Novick; Mr. Richard Parsons; Mr. Andrew Pincus; Mr. David Pottruck; Mr. John W. Sidgmore; Mr. Stanley S. Sokul; and Mr. Theodore Waitt. The following members were absent: Messrs. C. Michael Armstrong and Robert Pittman.

The Chairman called the meeting to order. He gave a brief synopsis of the Commission’s work at its first two meetings. He said he was encouraged by signs of consensus he saw emerging on closing the digital divide, reducing regressive telephone taxes and eliminating taxes on Internet access. He noted that disagreement existed on the application of sales taxes to the sale of goods and services over the Internet. For this meeting, he said his intention was to follow the Work Plan and accommodate presentations of proposals related to sales taxes. He then gave a brief synopsis of the agenda for the meeting and said it would be approved without objection. There were none. He then said it was not his intention to call for votes related to the Issues and Policy Options Paper, but rather to use the paper as a guideline for an open discussion.

The Chairman then introduced the first presenter, Mr. Andrew Marsland, of the Organization for Economic Cooperation and Development (OECD).

Mr. Marsland outlined OECD’s work on electronic commerce taxation issues. He said this work was part of a larger OECD effort to encourage development of the information society and foster a stable and predictable regulatory environment. The OECD objective is to allow eCommerce to flourish while protecting the revenue base, Mr. Marsland said. OECD ministers endorsed key taxation principles in October 1998. The principles, which Mr. Marsland said amount to an important international consensus, include neutrality and equity between forms of eCommerce and between eCommerce and conventional commerce. Compliance costs to business and administration costs to governments should be minimized, Mr. Marsland said. A final principle is flexibility such that the taxation system can adapt to technological and commercial change. Since 28 of the 29 OECD member countries have consumption taxes, the OECD challenge has been to translate the agreed principles into practice. Rules in effect call for eCommerce transactions to be taxed in the same way as other transactions — at the place of consumption. Determining exactly how to do it is the subject of much OECD debate. Determining where to tax business profits and how to deal with business-to-business transactions is also being debated, Mr. Marsland said.

The next speaker was Mr. Michel Aujean, the Director of Tax Policy at the European Commission. Mr. Aujean said the European Union (EU) has a common legal framework for both customs and indirect taxation. He said the EU has a single, harmonized tariff system and no internal borders. The Value Added Tax (VAT) provides for taxation of all goods and services within the EU. The EU has determined, as a principle, that it will tax tangible eCommerce at the point of import as it taxes other tangible commerce from outside the EU. Businesses charge and collect the tax, subject to thresholds. Taxes on services have been applied at the place of registration or establishment of the seller, and most eCommerce services are taxed this way within the EU at present. Changes are being envisaged, Mr. Aujean said, to ensure that the EU is able to collect taxes on business-to-consumer services, which, he acknowledged, is an extremely limited segment of eCommerce trade. He said the EU knows the VAT system must change to accommodate eCommerce and provide the certainty the business community has told the EU it needs to have.

The next speaker was Fred Smith from the Competitive Enterprise Institute. Mr. Smith said the Commission should be careful in recommending that taxing entities be allowed to tax people to whom they are not politically accountable. He criticized the state of software that is purported to be available to track and collect multi-state taxes. He spoke against taxation in general and said the promise of the Internet would be threatened by taxation. He also expressed concern about privacy issues and the trusted third party concept of the National Governors Association proposal.

For the benefit of the C-SPAN audience, the Chairman then introduced the members of the Commission and then called on Mr. Novick to provide an update on the deliberations of the World Trade Organization (WTO).

Mr. Novick said the Administration’s primary goal with respect to electronic commerce was unimpeded development of trade. He noted that the WTO determined in May 1998 to continue a moratorium on customs duties on electronic transmissions. He said there was broad consensus among America’s trading partners that the moratorium should continue, but he said the WTO, in its meeting in Seattle, did not conclude a formal declaration on this issue. He said the U.S. expects that countries will continue their present practices. He called attention to his written comments concerning the consensus on other trade issues that the Administration continues to pursue with its trading partners.

The Chairman then introduced Mr. Guttentag for an update on the Administration’s involvement with the Organization for Economic Cooperation and Development (OECD).

Mr. Guttentag reflected on his presentation to the Commission at its June meeting and again suggested that the Commission should support the framework conditions adopted by the OECD’s Committee on Fiscal Affairs, as described by Mr. Aujean. He said the OECD relies heavily on taxes imposed at the place of consumption and proposes reliance on voluntary cooperation and compliance. He likened preferences for voluntary compliance to provisions of proposals that the Commission would hear presented the next day. Mr. Guttentag endorsed the basic principles that guide the OECD’s work: neutrality, efficiency, certainty, simplicity, fairness and flexibility with a prohibition on discriminatory taxation. He also said new technologies should be used to simplify and improve tax system administration and said the key ingredient in international consumption is cooperation between governments and vendors. He urged an understanding of the nature and dimensions of international tax problems prior to efforts to solve them.

The Chairman then opened the floor for questions.

Mr. Andal asked if the EU and the U.S. were heading in different directions regarding consumption taxes on digitally transferred goods and services. He said he did not think that the tax could be collected in Europe, and he asked for a response from Messrs. Marsland, Aujean and Novick.

Mr. Marsland said it was the intention of EU countries to tax every aspect of consumption and that the challenge was development of a mechanism to capture sales of digitized products.

Mr. Aujean said EU legislation needed to be changed to tax business-to-consumer transactions in the same way that business-to-business transactions are taxed with a goal of a level playing field between the EU and the rest of the world. He added that the system that is presently envisaged involves application of existing VAT legislation through electronic registration of traders on the Web.

Mr. Novick said he did not believe the U.S. and the EU were moving in different directions on treatment of digitized goods at borders, but he said that electronic registration raises other concerns that may impact trade issues.

Mr. Andal asked Mr. Guttentag if differential tax treatment of digitized goods between the EU and the U.S. would create significant Internet tax problems around the world.

Mr. Guttentag said a relatively small amount of business is involved with digitized goods. He said since these taxes would be consumption taxes, they would be imposed at the location of consumption. It would, therefore, be up to the jurisdictions involved — the EU with its nations and the U.S. with its states — which should be free to tax digitized goods as they see fit.

Mr. Norquist questioned Mr. Novick regarding which country, region or group prevented the WTO from coming to consensus regarding tariff-free international electronic commerce. Mr. Novick said that the issue was one of process in which there was a range of disagreements that led to the ministerial being suspended short of a final declaration, which, he said, would have included the consensus on eCommerce. Since nothing is agreed to until everything is agreed to, the eCommerce issue was not finalized.

Messrs. Lebrun, Marsland, Aujean and the Chairman discussed the issue of nationally imposed consumption taxes in the EU and OECD countries and the latitude of subordinate political entities to supplement such taxes. Mr. Aujean said individual countries can set the VAT rates, but no alternative taxes can be imposed in the EU.

The Chairman asked Mr. Aujean if imposing VAT on goods entering EU countries did not amount to a tariff. Mr. Aujean said the EU was simply putting goods produced in the EU or imported into it on a level playing field. Additional discussion ensued regarding the taxability of products supplied by American or EU countries. Mr. Aujean clarified that material goods imported within the EU will be subject to tariff at a common EU rate and VAT at the rate of the destination country. Mr. Aujean also said that business income taxes were not harmonized within the EU, and each country did as it pleased.

Mayor Kirk and Mr. Smith then had a discussion about the needs of municipalities to provide the services that are required to support citizens. Mayor Kirk said communities cannot grow and prosper unless everyone pays a fair share of the costs. Mr. Smith acknowledged the needs of governments for revenue, but questioned whether the revenue generating systems of the past should be given sacred status. He said more creative taxation was necessary — where the payers of taxes directly received the benefits of the taxes.

Mr. Sokul asked Mr. Aujean how VAT would be collected on imports into the EU. Mr. Aujean said goods would go through an importation process where tariffs and VAT would be applied. If sellers do not collect the taxes at the time of sale, the delivery agents (such as FedEx or UPS) collect them, he said.

Mr. Sokul question Mr. Aujean on the issue of harmful tax competition asking to whom harmful tax competition is harmful. Mr. Aujean said the issue related to actions by member EU state tax administrators, some of whom have attempted to distort competition through very low effective levels of taxation for transactions reserved for non-residents.

Mr. Andal asked about the EU position regarding collection of VAT on digital music from California downloaded in Paris. Mr. Aujean said such a transaction is not presently taxed. He added that the EU is presently considering various options to collect taxes on such transactions. One would involve the EU requesting an American company to register, collect and remit VAT. Mr. Andal asked Mr. Aujean how an American merchant would know his customer was in an EU country. Mr. Aujean said the E-mail elements would indicate the place of taxation.

Messrs. Smith, Pincus and Marsland then discussed the issue of digital transactions and questions of determining the location of recipients and how much information recipients need to provide.

Mr. Pottruck, reflecting on the digital goods discussion, suggested that the Commission focus on the world of solvable problems rather than imponderable examples.

Governor Leavitt asked Mr. Aujean if the EU had considered exempting from VAT certain categories of digital products. Mr. Aujean said that suggestion had been discussed, but the focus remained on adapting the VAT system to new challenges. He said that it was clear that the EU did not yet have all the answers.

Mr. Guttentag said he agreed with Mr. Pottruck that the Commission should focus on actual, rather than digital, merchandise because the former makes up the majority of eCommerce. He said international cooperation would need to be increased as the flow of goods across boarders increases. He also cautioned against proposals that would encourage buyers to order overseas to avoid a tax that they would incur if they bought from a local merchant. He asked that the papers presented by Messrs. Aujean and Marsland be included in the record of the meeting. The Chairman noted that they would certainly be permitted to submit papers to the Commission.

Mr. Sokul raised the issue of privacy protection in Europe and the U.S. in light of proposals from foreign tax collection software developers. Mr. Pincus commented about privacy protection in the U.S. and said negotiations are ongoing with the EU.

In response to a question from Mr. Pottruck, Mr. Aujean outlined how the VAT system evolved from differing national systems in the EU, and he discussed its present structure.

Mr. Norquist questioned Mr. Aujean concerning VAT rates in Europe and whether the EU was pleased with the way the VAT rates had evolved over time with respect to an extension of VAT to services. Mr. Aujean said these were political decisions made by member countries because of a need for a straightforward method of generating revenue.

Mr. Guttentag commented on taxes a buyer would pay on European merchandise delivered in Virginia. He said the purchase would be exempt from VAT, but subject to Virginia use tax. He said Virginia and other states have agreements with the Customs Service so that notice can be given and reminders can be sent advising of taxes due.

Mr. Harris asked Mr. Guttentag if online transactions that are services were taxed, how would other services performed in a traditional context be taxed in the name of equity and tax fairness. Mr. Guttentag said that if all services were taxed, that should mean a lower tax rate overall. He said he was not proposing an extension of taxation to services, but if it were done, he said that all economically similar transactions should be part of the tax base. He also emphasized that such decisions were up to state and local governments. In response to a question from the Chairman relating to examples of governments lowering tax rates, Mr. Guttentag said that the Revenue Act of 1986 resulted in broadening the base for taxation, eliminating some deductions and lowering the rates substantially.

A further discussion ensued among Ms. Jones and Messrs. Aujean, Smith and Novick concerning the removal of VAT from goods exported from EU countries.

Governor Leavitt asked Mr. Smith if he believed sales taxes were viable for the 21^st century. He said yes, for some specific items, but said overall, the sales tax is a declining tax as the economy moves from goods to services to information. Governor Leavitt asked him what he would suggest as an alternative, and Mr. Smith suggested that income or other taxes could be increased to compensate, but recommended smaller, better government that needs lower taxes.

Mr. Lebrun spoke on the issue of the sovereignty of states and their ability to collect taxes on transactions conducted within their borders. He said transactions should not be judged differently because of the method of delivery of the product or service.

Mr. Sokul asked Mr. Aujean if he foresaw a time when the EU would agree to collect taxes for the U.S. states that charge them. Mr. Aujean said it would be up to the states to conceive a system whereby European traders would voluntarily agree to collect taxes.

Mr. Norquist said he agreed with Mr. Smith that government should not grow without limits. He said that the tax climate in the U.S. has been helpful in creating opportunities and jobs and reducing costs to business. He said federal taxes as a percentage of GDP had been reduced in the last five years, and he urged the states to work toward greater efficiency. He spoke against harmonization, and noted that it had meant a minimum tax of 15 percent in the EU.

Mr. Smith also spoke against harmonization and said creative competition in the private and political sectors was a way to get a better world.

After a recess, the Chairman introduced the next segment of the meeting that involved presentations of proposals related to sales tax on eCommerce that the Commission called for at its New York meeting. [At and after its New York meeting, the Commission set and refined a list of criteria that reflected the priorities of Commissioners regarding tax treatment of eCommerce.] The Chairman thanked those who submitted the 37 proposals the Commission received. He said that the proposals to be presented were selected by the Report Drafting Subcommittee. He called attention to the experts who were present at the meeting and then introduced each of the afternoon’s presenters along with their proposals.

The first presentation was of Congressman John Kasich’s Internet Tax Elimination Act by Chris Wysocki, the president of the Small Business Survival Committee (SBSC). Mr. Wysocki emphasized the benefits of eCommerce for the emerging digital economy and the harmful effects of state taxation of eCommerce. He urged adoption of Mr. Kasich’s proposal, which makes the Internet Tax Freedom Act’s moratorium permanent and prevents state and local governments from imposing taxes on eCommerce. He cited harmful effects on the economy, were eCommerce to be taxed, the growth of state revenues from 1992 to 1998 and the power of the Internet to create small businesses, which, he said would be threatened if they were forced to collect and remit taxes to some 7,500 jurisdictions. He cited an Ernst & Young study that said the cost to small retailers for collecting taxes in 46 states would be about 87 percent of the taxes collected. He said Main Street business was not losing customers to eCommerce because there is no price advantage when shipping is included. He said the Commission would send a terrible signal to small business if it recommended eCommerce taxation.

The next speaker was Adam Thierer, the Walker Fellow at the Heritage Foundation, who presented the E-Freedom Coalition’s proposal. The proposal urges government to stop taxing the telecommunication industry as if it were a regulated monopoly by reforming or eliminating five specific taxes, including Internet access taxes and the federal excise tax. On the sales tax issue, the Coalition proposes a permanent Internet Tax Freedom Act moratorium, clear nexus standards and definitions that will assist companies in determining when they can be required by a state or locality to collect sales taxes. This, he said, is the only plan that rests on sound economic foundations. He has concluded that the NGA proposal is untenable for several specific reasons he cited. He proposed, as an alternative, an origin-based system, which, he said, is the most politically sensible option available.

The Chairman then introduced Mr. Andal, who spoke about two proposals he presented to the Commission.

His first proposal builds on the physical presence doctrine in the Supreme Court’s Quill decision. It establishes a series of "bright-line" safe harbors and codifies Quill requirements for both sales taxes and business activity taxes so that it is easy to determine what is nexus and what is not. He addressed the issue of revenue losses to states as a result of uncollected eCommerce sales taxes by noting that there is no evidence of a revenue drain in California due to increases in Internet business activity as sales tax collections will see their highest increase in history in 1999. To address the level playing field issue, Mr. Andal said that state sales tax systems contain provisions that benefit states, but could be called uneven playing fields. He summarized by saying his proposal is the one legitimate solution that solves problems, involves less litigation, lower costs and compliance burdens, and will not cause significant revenue loss.

Mr. Andal’s second proposal called for a 4-R Act for telecommunications so that states could not apply higher property taxes on the telecommunications industry than they do on other business property. He said states should not disproportionately tax an industry that is being encouraged to invest more in the Internet backbone.

The Chairman then introduced Keith Landry, an attorney with Bell South Corporation, and Stacey Sprinkle, the assistant vice president of tax for ComNet Cellular. They represented a coalition of telecommunications companies that favor simplification of the tax system and elimination of the tax burden disparity between the telecommunications industry and other competitive industries. Mr. Landry said that the coalition had submitted a proposal involving a sound and rational process for achieving tax reform. Ms. Sprinkle said the coalition recommended the Commission endorse the reform measures for which the coalition is calling and ask Congress to encourage state and local government and industry representatives to work toward reform. She also suggested Congress should enact a law to establish a review commission that would, after three years, assess the progress of state and local governments and industry toward reform.

The final speaker of the afternoon was John Morabito, the vice president of Global Crossing, Ltd., who asked the Commission to endorse a proposal for a moratorium on sales and use taxes associated with the construction and operation of Web-hosting facilities. He said such a moratorium would provide an incentive for construction of such facilities in the U.S., as opposed to overseas, and in states that provide tax relief.

The Chairman then opened the floor for questions and discussion.

Messrs. Pottruck, Lebrun, Sidgmore and Andal then questioned Mr. Morabito concerning the need for the incentives he was proposing, the ability for states to provide them in the absence of federal leadership and the definition of the facilities that would benefit from tax incentives. Mr. Morabito said states have the authority to offer incentives. He added that his proposal attempted to develop and promote a national policy that would give companies an incentive to continue to develop facilities in the U.S. He said the facilities involved were the bricks and mortar involved with servers and routers and the material that goes into them.

Mayor Kirk and Messrs. Pottruck, Wysocki and Thierer then conducted a discussion about the constitutionality of proposals to exempt Internet purchases from taxation while continuing to tax Main Street purchases. They also discussed assertions about the amount Internet transactions would decrease if they were all taxed and the issue of empirical evidence regarding the net effect of eCommerce on state tax revenues. Mr. Thierer said there was not a lot of empirical work since this is a new field of economic study. Mayor Kirk and Mr. Thierer also discussed alternatives for municipal funding and the consequences of shifting revenue burdens among possible sources. The Chairman and Mayor Kirk also debated the issue of exemptions of certain goods from sales taxes.

Ms. Jones and Mr. Wysocki then discussed the position of the Small Business Survival Committee and other organizations and the issue of the federal government’s ability to set better tax policy than states.

Governor Locke and Mr. Wysocki discussed Congressman Kasich’s proposal as it relates to an exemption from payment of taxes on in-state Internet purchases from companies with many nearby retail stores.

Governor Leavitt and Messrs. Thierer and Wysocki discussed the viability of the sales tax system in the 21^st century as many large firms with presence in all states become involved in Internet business. Mr. Thierer noted that some have called for replacing the sales tax system, but he said he did not believe that was a viable option because of the reliance that governments place on the revenues from sales taxes. He listed several alternatives, among them an origin-based system.

Messrs. Pincus, Wysocki and Thierer discussed the potential, under the Kasich proposal, for an untaxed sale to occur if a buyer in a retail store went to an Internet kiosk in the store, ordered an item and picked it up at that time. Mr. Pincus said that the impact on sales taxes would be dramatic, and he suggested that, in a short time, every store of any size would integrate such a system, and no taxes would be paid on any purchases. There was further discussion concerning the proposal’s intent in this hypothetical circumstance.

Mr. Sokul suggested, since data is sparse in some areas of eCommerce, that the Commission might suggest to Congress that more studies are needed. He also asked Mr. Thierer why he thought the NGA proposal was problematic constitutionally. Mr. Thierer said the issue of "extraterritorial tax reach" would have the effect of a state taxing a company outside its state that does not have substantial physical presence therein.

Mr. Pincus, referring to the kiosk example mentioned earlier, said the revenue implications of the Kasich plan would involve all sales taxes, and he questioned if that kind of revenue impact would be sustainable.

Mr. Norquist questioned Mr. Thierer about alternate proposals for providing governmental funding. Mr. Thierer said alternative proposals had been suggested by members of the E-Freedom Coalition, which he represents, and were available at the Heritage Foundation Web site.

Mr. Guttentag said that tax-free Internet kiosk ordering in retail stores, which is implicit in the proposal presented by Mr. Wysocki, would result in the destruction of the sales and use tax system, which amounts to an average of one-third of state revenues. He said that the proposal should include recommendations for replacement of lost revenue.

Mr. Andal said Internet kiosk sales would be taxable under his proposal because of its clarification of physical presence standards. He said he did not believe the sales tax system, which provides about 37 percent of California’s revenue at a collection cost of one percent, is fatally flawed. He said there is no significant revenue loss due to Internet sales, and he said its problems involving nexus standards have been exacerbated by the Internet. The solution, Mr. Andal said, is a refinement of the existing system. He also said that those who want to change the system because they think it is not bringing in enough money have the burden of solving problems they create.

Ms. Jones said, although she comes from a state with no sales tax, she would not favor scrapping the present system because it broadens the tax base and promotes fairness.

Mr. Norquist asked Mr. Andal why he only aimed to rectify discrimination against telecommunications companies regarding property tax as opposed to other discriminatory taxes. Mr. Andal said others were focusing on other taxes and his proposal only dealt with ad valorem taxes.

Mr. Pincus then addressed the issue of the digital divide and concerns of fairness of the current tax system and any change to it that the Commission might recommend. He said the Commission should consider where the burden of sales taxation falls and where it might change based on some of the proposals that have been presented.

The Chairman said he believed the digital divide is a key issue and that the Commission should find a way to get people on the Internet. He said his proposal called for a federal clarification for the usage of surplus state Temporary Assistance to Needy Families (TANF) funds to give more access to the Internet for people of modest means.

Mayor Kirk commended the Chairman for addressing the digital divide in his proposal. He said that the issue is complex and involves not just computers, but the knowledge to use them. He also noted that 99 percent of Internet buyers use credit cards, and it will not help if people at the poverty level have a computer without the knowledge to use it or a credit card.

Mayor Kirk addressed comments to Mr. Andal concerning municipal needs for funding for basic services. He said the needs outstrip capacity to pay for them. He said even the most prosperous cities have unfunded needs.

Mr. Parsons spoke next about identifying key issues before the Commission. He said if the issue is sales tax and leveling the playing field, Mr. Andal’s proposal would be a good straw man. He also asked if there were something special about eCommerce that suggests it should be exempted from sales tax altogether. He said he does not see evidence to support the assertion that sales taxation will overly burden eCommerce. He also asked if there were something about eCommerce that indicates a need for reform of the entire sales tax system. He concluded by suggesting that the time had come for the Commission to narrow its focus and begin moving toward focusing on a recommendation.

Mr. Harris spoke at length about the complexity of the task before the commission. He asked if the Commission had taken the time to answer fundamental questions about the proper constitutional framework; federal versus state authority; whether eCommerce is inherently interstate commerce; whether Congress has the authority to mandate tax policy within the states; and whether states have a constitutional right to tax citizens in a different state. He said the Commission needed guidance on these constitutional issues.

The Chairman then adjourned the meeting calling to the attention of the Commission that it was in the St. Francis Hotel in 1973 that the Internet was born.

Minutes of the Meeting of the
Advisory Commission on Electronic Commerce
December 15, 1999
Westin St. Francis Hotel
335 Powell Street, San Francisco, California

The following members were present: The Honorable James S. Gilmore, III (Chairman); Mr. Dean F. Andal; Mr. Joseph H. Guttentag; The Honorable Paul C. Harris; Ms. Delna Jones; The Honorable Ron Kirk; The Honorable Michael O. Leavitt; The Honorable Gary Locke; Mr. Gene N. Lebrun; Mr. Grover Norquist; Mr. Robert Novick; Mr. Richard Parsons; Mr. Andrew Pincus; Mr. David Pottruck; Mr. John W. Sidgmore; Mr. Stanley S. Sokul; and Mr. Theodore Waitt. The following members were absent: Messrs. C. Michael Armstrong and Robert Pittman.

The Chairman called the meeting to order and introduced the Commissioners present. He then briefly described the day’s agenda and introduced the panel that would make presentations of sales tax-related proposals received by the Commission. The first presentation was "Streamlined Sales Tax System for the 21^st Century" by South Dakota Governor Bill Janklow, Tennessee State Representative Matthew Kisber and Chair of the Hennepin County, Minnesota, Board Randy Johnson on behalf of the National Governor’s Association, the National Conference of State Legislatures, the Council on State Governments, the National Association of Counties, the United States conference of Mayors, and the International City-County Management Association.

Governor Janklow said he did not dispute Congress’ authority to regulate interstate commerce, but said some accommodation needed to be made to 200 years of history that has left certain issues to the discretion of the states. He said that broad-based sales taxes are the states’ backbone taxes and that if the present national policies continue, sales taxes would need to be increased. He spoke against adoption of a tax policy that would wipe out small-town Main Streets. He said the rules of the game should not be changed, commerce should be allowed to take care of itself and businesses should succeed or fail based on the marketplace, not on tax policies adopted on the national level. He also said to favor eCommerce would create a loophole for late starters in the game of commerce.

Mr. Kisber said the NGA’s voluntary zero burden proposal provides a level playing field, is technologically feasible, accommodates the bricks and mortar business model, preserves the status quo on nexus, respects the privacy of buyers and sellers, and removes administrative burdens from sellers and shifts them to state governments.

Mr. Johnson stressed that the NGA proposal had the support of city, county and local officials throughout the US. He said there ought not be special government protection for Main Street or eCommerce merchants. He said that governments cannot run on empty tanks, and saying no to sales taxes, means higher income and property taxes. He said that the NGA proposal is not about taxing the Internet; rather, it is about taxing transactions. The proposal radically simplifies sales taxes and requires little or no action by the federal government, he said. He concluded by urging that free markets be left to work on their own.

The Chairman then introduced the next presenter, Mr. John Peha, from Carnegie-Mellon University, who spoke on the "Proposal on Taxation of Electronic Commerce."

Mr. Peha spoke in favor of a non-discriminatory tax policy whereby a buyer, based on his location, pays the same tax rate regardless of method of purchase. He did not take a position regarding which entity would receive the revenue -- the buyer’s state, the seller’s state or the federal government. He said his proposal would pass what he said were three key litmus tests: enforceability (trustworthy records an auditor could access); privacy (not compromise the privacy of buyers or sellers); and efficiency (voluntarily accredited trusted third parties, such as commercial verifiers).

The next presentation was on "Adopting Tax Technology to the Internet from the E-Commerce Transaction Tax Server" by Mr. Daniel Sullivan of Taxware International, Inc.

Mr. Sullivan described Taxware International’s technology, which he said was used by five companies represented by Commissioners. His system involves a product-specific world tax calculation system. The tax, if due, is calculated, and the results are passed to the seller, thus an audit record of the transaction is created along with reports for tax returns. Mr. Sullivan said his system is Internet ready, and his company has announced a transaction tax server. The tax server would receive transaction data and return tax data and the entire transaction amount to the merchant and then forward the tax amount directly to the taxing authority. Taxware would provide its software to taxing authorities without cost. The authorities could then load the transaction data into their databases or produce tax reports.

Mr. Charles McLure of the Hoover Institution spoke next on "Radical Simplification of Sales Taxes and Use Taxes: The Prerequisite for and Expanded Duty to Collect Use Tax on Remote Sales.

Mr. McLure said his proposal involves radical simplification. His main points were: there is no principled reason for a permanent exemption from sales taxes for electronic commerce; remote sales should be taxed by the state of destination of sales; taxes must be simple enough to make destination-based sales taxation feasible; and the burden of compliance on small sellers must be eliminated. His proposal suggests elimination of distinctions that do not make sense and are, in fact, indistinct (such as between goods and services and between local and remote commerce) and clarifies appropriate distinctions between businesses and consumers. The essence of his proposal is one rate per state and a uniform rate for digitized goods, to be administered jointly by the states.

The next speaker was James Goldberg, the general counsel of the North American Retail Dealers Association, (NARDA) whose presentation was entitled "Proposal Related to Electronic Commerce Taxes."

Mr. Goldberg said NARDA favored a level playing field for its members, who are primarily small traditional retailers of consumer electronics and appliances. He said the series of Supreme Court decisions, ending with Quill, have left state and local governments with an ineffective means to collect sales taxes that are lawfully owed. States, he said, should not be raising revenue through other means until they are satisfied that all existing taxes are collected. NARDA recommends federal legislation that would require remote sellers with no presence in states to collect and remit taxes on sales made to buyers in those states. Simplification would be required along with uniform definitions of taxable transactions. Education and simplification and negotiation with remote sellers for voluntary compliance would occur as federal legislation is developed.

Before introducing the final three proposals, the Chairman explained that the Commission received a large number of proposals from thoughtful people in response to its invitation, at its New York meeting. The Commission then selected representative groups for presentations at the San Francisco meeting. He also indicated that his own proposal would be included in discussions later in the day on the Issues and Policy Options Paper.

The next proposal was "A Modest Principle: No Net Net Tax" from Messrs. William McArthur and Peter Merrill of PricewaterhouseCoopers.

Messrs. McArthur and Merrill said they favor revenue neutrality as a principle that the Commission should support. Revenue neutrality means that any increase in taxes collected by governments should be accompanied by a reduction in the tax rate, which would ensure that the tax burden is not shifted to low-income consumers. A federal enforcement mechanism would be needed to ensure that states did not use the tax on remote sellers to increased taxes on constituents.

Next to be heard was the "Proposal from the Committee on State Taxation on Sales Tax Simplification" from Ms. Diann Smith, the general counsel of the Committee on State Taxation.

Ms. Smith contrasted the views of local merchants, Internet merchants and governments regarding changes in the tax system. She said any solution should be voluntary, involve incentives, result in radical simplification, provide some kind of vendor allowance, no risk of other kinds of taxes and have some type of test period.

The Chairman introduced Mr. Joseph Crosby of Ernst and Young, on behalf of the eCommerce Coalition, for the day’s final presentation, "Simplification of the State and Local Sales and Use Tax System."

Mr. Crosby began by commenting on the differences between taxes on the Internet and taxes on transactions that occur on the Internet. He said that the Internet was already taxed through many mechanisms and said that many sales on the Internet are currently taxable just as they would be if the transactions had taken place in another medium. He said remote sellers, including some Internet vendors, are not required to collect those taxes, and consumers rarely remit use taxes to their states. He suggested that the fundamental problem was a tax system that poses objectionable burdens on interstate commerce rather than uncollected taxes already due and that simplification was the key and only solution. He proposed several areas of simplification, some related to technology; others to policy. He said reducing burdens on vendors and compensating them for costs incurred in taxation were critical in any tax simplification proposal.

The Chairman then opened the floor for questions and answers and discussion.

Mr. Andal asked Governor Janklow if he agreed with Quill standards and his (Mr. Andal’s) Quill-clarifying proposal. He also asked if the governor thought that a technological solution could work without a uniform tax base.

Governor Janklow said he did not like Quill, but was willing to abide by it. He said he did not believe the Commission was charged by Congress to change the substantive law that deals with the Quill decision. He said problems, such as with uniformity, could be solved by the software community if it were asked to do so. He also said that South Dakota could respond to the issue by stopping "little brown trucks," [referring to United Parcel Service] note addresses on packages, and follow the trucks to their destinations.

Mr. Parsons asked Governor Janklow if he preferred that the moratorium be allowed to end with no further legislation.

Governor Janklow said that he favored working under the present rules with South Dakota being allowed to operate as it sees fit.

The Chairman and Governor Janklow then had a discussion about the constitutionality of searching delivery trucks and other constitutional issues, along with the question of empirical evidence that eCommerce is causing a reduction in sales tax revenues. The Chairman suggested that there is no evidence; Governor Janklow said the evidence is the number of people who say they do not want to collect taxes from South Dakota and other states.

Governor Locke said that after the moratorium expires states unable to increase taxation of transactions due to Quill and Bellas Hess rules, may try to find other ways of taxing the Internet. Reflecting on the various proposals that had been presented and noting that Quill and Bellas Hess are the law of the land, he asked if there would not be more complication and litigation if the Commission were to vote to codify Quill standards.

Mr. Charles McLure from the Hoover Institute said that although Quill makes no sense, it is the law, and if it is to be retained, then an attempt to codify it would be appropriate. He recommended that the larger system be fixed so rules could be enforced.

Governor Janklow commented that electronic nexus can be created more quickly in situations whereby states wish to enforce pornography or libel laws versus a commercial context.

Professor Walter Hellerstein of the University of Georgia School of Law commented on the issue of Quill and its relationship to constitutional law.

Mr. Dan Bucks, executive director of the MultistateTax Commission, said trying to codify the exact Quill language (physical presence as an indicator of substantial nexus) would lead to extensive litigation.

Mr. Lebrun, reflecting on his experience with the National Conference of Commissioners on Uniform State Laws (NCCUSL), said that a sales tax simplification effort could be drafted with the backing of the major constituencies within a year or two.

Mr. Norquist commended Governor Janklow for his comments about reducing spending in South Dakota. He then spoke of the high level of taxation already on the Internet and, specifically, through state and local telecommunications taxes, which he said averaged 14.1 percent. He noted that South Dakota telecommunications taxes were below that at about 9 percent. Mr. Norquist said he hoped the governor’s comments about stopping delivery trucks were made in jest. He then noted the growing sense in Congress against taxation and specifically commended Senators Hatch and McCain for their efforts. Mr. Norquist then asked Governor Janklow how many governors had endorsed the NGA proposal. He also asked if the governor favored reductions in telecommunications taxes (extension of the 4-R Act rules).

Governor Janklow said that16 governors were on his list. He stressed the proposal was, in fact, a proposal that he expected it would be an evolving document. On the extension of the 4-R Act rules, he said he favored the same treatment for telecommunications as for railroads and said that telecommunications in his state was taxed at the same rate as other industries. He added that he favored treatment of eCommerce like the railroads. Mr. Norquist asked Governor Janklow if that meant he favored a federal prohibition on discriminatory taxes. The governor said he favored state, not federal prohibitions on discriminatory taxes.

Governor Leavitt, as president of the NGA said the NGA’s proposal had been passed by the NGA’s Executive Committee and by a bipartisan group of nine governors. He said the proposal represented the attitude and direction of those who have been elected by the people of the country to represent state and local governments.

Mr. Harris and Governor Janklow then had an extensive discussion regarding Quill and its language that "Accordingly, Congress is now free to decide whether, when and to what extent the states may burden interstate mail order concerns with the duty to collect use taxes."

Mr. Sokul spoke next. He commented regarding Governor Janklow’s assertion that the evidence that the states have a looming problem with Internet tax collections is the number of electronic merchants who do not want to collect them. Mr. Sokul said the merchants do not want to deal with 50 different tax systems. He also made the point that there are many examples where online access to national markets is helping Main Street businesses survive. He asked Governor Janklow what the governor wanted the deliverables of the Commission to be — sanctioning zero burden, or asking Congress to let the states solve the problem.

Governor Janklow said, with simplification, Congress could leave the discretion to the states, and the NCCUSL could contribute.

Mr. Sokul then asked Diann Smith about the size of the problem of state enactment of taxes that discriminate against out-of-state commerce.

Ms. Smith said the problem was significant because taxpayers cannot be heard in the federal court system until state courts have been exhausted, then only with an appeal to the Supreme Court. Chances for Supreme Court hearings are small, she said. The problem will likely get worse with the explosion in electronic commerce, Ms. Smith said.

Mr. Pincus clarified, with respect to an earlier discussion, that the Internet Tax Freedom Act’s moratorium applies to multiple and discriminatory taxes on Internet commerce and Internet access fee taxes, and he said that Quill guidance is and has been in effect and is not subject to the moratorium. He then asked the NGA representatives and others on the panel how their proposals dealt with simplification.

Governor Janklow said the NGA proposal, like others, is a starting point that needs to be fleshed out. He said a proposal that takes a middle place between the extremes should be subject to debate and further framing.

Mr. Kisber said he believed that all organizations represented at the Commission meeting thought that simplification was a key component to any proposal.

Mr. Pincus said that simplification may be an element of a Commission recommendation. He recommended that there be some specific elements that describe what simplification means.

Mr. Sidgmore asked Governor Janklow if he thought it were impractical to overturn Quill and start over.

Governor Janklow said he believed it was not the charter of the Commission to recommend changing the law. In addition, he noted that he believed overturning Quill would be politically undoable. Consequently, he believes in avoiding drastic action while letting the states use their prerogatives to work out an improved system.

Mayor Kirk said he had heard several common denominators among the presentations, such as nondiscrimination and simplification. With respect to the concept of removal of burdens from vendors, he asked if vendors were not using third parties presently in transactions when they deal with credit card companies. He asked if the credit card companies could not collect and remit taxes.

Mr. Crosby responded that it would be a mistake to presume that by eliminating the vendor from the process that the burden has been eliminated. Rather, he said, it would be shifted, and there are policy and technological reasons for not doing that.

Ms. Jones spoke next. As a representative from a no sales tax state, she said she would not want to see [businesses in] her state have to collect taxes for others while receiving no benefit. She asked whether, if simplification took place, Quill would be overturned since Quill became an issue because of a lack of simplification and issues related to the collection process.

Governor Janklow said that Ms. Jones was correct; Ms. Smith said that Ms. Jones’ arguments were not necessarily correct because it could be shown that the mail order industry had relied on Quill and Bellas Hess; Mr. Goldberg said Quill would not necessarily go away just because of simplification.

The Chairman, with reference to the NGA proposal, asked who would pay the (hardware and software) costs vendors would incur in working with trusted third parties. He also asked for comment on how uniformity among definitions and exemptions could be achieved in all states and how digital goods would be identified and taxed.

Governor Janklow said he appreciated that there might be significant costs, but he emphasized that the NGA proposal was a starting point for a system that would resolve the sales tax issue without destroying a state’s tax base.

Mr. Kisber said the costs of development and implementation would be borne by states. He also said that uniform definitions would be part of simplification. States would retain the authority to decide which items would be taxed and which would not be taxed, but they would have to make changes based on a prescribed timetable.

Mr. Bucks said the NGA proposal called for taxes on digital goods, with specific rules to be developed.

The Chairman said he understood that there would be no audits under the NGA proposal. Mr. Kisber said there would be audits, and home states would be responsible. Governor Leavitt said there was no audit provision under the NGA proposal. If states accepted the software, compliance would be assumed.

The Chairman said, under his proposal, small Main Street retailers could compete with big businesses as a result of the Internet.

Mr. Parsons asked, under the NGA proposal, what motivation a California merchant doing Internet business with Virginia customers would have to participate in a voluntary system whereby he would have to collect Virginia taxes on sales to buyers in Virginia.

Governor Janklow said the motivation would be avoidance of audit liability and protection from a large obligation were they later determined to have nexus in places where they had not collected taxes

Governor Janklow also said that big business would likely participate; smaller ones would not.

Governor Leavitt said businesses with nexus in many states, presently paying taxes on sales to buyers in those states, would be interested in simplifying their tax burdens by dealing with only one entity — trusted third parties — whereby they would be protected from audits and compliance certification would be provided. Governor Leavitt said the Commission should ask vis a vis all the proposals: Is the sales tax system a viable tool for the 21^st century that can be fixed? If it can, the Commission needs to determine what criteria the system needs to meet. If it cannot be fixed, it ought to be scrapped, he said.

The Chairman said he did not believe the tax system was broken, and the issue before the Commission concerned whether the NGA proposal was feasible. He asked Governor Leavitt if it were.

Governor Leavitt said, if the exact proposal were to be implemented, problems could be found with it. But he said it was a good idea that could be improved, and the sales tax system was feasible, but not in its present form.

The Chairman concluded the morning session by emphasizing that the Congress asked the Commission to argue through the issues and have competent and sound people bring them forward. He said the Commission is successfully doing that.

The Chairman then called for a luncheon recess.

The Chairman reconvened the meeting after lunch and introduced the next panel of presenters. The Commission asked the group of seven traditional, virtual and combination ("clicks and mortar") retailers to provide a perspective on proposals that the Commission had received.

The first speaker was Mr. Peter Lowy, co-president of Westfield America, Inc., representing the International Council of Shopping Centers and the E-Fairness Coalition. Mr. Lowy said he supports a level playing field. His constituency opposes new eCommerce taxes, but says sales online should be subject to sales taxes. Taxes should be collected in a simple manner that he believes is technologically possible. He also supports revenue neutrality and consumer privacy. The E-Fairness Coalition has not taken a position on individual proposals, but would oppose any plan to promote a permanent tax haven for Internet sales because that would involve a government-imposed competitive advantage to eCommerce, and lead to increases in other taxes. He also said eCommerce does not need preferential tax treatment or subsidies.

Mr. David Bullington, the vice president of taxes for Wall-Mart Stores, spoke next. He said Wall-Mart collects taxes on all Internet sales. He believes the tax-free Internet proposals could have potentially devastating economic tax and social consequences. He agreed that state systems need overhaul and simplification, but said states need help and direction and incentives in that process. The difficulty is, he said, moving 46 states in a single direction in a short time. He said the complication related to thousands of taxing jurisdictions is overblown as he said he deals with them everyday, however he did acknowledge dealing with many delivery destinations is expensive for online retailers, and he said a minimum business threshold would be necessary. He said there is a need for uniform definitions and better uniformity across state lines and that the Commission could encourage states to take legislative action.

Mr. Frank Julian, operating vice president and tax council, at Federated Department Stores, Inc., spoke next. He said Federated collects more than $1 billion in sales taxes annually and his eCommerce segments collects taxes in states where stores are located. He said he would like nothing more than to get Federated out of the side business of collecting and remitting taxes. Concerns he has about the NGA proposal relate to determinations of taxable items; compatibility of software among retailers; protection of proprietary data; accounting for exempt customers; returns and adjustments; customer privacy; customer complaints about tax errors; third party gift sales; credit card fees; proprietary charge cards; and bad debts. Mr. Julian encouraged NGA proposal sponsors to seek significant input from the business community and the tax-paying public.

Mr. Craig Winn, chairman and founder, ValueAmerica, spoke next. He said America must stop taxing telecommunications and the Internet infrastructure disproportionately. The Internet and eCommerce is an important economic engine that needs to be taxed less to encourage its growth, Mr. Winn said. Consumption taxes now are based on nexus, which is based on geography, and the Internet knows no geography. The only fair, simple tax is a national sales tax. Since that is politically impossible, he said, the only alternative is to deal with pragmatic reality, which is that there is no opportunity to tax eCommerce apart from the rules of geography and nexus that currently exist.

Ms. Cindy Oakes of Dell Computer’s Tax Department, spoke next. She emphasized the cost and complication of collecting $400 million in sales taxes and filing 1,900 tax returns. She said has many of the same concerns Mr. Julian pointed out. The main complexity for Dell involves business-to-business sales. The company presently does not collect tax from consumers because Quill says it does not have to do so, Ms. Oakes said. Dell is asking for simplification and is concerned that any technological solution might fail due to bandwidth considerations given the present state of the art.

Ms. Katrina Doerfler from CISCO Systems, Inc., spoke representing the American Electronics Association (AEA), which supports nexus-clarifying proposals such as proposed by Mr. Andal. AEA supports the following tax principles: tax all commerce the same; simplify tax administration; retain and clarify nexus standards; avoid new Internet taxes; and consider tax issues in a global context. Ms. Doerfler recommended the Commission clarify nexus standards, which are confusing and inconsistent, and encourage states to simplify sales tax administration systems. Many proposals, she said are long on new process and short on radical simplification details.

Mr. Dan Kostenbauder, the general tax counsel at Hewlett Packard Company, spoke next. He said his major tax expenses are due to complexity and lack of uniformity within state sales tax systems. He emphasized the cost and time it takes to link tax calculation and enterprise business software. He also recommended that Congress and the states work toward simplicity and uniformity in sales taxes. He commended those states that provide vendor compensation for tax collection. Mr. Kostenbauder praised the NGA proposal’s government entity (trusted third parties) that would deal directly with taxpayers in place of merchants. State and local governments that receive the benefit of the sales taxes would, he said, bear the cost of collecting them, and that would foster the simplification that many favor and make other problems easier to solve.

The Chairman then opened the floor for questions and comments.

Governor Leavitt made the point that the NGA proposal covered both retail and E-tail and that it was not contemplated to have two systems. He asked the panelists if it they thought it would be possible to radically simplify the system in three to five years with the technology that has been discussed and, if so, would it be worth doing.

Mr. Julian said he believed it the Commission’s efforts would be worthwhile if they did nothing but simplify the sales tax system.

Mr. Winn said he did not think it would be possible to get 30,000 jurisdictions to agree on anything without dealing with the geography issues and eliminating nexus concerns. The only solution, he said, would be a politically unpalatable national sales tax.

Mr. Bullington said the International Mass Retail Association and the E-Fairness Coalition would work with the NGA on a grass roots and Congressional education effort.

Mr. Andal read an excerpt from an article that seemed to indicate a position of the International Council of Shopping Centers at odds with that expressed by Mr. Lowy. Mr. Lowy said there was no difference in that the projections for eCommerce by 2003 show that it will have a profound effect on the cities and towns where the ICSC does business.

Mr. Andal then questioned Mr. Bullington’s statement that the complexities of the tax system are overblown. He cited an example from Fresno, California. Mr. Bullington said he did not say it was easy; just that it is not as complex as some say. For example, he said there are, at most, 6,000 rate determinations to be made, not 30,000 as some have said.

Mr. Guttentag asked Ms. Doerfler several questions related to her comments regarding Quill and physical presence and related nexus standards. Ms. Doerfler said that the American Electronics Association believed that a codification of Quill and Bellas Hess would be a positive development, but she said she could not support an economic nexus theory such as the setting of a monetary sales threshold for nexus standards.

Mr. Norquist asked Ms. Doerfler to clarify her position regarding the effect of the adoption of Mr. Andal’s proposal on litigation over nexus standards. She said she believed litigation would decrease.

Mr. Norquist then asked Mr. Kostenbauder the costs to Hewlett Packard of linking its business software with its tax software. He said it was more than $2 million per year. For small companies, he said the cost estimates ranged from $100,000 to $500,000, mainly due to the complexity of the tax system. The economy would be better, he said if complexity and costs were reduced. Even if he were in agreement with the NGA proposal for other reasons, he could not support it due to the costs involved, Mr. Kostenbauder said.

The Chairman asked Mr. Bullington if it were true that Wal-Mart stores received tax breaks and incentives from municipalities due to their positive impact on communities. He also asked if sales were up for Wall-Mart.

Mr. Bullington said that retail received almost no incentives relative to locating in a particular area. The Chairman differed with Mr. Bullington on the incentives issue and said he would welcome further conversations on the subject. Mr. Bullington acknowledged that the economy was exceptionally good and Wal-Mart continues to grow and expand. Mr. Bullington also said that good social and tax policy dictated fixing the sales tax system now lest erosion occur in the future.

The Chairman then asked Mr. Lowy if it were true that municipalities promised shopping malls favorable tax treatment generally not provided to small businesses. Mr. Lowy said that incentives differed from state to state.

Mayor Kirk questioned Mr. Kostenbauder on the contrast between the $2 million annual cost for tax and business software integration and the $20 billion that Mr. Kostenbauder said was the U.S. portion of Hewlett Packard’s worldwide operations. Mr. Kostenbauder said the percentage was a small number. Mayor Kirk then asked Mr. Kostenbauder if Hewlett-Packard spent more on corporate memberships in social and golf clubs than on tax compliance. Mr. Kostenbauder assured the mayor that it did not.

After a recess, the Chairman introduced the discussion of the Issues and Policy Options Paper. He noted that the Work Plan called for preparation of such a paper to crystallize options and to facilitate discussions at a higher level of specificity. He said he did not intend to call for votes and noted that inputs he had received indicated Commissioners preferred to discuss issues in San Francisco and take final votes in Dallas. Inasmuch as Mr. Pittman could not be present, the Chairman said Mr. George Vradenburg, America Online’s senior vice president, would introduce the Issues and Policy Options Paper since Mr. Pittman and his staff had been instrumental in drafting the paper.

Mr. Vradenburg introduced the Issues and Policy Options Paper and acknowledged the members of the Report Drafting Subcommittee who contributed to it. He provided an overview of meetings the Subcommittee staff conducted to produce drafts of the paper and outlined the three major categories of the paper: tax treatment of sales; tax treatment of telecommunications providers; and issues that have received less attention — the impact of nexus standards, remedies for unconstitutional state and local taxes and the digital divide.

The Chairman thanked Mr. Vradenburg and Ms. Fishbein of America Online for their work in the preparation of the paper. He said that the paper was a vehicle to guide discussion in San Francisco and that he expected everyone would have a chance for involvement and to make inputs as the Commission moved toward voting on issues and options in Dallas.

The Chairman then turned to a discussion of specific issues and policy options, beginning with international taxes and tariffs.

Mr. Lebrun asked the federal representatives if it made sense for the U.S. to treat electronic commerce differently from other forms of commerce in terms of international tariffs. Mr. Guttentag said the Administration supported the idea of agreeing to certain standards and working with the EU in this area. Mr. Guttentag also said he agreed with Mr. Vradenburg’s comments that the Commission’s mission was directed in the tariff area.

Mr. Novick reiterated that the Clinton Administration’s position was to keep the Internet tariff-free. Mr. Norquist said he supported the Administration’s efforts to reduce tariff and non-tariff barriers in all circumstances. The Chairman said that he believed that a consensus position had been reached on international tax and tariff issues.

Mr. Pottruck then raised issues related to the process the Commission would use to review the Issues and Policy Options Paper and the consensus process between the San Francisco and Dallas meetings. He also asked for an opportunity to comment on the introduction in the Issues and Policy Options Paper. The Chairman said he believed that by the end of its meeting, the Commission would identify the areas where serious votes would take place in Dallas. He then asked Mr. Pottruck for his comments on the introduction.

Mr. Pottruck offered, as a broad theme, that the Commission should not reject an approach that might not be perfect if it would go a long way toward a great solution and move the ball forward. In the following sentence from the introduction, he recommended changing the word "remove" to "minimize," "In order to foster the growth of electronic commerce, any recommendations for change should remove financial and logistical burdens on sellers." Mr. Pottruck also suggested that the subject of preferential tax treatment for the Internet should be discussed in Dallas. Mr. Pottruck further commented that innovation is driving economic expansion and the Internet is an enormous source of innovation, but innovation occurs in a variety of societal segments.

The Chairman concurred with Mr. Pottruck’s "perfection" comment, agreed to make the word change in the introduction and agreed that Internet tax treatment would be subject to robust discussion in Dallas.

Returning to the subject of international taxes and tariffs, Mr. Sokul suggested that the Commission ought to recommend that Congress increase its oversight of the Executive Branch in these areas. Mr. Norquist said the Commission should commend the Administration for its positions and suggest that Congress play a role in continuing the process. Mr. Novick said that no action was necessary to implement the status quo. He also assured the Commission that Congress exercises its oversight role quite diligently. Mr. Sokul said that the Commission must remember that its recommendations go to Congress. The Chairman asked Mr. Sokul to draft some language to be reviewed by Messrs. Novick, Guttentag and Pincus for a vote in Dallas.

Mr. Guttentag said he believed the international taxes and tariffs language in the Issues and Policy Options Paper was problematic and needed further discussion. Specifically, he was concerned with the implication that the U.S. should prohibit EU VAT on U.S. goods and that the U.S. would want to exempt EU goods coming into the U.S. from sales taxes. The Chairman indicated the issue remained open for discussion. He said he hoped the Commission would not think the EU’s VAT system should be a guidepost for the U.S.

Mr. Pincus said he thought the Commission’s international recommendation would be influenced by its domestic recommendation.

Chairman Gilmore then moved to a discussion of Internet access taxes and policy options. Mr. Pottruck said he had not heard any support for a tax on access. Mr. Andal agreed and suggested that it be removed as a policy option. Mr. Lebrun said he thought it was premature to remove anything. He said the concept of bundling services and the issue of protectionism for some services dictated a need for further study and discussion. Mr. Guttentag said that further study and language clarification was necessary. Mr. Norquist said he sees a Commission and a national consensus against access taxes.

The Chairman then asked Mr. Griffith to read the definition for Internet access. Mr. Lebrun said, since the definition includes communications services that may provide for more than just Internet access, he asked how Internet access could be separated for tax purposes. The Chairman agreed to leave the section as is with the intent for further attention in Dallas.

The Chairman next turned to a discussion of the tax treatment of telecommunications. Mr. Norquist asked if anyone favored retention of the tax. Mr. Lebrun said the Commission’s position on this should be taken as part of its final recommendation. Mr. Guttentag said the Administration believed it was an important tax that generated $4 billion per year. He said he did not believe there was consensus on this issue. Mr. Pottruck said he believed the tax was regressive and repeal of it would improve telecommunications in the U.S. Mr. Harris asked Mr. Guttentag if the tax were not making it more difficult for poor people to access the Internet. Mr. Guttentag said that there were merits to calls for repeal of the tax, but they should be considered in light of other budgetary considerations. Mr. Pincus said that a reduction of $4 billion in one revenue stream needed to be offset by a reduction in expenditures or by other revenues. Ms. Jones said she believed it was a discriminatory tax that merited continued debate in Dallas, but she noted balancing the budget was a Congressional as well as an Administration issue.

Mr. Andal suggested that a $4 billion annual shortfall could be taken out of the projected budget surplus. Reflecting on the hard choices the Commission would have to make in Dallas, Mr. Andal asked the Administration representatives to come to the Dallas meeting prepared to tell the Commission where they stood on the telecommunications and access tax issues. Mr. Sokul said he agreed with Messrs. Pottruck and Harris and Ms. Jones that this is regressive tax that affects the digital divide.

The Chairman then restated his telecommunication tax elimination proposal, which calls for an elimination of two of the three percent initially while giving the states the remaining one percent for a period of three years as an incentive contingent on simplification of multiple and overlapping state and local telecommunications taxes. At the end of three years, states that simplified their taxes would be allowed to continue charging one percent at the state and local levels.

Mayor Kirk and Mr. Norquist said they favored the total elimination of the tax.

Mr. Pottruck said he believed simplification would not take place without an incentive. He challenged the Report Drafting Subcommittee to come back to the Commission in Dallas with a realistic incentive.

Mr. Waitt then questioned language in the Internet Tax Freedom Act that requires Commission recommendations to be tax and technologically neutral and apply to all forms of remote commerce. He asked if that meant any recommendation, for example, to abolish a tax must include a provision to make up for lost revenue in order to be tax neutral. The Chairman said he did not believe that was the intent of Congress, but he agreed to seek an interpretation before the Dallas meeting.

Mr. Pincus spoke next about the issue of state and local telecommunications taxes and asked if the opinion of state and local officials could be sought. The Chairman said that any inputs from state and local officials to the Commission would be shared with all Commissioners and that Commissioners representing those constituencies were welcome to speak to their interests.

The Chairman next moved to the issue of tax treatment of telecommunications property. Mr. Andal, the sponsor of a proposal to prohibit discriminatory ad valorem taxes on interstate telecommunications equipment, said he believe such taxes discriminate against the Internet infrastructure backbone. Ms. Jones said she was concerned about telling states how they should tax. Mr. Andal said protection is warranted because of the interstate character of the telecommunications business. Ms. Jones said some was intrastate, and deciding which are and which are not is an example of issues, she said, that the Commission should not study. Mr. Norquist said the issue was proper to study because the Commission’s charter called for it to look at total tax burdens and that the taxes may have made sense when telecommunications was a government-regulated monopoly, but make less sense in a competitive world. Mr. Lebrun said he agreed with Ms. Jones that this issue stretched the scope of the Commission’s charge.

Chairman Gilmore then introduced the Commission’s central sales tax issue, and he reviewed the seven options spelled out in the Issues and Policy Options Paper. Mr. Lebrun asked if taxation of services were intended to be addressed by each option. Mr. Vradenburg called attention to the section heading that discusses tax treatment of tangible personal property and taxable services and noted that some options deal with services, and others do not. The Chairman pointed out that his proposal does not deal with service taxation.

Mr. Andal called for a clarification of the taxation of digitized goods, and asked for the opinion of Mr. Art Rosen regarding whether his (Mr. Andal’s) proposal would invite new litigation or reduce litigation. After discussing the issue, Mr. Rosen concluded that, with greater specificity, the likelihood for litigation would be reduced. Mr. Andal also said that his proposal to offer specific definitions for "substantial physical presence" would reduce, not increase litigation.

Mr. Pottruck then commented on Mr. Andal’s proposal saying he supported addressing Quill issues as a way of dealing with Internet sales taxes inasmuch as the moratorium did not refer specifically to sales taxes. He said Mr. Andal’s proposal was a good beginning and that the Commission should think about a recommendation to Congress about clarifying the issues around Quill.

Ms. Jones questioned the rationale for the provisions in Mr. Andal’s proposal that affected business activity taxes in addition to sales and use taxes.

Mayor Kirk said Mr. Andal’s proposal went beyond what the Court envisioned in the Quill decision. He said the proposal provided a roadmap for businesses wanting to avoid paying income taxes, and he said he would be opposed to it.

Mr. Andal responded that the Quill and Complete Auto Transit decisions set standards that were not defined and did not recognize disputes between states. He said his proposal was designed to take away some of the conflicts that exist in state courts over substantial physical presence. Mayor Kirk said the proposal would permit businesses to avoid nexus and taxes. Mr. Andal said his proposal applied to all remote sellers and that 98 percent of the owed tax is paid and collected now. He also said that they would not and could not avoid falling under nexus rules.

Mr. Pottruck said that he doubted the Commission would recommend a solution that could be implemented immediately. He said the Commission could recommend to Congress that it take up the redefinition of Quill as an important order of business.

Mr. Parsons said he did not see anything in Section IV A of the Issues and Policy Options Paper that would help a rational man understand what it is about electronic commerce that warrants treating it differently from other forms of commerce. He said he was looking for something more than unsubstantiated arguments. He said he would look for tangible facts, analysis and evidence that would help the Commission determine the best recommendation to Congress. He also asked what would be the long-term impact of extending the moratorium, inasmuch as it does not prevent states from attempting to reach Internet sales.

Governor Leavitt said three basic questions in this area were: are sales taxes a viable tool for the 21^st century; should eCommerce have special privileges or should there be a level playing field; and how do you get to whatever situation the Commission recommends. He said there might be iterations of the seven policy options in section IV A of the paper.

The Chairman, in discussing his proposal, said he believed sales taxes were viable for the future and that eCommerce should not be treated differently or privileged. He said he could not assume that not taxing it would mean that it were privileged. He said his proposal only dealt with remote sales, however Congress might choose to define them. He said his definition was narrow and excluded business-to-business Internet sales. He acknowledged that not taxing Internet sales may be an advantage to Internet businesses, but he said that traditional business had advantages not available to Internet businesses, and he said there is no empirical evidence that the growth of the Internet will rise so high that it will take away business from traditional sources. He said he saw the Internet as an opportunity for small business without large capitalization to compete with bigger businesses and increase their market shares. He concluded by saying that the Internet is helping to drive the economy and that he saw no evidence of an impending collapse. He recommended no business-to-consumer Internet taxes, no access taxes and an elimination of the three percent federal telecommunications tax with a one percent incentive to states for simplification of tax structures.

Mr. Norquist asked the Chairman if he wished to discuss his proposal regarding the use of TANF (Temporary Assistance to Needy Families) funds to empower needy families with computers and access as a way of addressing the digital divide. The Chairman said his proposal asked Congress to determine if federal regulations would permit the use of surplus TANF funds for this purpose.

Mr. Parsons asked, related to quantification of the Chairman’s proposal, how much money that is presently owed but not paid by consumers on Internet sales would be foregone by the Chairman’s proposal. The Chairman said there is no evidence now that it is a large amount, and he acknowledged the anxiety of those who try to predict future amounts.

Governor Leavitt said that the horizon is 20 to 30 years and that the Commission should consider the potential of the power of the Internet. He also said he agreed with the Chairman that digital transactions should not be subject to tax. Lastly, acknowledging that evidence was hard to come by, he said his own experience and that of others convinced him that people are using the power of the Internet to add convenience to their lives.

Mr. Waitt said he believed it was important to clarify the Quill nexus standards. He noted that the Chairman clarified his proposal (IV A 4) to apply to all remote sales. He suggested that options IV A 1 and IV A 3 also needed to be applied to all remote sales. He identified with Mr. Parsons’ comments about the need for empirical data on Internet sales. He said Gateway had stopped charging sales tax in most states due to vagaries concerning nexus definitions. He said the company’s telephone sales (based on short term data) had increased five percent, and he said it appeared Internet sales had risen by twice that rate. He said that if the Chairman’s proposal were extended to all remote sales, the impact would be substantially greater than just for Internet sales. He also said the Commission should be concerned with the total tax strategy for the 21^st century, of which remote commerce is a part. He said the elimination of all Internet sales taxes would risk widening the digital divide rather than close it. He said Gateway had refused 184,000 families credit for computers in October and 250,000 in November and that follow-up surveys showed that these families did not purchase a computer anywhere.

Mr. Parsons asked the Chairman to contrast his proposal to Mr. Andal’s nexus clarification. The Chairman said his proposal called for an elimination of sales tax on Internet remote sales regardless of nexus.

Mr. Sidgmore said he agreed with Mr. Waitt that the digital divide would get worse if Internet sales were tax exempt. He said an Internet tax exemption would create a special class around the Internet, and he said he believed traditional businesses would be hurt. Regarding quantification of the impact of Internet sales on tax revenues, he said the predicted dramatic growth of the Internet would mean that the "traditional economy" will lose power and sales tax revenues will be reduced. Given the infancy of the medium, Mr. Sidgmore asked if it would not be prudent to promote the Internet’s development by delaying three or four years a tax or no tax decision.

Mayor Kirk said that he wished to associate himself with the Comments of Messrs Waitt and Sidgmore with respect to the digital divide and the future economic impact of the Internet.

The Chairman then moved to consideration of the resolutions submitted by Mr. Norquist [attached]. Mr. Lebrun said that he remained opposed to piecemeal voting on such resolutions that should be considered as part of a final report. Mr. Norquist then put forward Resolution One calling for sunset clauses for all federal telecommunication taxes. He said he did not call for a vote on this resolution, but wanted it to be publicly presented. His Resolution Two dealt with business activity taxes. He also did not call for a vote on this resolution noting that this was the first time it was put forward. He asked for votes on Resolutions Three and Four — a prohibition on Internet access taxes and the elimination of the federal three percent telecommunications tax. He said he thought it was important to demonstrate to the country that the Commission had consensus on these issues.

Mr. Lebrun noted that by voting on these resolutions, the Commission would be piecemealing votes on issues that have been discussed. He said he believed there was a consensus to look at these issues again in Dallas as part of the Commission’s completed work. He then moved to table Resolutions Three and Four. Mr. Novick seconded the motion. Mr. Norquist said he believed it was important for the Commission’s voice to be heard as the Administration was developing its budget, which would be presented prior to the Commission’s meeting in Dallas.

The Chairman ruled that further debate was not permitted on a motion to table, so he called for a roll call vote among the 15 Commissioners present noting that a simple majority would be eight. Mr. Andal called for a point of order and said that Resolution 4 had not been formally offered. The Chair ruled that resolutions 3 and 4 had been offered.

A vote was then taken on the motion to table Resolutions 3 and 4 as offered by Mr. Norquist. The motion to table passed 10 to 5 with Messrs. Andal, Harris, Norquist, Sokul and the Chairman voting no; and Messrs. Guttentag, Lebrun, Novick, Parsons, Pincus, Pottruck, Sidgmore, Waitt, Ms. Jones and Governor Leavitt voting yes.

Mr. Pottruck spoke next, saying that the Commission’s job is to make a recommendation about the right approach for a 21^st century sales tax solution. He said he appreciated the debate among Commissioners and the input from outside presenters and looked forward to a productive dialog in anticipation of the Dallas meeting.

The Chairman then moved to a discussion of the issue of taxes on the sale of digital goods. Mr. Lebrun acknowledged the complexity of the issue and noted it deserved further discussion prior to a final decision

The Chairman then introduced the nexus issue from the Issues and Policy Options Paper, and a brief discussion ensued regarding the issue and Mr. Andal’s proposal.

The Chairman then introduced Section V of the Issues and Policy Options Paper, Business Activity Taxes. He then asked Mr. Sokul to comment on Section VI, Redress Mechanism for Imposition of Unconstitutional State and Local Taxes. Mr. Sokul suggested that federal courts should hear the federal question involved in this issue rather than each state court involved. He promised to provide Commissioners additional information.

The Chairman then introduced Section VII concerning the Digital Divide and noted that his proposal called for a clarification of the ability of states to spend surplus TANF funds for the purchase of computers and access for needy families. Mr. Norquist asked that other tax reduction suggestions be added to Section VII, such as the three percent federal telecommunications tax, access tax and reduction in state and local taxes, all of which, he said, exacerbate the digital divide. Mr. Norquist then asked where the Clinton Administration representatives stood on Section VII. Ms. Jones suggested that training for families be considered a part of any use of TANF funds to address the digital divide.

Mr. Pincus said that there was a preliminary indication that surplus TANF funds could be used to address the digital divide issue. He promised to have a final view on that for the Dallas meeting. Mr. Lebrun said that he would ask South Dakota Governor Janklow to provide information to Commissioners on his program for wiring schools and his position on the issue. Mr. Guttentag said the Commission should not look on the TANF proposal as the sole solution to the issue of the digital divide.

The Chairman then called for approval of the minutes of the New York meeting. Mr. Guttentag asked that small wording changes be permitted; the Chairman agreed. The minutes were unanimously adopted.

The Chairman then called on Ms. Jones for an update on federal funding for the Commission. She called attention to the revised budget and noted that Congress had provided $1.4 million for the Commission’s operation. She thanked Senators Lott and Gregg and Congressman Bliley for their efforts in funding the Commission. Ms. Jones also noted that the budget does not call for compensation for in-kind services already provided and that it does call for reimbursement for corporate contributions and the contribution from the Commonwealth of Virginia as the last expenditures. A motion to accept the budget was moved, seconded and unanimously approved. The Chairman thanked Gateway Inc., America Online, Charles Schwab Corporation, AT&T, MCI WorldCom, Time-Warner and the Commonwealth of Virginia for providing funding to get the Commission started.

The Chairman then discussed the final report process. The Work Plan, he said, calls for a draft to be distributed to all Commissioners with the potential for one or more conference calls between the San Francisco and Dallas meetings. At the Dallas meeting, the primary task will be to approve the final report and to debate motions to modify or amend it, he said. Should the Commission determine that additional input is required, a limited substantive program can be scheduled, the Chairman said. He added that he envisioned the report consisting of an overview of the Commission’s legislative charge, a synopsis of the Commission’s deliberations, and objective narrative explaining the tax issues implicated by the Internet economy and policy recommendations. He noted that the Commission would consider proposals that may come forward and that there would be ways to include information in the final report that that is not part of a formal recommendation.

Mr. Pincus thanked Heather Rosenker and the Commission staff or putting together an exceptional meeting.

The Commission then voted to adjourn.

Whereas many Americans cannot use the Internet due to the cost of

access, and

Whereas taxes and other government-imposed levies on telecommunications services increase costs for consumers, making the Internet less accessible, and

Whereas government levies that make the Internet less accessible are contrary to stated government goals of making the Internet accessible to all,

Therefore, be it resolved, the Advisory Commission on Electronic Commerce recommends that Congress set specific achievable goals for any taxes or other levies that increase telecommunications costs for consumers, and

Be it resolved that the Commission recommends that Congress sunset any taxes or other levies on telecommunications services once the specific goals outlined for such taxes and other levies are achieved.

Whereas states have traditionally imposed corporate income and/or business activity taxes only upon businesses that operate, and therefore receive public benefits and protections, within each state, and

Whereas recently a significant number of states have attempted to impose their business activity taxes to burden those businesses that are not provided any measurable public protections or benefits by the taxing states, and

Whereas these states are attempting to tax the income of out-of-state corporations engaging in virtually no income-producing activity in those jurisdictions, and

Whereas some state tax collectors have begun to impute physical presence to companies due to their virtual or electronic presence, or due to their ownership of equipment needed solely to transfer information in a cyber economy, and

Whereas the business community's concerns over being subjected to unfair income or business activity taxes has been heightened by recent court rulings in several states that "impute" physical presence in various legal contexts due to their virtual or electronic presence, and

Whereas such attempts at taxation constitute an unfair attempt by some states to reach beyond their borders and impose new layers of taxation,

Therefore, be it resolved that a company that uses an Internet service provider or that places digital data on an Internet service provider's web server in a state would not have "substantial physical presence" in that state and should not be subject to income or business activity taxes in that state; and

Be it further resolved that a company that uses communications services in a state should not have "substantial physical presence" in that state and should not be subject to income or business activity taxes in that state;

Be it further resolved that a company that owns only intangible property, or is only "affiliated" with another company in another state, should not have "substantial physical presence" in a state and should not be subject to income or business activity taxes in that state.

Resolution supporting no taxes on Internet access

Whereas information technology industries account for more than one-third of real growth in the United States' Gross Domestic Product over the past three years with the Internet driving the economic success of this country over that time period, and

Whereas our goal should be what every American citizen and business have access to the Internet, and

Whereas the Washington Post recently reported that Japanese citizens have less access to the Internet due to high telephone taxes and fees, and

Whereas it is inconsistent public policy to spend millions of dollars to connect schools and institutions across America to the Internet while at the same time tax the very access they are then able to achieve, and

Whereas the taxation of Internet access at any level would negatively impact education and economic growth in this country and raise greater barriers to access for those who have the least means of attaining access in the first place, and

Whereas this artificial increase in the cost of Internet access must be ended or not allowed to be implemented in the first place,

Therefore be it resolved that no taxes or fees should be levied on the retail or wholesale provision of Internet access at any level.

Resolution recommending that the 3% tax on telecommunications services and use should be eliminated.

Whereas, the 3% telecommunications tax was put into place to fund the Spanish-American War, and,

Whereas, this tax has continued to persist even though by last count the War has ended, and,

Whereas, this tax only serves to raise the rate of telecommunications on every person in the country, and raises the costs to those who are attempting to access the Internet, and

Whereas, taxation on telecommunications use decreases the efficiency of telecommunications, and,

Whereas, taxation on telecommunications falls most heavily on those least able to afford the extra cost, and,

Whereas, this tax may be the explanation as to why some areas have less access to the Internet than other areas, and,

Whereas, eliminating arbitrary barriers to Internet access should be a goal, and,

Therefore, be it resolved that the 3% tax on telecommunications services and use should be eliminated.