Sales and Use Tax

As most consumers are aware, most states impose a sales tax on intrastate purchases, whereby the seller collects the tax and subsequently remits it to the taxing authority. On the other hand, a use tax can be imposed on a resident's purchase from an out-of-state-vendor, and essentially represents a tax on the use, consumption, or storage of property acquired in a transaction not subject to sales tax (Vanderhoff n/a). Many (45) states impose a sales and use tax, which account for one third of all state taxes and one-fourth of the total revenue raised by states (Cline & Neubig1999).

Likewise, many local governments assess  sales and use tax, although collections represents a smaller source (11%) of revenue for these governmental bodies. Not surprising, the importance of these taxes varies significantly among the states, with five states receiving more than 50 percent of their tax revenue in the form of sales and use taxes, as compared to these taxes accounting for less than 25% of tax collections for six states (Cline & Neubig1999). As such, subjecting e-business transactions to these taxes constitutes an important issue for many state and local governments.

Congress passed the Internet Tax Freedom Act in October 1998, which placed a three-year moratorium on most forms of Internet taxation, including taxes on electronic commerce and Internet access (Hann 1999). However, state and local taxes already enacted by nine states on e-transactions were grandfathered in by the act. As a result of this moratorium, it was estimated that less than 170 million dollars in sales and use taxes were not collected in 1998, a rather substantial sum, yet representing only one-tenth of one percent of total state and local government sales and use tax collections for that year.

Two reasons are often given for the less than significant effect on revenues. The first is that at present 80% of e-commerce is business-to-business sales that are either not subject to tax or are already subject to tax by in-state business purchasers. Secondly, a majority of business-to-consumer sales involve intangible services or exempt products (Cline & Neubig1999). Several constitutional requirements must be considered in deciding whether state and local governments have the power to tax Internet commercial transactions.

The Commerce Clause grants power to Congress to regulate interstate commerce. The clause also has been interpreted to have a negative or dormant component as well, which is typically used to limit state regulation where Congress has failed to act. As a result, it has been determined that states can impose taxes affecting interstate commerce where it is applied to an activity having a substantial nexus with the state, is fairly apportioned, is not discriminatory, and is fairly related to services provided by the state (Vanderhoff n/a).

Generally an out-of-state business must have a physical presence within a state in order for the sufficient nexus requirement to be met. Given the make-up of the Internet, a physical presence may be lacking. Similarly, the 14th Amendment Due Process Clause must be considered. This clause requires some minimum connection between a state and the person, property or transaction sought to be taxed. Clearly, these are significant hurdles that must be jumped before local governments will be given the power to tax. Encryption involves the use of cryptographic algorithms to protect and keep private electronic communications.

Integrity of documents and privacy of communications is critical before business people and consumers will choose to rely heavily on e-commerce. It would seem that allowing freedom for encryption would be no problem. However, law enforcement argues for restrictions on encryption. The encryption regulation debate involves disputes between the needs of business for integrity and privacy, the First Amendment's right to free speech, and the need of law enforcement to track criminal behavior, such as espionage, terrorism, money laundering, and other crimes.

Businesses desire unrestricted encryption use to protect their trade secrets, financial information, patents, and customer information. Business also needs to ensure that communicated documents are intact, not tampered with, and authentic. "Unprotected communications may be read and their contents stolen by unintended recipients. For e. g. , the French government is reportedly gleaning economic and technological intelligence from American companies and passing information on to their French competitors" (Katz 1999 p. 34).

Consumers want assurance that information about them is not easily accessible by unscrupulous others. Business needs to ensure confidentiality of consumer information including their wages, addresses, savings, credit card numbers, etc. Encryption is a mechanism businesses use to garner customer trust. Law enforcement and national security interests want restrictions on encryption usage and exportation. The government strictly controls exports of commercial encryption technology. Compliance failure can lead to significant civil and criminal consequences.

Additionally, there are numerous other laws in the legislative process at the federal and state levels. The federal courts have also gotten involved and the Ninth District in Bernstein v. U. S. Department of State indicated the "distinction between print and electronic media is increasingly untenable" and encryption software is protectable under the First Amendment (Bernstein v. US 1997). Note, however, that the content of the software may be regulated under certain circumstances. President Clinton issued Direction 63 calling for a detailed plan to protect Americans against cyber disruptions.

He stated, "if we are to continue to enjoy the benefits of the Information Age, preserve our security and safeguard our economic well-being, we must protect our critical computer-controlled systems from attack". He also indicated that our nation's security needs must be balanced with our civil liberties. Additionally, he stated "each sector must decide for itself what practices, procedures, and standards are necessary for it to protect its key systems". The critical sectors to which President Clinton referred were the economy, national security, public health and safety (National Plan 2000).