November 16, 1999

STREAMLINING THE SALES TAX SYSTEM

An Address by Governor Michael O. Leavitt
to the National Press Club

Over the next decade, forces of globalization will reshape governments more profoundly than the industrial revolution and the progressive era combined. With today's technology, the boundaries that have defined political jurisdictions for two centuries are becoming less relevant. Nowhere is the transformation more evident than on questions of the Internet and tax policy.

That is my subject today, and my remarks will center around the following points:

It should be our practice to do all within reason to nurture expansion of the Internet and adapt to the changes it produces. The Internet should not be taxed. That means no bandwidth taxes, no byte taxes, no access taxes and no multiple or discriminatory taxes on the Net itself.

In the century ahead, "e-tailing" will not simply replace brick-and-mortar retailing. The two will converge in a new world of "clicks and mortar," and it will be a convergence that demands a level playing field as its first principle.

The Internet is a powerful engine of economic expansion. Many worry that compelling Internet businesses to collect sales taxes would impede its growth and expansion. Today, I propose a three-to-five-year period during which no changes would be made in the ability of states to require businesses outside their borders to collect sales tax on their behalf.

The existing system of sales tax will not work in the 21st century. It is unthinkably complex and incompatible with the direction of commerce in the world. So we modernize it. In tandem with the standstill period I just referenced, state and local governments propose creation of a pilot sales tax system for the 21 st century. It would be elegantly simple; it would create a level playing field; and it would be entirely voluntary.

Those are the main points. I'll elaborate on them and outline what I believe will be the future of this issue as a political and policy debate over the next six to eight years. I would also like to comment on proposals from other quarters that would have Congress step in to control state and local tax policy.

In 1998, Congress passed the Internet Tax Freedom Act. State and local governments participated actively in the discussion and supported a moratorium on taxes imposed directly on the Internet itself. Again, let me say there should be no taxes on bandwidth, no taxes on access, no discriminatory or multiple taxes. This is critical to protecting the long-term viability of the Internet.

There is little dispute on this point. The sales tax issue is more problematic.

Complexity, Inequality and Change

Let me tell three quick stories that illustrate the current dilemma.

I was in California with my family. I bought some groceries over the Internet. My money went to New York; the groceries were shipped from New Jersey; and they were sent to my home in Utah. Where did that transaction take place? How should it be taxed, or should it be taxed at all? If it is taxed, whose school system, roads and public safety programs get the benefit? All four states could make a claim.

Among the things I purchased that day was a bottle of peanuts. That sounds like a straightforward product, but it's not that easy under tax law. If those peanuts were raw peanuts and I lived in one of five states, the law would require that I pay sales tax on them. If they were roasted, 11 states would charge sales tax. If they were honey roasted, the list grows to 21. Once peanuts meet up with caramel corn and become Fiddle Faddle, it's no longer a food – it's a snack – and 31 states will require sales tax on it.

The tax managers of national and regional retailers tell of mind-numbing difficulty and expense in sorting through layers of these definitions and rules. They submit hundreds of sales tax reports every quarter on a million different products in thousands of jurisdictions. In a world where friction kills prosperity, this degree of complexity is unacceptable.

Story Number Two. Not long ago, I borrowed a book from a friend, "The Lessons of History" by Ariel and Will Durrant. I marked it up quite a bit and realized I could not return it in that condition. I logged on to Amazon.com to buy my friend a new copy. Amazon was selling it for $16.95. I checked a few other sources to compare prices.

On another website – one for a bookstore chain with a store in my city – I found it again for $16.95. But because this second store had a physical presence in my state, a concept known as nexus, it was required to collect $1.06 in sales tax. So I had a choice – $16.95 or $18.01. The same book, the same price, the same computer on the same night. One required collection of sales tax; the other did not. Can anyone possibly regard that as fair?

Last story. My wife, Jackie, has resisted Internet shopping. We needed a sofa bed for our basement. One day I suggested she try and find one on the Internet. Now, my wife, she's a shopper. She checked every furniture website she could find and settled on a sofa she liked. The next thing I know she's looking through the yellow pages for a local dealer that carried that line. She drove down to the store, sat on an identical sofa in a different color, felt the fabric in the sample book and then drove home to click in her very first Internet order.

"Why didn't you just buy it from the store?" I wanted to know. She told me that with the $65 in shipping and handling, the prices were about the same. "But get this," she said, "No sales tax!" I said, "Jackie we need to talk."

Same sofa, same price. The difference ... sales tax. By law we owed it. But like most consumers, my wife did not know that, and because of the complexity in determining sales tax on remote sales, there has been no impetus or system for collecting it. Until now.

But again, is it fair for a store to lose a sale on the basis of a tax that is owed but not collected? Is it fair to other people in a community who pay their fair share of schools, roads, and public safety when they buy at the store and pay the tax.

Let me put it even more simply. Is it acceptable to discriminate by collecting no tax from the techno-shopper with the Palm Pilot and Sharper Image catalogue but demanding it without fail at the cash register from the traditional shopper who may not be able to afford a computer?

No, it isn't fair, and it's lousy, indefensible tax policy. The current sales tax was a great system of taxation for the agriculture and industrial economy it was created for. But it is unworkable now.

My wife's first Internet shopping experience is instructive in another way. It foreshadows the future of Internet retailing. It has become increasingly clear that the first wave of this information revolution featured "dot.com" companies exclusively devoted to electronic commerce. The Amazons of the world have taken the stock market by storm. They have captured the imagination of enterprising business people and are clearly reshaping the nature of consumer sales.

However, the second, more sustainable wave – the wave by which people will begin to operate profitably and turn it into a true retailing revolution – has begun. It is occurring as the traditional retailers – be they national, regional or local mom-and-pops – start transforming themselves from solely storefront businesses to storefront and online businesses. From bricks and mortar to clicks and mortar. The successful retailer of the future will have a retail presence, a catalogue presence and an Internet presence, all catering to different segments of society, each weaving part of an integrated whole.

This week I received a letter from Radio Shack Chairman Leonard Roberts, describing his company's plan for a clicks-and-mortar strategy. Radio Shack has 7,000 stores nationwide, yet it has spent millions of dollars developing RadioShack.com to offer customers vastly more products and services than can be offered in each retail store. In his letter to me, Leonard Roberts had but one request: a level playing field. This is what he wrote:

"Today's savvy consumers expect to be able to integrate the Web with in-store shopping. And savvy retailers are freely willing to cannibalize part of their in-store business because of the great Internet potential. Provided there is a level competitive playing field among all those selling on the Web, we believe retail Internet sales could represent more than 20% of the increase in total retail sales in the next decade. As this sector of retail expands, so will the problem of lack of tax parity between traditional and virtual retailers."

Retailers such as Wal-Mart, Sears and JC Penney are rapidly preparing to enter this market, fully recognizing the advantage developed by the combination of their assets. What do they want? Equal treatment. Gateway Computer pioneered mass-customized computers sold on a remote basis. They, too, have begun the move toward second-wave "e-tailing." Gateway's country store concept expands daily and the company is seen as an emerging leader. You're going to see a lot more of this. Clicks and mortar are the future.

Likewise, many of the first-wave dot.coms are branching out the other way to establish storefront locations. Amazon.com recently established six distribution centers throughout the country. This gives Amazon nexus to those seven states – the physical connection that triggers the obligation under the laws of those states and their municipalities to collect sales tax. It means even Amazon.com will be subject to an Industrial Age sales tax system.

Imagine walking into your regular grocery store and loading up the cart. You head for checkout, and there are four cash registers. One collects sales tax; the other three do not. Would this be fair? Would people see it as good tax policy or rational behavior on the part of the store? No. Think of it another way. You pull your car into a gas station and discover that one of three pumps charges a gasoline tax to pay for roads. Is that fair to those who had to buy gas on the taxed pump, while others driving the same roads got the tax-free pump?

These examples make no more sense than a retail system where a store has a catalogue, a website and a retail outlet, but only one of those three entities has to collect tax and the others do not. We all despise paying taxes. But we despise unfair treatment, too. Equal treatment; a level playing field. That's the American way.

A New Vision; A Better Way

Today, the National Governors Association in conjunction with six other organizations representing state and local governments has released a proposal for a Streamlined Sales Tax System for the 21st Century. A copy of the proposal is available, but I'd like to provide an overview.

First off, it's a pilot program. White it is being tested and refined, Internet sellers will continue to enjoy the same favorable treatment in the states where they do not have nexus. This will assure that the Internet grows and expands in a way as to provide ubiquitous opportunity for the Internet industry. This is a reasonable approach in both economic and practical terms. The Internet is an industry in its infancy and should be treated with great care.

Likewise, it is impossible to make radical changes in a system as complex as the sales tax system. The pilot program will allow new concepts to be tested and proven prior to their implementation, and only those who voluntarily choose to will be involved. This is a 21 st century idea – government saying to business, "Here's a new system, you're not required to use it, but if it is in your best interest to do so, go ahead."

At the end of the three-to-five year trial period, if the system has proven itself as workable and prudent, policy makers can then proceed to discuss its use in the development of a unified system that provides a level playing field for all members.

Here's how the pilot will work:

Over the next 18-24 months, a significant number of states will propose legislation creating a "zero-burden" program – the pilot. Initially, two groups will be eligible: remote sellers and retailers with a physical presence in multiple states. The zero-burden legislation will create uniform product codes and sourcing rules. It will initiate the process of devising standard definitions and limit the number of times local governments can change their rules and rates. And again, it will be voluntary.

Businesses who want to use the new system register on a website, making them a zero-burden participant in every applicable state. Those electing to use it then choose an administrator, referred to as a Trusted Third Party (TTP), from a list of independent organizations approved by the states to administer and distribute sales tax collection for the seller. The TTP provides the seller with software, certified by the zero-burden states. The software will be embedded in the sellers' software, and it will do three things:

Calculate the tax in the jurisdiction where the goods are delivered.
Charge the appropriate tax to the buyer's credit card at the time of sale and send it to the account of the TTP.

Track the amount through the TTP and remit the tax to the state or municipality.
This is a radical simplification and massive reduction of the burden shouldered by retailers. When fully implemented, the Federation of Tax Administrators estimates that the savings to American business will be in excess of $4 billion every year.

Gone is the requirement to monitor rules, rates and laws in 7,600 different taxing jurisdictions across the United States. The tax audits, administrative hearings, contentious disputes, the risk of bad debts, the need to keep warehouses full of records and to police tax exemptions – all gone.

Where do we go from here?

I'd like to give this entire debate context by laying out what I believe will be the progression of this issue over the next six to 10 years.

Debate on this issue heightened considerably by the creation last year of the Advisory Commission on Electronic Commerce, which must release a report in April. The commission has served an important purpose in that positions are being solidified and a vast education has begun. However, there are only two meetings left. When the report comes out in April, I believe it will not be conclusive.

During the balance of the 105th Congress, various bills will be filed, ranging from a federal solution – i.e., a national sales tax – to pre-empting the states. In the political climate of an election year, I suspect none of those efforts will be successful.

Electronic commerce will continue to explode during the next 15 months, including two Christmas seasons that will shatter all previous expectations.

The nation's major retailers, which have yet to make their presence known in this debate, will wake up and realize they are at a serious disadvantage – a 6% to 8% price disadvantage, to be exact, due to the fact they have nexus. By this time, they will have spent hundreds of millions of dollars worth of investment in their own electronic commerce systems. They're going to launch a catch-up campaign pressing for a level playing field.

Meanwhile, the pilot sales tax system is in place. It will have been tested and refined, and a high percentage of retailers with multi-state nexus, and even a number of dot.com companies will be voluntarily using it.

By the year 2002 or 2003, more and more dot.com companies will have shifted to the clicks and mortar standard. Meantime, states and local governments will have begun to see serious erosion in their sales tax revenues.

The shift to clicks and mortar retailing, along with the pressure brought by major retailers will force serious discussion. The pilot will already be handling a large percentage of electronic commerce, and the number of retailers using it has increased.

Debate will move toward a unified system. The effort will be made to have standard definitions and systems. What isn't possible now will be possible then: a level playing field with a unified system nationwide.

A National Solution, Not a Federal System

There is a campaign to prohibit state and local governments from creating tax systems in their local communities. It is being waged under the banner of free trade and the suggestion that collecting currently-owed sales taxes somehow constitutes a new tax on the Internet. This effort is misguided, its message misleading.

Free trade means level playing fields, not special advantages. The prohibitionist campaign is an effort to give an unfair competitive advantage to one group of sellers. It is protectionism cloaked as free trade. And its proposed solution is unconstitutional. That solution is to have Congress step in and take away – prohibit – the ability of states and local governments to control their own tax policies. Thomas Jefferson would roll over in his grave.

If a state does not want to tax remote sales, that is the state's prerogative. Four states don't have sales tax at all. It is their choice. The states and local governments that provide public education, highway maintenance and police are the ones to determine how they will pay for it. Not Congress. This is the most fundamental of American principles.

Asking Congress to roll over the most important of state roles is a clear invitation for an all-powerful federal government. I would ask particularly my fellow Republicans: Are we not the party of devolution? Are we not the party that believes government closest to the people governs best?

The Time is Now

In closing, let me re-emphasize some key points:

There is no new tax involved in a streamlined sales tax system. None. Every tax obligation talked about exists today. The sales tax has been around nearly as long as this nation. It is not a new tax. Citizens know what it is and what it pays for – the schools their children attend, the roads they drive and the fire and police departments that protect them.

The new streamlined sales tax system, when fully deployed, treats every buyer the same. No special privilege, no selective burden, just a level playing field.

The new system is voluntary. Whether you're a New Hampshire that has no sales tax or a Nevada, where sales tax comprises 80 percent of all state revenue, it's your choice. If you don't like it or don't need it – don't use it.

Finally, the time, for a solution is now. There is a point in the life of every problem when it is big enough to see and small enough to solve. We are at precisely that moment in the life of this challenge.

Internet sales currently make up a very small percentage of our gross national product, but no serious person doubts the rapid expansion of this segment and its propensity to encompass every aspect of our economy. The sales tax problem has to be dealt with seriously and fairly . It will not be solved easily or quickly. Changes of this magnitude are best undertaken with care and deliberation.

I am here on behalf of the seven major organizations in America comprised of elected officials – governors, mayors, commissioners and legislators – chosen by voters throughout this country to lead state and local governments. These are the governments closest to the people, with the greatest incentive of all to ensure fair taxation and maintain good public service.

We have a modernizing proposal here, not a protectionist prohibition. We have the solution of the century.