E-Commerce Taxation & Regulation

I caught this tidbit today in a Washington Post article about Julius Genachowski’s tenure as Federal Communications Commission chairman:

He wound up presiding over a crucial period in which the powerful companies of Silicon Valley turned into Washington power players. Lobbying the FCC has become a major economic franchise. Each day, hundreds of dark-suited lawyers crowd the antiseptic, midcentury-modern agency building.

Can anyone think this is a good thing? To be clear, I don’t think Genachowski is solely responsible for Silicon Valley innovators getting more aggressive in Washington or for tech lobbying becoming “a major economic franchise” at the FCC. There’s plenty of blame to go around in that regard. Regardless, every legislative and regulatory action that opens the door to greater regulation of the information economy also opens the door a bit wider to unproductive rent-seeking and cronyist activities. Moreover, every minute and every dollar spent focusing on making legislators and regulators happy is another minute and dollar that could have better been spent making consumers happy in the marketplace. It’s a pure deadweight loss to society.

And there has been a remarkable expansion in such tech lobbying activity over the past decade, as the following charts illustrate. The first shows the dramatic growth of lobbying by computer and Internet companies relative to other sectors and the second shows lobbying spending by specific computer and Internet companies. [Click to enlarge.]

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With each passing year, Washington’s appetite for Internet regulation grows. While “Hands Off the Net!” was a popular rallying cry just a decade ago—and was even a shared sentiment among many policymakers—today’s zeitgeist seems to instead be “Hands All Over the Net.” Countless interests and regulatory advocates have pet Internet policy issues they want Washington to address, including copyright, privacy, cybersecurity, online taxation, broadband regulation, among many others.

Rep. Darrell Issa (R-CA) wants to do something to slow down this legislative locomotive. He has proposed the “Internet American Moratorium Act (IAMA), which would impose a two-year moratorium on “any new laws, rules or regulations governing the Internet.” The prohibition would apply to both Congress and the Executive Branch but makes an exception to any rules dealing with national security.

Will Rep. Issa’s proposal make any difference if implemented? Any congressionally imposed legislative moratorium is a symbolic gesture and not a binding constraint since Congress is always free to pass another law later to get around an earlier prohibition. So, in that sense, a moratorium might not change much. Nonetheless, such symbolic gestures are often important and Issa is to be commended for at least trying to raise awareness about the dangers of creeping regulation of online life and the digital economy.

If policymakers really want to take a more substantive step to slow the flow of red tape, they should consider a different approach. Instead of (or, perhaps, in addition to) a two-year legislative moratorium, they should impose a variant of “Moore’s Law” for information technology laws and regulations. “Moore’s Law,” as most of you know, is the principle named after Intel co-founder Gordon E. Moore who first observed that, generally speaking, the processing power of computers doubles roughly every 18 months while prices remain fairly constant.

As I argued in a Forbes column earlier this year, we should apply this same principle to high-tech policy. Continue reading →

Post image for Dan Provost on indie capitalism

Designer Dan Provost, co-founder of the indie hardware and software company Studio Neat, and co-author of It Will Be Exhilarating: Indie Capitalism and Design Entrepreneurship in the 21st Century, discusses how technological innovation helped him build his business. Provost explains how he and his co-founder Tom Gerhardt were able to rely on crowdfunding to finance their business. Avoiding loans or investors, he says, has allowed them to more freely experiment and innovate. Provost also credits 3D printing for his company’s success, saying their hardware designs–very popular tripod mounts for the iPhone and a stylus for the iPad–would not have been possible without the quick-prototyping technology.


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Steve Titch gave you a thorough run-down last week. Now Tim Carney has a quick primer on the push by big retailers to increase tax collection on goods sold online.

S. 1832, the Marketplace Fairness Act currently enjoys no affirmative votes on WashingtonWatch.com. Good.

The U.S. Senate holds hearings Wednesday on the so-called Market Fairness Act (S. 1832), which would be better dubbed the “Consumer and Enterprise Unfairness Act,” as it seeks to undo a critical requirement that prevents states from engaging in interstate tax plunder.

In a series of court decisions that stretch back to the 1950s, the courts have consistently affirmed that a business must have a physical presence within a state in order to be compelled to collect sales taxes set by that state and any local jurisdiction.

That meant catalogue and mail order businesses were not required to collect sales tax from customers in any other state but their own. The three major decision that serve as the legal foundation for this rule, including Quill v. North Dakota, the case cited most frequently.

Quill left room for Congress to act, which indeed it is doing with the Market Fairness Act. The impetus for the act has nothing to with the catalogue business, however. Rather, it’s the  estimated $200 billion in annual Internet retail sales, a significant portion of which escapes taxation, that’s got the states pushing Congress to take a sledgehammer to a fundamental U.S. tax principle that has served the purpose of interstate commerce since 1787.

That year, of course, is when the U.S. Constitution replaced the Articles of Confederation. One of the flaws of the Articles was that it permitted each of the states to tax residents of others. Rather than get the budding nation closer to the nominal goal of confederation, it was endangering the expansion of vital post-colonial commerce by creating 13 tax fiefdoms and protectorates. The authors of the Constitution wisely addressed this by vesting the regulation of interstate commerce in the federal government.

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Proponents of higher taxes have taken to calling the exemption that out-of-state online shoppers enjoy a “loophole,” as if it were an unintended flaw in two established court rulings that addressed the power of one state to tax residents of another.

My latest commentary at Reason.org looks at the so-called Marketplace Fairness Act, a bill that the House Judiciary Committee has scheduled for hearings tomorrow. The bill aims to help states collect sales taxes on out-of-state purchases, typically made via catalogue or, to an ever-greater extent, the Internet. Two Supreme Court decisions, Quill vs. North Dakota and National Bellas Hess vs. [Illinois] Department of Revenue, both of which pre-date Internet shopping, protect out-of-state consumers from the taxman’s reach.

As I write:

Editorials and op-eds supporting the bill, such as in the Arizone Daily Star and the Chicago Sun-Times, say it will close a “loophole” that allows Internet purchases to escape taxation. This is akin to saying the Supreme Court’s Miranda decision is a loophole for defendants to escape prosecution. No doubt some overzealous prosecutors may think so, but in truth, Miranda sharpened and affirmed the right of due process already present in the Fourth and Fifth Amendments. Likewise, in Quill and Bellas Haas, the courts sharpened and affirmed the Constitution’s commerce clause that prevents one state from taxing residents of another.

Seeing it as counterproductive to an interdependent economy, the Founders did not want states plundering each other’s residents and enterprises with taxes. Yet that’s exactly the environment the Marketplace Fairness Act sets up. New York State can tax residents of Illinois and the Prairie State can tax Hoosiers.

In doing so, the Marketplace Fairness Act ignores the constitutional underpinnings of the Quill and Bellas Hess decisions and treats the Internet sales tax issue as a procedural issue when the in fact the constitutional bar is set much higher. The giveaway, however, is the portion of the bill that requires states to simplify their state tax collection procedures before launching cross-border taxation. It’s an unusual quid pro quo, perhaps because Congress has to offer states the prerequisite of a buy-in. That’s because any attempt to impose a tax collection structure wholesale on the states would likely face a constitutional challenge on 10th Amendment grounds of state’s rights.

In reality, the states, struggling as they are with debt crises of their own making, are angling for a greater piece of the $200 billion Americans are spending with Internet merchants each year. Of course, not all of this goes untaxed; on-line retailers who have brick-and-mortar stores within a state must collect tax from residents in that state. Besides creating a mess of competing state tax grabs, this law stands to increase paperwork and complexity for thousands of small online businesses and catalogue firms, who would now be obliged to calculate taxes on some 11,000 sales tax jurisdictions throughout the country. Whether or not it’s “simplified” in line with some Congressional definition, it still stands to be the burden as noted in Quill and Bellas Hess.

But all the talk of loopholes, level playing fields and what does or does not constitute a “burden” diverts attention from the real issue. The Marketplace Fairness Act is not about the Internet, e-commerce, the marketplace or fairness–it’s about what the Constitution says about the power of state governments to tax citizens beyond their borders.

The Reason Foundation today has published the Telecommunications and Internet section of its 2011 Annual Privatization Review.

Although there’s been a bit of lead time since the articles were written, they are still timely. Notable is the discussion on the collection of state sales taxes from Internet retailers, back in the news now that Amazon.com has reached an agreement with the state of Texas to collect sales taxes from consumers in the Lone Star State. The settlement concludes a lengthy battle in Austin as to whether Amazon’s distribution facility in Ft. Worth constitutes a “nexus” as defined in previous court cases.

While a blow to Amazon’s Texas customers (full disclosure: I count myself as one), the action may shed further light on the debate as to how much advantage the Amazon has because it can waive sales tax collection. Competitors such as ailing Best Buy have said it’s enough to hurt brick-and-mortar retailers. Amazon points to findings that in New York, the most populous state where it collects sales tax, sales have not fallen off. Soon we’ll see if Texas tracks with that data as well. If it does, it will further validate opinions that Amazon and other on-line retailers are succeeding because they have fundamentally changed the way people shop, not because they can simply avoid sales taxes.

Also in the report look for updates on the FCC’s options for the next spectrum auction, state and federal policymaking on search engines and social networking sites, and how priorities may change as the FCC migrates from the current Federal Universal Service Fund to its new more broadband-oriented Connect America Fund.

The telecom section of APR 2011 can be found here.

A few weeks back, now-former Best Buy CEO Brian Dunn blamed the retailer’s $1.7 billion quarterly loss and its decision to close 50 stores nationwide on the fact that its online competitors, Amazon.com in particular, “aren’t encumbered by the costs of running physical locations and in many cases don’t have to collect sales tax.”

Dunn’s comments rehash the now-familiar meme that forcing e-retailers to collect sales tax is the silver bullet to saving brick-and-mortar retailers. It gives politicians on all sides cover–for some, it’s a way to keep revenues coming in for excessive spending. For others, it’s a handy way to wave the flag for local commerce.

But slapping consumers with more taxes isn’t going to save retailing. In a short piece this week, BusinessWeek explores the fundamental shifts online retailing has created in consumer behavior. Here’s a nugget from the article:

Best Buy’s decline reflects a cultural shift that’s reshaping the retail world. All big-box stores, and Best Buy in particular, thrived in an era when comparison shopping meant physically going from store to store. The effort required of consumers was a kind of transactional friction. With the advent of mobile technology, friction has all but disappeared. Rather than ruminate with a salesperson before making a selection, tech-savvy consumers are more likely to walk into stores, eyeball products, scan barcodes with their smartphones, note cheaper prices online, and head for the exit. Shoppers can purchase virtually any product under the sun on Amazon or eBay while sipping a latte at Starbucks. For traditional retailers, that spells trouble, if not death. “So far nothing Best Buy is doing is fast enough or significant enough to get in front of these waves,” says Scot Wingo, CEO of e-commerce consulting firm ChannelAdvisor.

Certainly e-commerce created competitive problems for Best Buy, but the sales tax advantage was likely the least of them. Brick-and-mortar retailing is facing an out-and-out crisis that’s going to require creativity and innovation to solve. Taxing consumers who buy online won’t do much toward that end.

And for more, see Adam’s post on Heritage Foundation’s new report on Internet tax policy.

Heritage Foundation released a new study this week arguing that “Congress Should Not Authorize States to Expand Collection of Taxes on Internet and Mail Order Sales.” It’s a good contribution to the ongoing debate over Internet tax policy. In the paper, David S. Addington, the Vice President for Domestic and Economic Policy at Heritage, takes a close look at the constitutional considerations in play in this debate. Specifically, he examines the wisdom of S. 1832, “The Marketplace Fairness Act.” Addington argues that, “enactment of S. 1832 would discourage free market competition” and raise a host of other issues:

The Constitution of the United States has set the legal baseline—the level playing field—around which the American free-market economy has built itself. The Constitution, as reflected in the Quill decision, is the source of the present arrangement regarding collection of state sales and use taxes by remote sellers. Ever since the Supreme Court decided Quill in 1992, American businesses have made millions of business decisions in the competitive marketplace based in part on settled expectations regarding state taxation affecting their sales transactions. The states and businesses advocating S. 1832 seek to change the current, constitutionally prescribed playing field. They seek to use governmental power to intervene in the economy to help in-state, store-based businesses by imposing a new tax-collection burden on out-of-state competitors who sell over the Internet, through mail order catalogs, or by telephone. Free-market principles generally discourage such government intervention in the economy to pick winners and losers based on legislative policy preferences.

Veronique de Rugy and I raised similar concerns in both a recent Mercatus white paper (“The Internet, Sales Taxes, and Tax Competition“) and an earlier 2003 Cato white paper, (“The Internet Tax Solution: Tax Competition, Not Tax Collusion”). We argued that there are better ways to achieve “tax fairness” without sacrificing tax competition or opening the doors to unjust, unconstitutional, and burdensome state-based taxation of interstate sales. Specifically, we point out that an “origin-based” sourcing rule would be the cleanest, most pro-constitutional, and pro-competitive alternative. I also discussed these issues at a recent Cato event. [Video follows.]

Reason.org has just posted my commentary on the five reasons why Federal Trade Commission’s proposals to regulate the collection and use of consumer information on the Web will do more harm than good.

As I note, the digital economy runs on information. Any regulations that impede the collection and processing of any information will affect its efficiency. Given the overall success of the Web and the popularity of search and social media, there’s every reason to believe that consumers have been able to balance their demand for content, entertainment and information services with the privacy policies these services have.

But there’s more to it than that. Technology simply doesn’t lend itself to the top-down mandates. Notions of privacy are highly subjective. Online, there is an adaptive dynamic constantly at work. Certainly web sites have pushed the boundaries of privacy sometimes. But only when the boundaries are tested do we find out where the consensus lies.

Legislative and regulatory directives pre-empt experimentation. Consumer needs are best addressed when best practices are allowed to bubble up through trial-and-error. When the economic and functional development of European Web media, which labors under the sweeping top-down European Union Privacy Directive, is contrasted with the dynamism of the U.S. Web media sector which has been relatively free of privacy regulation – the difference is profound.

An analysis of the web advertising market undertaken by researchers at the University of Toronto found that after the Privacy Directive was passed, online advertising effectiveness decreased on average by around 65 percent in Europe relative to the rest of the world. Even when the researchers controlled for possible differences in ad responsiveness and between Europeans and Americans, this disparity manifested itself. The authors go on to conclude that these findings will have a “striking impact” on the $8 billion spent each year on digital advertising: namely that European sites will see far less ad revenue than counterparts outside Europe.

Other points I explore in the commentary are:

  • How free services go away and paywalls go up
  • How consumers push back when they perceive that their privacy is being violated
  • How Web advertising lives or dies by the willingness of consumers to participate
  • How greater information availability is a social good

The full commentary can be found here.