Congressional Intervention in State Taxation:
A Normative Analysis of Three Proposals
by
Charles E. McLure, Jr.
Hoover Institution, Stanford University
Walter Hellerstein
University of Georgia Law School1
Congress currently is considering or is about to consider three significant pieces
of proposed legislation affecting state taxation: a proposal to extend (and perhaps expand)
the Internet Tax Freedom Act (ITFA); a proposal to allow states to require collection of
taxes on remote sales if they simplify their tax system in accord with the Streamlined
Sales Tax Project (the Streamlined Sales and Use Tax Act (SSUTA)); and a proposal to
expand nexus restrictions on business activity taxes (BATs). In this paper, we consider
the merits of congressional intervention to limit and expand state taxing authority from a
tax policy perspective informed by a normative analysis of the appropriate role of the
federal government vis-à-vis state taxing authority. Part I provides an overview of
congressional intervention in state tax matters against the background of the historical,
political, and constitutional understanding of state tax sovereignty. Part II provides an
overview of the normative principles of tax policy that should inform congressional
intervention in state tax matters in light of the background described in Part I. Part III
describes the three congressional proposals at issue, elaborates upon the key normative
considerations that bear on them, and applies those norms in evaluating the proposals.
I.
Historical, Political, and Constitutional Overview
Insofar as state taxation affects interstate commerce, Congress has virtually
unlimited authority to restrict or expand the inherent taxing authority that the states
possessed when they joined the Union insofar as state taxation affects interstate
commerce.2 The U.S. Supreme Court has made it clear, for example, that the authority
the Constitution confers upon Congress "to regulate commerce … among the several
States"3 gives Congress plenary power over the channels of interstate commerce.
Accordingly, "Congress may keep the way open, confine it broadly or closely, or close it
entirely,"4 subject only to the restraints that the Constitution imposes on Congress's own
power -- restraints that do not materially limit Congress's power to legislate with respect to
state taxes. Indeed, the Court has explicitly indicated that Congress possesses power to
legislate uniform state tax rules for commerce among the states. It has observed that "[i]t is
clear that the legislative power granted to Congress by the Commerce Clause of the
Constitution would amply justify the enactment of legislation requiring all States to adhere
5
to uniform rules for the division of income." Moreover, it is equally clear that Congress
may consent to state legislation as part of a rational solution to the problem of taxing
interstate commerce, even if such legislation would be unconstitutional under the "dormant"
6
Commerce Clause in the absence of such consent. As the Court observed in Quill Corp. v.
1
North Dakota,7 which reaffirmed the dormant Commerce Clause principle that the physical
presence of an out-of state vendor is an essential prerequisite of a state’s power to require
the vendor to collect the state's use tax, "Congress is . . . free to decide whether, when, and to
what extent the States may burden mail-order concerns with a duty to collect use taxes."8
Despite the broad power that Congress possesses to legislate regarding state
taxation of interstate commerce, historically Congress has rarely exercised this power, at
least by comparison to the vast body of congressional legislation restricting state
regulation of interstate commerce. Public Law 86-272, which limits the states' power to
tax income that an out-of-state vendor derives from sales into a state when the vendor’s
only activities in the state are the solicitation of orders for tangible personal property, is
the most significant piece of federal legislation restricting state taxing power.9 Apart from
this statute, Congress has restricted state power (other than state power to tax the federal
government or its instrumentalities) only in narrowly defined circumstances. For
example, in adopting the Railroad Revitalization and Regulatory Reform Act of 1975,10
Congress prohibited the states from taxing railroad property more heavily than other
commercial and industrial property. Congress subsequently extended similar protection to
motor carriers,11 and to air carriers.12 In amending the federal securities acts in 1975,
Congress imposed limitations on the power of states to levy stock transfer taxes.13
Federal legislation also prohibits the states from imposing user charges in connection
with the carriage of persons in air commerce;14 it "supersede[s] any and all State taxes
insofar as they now or hereafter relate to any employee benefit plan" instituted pursuant
to the Employee Retirement Income Security Act (ERISA);15 it prohibits the states from
imposing electrical energy taxes discriminating against out-of-state purchasers;16 it
prohibits localities from taxing providers of direct-to-home satellite services;17 it
prohibits states from taxing interstate passenger transportation by motor carriers18; and it
authorizes, under specified conditions, state taxation of charges for mobile
telecommunications services.19
The question naturally arises as to why Congress has so rarely intervened in
matters of state taxation and generally has done so only in the most targeted manner
when it has restricted or expanded state taxing authority. We believe that the answer lies
in the strong tradition of state tax sovereignty, which is reflected in long-standing
political and constitutional understandings. The states' sovereign power of taxation has
always been regarded as essential to their independent existence and thus to the federal
scheme that the Framers created. Writing in The Federalist in 1788, Alexander Hamilton
declared:
[T]he individual States should possess an independent and uncontrollable
authority to raise their own revenues for the support of their own wants …. I
affirm that (with the sole exception of duties on imports and exports) they would
retain that authority in the most absolute and unqualified sense; and that any
attempt on the part of the national government to abridge them in the exercise of
it would be a violent assumption of power unwarranted by any article or clause of
the Constitution.20
2
Throughout our constitutional history the U.S. Supreme Court has made similar
statements reflecting its view that the states' taxing powers are critical to their separate
existence and are an essential element of state sovereignty. Thus Chief Justice Marshall
observed in 1824 that the states' "power of taxation is indispensable to their existence."21
Fifty years later, the Court echoed these sentiments when it declared:
That the taxing power of a State is one of its attributes of sovereignty; that it
exists independently of the Constitution of the United States, and underived from
that instrument; and that it may be exercised to an unlimited extent upon all
property, trades, business, and avocations existing or carried on within its
territorial boundaries of the State, except so far as it has been surrendered to the
Federal government, either expressly or by necessary implication, are
propositions that have often been asserted by this court. And in thus
acknowledging the extent of the power to tax belonging to the States, we have
declared that it is indispensable to their continued existence.22
The Court has reiterated these beliefs in its modern opinions: "When dealing with their
proper domestic concerns, and not trenching upon the prerogatives of the National
Government or violating the guaranties of the Federal Constitution, the States have the
attribute of sovereign powers in devising their fiscal systems to ensure revenue and foster
their local interests."23
We should not be surprised by the deeply entrenched belief that state tax
sovereignty is fundamental to the states' political independence. To be sure, as a matter of
theory, taxing powers might be lodged exclusively at the national level and tax revenues
distributed to the states without any limitation on how such revenues might be spent,
thereby giving the states "spending" sovereignty without "tax" sovereignty. There are at
least three problems with such an arrangement. First, we know from experience that he
who pays the piper calls the tune. Consequently, tax revenues raised at the national level
are unlikely to be distributed to subnational levels of government without material
restraints on how such revenues may be spent, thus compromising spending sovereignty.
Moreover, without independent taxing authority, a state's ability to determine the size, as
well as the shape, of the public sector is likely to be substantially limited. Finally,
experience in other countries shows that when subnational governments spend money
provided by higher levels of government public spending tends to be bloated and
wasteful.24
The understanding that states' tax sovereignty is essential to their independent
political status in the federal system has never been regarded as inconsistent with the
view that the federal government likewise possesses sovereign tax powers. To draw once
more on the words of Chief Justice Marshall:
The power of taxation … is a power which, in its own nature, is capable of
residing in, and being exercised by, different authorities at the same time. We are
accustomed to seeing it placed for different purposes, in different hands….
Congress is authorized to lay and collect taxes …. This does not interfere with the
3
power of the States to tax for the support of their own governments; nor is the
exercise of that power by the States an exercise of any portion of the power that is
granted to the United States.25
More recently, the Court made a similar point in observing that "[c]oncurrent federal and
state taxation of income … is a well-established norm."26
The preceding discussion should not be taken to suggest that a state taxing statute
may never be incompatible with either the express or implied restraints that the
Constitution imposes on the states or with the exercise of congressional power to preempt
state taxation. State tax sovereignty should not be confused with state tax supremacy.
Nevertheless, despite the existence of some overriding restraints on state tax sovereignty,
the widely shared understanding that the states' independent powers of taxation are
central to their political identity in the federal system, and compatible with the existence
of like powers in the national government, necessarily informs the analysis of the proper
balance of federal and state power in matters of state taxation, and, in particular, when
congressional intervention in state matters is appropriate.
One further observation may be in order regarding what may be considered as a
"disconnect" between the existence of broad congressional power to control state taxation
of interstate commerce and the almost total absence of significant congressional
legislation exercising such power. For many years, state taxation of interstate commerce
simply was not a problem worthy of congressional attention. For much of the nineteenth
century, economic activity was predominantly local, and states, as well as local
governments, relied largely on the property tax as a source of revenue.27 The first modern
state corporate income tax was not enacted until 1911 and states did not adopt broadbased sales taxes until the 1930s. As the national economy became increasingly
integrated, the U.S. Supreme Court found that diverse and complex state tax laws can
impose an unacceptable burden on interstate commerce, and it explicitly invited Congress
to forge more comprehensive measures to alleviate such burdens than those it was
capable of providing through case-by-case adjudication.28 Although the case for
congressional intervention in state taxation therefore may be more compelling today than
it was in the past, the dangers associated with such intervention are also more acute,
because the power Congress possesses to do good is matched by its power to do harm.
Indeed, these dangers are evident in both existing and proposed legislation that we
discuss below – legislation that in some respects is more reflective of the exercise of raw
political power than of the dictates of sound tax policy.
II.
A Normative Perspective
A.
Types of Congressional Intervention
Congress can intervene in state tax matters in any one of three ways. It can
prohibit or limit states' exercise of their existing powers of taxation; it can consent to the
exercise of state tax powers that would have been barred in the absence of such consent;
and it can combine the first two types of intervention, permitting the states to exercise
4
powers of taxation they might not otherwise possess but only if they do so in a manner
prescribed by Congress (which may curtail power the states otherwise possess).
Most congressional intervention in state tax matters has been of the first type.29
Nevertheless, Congress has on occasion explicitly consented to the exercise of state
taxing authority that would have been barred in the absence of such consent. For
example, when the U.S. Supreme Court overruled long-standing precedent that multistate insurance companies were not engaged in "commerce" in holding that "insurance"
constituted "commerce" for purposes of the antitrust laws,30 Congress quickly restored
the status quo ante by enacting the McCarran-Ferguson Act,31 which, among other things,
left the states free of Commerce Clause restraints in taxing the insurance industry. The
act declared that "the silence on the part of Congress shall not be construed to impose any
barrier to the regulation or taxation of [the business of insurance] by the several states."32
Similarly, Congress has on occasion enacted legislation combining interventions
of the first and second types, as illustrated by the recently enacted Mobile
Telecommunications Sourcing Act (MTSA).33 Under jurisdictional standards that the
U.S. Supreme Court articulated in Goldberg v. Sweet34 under the Commerce Clause, the
“only” states with “a nexus substantial enough to tax a consumer's purchase of an
interstate telephone call” are (1) “a State … which taxes the origination or termination of
an interstate telephone call charged to a service address within that State” and (2) “a State
which taxes the origination or termination of an interstate telephone call billed or paid
within that State.”35 The implications of these standards for taxation of the wireless
telecommunications industry are troublesome to say the least. Consider a business
traveler who lives in State A, where she receives her monthly phone bill, and, while in
State B on business, makes a call to State C. Under Goldberg, none of these States can tax
the charges for the call, because none of them can claim that the call either originates or
terminates in the state and is charged to a service address in the state or is billed or paid
within the state.36
The difficulties involved in taxing mobile telecommunications under the regime
the Court established in Goldberg led Congress, with the joint support of the
telecommunications industry and the states, to enact the MTSA, which permits the states
to tax all mobile telecommunications charges (for services provided by the customer's
"home service provider") at the customer's "place of primary use."37 The key operative
language of the MTSA, which both expands and contracts state power to tax charges for
mobile telecommunications, provides:
All charges for mobile telecommunications services that are deemed to be
provided by the customer's home service provider … are authorized to be
subjected to tax, charge, or fee by the taxing jurisdictions whose territorial limits
encompass the customer's place of primary use, regardless of where the mobile
telecommunications services originate, terminate, or pass through, and no other
jurisdiction may impose taxes, charges, or fees on charges for such mobile
telecommunications services.38
5
The expansion of state power is provided by the grant of authority to the state of the
customer's home service provider to tax the charge for wireless services regardless of
whether that state possesses power to tax the call under the preexisting standards of
Goldberg v. Sweet. The contraction of state power is contained in the final clause that
prevents any state other than the state of the customer's home service provider from
taxing such charges, even if that state possessed power under Goldberg v. Sweet to tax
the charge.
B.
Normative Criteria Bearing on Federal Limitation of State Taxing Power:
Overview
The case for state tax sovereignty delineated in Part I is not categorical; there are
important reasons why state tax sovereignty should not be unlimited. Judicial or
legislative limits on state action may thus be appropriate, especially when it is the lack of
coordination of state policies that causes problems. But inappropriate federal limitations
on state taxing sovereignty can also be problematical. Inappropriate state policies and
inappropriate federal limitations on state action can create three types problems: adverse
economic effects (including economic distortions and inequities), excessive compliance
costs, and revenue loss, the last of which may result from increased opportunities for tax
planning.
Remedies should be designed carefully to address existing problems and avoid the
creation of new ones. The proper remedy depends on the nature and source of the
problem. Where the policies of a single state entail unacceptable economic effects, such
policies should be prohibited or otherwise curtailed. Where lack of interstate
coordination of state tax policies causes needless complexity and excessive compliance
costs, coordination and simplification should be required. Where federal limitations on
state actions, which may be either judicial or legislative, create adverse economic effects
or revenue loss, they should be modified; this, in turn, may require as a prerequisite the
modification of the state policies that initially led to the limitations.
Legislative remedies can be more nuanced than judicial remedies. The judiciary
can determine whether something is or is not allowed under the U.S. Constitution or
federal statutes, but it cannot and should not undertake the essentially legislative task of
enumerating in detail what is permitted or prohibited or prescribing the precise conditions
under which a state action would or would not be acceptable. Indeed, the U.S. Supreme
Court has steadfastly refused to undertake such legislative tasks and has frequently
recognized that the function of prescribing fine-tuned and detailed rules governing state
taxation of interstate commerce is properly within Congress’s -- not the Court’s -domain.39
Quill itself clearly illustrates the point. In Quill, the Court reaffirmed a simple,
“bright-line” prohibition on a state’s ability to require a vendor without physical presence
in the state to collect the state’s use tax, because of the burden that such a requirement
would impose on such a vendor in light of the complexity created by lack of coordination
among the states in their sales tax regimes. The Court pointedly did not establish a
6
threshold level of sales or indicate the contours of interstate coordination that would be
required for a state constitutionally to impose a collection obligation on a remote vendor.
To the contrary, the Court indicated that Congress could revise whatever “bright-line”
prohibition the Court may have articulated under the dormant Commerce Clause in any
manner that Congress sees fit, and, in particular, “is . . . free to decide whether, when, and
to what extent the States may burden mail-order concerns with a duty to collect use taxes."40
We are dealing here with three cases that have the following characteristics:
Internet Tax Freedom Act (ITFA). Proponents of this legislation claim that the
states must not be allowed to tax Internet access, in order to prevent adverse economic
consequences, namely hindrance of the growth of the Internet and electronic commerce
and aggravation of the digital divide between the more affluent, who generally have
ready access to the Internet, and the less fortunate, who are less “wired.” Opponents
object that even if these economic benefits are real, they are not significant enough to
justify the substantial revenue cost to the states of exempting Internet access, especially
once one considers the legislation’s broad definition of “Internet access.”
Streamlined Sales and Use Tax Act (SSUTA). State sales and use taxes41 are so
complex that requiring vendors who lack a physical presence in the taxing state to collect
use taxes would have the adverse economic effect of imposing an undue burden on
interstate commerce – a fact the U.S. Supreme Court recognized when it established the
physical presence test of nexus in National Bellas Hess, Inc. v. Department of Revenue42
and when it reaffirmed that test in Quill. Yet that test also creates the undesirable
economic effect of placing Main Street merchants at a competitive disadvantage, relative
to remote vendors, and undermines both revenues and the equity of the sales tax system.
SSUTA represents an attempt to remedy all these defects. It would prescribe
simplification of the sales and use tax system as a condition for the elimination of the
physical presence test, and generally authorize states that participate in the simplification
effort to require remote vendors to collect use tax for those states.
Business Activity Tax (BAT) Legislation. Public Law 86-272 prohibits imposition
of income taxes on those who, with only minimum contact with the taxing state, sell
tangible personal property to customers located there. This statute reduces complexity
for remote vendors, who otherwise might be required to pay tax to any state where they
make sales.43 But it also undermines equity and the revenue of state governments. The
proposed legislation would expand the nexus protection afforded by Public Law 86-272,
by extending it to all “business activities taxes,” making it applicable to all sales (not only
sales of tangible property), establishing a physical presence test similar to that of Quill,
and providing explicit safe harbor rules. Thus it would further reduce complexity, but at
the cost of aggravating revenue losses and inequity.
7
III.
Application of Norms to Recent Congressional Initiatives
In the final part of this paper, we describe the three congressional proposals at
issue, elaborate upon the key normative considerations that bear on them, and apply those
norms in evaluating the proposals. In some instances our analysis suggests that the tax
base should be broadened and in some that it should be narrowed. We do not conclude
from this, however, that taxes should be correspondingly higher or lower. Rather, we
assume a revenue-neutral process in which changes in tax bases occurring in a particular
state would be compensated by changes in tax rates, in order to leave revenues in that
state unchanged.
A.
The Internet Tax Freedom Act Extension
1.
The Internet Tax Freedom Act
In 1998, Congress enacted the Internet Tax Freedom Act (ITFA).44 The Act imposed
a three-year moratorium (subsequently extended for another two years)45 on three types of
taxes: (1) taxes on Internet access; (2) discriminatory taxes on electronic commerce; and (3)
multiple taxes on electronic commerce. ITFA expired in October 2003 and, as of this
writing, it has not been reenacted.
a.
Taxes on Internet access
The prohibition against taxes on Internet access forbade states from taxing charges
for "a service that enables users to access content, information, electronic mail or other
services over the Internet."46 In short, it forbade the states from taxing the monthly fee that
America Online and other Internet access providers charge to their customers for connecting
to the Internet. The Act, however, did not apply to any tax that "was generally imposed and
actually enforced prior to October 1, 1998."47
b.
Discriminatory taxes
The Act's prohibition against discriminatory taxes on electronic commerce would
have had little impact had it been limited to that concept as it is generally understood, since
there are no taxes of which we are aware that single out transactions in electronic commerce
for invidious treatment. However, because Congress defined "discriminatory taxes" to
include certain taxes in which a remote seller has only minimal nexus with the state, the
ITFA may have had some impact with respect to use tax collection obligations. Specifically,
Congress classified as "discriminatory" any tax (other than a grandfathered tax on
Internet access), if the "sole ability to access a site on a remote seller's out-of-State
computer server is considered a factor in determining a remote seller's tax collection
obligation."48 In substance, it forbade states from imposing taxes on Internet sales by
"remote" (i.e., non-physically present) sellers, if the state relied on the purchaser's "sole
ability" to access the seller's out-of-state computer server as a factor in determining
whether the remote seller has nexus with the state and, consequently, an obligation to
collect a tax on the transaction.49 ITFA also prevented the states from claiming that they
8
have nexus with a remote seller for purposes of requiring the remote seller to collect a use
tax on its Internet sales into the state by characterizing an Internet access provider (e.g.,
America Online) as the remote seller's agent "solely as a result of (I) the display of a
remote seller's information or content on the out-of-State computer server" of the Internet
access provider or "(II) the processing of orders through the out-of-State computer
server" of the Internet access provider.50
c.
Multiple Taxation
ITFA's prohibition of multiple taxation of electronic commerce was not a model of
clarity. A multiple tax was defined as
any tax that is imposed by one State …on the same or essentially the same electronic
commerce that is also subject to another tax imposed by another State … (whether
or not at the same or rate or on the same basis), without a credit (for example, a
resale exemption certificate) for taxes paid in other jurisdictions.51
Congress excluded from this definition of a "multiple tax" sales or use taxes imposed
concurrently by a state and its political subdivisions on the same electronic commerce and
"a tax on persons engaged in electronic commerce which may also have been subject to a
sales or use tax thereon."52
Although one can discern Congress' objective in enacting this provision -- to prevent
the same electronic commerce from being subject to tax by more than one state -- the
language that Congress chose to accomplish that goal was opaque at best. While the policy
objective of preventing more than one state from taxing "the same electronic commerce"
might leave some room for debate, the prevention of states from taxing "essentially the same
electronic commerce" was almost an invitation for controversy. Indeed, it read more like
cocktail party conversation than a carefully thought out restraint on state taxing power.
Moreover, Congress apparently believed that two states can tax "the same" or "essentially
the same" electronic commerce, even if the two levies are not imposed "on the same basis."
In any event, it is fair to say -- especially in light of the "grandfather clause" -- that
there was less than met the eye when ITFA's taxation moratorium was originally enacted
(and then renewed for two years). It was in substance a narrowly based prohibition on
Internet access charges with few other practical implications for state taxing authority.
However, during debates over the extension of ITFA -- a debate that is continuing -- the
stakes became much higher. Although there was never agreement about the language of any
bill proposing to extend or expand ITFA, or, indeed, precisely what the proposed language
meant, it is clear that some of the proposals would have (1) made the legislation permanent,
(2) eliminated the grandfather provision, and (3) extended the prohibition to certain
telecommunications utilized to provide "Internet access," which arguably included a broad
range of Internet services (including Internet telephony).53 Our ensuing evaluation does not
enter into the controversy over precisely what the various proposals for extension or
expansion mean. Rather we focus on what types of congressional action, if any, would make
sense from a normative perspective.
9
2.
Principal Normative Considerations Bearing on a Tax Exemption
for Internet Access
In considering the normative case for exempting Internet access, it is useful to
begin with the unrealistic situation in which the taxation of goods and services is
economically neutral and then consider the actual situation, in which there are important
deviations from economic neutrality. Since “Internet access” has been interpreted in
several ways, we consider first a narrow interpretation that allows an exemption only for
Internet access in the limited sense of connecting to the Internet, and then the much more
sweeping interpretations that include exemption of telecommunications and/or digital
content sold over the Internet.
a.
Economically neutral sales taxation
An economically neutral tax system would not interfere with market choices –
choices of what to consume and produce and how to organize and finance production and
distribution. A neutral system of sales taxation54 would follow these four tenets: a) all
sales to consumers would be taxed uniformly, b) all sales to business would be exempt, c)
these rules would apply whether sales were made by in-state vendors or by out-of-state
vendors, and d) the system would be simple – or at least as simple as possible, consistent
with other objectives.55 Principled deviations from such a regime can be justified in three
situations. First, it may not be cost-effective to require all vendors to collect the tax. (For
example, it would not be administratively feasible to require teenagers to collect sales tax
on lawn-mowing services.) We do not discuss this issue further. Second, if consumption
of particular products takes a disproportionate fraction of the income of the poor,
exemption of such products may further distributional objectives. However, an
exemption is likely to involve relatively little “bang for the buck,” because the non-poor
consume more of most products than do the poor, and there are generally much more
efficient ways to achieve distributional objectives, such as refundable income tax credits.
Third, consumption of certain products creates social benefits that are not reflected in
product prices (what economists call external benefits).56 It may thus be thought
appropriate to subsidize such consumption by exempting it from generally applicable
taxation, as is done with most education and health care.57
Proponents of exempting Internet access have often failed to articulate clearly the
economic principles underlying their position. There are, however, two principled
arguments that might support exemption of Internet access, narrowly defined, in a system
that is otherwise economically neutral. First, one might argue that the expansion of
Internet access creates external benefits and that such access should thus be subsidized by
relieving it of the tax burden imposed on other goods and services or taxing it at a lower
rate. Second, it may be considered important to subsidize Internet access in order to
bridge the digital divide between relatively poor non-users and more affluent users.
(Whether this is seen as involving the (current and future) distribution of income or as
involving external benefits, such as reducing crime and welfare dependency, is of little
consequence for the present discussion; the conclusions are roughly the same in either
10
event.) Cursory examination of these arguments reveals either that they are invalid or
that, even if valid, they would not justify the loss of revenue inherent in exemption of
Internet access.
“Network effects” are one example of potential external benefits. Network effects
occur when the benefits a user of a network receives depend on the size of the network58
Thus, for example, there is no benefit to having a telephone if no one else has one, and
not much benefit if only one other person has one. A third member of the network will
double the potential benefits enjoyed by each of the first two members, because they can
talk to two other parties, instead of only one. External benefits occur in this setting
because someone considering joining the network does not consider the benefits created
for existing users. It might be thought that there are enough unexploited network effects
to justify subsidizing Internet access in order to encourage greater use of the Internet.
One way to subsidize Internet access by households would be to exempt it from
otherwise applicable taxation.59
This argument for exempting Internet access is no longer valid, if ever it was.
The strongest case for such a subsidy would be to “jump-start” the growth of the Internet,
so that it could achieve critical mass.60 With estimates of more than 2 billion Internet
users, about 150 million of whom reside in the United States,61 such an “infant industry”
argument is ludicrous. Moreover, the case for a subsidy depends on the size of network
effects, relative to the private benefits realized by users, and (because of the revenue
consequences of exempting Internet access of existing users) on the size of the pool of
potential new users, relative to the pool of existing users.62 It is difficult to quantify
network effects, but it defies belief to suggest that the external benefits of adding more
users to the Internet are significant at this stage of the cyber-revolution or that they could
justify the revenue loss of exempting Internet access of all existing household users. 63
In theory, it would be possible to adjust the tax system to encourage network
effects, while avoiding significant revenue loss, by limiting the exemption of Internet
access to new users, but, as a practical matter, this does not seem to be administratively
feasible.64 Exempting only basic access would be preferable to exempting all Internet
access, since the revenue costs, although far from inconsequential, would be lower, but
that raises difficult definitional problems – problems that could best be addressed by
simply exempting a given dollar amount of monthly charges.65
An argument can also be made that access to broadband should be subsidized, the
point being that access to broadband reduces “hourglass (waiting) time” and thus
encourages more use of the Internet, which in turn creates network effects and spurs the
development and availability of digital content. It seems, however, that private benefits
of broadband access are sufficiently large, relative to any conceivable external effects,
that a subsidy to broadband access by households is not justified. (Recall that business
use of broadband, which almost certainly far outweighs potential household use, would
be exempt under an economically neutral tax system. We discuss exemption of digital
content further below.) The development of Internet telephony (transmission of telephone
messages over the Internet) provides another powerful reason to avoid exemption of
11
Internet access. Since Internet access automatically entails the possibility of Internet
telephony, exemption of all telecommunications would be required to avoid giving
Internet telephony a competitive advantage over other forms of telephony.66 Total
exemption of telecommunications would, of course, entail an enormous loss of state and
local tax revenues.67 This also provides ample reason not to adopt the proposal to exempt
basic Internet access; parity would demand that such an exemption should be matched by
exemption of basic charges for other forms of telecommunications.
Some definitions of Internet access are so broad that the ITFA would exempt
digital content. There is, however, no principled justification for exempting digital
content that is transmitted over the Internet. Such an exemption would create a
competitive advantage for downloaded digitized products that can also be (and
traditionally have been) delivered in tangible form. This would be a significant blow to
Main Street merchants, who sell the latter type of products, and would discriminate
against those who buy them, typically the less educated and the poor.
If bridging the digital divide is seen to be a question of external benefits, the
conclusion is similar to that for network effects. Inducing poor non-users of the Internet
to become users may have social benefits, but exempting all Internet access (or even
basic service) is an extremely costly way to achieve them. If, on the other hand, the issue
is seen to be one of income distribution, exempting Internet access also cannot be
justified. Since the lion’s share of Internet access is consumed by the non-poor, a general
exemption, even if limited to basic service, would not have the posited distributional
effects, and limiting the exemption to the poor would not be administratively feasible.68
A final non-technical point deserves attention. One can identify many instances
in which textbook analysis of external economies, distributional effects, and other forms
of “market failure” might seem to justify corrective governmental intervention. Yet, for
the most part, the United States sensibly does not follow this approach, preferring the
sometimes imperfect results of market forces to the very real risks inherent in
intervention. (The risk is not just that economic results will be worse; perhaps as
important, once one starts down the road to intervention, by providing preferential
treatment of selected sectors, it is politically difficult to withstand the entreaties for
special treatment of others.) We should keep in mind the admonition of former president
Ronald Reagan, even recognizing that it is the rhetoric of a politician rather than the
analysis of a public finance economist, that “[t]he taxing power of government must be
used to provide revenues for legitimate government purposes. It must not be used to
regulate the economy or bring about social change. We've tried that, and surely we must
be able to see it doesn't work.” (February 18, 1981). It is anomalous that many who
fancy themselves to be supporters of free-market economics advocate exemption of
Internet access, in order to encourage the growth of the Internet.
b.
Economically defective sales taxation
Extant state and local sales taxes deviate from the principles stated earlier, in that:
a) not all sales to consumers are taxed uniformly, b) not all sales to business are exempt,
12
c) sales often are not taxed when made by out-of-state vendors, and d) the system is
needlessly complicated. We discuss here the first two types of deviations, reserving
discussion of the last two to the part of the next section on “Principal Normative
Considerations Bearing on Nexus Over Remote Sellers for Purpose of Requiring
Collection of State and Local Use Taxes.”
All states apply their sales taxes primarily to goods, leaving many services
exempt. Given this, one might think that Internet access and digital content should also
be exempt. However, achievement of economically neutral sales taxation requires the
taxation of all goods and services consumed by households. Accordingly, from a
normative perspective, the appropriate solution is to broaden the tax base to include
household purchases of Internet access and digital content, not to exacerbate the
deviation from an ideal tax base by exempting such purchases.
All states exempt tangible products bought for resale and most states extend this
principle to products incorporated or used “directly” in the manufacture of products for
sale. On the other hand, most states tax a wide range of products that are used only
“indirectly” to produce goods that are resold or to distribute them (e.g., when an
automobile manufacturer or dealer acquires office equipment). Consistency might seem
to demand that business purchases of telecommunications, Internet access, and digital
content should be taxable, because they are not acquired for resale as such (much like the
office equipment acquired by an automobile manufacturer or dealer).69 But, again, the
right way to address this long-standing defect is not to expand the taxation of business
purchases; rather, all telecommunications, Internet access, and digital content should be
exempt when purchased by business.
3.
Summary Comment Evaluating ITFA Legislation
The case for exempting Internet access by households is weak, no matter how
Internet access is defined (narrowly, as embracing only connection to the Internet or more
broadly to include telecommunications and/or digital content). Even an exemption for
only basic Internet access is an extremely inefficient way to achieve the posited
objectives. On the other hand, all business purchases of Internet access,
telecommunications, and digital content should be tax-exempt. We reiterate that these
conclusions, and others in this paper that suggest a broader or narrower tax base, are not a
recommendation for higher or lower taxes. Rather, we assume a revenue-neutral process
in which changes in tax bases would be compensated by changes in tax rates, in order to
leave revenues unchanged in each state.
B.
Streamlined Sales and Use Tax Legislation
1.
The Streamlined Sales and Use Tax Act (SSUTA)
Legislation has been introduced in Congress authorizing the states, under
specified conditions, to require collection of sales and use taxes with respect to sales by
remote sellers, notwithstanding their lack of physical presence in the state (otherwise
13
constitutionally required under the Quill decision), if the states conform to the provisions
of the Streamlined Sales and Use Tax Agreement (the "Streamlined Agreement").70 The
legislation “consents” to the Streamlined Agreement, thereby authorizing the states,
consistent with other provisions of the legislation, to require collection of taxes on remote
sales notwithstanding Quill. The Streamlined Agreement requires that 10 states
comprising at least 20 percent of the total population of all states with sales taxes
significantly simplify and harmonize their sales and use tax regimes by providing, among
other things, a centralized, one-stop multistate registration system; uniform definitions of
product and product-based exemptions; uniform sourcing rules; uniform procedures for
certifying tax collection software and intermediaries; uniform rules for bad debts;
uniform rules for tax returns and remittances; consistent electronic filing and remittance
methods; single state-level administration for all state and local taxes; reasonable
compensation for sellers who administer sales and used tax; and appropriate protections
for consumer privacy. If the states satisfy the Streamlined Agreement’s requirements,
Congress would authorize collection by remote sellers, but with additional conditions and
limitations (beyond those required by the Streamlined Agreement). These include, among
other things, an exception for “small” sellers (those with less than $5 million of
nationwide remote sales) and federal court review of controversies arising under the
Streamlined Agreement.
2.
Principal Normative Considerations Bearing on Nexus Over
Remote Sellers for Purpose of Requiring Collection of State and
Local Use Taxes
We believe analysis of these considerations will be advanced by subdividing the
inquiry in two respects. First, we focus on collection of state use taxes before examining
the problems caused by the existence of local sales and use taxes. Second, we approach
both sets of issues under alternative assumptions of what is achievable from a practical
standpoint. We initially address the nexus question on the somewhat utopian assumption
that all – or least most – desirable changes are possible. We then revisit the question
under the more realistic hypothesis that there will continue to be at least some diversity in
state and local tax rules.
a.
Uniform state sales tax rules
Under an ideal retail sales tax, sales would be taxed by the jurisdiction of
destination. Moreover, as we have already observed in connection with the discussion of
ITFA, only sales to households would be taxed; sales to business would be exempt. For
reasons of social policy, it may be thought desirable to exempt certain categories of
consumer purchases, for example, food and prescription drugs, despite the complexity
and economic distortions this creates. In addition, states should provide vendor discounts
to both local merchants and remote vendors to compensate them for the cost of collecting
sales and use tax.71 Such compensation should reflect actual incremental costs of
collecting tax and the fact that costs are relatively much higher for vendors with a small
sales volume in a given state than for those with a large volume.72
14
If all sales to business were exempt in all states (or even if some such sales were
taxed, but the rules for exemption were the same in all states), if definitions of products,
exemptions of consumer purchases, and administrative procedures were also uniform
from state to state, and if a remote vendor making only small amounts of sales in a state
could register, file, and remit tax to its home state, which would forward the revenue to
the state of destination, rather than completing these administrative requirements in each
state where it makes sales, compliance with state sales and use taxes would be relatively
simple, even for remote vendors.73 In particular, a vendor located in one state could
relatively easily comply with the state use tax of another state, because of the uniformity
across states. In such an environment there would be little reason for a nexus rule
excusing remote vendors from collecting use tax,74 and the vendor discounts offered to
remote sellers would not need to be much higher than the discounts provided local
merchants.
b.
Diverse state sales tax rules
None of the “ideal” preconditions for simple compliance listed in the previous
paragraph currently exists. Definitions of products, exemptions for sales to business,
exemptions of consumer purchases, and administrative procedures are not uniform, and it
is not possible for a remote vendor to complete administrative procedures in its home
state. Moreover, vendor discounts are generally woefully inadequate to compensate for
costs of compliance, especially for small remote merchants. In such an environment it
would not be appropriate to require remote vendors to incur costs of collecting use tax,
especially in situations where the amount of revenue at stake does not justify the
considerable cost of collection.
There are two ways to deal with this situation. One would be to allow the
diversity to continue unabated, but require that states pay realistic vendor discounts – that
is, vendor discounts that accurately reflect the incremental cost of compliance for remote
vendors of various sizes. The second would be to require greater uniformity, allow
correspondingly lower vendor discounts, and impose a nexus standard that would relieve
small remote vendors of the obligation to collect use tax where incurring the compliance
costs to collect a modest amount of revenue cannot be justified. Such a nexus standard
would, of course, be based on the volume of sales a remote vendor made to a given state.
How high the threshold was set would depend on the degree of uniformity. As noted
earlier, there would be little or no reason for a nexus rule if there were enough
uniformity.
Both these techniques would prevent the states from foisting off on remote
vendors the costs of dealing with the unwarranted diversity that characterizes the current
state sales and use tax system. They differ in one important respect.75 State compensation
for the costs caused by the complexity of the current system would entail continuation of
the deadweight cost to society that could be avoided by reducing complexity and thus
costs. Thus the second alternative is preferable, because it would reduce those costs.
Merchants who now bear the costs of compliance, with little or no compensation, would
benefit from both the reduction in complexity and the state compensation for their
15
remaining costs.
c.
Uniform local sales taxes
The existence of local sales and use taxes complicates the picture considerably.
Suppose first that there were a uniform system of state sales and use taxes of the type
described above, that at most only one level of local government levied sales and use tax
in a given state, that all local governments at that level in the state imposed the tax and at
the same rate, and that states collected the tax for local governments. Under these
circumstances, remote sales need not cause serious problems. There would be no
problem in knowing the correct local tax rate to apply, since local tax would apply to all
taxable sales in the state. This means that there would be only one combined state and
local rate per state. The only issue would be how to get use tax revenue to the
jurisdiction of destination of sales.
It might be possible for remote vendors to differentiate between sales made to
buyers in various local jurisdictions and report the results to the state. It would be far
simpler – and probably produce an acceptable result – for the state government to collect
use tax on remote sales by adding the local rate to the state rate and divide the revenues
among local governments in proportion to receipts of tax collected by local merchants.76
d.
Diverse local sales taxes.
Again, reality is much more complicated than the scenario just described. More
than one level of local government in a given state may levy sales and use taxes, all
jurisdictions at a given level may not impose the tax, state and local tax bases may not be
identical, even in a single state, and some local governments administer their own sales
taxes. In this environment it may be difficult merely to determine the correct tax rate to
apply to a given transaction and to channel the revenue to the correct jurisdiction. The
need to deal with unique local tax bases and local tax administration further complicates
matters.
Solving this problem by prohibiting local sales and use taxes would be
impractical, both because sales taxes are an important source of local revenue in many
states and because revenues have previously been pledged to service bonds issued to
finance capital improvements. Nor would simply levying a use tax at “one rate per state”
and sharing the local part of revenues with local governments in proportion to receipts
from taxes collected by local merchants give the theoretically correct answer. All things
considered, the best choice may be either to exempt remote sales from local use tax
entirely or to collect tax at a single uniform rate in each state and share revenues among
local jurisdictions in a manner chosen by the state.
3.
Evaluation of the Streamlined Sales and Use Tax Act (SSUTA)
Based on the normative criteria outlined above, we believe that the SSUTA is
fundamentally a move in the right direction – the prescription of simplification and
16
greater uniformity in conjunction with the removal of nexus rules that create undesirable
economic consequences Under the prescribed conditions of simplification and
uniformity, nexus rules would no longer be needed to reduce complexity and thus could
no longer be justified. The requirement of “reasonable compensation for all sellers that
administer, collect, and remit sales and use tax,”77 including, in particular, “compensation
that covers all tax processing costs of remote sellers”78 reinforces our view that the
SSUTA recognizes the importance of requiring vendor discounts to compensate for
incremental costs of compliance, which would still be much higher than they need to be,
because of the complexity that would remain even under the Streamlined Agreement. We
also believe that the requirement that the state and local tax base within any jurisdiction
be “identical” – which is explicitly embodied in the Streamlined Agreement79 and,
therefore, by implication, in the SSUTA – is an essential component of the legislative
proposal that we endorse as a matter of principle. Finally, we believe that the legislation
strikes the proper balance between the interests of state sovereignty and those of national
economic unity. It respects the states' ability to establish their own tax rates, and, indeed,
even goes so far (perhaps further than we would have gone) as to allow the states
freedom to define their own tax bases. At the same time, it imposes significant
requirements on the states to harmonize and simplify their systems and thereby to provide
the proper predicate for requiring collection by remote sellers.
Having expressed our general agreement with the thrust of the SSUTA, we wish
to make it clear that there are many aspects of the legislation, not to mention the untidy
reality surrounding it, about which we are skeptical, uncomfortable, and, in some
instances, in flat disagreement. For present purposes, we simply identify these concerns,
because full exploration of them would demand more time and space than we currently
have. Nevertheless, we believe that these concerns must be addressed in the public debate
over the wisdom and shape of the SSUTA, and our endorsement of the SSUTA as a
matter of principle is conditioned on the assumption that these concerns will be the
subject of robust and open debate.
First, we believe that the “minimum simplification requirements” prescribed by
the SSUTA80 and embodied in the Streamlined Agreement must be more than empty
promises that are ignored in fact. While no one can seriously quarrel with the desiderata
embodied in the SSUTA and the Streamlined Agreement, the devil (as they always say)
is in the details, and there is considerable controversy as to whether the current efforts of
the states to implement the Streamlined Agreement satisfy the promise of meaningful
simplification.81 It essential that Congress examine carefully the extent to which the
efforts of the states to implement the Streamlined Agreement have in fact adequately
simplified and harmonized the states’ sales and use tax regimes before it puts its
imprimatur upon the SSUTA in any form.
Second, we question whether the thresholds established by the SSUTA make any
sense. The SSUTA provides that no seller shall be subject to any requirement that it
collect taxes on remote sales when the seller and its affiliates have less than $5 million of
gross remote sales or when an individual seller has less than $100,000 of gross remote
sales (even when its affiliates exceed the $5 million threshold). We believe the thresholds
17
are misguided on two counts. First, and most importantly, thresholds (as we observed
above) are justified when the costs of compliance are not commensurate with the revenue
collected. This is an inquiry that depends on the volume of sales that a remote vendor
makes to any particular state, not on its nationwide volume of sales. If a company makes
$4,999, 999 into State A and $1 of remote sales into every other state, there is no warrant
for requiring collection of the taxes on remote sales except in State A. Moreover, the
vendor compensation, if properly calculated for the other states, would almost certainly
far exceed the revenue at issue. In short, Congress should focus on thresholds on a stateby-state basis. Second, we see no justification for providing an exception for affiliated
sellers who happen to have less than $100,000 of gross sales. Congress should make up
its mind whether it wants to treat affiliated sellers as a single unit or not. The SSUTA
generally treats them as a single unit (which we believe is sound), but then provides an
exception for “small” affiliates. To us this is simply an invitation for tax planners to
create separate affiliates who have less than $100,000 of remote sales and therefore need
not collect taxes on such sales.
Finally, we wish to make it clear that we are persuaded to express our support for
the SSUTA, despite some misgivings, because we are at a critical juncture where
Congress has a unique opportunity to act. Although in an ideal world we might urge
Congress to tell the states to go back to the drawing boards and get it “right” – adopting a
uniform tax base, as well as uniform definitions, providing administrative procedures that
are uniform from state to state, permitting small vendors to comply with tax collection
requirements in their “home” state, etc. – we recognize that the world is less ideal than
we might like it to be. Accordingly, we believe that the SSUTA may be our “last best
chance” (at least during our lifetimes) of achieving significant, if less than perfect, reform
and improvement of the state sales and use tax system. In the end, notwithstanding our
reservations about the SSUTA in its present form, we believe that the “perfect” should
not be permitted to drive out the “good,” and that the second-best solution embodied in
the SSUTA, modified we hope by some of the suggestions we have made above, will
result in meaningful improvement of the states sales and use regimes as they exist today.
C.
Business Activity Tax Legislation
1.
The Business Activity Tax Simplification Act
Legislation has been introduced in Congress limiting the states’ power to impose
business activity taxes (BATs).82 The proposed legislation prevents the states from
imposing net income taxes or other “direct” taxes on business activity (e.g., gross receipts
taxes), unless the taxpayer satisfies the statutorily prescribed nexus requirements. The
most significant of these requirements are a physical presence requirement (exceeding 21
days of physical presence). In substance, the legislation expands the requirements of
Public Law 86-272,83 which imposes limited nexus requirements with respect to net
income taxes on income from the sale of tangible personal property, to any BAT on any
form of business activity (including the sale of services and intangibles), and provides a
number of specified “safe harbors” for physical presence (e.g., the 21-day requirement,
18
activities in connection with the possible purchase of goods or services, and participation
in educational or training conferences).
2.
Principal Normative Consideration Bearing on Nexus for
for BAT Legislation
As in the discussion of ITFA and SSUTA, we begin by asking what nexus
standards would be appropriate under an ideal tax regime, in this context one in which all
states used the same income attribution rules. Then we ask what nexus rules would be
appropriate under the more realistic assumption that the tax regime is less than ideal,
namely, that income attribution rules are not uniform.84
a.
Uniform income attribution rules
Corporate income should be subject to tax in the state where it is earned, at rates
chosen by the state. It is, however, generally not realistic to try to employ geographic
separate accounting to determine the source of income for a corporation that carries on
integrated economic activities across state lines. Leaving aside the obvious fact that
corporations do not keep books on a state-by-state basis, and should not be required to
incur the enormous compliance costs required to do so, geographic separate accounting
would fail to take account of the economic interdependencies between activities
occurring in different states and would be vulnerable to manipulation of transfer prices on
transactions occurring within the corporation to shift income to low-tax or no-tax states.
The states have thus long used formulas to apportion “business income,” by far the
majority of corporate income, between in-state and out-of-state activities. Some states
“combine” the activities of affiliated corporations deemed to be engaged in a “unitary
business” for two of the same reasons they use formula apportionment, economic
interdependence and difficulties of transfer pricing.
The choice of apportionment formulas (including the weights to put on the
various apportionment “factors”) and the definition of each of the factors are, to some
extent, arbitrary, as are the definition of apportionable income, the exact standard to use
in determining the contours of a unitary business, and administrative procedures. But it is
clearly advantageous for all states to define apportionable income in the same way, use
the same apportionment formula,85 define the apportionment factors in the same way,
employ unitary combination, employ the same definition of a unitary business, and utilize
the same administrative procedures. Uniformity would minimize compliance costs and
prevent gaps and overlaps in the tax system, with the attendant inequities and distortions.
Combination, rather than separate entity accounting, is required to combat tax planning
and prevent loss of revenue. With uniform income attribution rules and administrative
procedures, a single spreadsheet would provide a comprehensive division of income of
the relevant corporate group among the various states, including those that have no
income tax, and there would be little or no need for nexus rules. Introduced into this
environment, a nexus threshold like that currently embodied in Public Law 86-272
would, in the first instance, almost certainly create “nowhere income” – income attributed
to states that lack jurisdiction to tax it86 – and a high nexus standard would probably lead
19
to suggestions for ways to prevent this from happening, such as excluding the taxpayer’s
factors in the state where it lacks nexus from the denominator of the apportionment
formula.87
Uniform income attribution rules are necessary for a satisfactory solution, but
they are not sufficient. Even if income attribution rules were uniform, there might be
adverse economic consequences, opportunities for tax planning, and “nowhere income;”
these possibilities would depend on the particular rules chosen. For example, if the
uniform rules included apportionment based solely on sales, a nexus standard based on
anything but a sales threshold would have this effect. This can be illustrated by the
interaction of Public Law 86-272 and uniform adoption of sales only apportionment.
Under this regime a corporation would pay little or no BAT in a state either i) if it had
substantial sales in the state, but could take advantage of the Public Law 86-272 safe
harbor, or ii) if it had a substantial physical presence but only minimal sales.
b.
Diverse income attribution rules
The BATs currently levied by the states often provide substantially different
solutions to the problem of attributing income to its source. Definitions of apportionable
and allocable income differ. Some states do not require combination, and those that do
often have inconsistent definitions of the combined group. Nor do all states use the same
apportionment formula or define the apportionment factors (especially sales) in the same
way. Finally, administrative procedures are not uniform. The result is complexity, gaps
and overlaps in taxation, adverse economic effects, opportunities for tax planning, and
loss of revenue. While a nexus threshold is arguably appropriate under these
circumstances to reduce complexity, a badly chosen threshold will aggravate the other
problems, just as in the case of uniform income attribution rules.
The only persuasive justification for nexus rules is to ameliorate complexity – to
avoid payment or collection of taxes where the revenue involved is not worth the cost of
compliance and administration. This implies that nexus rules for BATs should take
account of the taxpayer’s apportionment factors in a state88 That is, if a taxpayer does not
have at least one factor in the state that exceeds a certain threshold, stated alternatively as
a minimum dollar amount or a minimum fraction of the taxpayer’s total of that factor, it
should not be liable for BAT in that state. Conversely, if it exceeds the threshold for at
least one factor that appears in the state’s apportionment formula, it should be deemed to
have nexus for BAT in that state.89
How high nexus standards should be depends on how much diversity there is in
the state BATs. If there were little or no diversity, the standard could be quite low or
non-existent, as noted earlier. On the other hand, substantial diversity would call for a
much higher standard. This implies that if the states want the Congress to enact a low
nexus standard for BAT they should be required to reduce substantially the diversity of
their taxes.
20
3.
Evaluation of Proposed BAT Legislation
As noted earlier, legislation has been proposed that would expand the nexus
protection provided by Public Law 86-272 by making it applicable to income from any
type of sales (not merely sales of tangible products) and specifying activities that could
be conducted in a state without creating nexus for BAT. In other words, it specifies that a
physical presence is required to create nexus; sales are not enough.
The proposed legislation is clearly inconsistent with the normative considerations
delineated above. It would expand the scope for the creation of “nowhere income,” and
thus aggravate the opportunities for tax planning and the revenue loss created by Public
Law 86-272. This is especially true in states where sales are the only or primary factor
used to apportion income – a rule that has been advocated by many of the same business
interests that are seeking a physical presence nexus rule for BAT.
Beyond the normative considerations that we believe should shape congressional
policy regarding nexus for BAT purpose, we believe it important to identify and discuss
several unsound arguments that are often heard in the present debate. The following
excerpt from a policy statement by the Council for State Taxation is representative of one
such view:
Determinations of jurisdiction to tax should be guided by one fundamental
principle: a government has the right to impose burdens—economic as
well as administrative—only on businesses that receive meaningful
benefits or protections from that government. In the context of business
activity taxes, this guiding principle means that businesses that are not
present in a jurisdiction and are therefore not receiving any benefits or
protections from the jurisdiction, should not be required to pay tax to that
jurisdiction.90
This line of reasoning is indefensible, whether the benefits corporations receive
are defined broadly, to mean the ability to earn income, or defined more narrowly to
mean specific benefits of public spending, one of which is the intangible but important
ability to enforce contracts, without which commerce would be impossible. A profitable
corporation clearly enjoys both types of benefits. It is true that in-state corporations may
receive greater benefits than their out-of-state counterparts, for example, because they
have physical assets that need fire and police protection. But this is a question of the
magnitude of benefits and the tax that is appropriate to finance them – something that is
properly addressed by the choice of apportionment formula and the tax rate, not the type
of yes/no question that is relevant for issues of nexus.91 The answer must clearly be a
resounding “Yes,” to the question, "whether the State has given anything for which it can
ask return."92
A second invalid argument relies on the Revolutionary War rallying cry, “No
taxation without representation.” Opponents of tighter nexus rules suggest that such rules
would violate the basic American principle that there should be no taxation without
21
representation. This argument fails on several grounds. First, not all rallying cries of the
Revolutionary War made their way into the Constitution. An inviolate link between the
right to vote and the duty to pay tax is not among those that did. Individuals who lack the
right to vote due to non-residence are nonetheless (properly) taxable. Second, virtually
all of the taxes under discussion here are (or would be, under a tighter nexus standard)
paid or collected by corporations, not by individuals. Since corporations do not vote, this
argument is something of a red herring. Beyond that, out-of-state taxpayers, whether
actual or potential and whether corporations or individuals, have the same right to be
represented by lobbyists as do in-state corporate and individual taxpayers. Indeed,
corporate officials can probably do their own lobbying without running afoul of existing
nexus standards, let alone sensible ones.93 Thus this charge lacks substance. Third, the
same argument could be made against payment of property taxes.94 Finally, and most
fundamentally, the type of taxation that would occur under sensible nexus rules would
not discriminate against out-of-state business (something the U.S. Supreme Court would
not countenance). Rather, sensible nexus rules would prevent discrimination in favor of
out-of-state business, by subjecting them to the same rules as in-state businesses, except
as required to prevent excessive complexity. Even if it were true that out-of-state
businesses had no representation, it is difficult to see the harm in requiring that they pay
or collect the same taxes as their in-state competitors. (With uniform taxation, in-state
businesses can be expected to help protect the interests of their out-of-state competitors in
the political arena, since they will pay the same taxes.)
4.
The Issue of Linkage
It has been suggested that enactment of the SSUTA and the BAT legislation
should be linked – that both are good, but neither should be enacted without the other.95
It may be appropriate under certain circumstances to link reforms. For example,
it has long been recognized that it might be possible to link state action to simplify their
sales and use taxes with federal action to allow an expanded duty for remote sellers to
collect use taxes, thereby reducing the adverse economic effects caused by the physical
presence test of nexus, as well as complexity. This linkage is entirely appropriate, as the
National Bellas Hess/Quill decisions were a response to the complexity of these taxes. It
would not be appropriate to allow an expanded duty to collect, in the absence of
simplification, and true simplification, although desirable for its own sake, may occur
only if the federal government holds out the “carrot” of an expanded duty to collect.
By comparison, the proposed linkage of SSUTA and the BAT legislation is only
political; it has no inherent logic. It is intended a) to create a quid-pro quo for action on
the two issues and b) to allay fears that the lower nexus threshold for use taxes would
seep over into a lower threshold for BATs. The second of these is more appropriately
addressed by establishing the type of nexus standard based on the presence of
apportionment factors described earlier.
22
IV.
Conclusion
Debates over the propriety of congressional intervention in state tax matters are
intense and important, because they touch one of most sensitive nerves of our federal
system – the tension between the states’ right to exercise their sovereign tax powers and
the nation’s interest in a common market unfettered by burdensome state regulations.
Understandably, but unfortunately, such debates often generate more heat than light, and
the debates over the ITFA, SSUTA, and BAT legislative proposals are no exception. In
this paper, we have attempted to contribute to a reasoned consideration of these
legislative proposals by identifying the principal normative criteria that should guide the
inquiry into their merits and by evaluating the proposals in light of those criteria.
Although we are not so optimistic or naïve as to believe that our conclusions will
command universal support, we do hope that our analysis will help inform and elevate
the debate over these legislative proposals.
23
NOTES
1
This paper was sponsored by the National Governors Association (NGA). The views expressed in this
paper are, however, entirely our own and do not necessarily reflect those of the NGA. The authors would
like to thank Hal Varian and George Zodrow for their helpful comments on an earlier draft of this article.
All remaining errors are our own.
2
See generally Walter Hellerstein, “Federal Constitutional Limitations on Congressional Power to
Legislate Regarding State Taxation of Electronic Commerce,” National Tax Journal, Vol. 53, No. 4, Part 3
(December 2000), pp. 1307-25.
3
U.S. Const. art. I, § 8, cl. 3.
4
Prudential Insurance Co. v. Benjamin, 328 U.S. 408, 434 (1946).
5
Moorman Manufacturing Co. v. Bair, 437 U.S. 267, 280 (1978).
6
Under the so-called "dormant" or "negative" Commerce Clause, the U.S. Supreme Court has construed the
affirmative grant of power to Congress to regulate interstate commerce as embodying implied restraints on state
legislation, even when Congress does not act. See generally Jerome R. Hellerstein and Walter Hellerstein, State
Taxation, 3rd ed (Boston: Warren, Gorham & Lamont, 1998), chapter 4. Over the course of the past two
centuries, the Court has handed down hundreds of decisions delineating these negative restraints, which
include, in the area of state taxation, the requirements that "the tax is applied to an activity with a substantial
nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is
fairly related to the services provided by the State." Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 288-89
(1977).
7
504 U.S. 298 (1992).
8
Id. at 318.
9
15 U.S.C. §§ 381-84.
10
Pub. L. 94–210, 90 Stat. 54, 49 U.S.C. § 14501.
11
49 U.S.C. § 14502.
12
49 U.S.C. § 40116.
13
15 U.S.C. § 78bb(d).
14
49 U.S.C. § 40116.
15
29 U.S.C. § 1144(a).
16
15 U.S.C. § 391.
17
47 U.S.C. § 251.
18
49 U.S.C. § 14505.
19
4 U.S.C. § 116 et seq.
20
The Federalist No. 32 (A. Hamilton), reproduced in The Federalist Papers (New York: Mentor, 1961),
24
pp. 197-201. Some of the more extravagant statements regarding the scope of the states' sovereign powers
of taxation found in The Federalist, made to emphasize the importance of such powers to the states'
independent political existence, are not accurate descriptions of the legal scope of such powers under
current constitutional doctrine.
21
Gibbons v. Ogden, 22 U.S. (9 Wheat.) 1, 199 (1824). See also Weston v. City of Charleston, 27 U.S. (2
Pet.) 449, 466 (1829) ("The power of taxation is one of the most essential to a state, and one of the most
extensive in its operation.").
22
Railroad Co. v. Penniston, 85 U.S. 5, 29 (1873).
23
Allied Stores of Ohio, Inc. v. Bowers, 358 U.S. 522, 527 (1959).
24
See Mariano Tommasi, “Federalism in Argentina and the Reforms of the 1990s,” and Alberto DiazCayeros, José Antonio González, and Fernando Rojas, “Mexico’s Decentralization at a Crossroads,” both
presented at the Workshop on Federalism in a Global Environment, Stanford University, June 6-7, 2002,
and forthcoming in T. N. Srinivasan and Jessica Seddon Wallack, editors, Federalism and Economic
Reform in a Global Environment.
25
Gibbons v. Ogden, 22 U.S. (9 Wheat.) 1, 199 (1824).
26
Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 448 (1980).
27
See Hellerstein and Hellerstein, supra note 6, chapter 1.
28
During the 1960s, Congress undertook an extensive study of state income, capital stock, gross receipts,
and sales and use taxation, and it recommended the enactment of legislation. See Special Subcomm. on
State Taxation of Interstate Commerce of the House Comm. on the Judiciary, State Taxation of Interstate
Commerce, H.R. Rep. No. 1480, 88th Cong., 2d Sess. (1964); H.R. Reps. Nos. 565 and 952, 89th Cong.,
1st Sess. (1965). However, no legislation was ever enacted as a result of this study and its
recommendations.
29
See supra notes 9-19 and accompanying text.
30
United States v. South-Eastern Underwriters Ass'n, 322 U.S. 533 (1944).
31
15 U.S.C. §§ 1011-1015.
32
Id.
33
114 Stat. 626 (July 28, 2000), codified at 4 U.S.C. § 116 et seq.
34
488 U.S. 252 (1989).
35
Id. at 263.
36
The issues become even more complex if the customer is billed not on a transaction-by-transaction basis,
but instead pays, say, $50 per month for 500 minutes of calls regardless of where the calls originate or
terminate. Indeed, if the customer were billed at a flat rate, the Goldberg-mandated inquiry would be
virtually impossible, since there would be no breakdown of the charges for the calls on a transaction-bytransaction basis. A typical wireless phone bill simply shows the calls made and the minutes consumed
with no itemized price allocation if one does not exceed the number of flat rate minutes. Indeed, the
“charge” shown for such individual calls is “$00.00.”
37
4 U.S.C. § 116 et seq.
25
38
Id § 117(a).
39
See, e.g., Moorman Mfg. Co. v. Bair, 437 U.S. 267, 278-80 (1978).
40
Quill Corp v. North Dakota, 504 U.S. 298, 318 (1992).
41
Sales taxes are imposed on the sale of goods or services within the state. States lack the constitutional
authority to impose a sales tax on goods or services sold outside the state to resident purchasers. To deal
with the potential loss of business and revenue that would result if the states' residents made out-of-state
purchases to avoid the state's sales tax, states enacted use taxes imposed on the use of goods or services
purchased outside the state but used within the state. Use taxes are functionally equivalent to sales taxes,
and every state that imposes a sales tax also imposes a use tax in an effort to impose a uniform tax on
taxable goods or services sold or used within the state. See generally Hellerstein and Hellerstein, supra
note 6, at ¶ 16.01[2]. Because the distinction between sales and use taxes has no bearing on the normative
issues that are the concern of this paper, the discussion in the paper generally does not distinguish between
sales and use taxes, and it refers to such taxes interchangeably when discussing use taxes.
42
386 U.S. 753 (1967).
43
Whether this is true would depend on whether the physical-presence test of nexus applies to income
taxes, an open question; state statutory requirements for filing income tax returns (e.g., whether an
enterprise is deemed to be “doing business” in a state); and the formula the state uses to apportion the
income of multistate enterprises, in particular, how sales are “sourced”. All states include sales in their
apportionment formulas, but some source sales of intangible property and services in such a way that there
would be no liability, even in the absence of Public Law 86-272.
44
Pub. L. No. 105-277, §§ 1101-04, 112 Stat. 2681-719 to 2681-726 (1998). For a general discussion of ITFA,
see Walter Hellerstein, “Internet Tax Freedom Act Limits States' Power to Tax Internet Access and Electronic
Commerce,” Journal of Taxation, Vol. 90, No. 1 (January 1999), pp. 5-10.
45
In November 2001, Congress retroactively extended ITFA for two years through October 2003. "Internet
Tax Nondiscrimination Act," H.R. 1522, 107th Cong., 1st Sess. (2001).
46
ITFA § 1104(5).
47
ITFA § 1101(a)(1).
48
ITFA § 1104(2)(B).
49
This provision contains a fundamental ambiguity: whether the critical phrase "a remote seller's out-ofState computer server" -- which a state is barred from considering in determining the out-of-state seller's
nexus with the state -- should be read from the vantage point of the taxing state or from the vantage point of
the seller. If read from the perspective of the taxing state, which is the more natural reading, the provision
is redundant with existing constitutional jurisprudence and is thus virtually meaningless. It would prevent a
state from asserting nexus over an out-of-state Internet seller if the state relied solely on the seller's
computer server in some other state as a factor in considering whether the taxpayer had nexus in the taxing
state. But existing constitutional law would preclude an assertion of jurisdiction in these circumstances.
Hence the provision would have added nothing to existing constitutional protections. If the phrase "a
remote seller's out-of-State computer server" is read from the standpoint of the seller, so that a state would
be forbidden from imposing a use tax collection obligation on a remote Internet seller based exclusively on
the presence of the seller's server in the taxing state, then the provision would have had some theoretical
significance, but not much practical impact. Most states have indicated that they would not assert
jurisdiction over an out-of-state seller based solely on the presence of the out-of-state seller's server in the
state.
26
50
ITFA § 1104(2)(B)(ii). This provision contained an ambiguity similar to that contained in the provision
described above, see supra note 49: whether the "out-of-State computer server"---which a state is barred
from considering in determining whether the Internet access provider is the agent of the remote seller--should be read from the vantage point of the taxing state or from the vantage point of the seller. For reasons
set forth above, the provision would have had meaning only if read from the standpoint of the seller. Thus
read, it would prevent a state from asserting nexus over an out-of-state Internet seller if the state relied
solely on the Internet access provider's computer server in the taxing state as a factor in considering
whether the Internet access provider was the remote seller's nexus-creating agent in the taxing state.
Construed from this perspective, the provision essentially forbade the states from invoking an "attributional
nexus" theory based solely on the remote seller's use of the Internet access providers in-state server.
51
ITFA § 1104(6)(A).
52
ITFA § 1104(6)(B).
53
For varying perspectives on this debate, see Robert Cline, “Critique of Multistate Tax Commission's
State and Local Revenue Impact Estimates of H.R. 49,” State Tax Notes, Vol. 30, No. 4 (Oct. 27, 2003), pp.
317-19; Harley Duncan, “States' Approach to ITFA Problems,” State Tax Notes, Vol. 30, No. 4 (Oct. 27,
2003), pp. 311-15; Harley Duncan and Matt Tomalis, “On the ITFA: Telecom’s Trojan Horse,” State Tax
Notes, Vol. 31, No. 2 (Jan. 12, 2004), pp. 129-32; Michael Mazerov, “Making the Internet Tax Act
Permanent in Currently Proposed Form Would Hurt States,” State Tax Notes, Vol. 30, No. 4 (Oct. 27,
2003), p. 321-37.
54
As noted earlier, see supra note 41, we draw no distinction between sales and use taxes. Such a
distinction has no place in a sensible sales tax system.
55
Among the many places where this is explained are Charles E. McLure, Jr., “Achieving Neutrality
Between Electronic and Nonelectronic Commerce,” State Tax Notes, Vol. 17, No. 3 (July 19, 1999), pp.
193-97, and Hellerstein and Hellerstein, supra note 6, at ¶¶ 12.05, 12.06. That these tenets were included
in a popular undergraduate textbook almost 50 years ago indicates clearly that they have long been an
important part of the conventional wisdom among tax experts; see Walter Hellerstein and Charles E.
McLure, Jr., “Sales Taxation of Electronic Commerce: What John Due Knew All Along,” State Tax Notes,
Vol. 20, No. 4 (January 1, 2001), pp. 41-46; also in the proceedings of the 93rd annual conference on
taxation of the National Tax Association, Santa Fe, November 11, 2000, pp. 216-22. The first three
principles underlie the value added taxes levied in the European Union and perhaps 90 other countries
around the world. (Simplicity is less common.) See Charles E. McLure, Jr., “EU and US Sales Taxes in the
Digital Age: A Comparative Analysis,” Bulletin for International Fiscal Documentation, Vol. 56, No. 4
(April 2002), pp. 135-145.
56
Readers might have expected us to list a fourth situation where deviation from the tenets is appropriate,
namely, where requiring out-of-state vendors to collect tax may impose an unacceptable burden on
interstate commerce, because of the lack of uniformity of sales taxes from state-to-state. If, however, all
states followed the first two tenets (tax all sales to households and exempt all sales to business), there
would be substantially more uniformity – and much less complexity –than in the current system. In that
case, lack of uniformity would seem to derive primarily from inconsistent exemptions of household
consumption (including inconsistent definitions of exempt products) and inconsistent administrative
requirements. See Charles E. McLure, Jr., “How — and Why — the States Should Tax Electronic
Commerce: Explanation of My ACEC Proposal for Radical Simplification,” State Tax Notes, Vol. 18, No.
2 (January 10, 2000), pp. 129-40, Appendix A, or Charles E. McLure, Jr., “The Taxation of Electronic
Commerce: Background and Proposal,” in Nicholas Imparato, Public Policy and the Internet: Privacy,
Taxes, and Contracts (Stanford, Calif., Hoover Institution Press, 2000), pp. 49-113. We do not discuss this
case further here, but do so in Section III(B) below ( “Principal Normative Considerations Bearing on
Nexus Over Remote Sellers for Purpose of Requiring Collection of State and Local Use Taxes”).
27
57
Similarly, consumption of some products may entail public spending or be associated with external costs,
either of which could justify higher taxation than is imposed on other products. For example, consumption
of motor fuels is directly related to motor vehicle operation, which requires the construction and
maintenance of roads and highways and may cause congestion and pollution.
58
See generally George R. Zodrow, “Network Externalities and Indirect Tax Preferences for Electronic
Commerce,” International Tax and Public Finance, Vol. 10, No. 1 (January 2003), pp. 79-97; also in State
Tax Notes, Vol. 28, No. 11 ( June 16, 2003), pp. 969-79.
59
Under the assumption that taxation is economically neutral, business purchases of Internet access would
be exempt, just like all other business purchases of goods and services. Thus the argument for a subsidy to
all users of the Internet would imply not merely an exemption for business purchases of Internet access, but
that business should benefit from an actual subsidy. We do not examine this issue further, because the
basic argument for subsidizing Internet access is weak.
60
See Zodrow, International Tax and Public Finance, supra note 58, at pp. 82-83; Zodrow, State Tax
Notes, supra note 58, at pp. 970-72.
61
"Internet Statistics," available at www.nielsen-netratings.com (visited 2/6/04).
62
Thus it is one thing to exempt 1 million existing users (as well as new users) in order to induce 100
million potential users to join the network, and quite another matter to exempt 100 million existing users in
order to induce 1 million potential users to join. While the exemption would eventually benefit 101 million
users in both cases, the revenue cost of inducing new use would be very different in the two situations: the
tax on only 1 million existing users in the first, but the tax on 100 million existing users in the second.
63
Thus, after a careful evaluation of network externalities, Zodrow writes:
At current levels of computer usage, it seems likely that the marginal external benefits
from increases in the number of computers connected to the Internet are fairly small -certainly relative to the size of the Internet or the number of transactions conducted over
the Internet, and probably in an absolute sense. …That is, the marginal external benefit
of adding another user to the network may indeed be large at low and intermediate levels
of network usage. Nevertheless, such benefits will eventually become small at a large
enough network size because the marginal joiners will be increasingly low demanders,
who place a relatively small value on the benefits of joining the network and also
generate small external benefits because they participate less in network activities.
Although it would be difficult to prove that the marginal external benefits of adding
another user to the Internet are currently small, the size of the existing network suggests
this is likely to be the case.
Citing 1999 figures on Internet access and usage, Zodrow concludes: “Figures of this magnitude
(especially if updated to reflect growth over the intervening two years) suggest that the period of explosive
Internet growth is rapidly coming to a close…” and “marginal network externalities are likely to be
relatively small.” Zodrow, International Tax and Public Finance, supra note 58, at pp. 85-86; Zodrow,
State Tax Notes, supra note 58, at pp. 973-74. Two more years of growth have occurred since those words
were written in 2001.
64
Internet access providers (IAPs) commonly provide special startup packages, with low initial rates for 3
to 6 months, followed by a bump up to the standard rate. Although the primary purpose of such special
rates is presumably to attract customers from other IAPs, they may help create network effects. It would be
possible to allow IAPs to package a sales tax reduction as part of the deal, but there seems to be no way to
prevent the benefit being made available repeatedly to those who switch IAPs.
28
65
If this approach were adopted for political reasons, the exemption should not be indexed for inflation, so
that its real value would decline over time.
66
See Martin Sullivan, “Will VOIP Telephone Service Be Subject to Telephone Taxes,” Tax Notes, Vol.
102, No. 4, (January 26, 2004), pp. 458-66, or State Tax Notes, Vol. 31, No. 5 (February 2, 2004), pp.
385-92.
67
Of course, the revenue loss would not be nearly as large if business purchases of telecommunications
were already exempt, as they would be under the economically neutral system. It should also be noted that
the telecommunications industry is currently subjected to far higher taxes than other industries; see Council
on State Taxation (COST) Telecommunications Tax Task Force, “2001 State Study and Report on
Telecommunications Taxation,” reproduced as a Special Report in Tax Management (Bureau of National
Affairs), Multistate Tax Report, Vol. 9, No. 2 (February 22, 2002). Since such deviations from uniform
taxation cannot be justified, this excessive taxation should be eliminated, in order to avoid placing
telecommunications at a competitive disadvantage, which would occur even if Internet access and thus
Internet telephony were taxed like other products.
68
It would, in theory, be possible to use a refundable federal income tax credit to make the subsidy
available only to the poor. Such an approach would at least put the cost in terms of lost revenue on the
federal government, where it belongs, but this approach is fraught with difficulties. We do not discuss it
further.
69
This raises an interesting question of interpretation, namely, whether telecommunications services and
digital content purchased by Internet service providers should be exempt, since they can be seen as
purchases for resale. Under existing statutes and case law, the answer to that question would turn on such
inquiries as whether the telecommunications services or content are being resold as such or rather are being
“consumed” in the course of delivering a different service or product and whether the ultimate service or
product that is sold is subject to tax, since the sale-for-resale exemption is designed to avoid pyramiding of
the tax. The conceptually correct solution – exemption of all sales to business -- avoids the need to make
these often difficult determinations.
70
The description of this legislation is based on the Streamlined Sales and Use Tax Act, S. 1736, 108th
Cong., 1st Sess. (2003). Similar legislation will almost certainly be (if it has not already been) introduced
into Congress during the Second Session of the 108th Congress.
71
It seems to be more common to argue that vendors should be compensated for collecting sales taxes than
to argue for compensation for collection of withholding taxes, although both cases involve private firms
acting as collection agents for taxes owed by third parties. A strong case can be made on policy grounds,
but rarely is, that those who pay income and other direct taxes should be compensated for at least part of
their costs of compliance and litigation (but not costs of tax planning), in order to reduce the inclination to
enact complex statutes. Since the federal government is the source of most complexity in the income tax, it
should be responsible for this aspect of taxpayer compensation.
72
Vendor costs should cover only the additional costs vendors incur in order to comply with tax collection
obligations. Thus, for example, they should not cover any of the costs of processing credit card purchases,
except to the extent that such costs result from calculation and collection of tax.
73
This is not intended to be a complete list of the ways in which state sales and use taxes could and should
be made uniform. It is intended to paint the “big picture.”
74
We say this fully appreciating that in a world of truly independent sovereign states, there may be no
jurisdictional authority to require a remote vendor to comply with another state’s consumption tax rules,
even on the utopian assumption that all such states had identical consumption tax rules. As we have noted
above, however, in the U.S. federal system, there is ample authority for Congress to authorize such
collection, subject only to the loose restraints that the Due Process Clause imposes on the exercise of state
29
taxing authority.
75
They would differ in other respects as well (e.g., in the extent to which they treat customers of remote
vendors and local merchants the same), none of which seems worth discussing in detail.
76
Whether merchants currently paying local sales and use taxes under so-called “direct pay” authority –
whereby certain taxpayers are permitted to self-assess sales and use taxes rather than paying them to their
vendors – would continue to pay under this regime or would be integrated into the regime described in the
text is a question that would need to be addressed. We leave this question, and many other detailed
questions that could be raised about such a regime, to another day.
77
SSUTA § 6(12).
78
Id. § 4(c).
79
Streamlined Agreement § 302. The effective date of this provision is January 1, 2006.
80
SSUTA § 6.
81
See generally George S. Isaacson, “A Promise Unfulfilled: How the Streamlined Sales Tax Project Failed
to Meet Its Own Goals for Simplification of the State Sales and Use Taxes,” State Tax Notes, Vol. 30, No.
4 (Oct. 27, 2003), pp. 339-52. We recognize, of course, that the cited reference is the partisan testimony of
a skilled advocate on behalf a client (the Direct Marketing Association), whose constituency benefits
roundly from the existing regime under which many of its members have no constitutional obligation to
collect use taxes on remote sales. Nevertheless, a number of the points raised in the testimony cannot be
dismissed as mere rhetoric, and plainly warrant further consideration by Congress and its staff.
82
The description of this legislation is based on the Business Activity Tax Simplification Act of 2003, H.R.
3220, 108th Cong., 1st Sess. (2003). Similar legislation will almost certainly be (if it has not already been)
introduced into Congress during the Second Session of the 108th Congress.
83
See supra note 9 and accompanying text.
84
We ignore the question of separate nexus with localities because it does not appear to have generated any
controversy in the BAT debate and is not an issue under Public Law 86-272 (or the proposed BAT
legislation extending Public Law 86-272). Although Public Law 86-272 (and the proposed BAT
legislation) cover state and local income taxes and BATs, the basic nexus restraint is imposed at the state
level only. In other words, if there is nexus within a state, a locality within that state may impose a BAT,
even if there is no “independent” nexus within the locality under the nexus standards applied at the state
level. The same analysis applies under judicially articulated constitutional doctrine. See Aldens v. Tully, 49
N.Y.2d 525, 404 N.E.2d 703 (1980) (existence of nexus with a state provides sufficient nexus for a state to
require a vendor to collect a use tax imposed by a locality within the state, even if the vendor has no
“independent” nexus with the locality).
85
On the importance of a uniform apportionment formula, see National Tax Association, “Report of
Committee on the Apportionment between States of Taxes on Mercantile and Manufacturing Business,”
Proceedings of the National Tax Association, 1922, p. 202. (“All methods of apportionment ... are
arbitrary -- the cutting of the Gordian knot. ... [T]here probably are a number of different rules, all of
which may work substantial justice... [T]he only right rule ... is a rule on which the several states can and
will get together as a matter of comity.”)
86
Only if the states adopted a uniform apportionment formula without a sales factor would a nexus
threshold based on sales be unlikely to create “nowhere income.”
87
Some states employ a “throwback” rule that attributes sales otherwise attributable to a state that lacks
jurisdiction to tax to the state of origin of such sales. It would seem more logical simply to eliminate sales
30
to the no-nexus state from the denominator of the sales factor. Whereas this rule would eliminate the
possibility of “nowhere income,” reliance on “throwback” would do so only if adopted by the state of
origin.
88
Nexus rules intended to mitigate complexity for multistate corporations could be designed also to take
account of the taxpayer’s total apportionable income, since there will be little tax liability if there is little
apportionable income, even if the taxpayer has a large amount or a large fraction of its apportionment
factors in the taxing state. But lack of enough taxable income to justify costs of compliance is not an
acceptable basis for a solely in-state corporation not to file a tax return.
89
See also Charles E. McLure, Jr. "Implementing State Corporate Income Taxes in the Digital Age,”
National Tax Journal, Vol. 53, No. 4, Part 3 (December 2000), pp. 1287-1305. In principle, the nexus rule
should be tailored to the apportionment formula employed by the state. Suppose, for example, that state A
used a three-factor formula, but state B used only sales to apportion income. In state A there would be
three alternative thresholds, one for each factor in the formula, exceeding any of which could trigger nexus.
In state B there would be only a sales threshold. The Multistate Tax Commission has proposed a rule that
considers the presence of all three factors, regardless of the particular formula the state uses. As a practical
matter, the two rules are likely to have quite similar effects, as the sales threshold is the one that is most
likely to be effective in most cases where nexus is at issue.
90
Council on State Taxation, “Jurisdiction to Impose Business Activity Tax,” a policy position, available
at: http://www.statetax.org/Content/NavigationMenu/Legislative/Policy_Statements/Default271.htm
(emphasis supplied).
91
For earlier expressions of this view, see Walter Hellerstein, "Jurisdiction to Tax Income and
Consumption in the New Economy: A Theoretical and Comparative Perspective," Georgia Law Review,
Vol. 38, No. 1 (Fall 2003), pp. 1-70, and Charles E. McLure, Jr., "Source-Base Taxation and Alternatives
to the Concept of Permanent Establishment, in Report of the Proceedings of the World Tax Conference:
Taxes without Borders (Toronto: Canadian Tax Foundation: 2000), pp. 6:1-15.
92
Wisconsin v. J.C. Penney Co., 311 U.S. 435, 444 (1940). It is worth noting that the failure to receive
quantifiable benefits from the state is not, at least in constitutional terms, a defense to the imposition of a
tax. As the U.S. Supreme Court observed in Commonwealth Edison Co. v. Montana, 453 U.S. 609 (1981),
in rejecting a taxpayer's argument that the severance tax imposed on its coal far exceeded the benefits it
received from the state and that the tax therefore violated the Commerce Clause:
"[a] tax is not an assessment of benefits. It is, as we have said, a means of distributing the
burden of the cost of government. The only benefit to which the taxpayer is
constitutionally entitled is that derived from his enjoyment of the privileges of living in
an organized society, established and safeguarded by the devotion of taxes to public
purposes."
Id. at 623 (quoting Carmichael v. Southern Coal & Coke Co., 301 U.S. 495, 521-22 (1937)).
93
This raises interesting and perhaps complicated questions that cannot be addressed here. To meet this
objection there could be a safe harbor for coming to a state for the purpose of “[m]eeting government
officials for purposes other than selling goods and services,” as in the BAT legislation.
94
The fact that property taxes are “in rem” and may be satisfied by sale of the property in question (rather
than a direct action against the taxpayer) does not, as a practical matter, undermine our essential point that
the taxation (and involuntary deprivation of property associated with taxation) may not be resisted on the
ground that the person (individual or corporate) who bears the burden of the deprivation has no voting
rights in the taxing state.
95
Council on State Taxation, “Federal Standard for Imposition and Collection of State and Local Taxes,” a
31
policy position, available at:
http://www.statetax.org/Content/NavigationMenu/Legislative/Policy_Statements/Default271.htm.
32