All Things Digital

As one of the original 13 colonies, you’d think that New York State would have a particular antipathy toward things like “taxation without representation.” And perhaps it does, just not when it’s the one doing the taxing.

The state recently passed a so-called Amazon Tax, a new law compelling out-of-state online retailers to start collecting New York sales tax. The law, designed to recover sales taxes potentially lost to Internet purchases, requires any e-tailer with even a single affiliate site with a New York State address–say, a blog that earns a referral fee for sending customers to Amazon (AMZN)–to collect sales tax on all goods sold in the state, even those not sold through the affiliate.

Its authors say it will contribute about $50 million to the state’s budget, and it might, if Amazon doesn’t get it declared unconstitutional first. Earlier this week, the company filed a suit challenging the law because it imposes tax-collection obligations on retailers, online and off, with no physical presence in the state. Worse, it does so based on nothing more than advertising in New York, a definition that includes retailers with even the slightest connection to the state.

Said Amazon: “This statute was intended to impose tax-collection obligations on out-of-state Internet retailers such as Amazon. Nonetheless, the statute, as drafted, on its face would also impose tax-collection obligations on non-Internet out-of-state retailers who pay New York print media, television or radio outlets to advertise their products and thereby refer New York customers to buy them.”

Sen. Ted Stevens was right: The Internet is not a big truck. It’s “a series of tubes”–tubes that can be filled to capacity by “enormous amounts of material.” And, according to AT&T, that’s going to happen about two years from now.

In remarks at the Westminster eForum on Web 2.0 this week in London, Jim Cicconi, vice president of legislative affairs for AT&T (T), said the Internet will hit its capacity in 2010. “The surge in online content is at the center of the most dramatic changes affecting the Internet today,” Cicconi said. “In three years’ time, 20 typical households will generate more traffic than the entire Internet today. We are going to be butting up against the physical capacity of the Internet by 2010.”

Clearly, some bigger tubes are in order here–$55 billion worth of them, according to Cicconi, who was quick to note that it will be companies like AT&T footing the bill for them. “There is nothing magic or ethereal about the Internet–it is no more ethereal than the highway system,” he said. “It is not created by an act of God, but upgraded and maintained by private investors.”

Ah yes, private investors. Like the ones who promised in the mid-1990s to provide fiber-optic connections to millions of households across the country in exchange for some $200 billion in tax cuts? The ones who never delivered on that promise, content to pocket direct tax credits of, on average, $2,000 per subscriber, without fulfilling their end of the bargain? Those investors?

As far as solutions for California’s $14 billion budget deficit go, taxing “digital property” is nearly as outlandish as Gov. Arnold Schwarzenegger’s proposed $4.8 billion cut in education spending.

Yet it’s being bandied about by Democratic State Assemblyman Charles Calderon, whose Assembly Bill 1956 would expand the state’s sales tax to digital goods–music downloads, e-books, pornography and what-not. “The notion of taxing tangible, physical property is really an industrial-era construct when we made widgets and sold widgets,” Calderon argues. “Now it’s not about widgets, it’s about information, and selling information and moving information.”

It certainly is, but is it really prudent to slap an iTax of 8.25% to 8.75% on such information? Especially when those who peddle it could pretty easily create a separate entity out-of-state and avoid it altogether? Driving away e-commerce certainly isn’t going to do California’s budget any good. “When you charge these taxes, all these e-commerce [companies] are going to move outside of California,” said Michelle Steel, a member of the California State Board of Equalization. “California is the high-tech state; why would you want to kick them out?”

Good question. Because if you do force them out, who’s going to provide the state with its massive tax windfalls? From an Associated Press report from January, 2007:

After cashing in more than 9 million shares valued at $3.7 billion last year, 16 Google insiders will owe the Golden State as much as $380 million in taxes–enough to cover the salaries of more than 3,000 state workers.”

Oracle’s Larry Ellison was given a bit of a respite from the financial beating he’s taken over the past few days by the empathic folks at the San Mateo (Calif.) County assessor’s office. The Oracle (ORCL) chairman, worth $25 billion according to Forbes, recently had the value of “Sanbashi,” his grandiose 23-acre Imperial Palace in Woodside, Calif., reassessed from $173 million to about $70 million.

Why the sudden decline in value? Well, like all 16th-century Shogun estates with authentic Japanese teahouses and strolling gardens it suffers from–in the words of Ellison’s appeal–”significant functional obsolescence.” And that obsolescence is so significant that it entitles the world’s 14th wealthiest man to a $3 million tax refund.

Sadly for San Mateo County, that refund will be paid from property taxes that otherwise would have gone to schools, among other things. And what will Ellison do with the money? Who knows. Perhaps he’ll spend it on another 30-ton “shower rock” like the one in Sanbashi, which he reportedly “auditioned” by pretending to shower in front of it.

With millions of dollars in virtual currency changing hands each month in simulated worlds like EverQuest and Second Life, there are increasing reports of virtual-world moguls amassing real-world riches and scholars warning that these online worlds could be the “21st century’s equivalent of hiding funds offshore.” So it may be only a matter of time before tax authorities open a virtual office or two. And in the not-too-distant future, they may.

Congress’ Joint Economic Committee is expected to issue a report on the potential taxation of virtual goods by the end of July. No word yet on what it might say, although a JEC director has suggested that “as long as virtual activity stays within the virtual economy, it shouldn’t be taxable.” So is that to say that there are tax consequences for activity that extends beyond it? Sounds like it. “Any time someone wins a tangible prize or award, the value is reportable as taxable income,” an Internal Revenue Service rep told CNN earlier this year. “An accumulation of ‘points’ would not result in tax consequences, but redeeming or selling them for money, goods, or services would.”

Last year was an exceptional one for online retailers, in which e-commerce spending, excluding travel-related purchases, eclipsed $100 billion–a 24% increase over 2005. And 2007 promises to be even better.

Little wonder, then, that state and local governments are lobbying Congress for the right to tax not just Internet connectivity, but online sales as well. Earlier this week, Sen. Mike Enzi (R., Wyo.) introduced a bill that would impose a mandatory sales tax on Internet purchases. The “Sales Tax Fairness and Simplification Act” would levy a sales tax on all Internet purchases, one that would yield billions in revenues for states and municipalities who, according to Enzi at least, are going to collect them one way or another. “Are we implicitly blessing a situation where states are forced to raise other taxes, such as income or property taxes, to offset the growing loss of sales-tax revenue?” Enzi said at a U.S. Senate hearing yesterday. “I want to avoid that.”

Turns out a few of Enzi’s colleagues feel they’d like to avoid the legislation he’s proposed. Among them, Sen. Ted “Series of Tubes” Stevens (R., Alaska). He would like “to see an impregnable ban on taxes on the Internet,” he said, noting that “the Internet is not something you just dump something like taxes on–it’s not a truck.”

It’s worth noting as well that a sales tax on e-commerce is not the only issue here. Also on the table: the expiration this November of a 1998 law that dictates that local governments in the U.S. generally cannot tax Internet access. If the ban is allowed to expire as state tax collectors hope, we could end up paying an additional 30% for Internet access and, perhaps, even a tax on email (shudder). “They might say, ‘We have no interest in having taxes on email,’ but if we allow the prohibition on Internet taxes to expire, then you open the door on cities and towns and states to tax email or other aspects of Internet access,” said Sen. John Sununu (R., N.H.). “We need to be honest about what we’re endorsing and what we’re opposing.”