Conflict on the Hill

Industry reps and government officials prepare to do battle over Internet taxes and other tech issues

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Venture capitalists have gone from smitten to sorry. The stock market has relegated it to the doghouse. The medias two-year panegyric has transformed into a scolding. Now its Congress turn to take another look at the Internet.

From taxation to privacy, intellectual property to telecommunications, the sudden realization that everything with a dot-com after it will not immediately transform society and commerce — and that the Internet is not a bottomless wealth machine for the nation — will add a new dimension to the myriad of technology debates destined for Capitol Hill.

Instead of facing a precocious, wildly gifted child of technology with a breathtakingly promising future and an apparent need for coddling, lawmakers in the 107th Congress that convenes this month will be confronted with a troubled teen.

That may not be a bad thing for the Internet in Washington, D.C. In fact, it could be a glimmer of silver lining amid the gathering clouds for the majority of technology companies that, when it comes to regulation, believe less is better.

Rather than arguing that the Internet is the golden goose that should be allowed to grow untouched, tech lobbyists can now argue that government interference could swiftly sink the foundering ship.

"You can kick a dog that is up, but its hard to kick a dog that is down a little bit," says Jerry Berman, executive director at the Center for Democracy and Technology, one of the leading cyberspace civil liberties organizations in Washington, D.C.

But there is a flip side to the apparent fragility. With the loss of the heady optimism and enthusiasm could come an attitude among some lawmakers that since the Net isnt omnipotent, it really isnt all that special. Some Web champions used to proclaim e-commerce as the backbone — or, at least, the developing backbone — of an exuberant, invincible economy. Lobbyists would admonish lawmakers: Do you want to be known as the politician who, by meddling with the Internet, messed it up?

But by any measure, its fair to say that, at least for now, e-commerce is surely on crutches, if not laid up in a hospital bed. And any argument that it is the foundation of a national economy — and therefore should not be touched — is going to be challenged.

Adding to the pressure to regulate the Internet will be brick-and-mortar industries that were taken off guard by the rocket of electronic commerce. Now, established industries are beginning to understand how the Net could affect their bottom lines. They are getting organized, and they are lobbying legislators to come to their rescue.

"Congress naturally does want to help the high-tech industry and get in synch with that world, both as an economic issue and for political fundraising reasons. And when it was a one-way street, it was easy," says Stan Sokul, a high-tech lobbyist who has been active on Capitol Hill for more than 15 years. "But when the old-line industries line up and fight back, its not going to be as synergistic anymore. Its going to create conflicts for the members [of Congress], and its not going to be as easy to hoe the row for the high-tech community anymore."

This month, the technology battles begin fresh in the 107th Congress. The Senate is evenly split, and the House of Representatives is a house even more divided than in the 106th Congress. There is a new commander in chief — as well as a new party — running the executive branch of government. The transition from Bill Clinton to George W. Bush will be the first change in administrations of the World Wide Webs short but remarkable life. Old approaches to the Net will be cast aside, and new ones will get tested.

Either way, Congress is ready to roll. Technology was the subject of myriad hearings during the last Congress, and the diversity of hearings will continue apace. But, according to experts, a handful of issues are expected to capture lawmakers attention and energy with particular vigor in this Congress: e-commerce taxation, privacy and telecommunications policy.

Tax Time?

The biggest question likely will be whether Congress should empower states to force out-of-state retailers — dot-coms, for example — to serve as sales tax collectors.

Most states and local governments think it should. Many technology companies and conservatives, on the other hand, are vehemently opposed.

Congress hasnt yet decided.

The issue looms as a major battle this year on Capitol Hill. A three-year deadline on the imposition of new or discriminatory taxes on electronic commerce runs out in October. And if Congress doesnt extend the deadline, conservatives and e-tailers fear states will begin devising ingenious ways of taxing electronic commerce.

Last year, the 19-member Advisory Commission on Electronic Commerce, which was established by Congress to examine issues of e-commerce and taxation and advise Congress, was divided over the issue. It was unable to muster enough votes to issue a formal opinion to Congress on how to proceed, although there was a simple majority of members who agreed that e-commerce should not be subject to sales or use taxes.

Despite the lack of consensus from the commission, the House of Representatives acted quickly after the dismantling of the commission in June to pass a new moratorium on e-taxes. But the measure stalled in the Senate, where it died.

The push for passage of an extended moratorium will descend upon Capitol Hill almost immediately in the 107th session, led by technology lobbyists and conservatives on the antitax side, and government and retail interests on the other.

The dot-com decline is already figuring into the rhetoric.

"It will add an element to the debate," says Rep. Bob Goodlattee, R-Va. "Its definitely premature for [proponents of e-commerce taxation] to force this issue through the Congress and add an additional burden on the e-commerce economy."

Ben Isaacson, executive director at the Association for Interactive Media, a dot-com trade group, agrees.

"The debate that has been raging is the e-commerce pure plays [Web sites without brick-and-mortar stores] are taking money away from the brick-and-mortar infrastructure," Isaacson says. "Many of those pure plays are now struggling to stay alive . . . They are going to recognize the arguments they were making a year ago are no longer relevant, and if they are going to consider imposing a tax collection on remote sellers, they are looking at wiping out what is already a fragile growth industry."

Meeting the technologists and conservatives fervor to pass the moratorium is a coalition of state and local governments and many brick-and-mortar retailers, represented in Washington, D.C., by their primary trade organization, the National Retail Federation. Rather than denounce the moratorium outright, however, the NRF says it will endorse the moratorium if Congress will help it solve the complex issues surrounding tax collection on remote sales.

"The more education we do on [Capitol] Hill, the more members of Congress realize this is not just the retail industry wants a tax increase," says Sarah Whitaker, director of government affairs at the NRF. "This is a tax that is not being collected, and it gives online retailers an unfair advantage."

The antitax forces will undoubtedly make the argument that e-commerce is clearly too fragile at this point to withstand taxation, Whitaker says. But as legislators understand how much sales tax revenue states are losing because of uncollected taxes, they grow increasingly sympathetic to the states. In addition, she says, while the dot-coms may point to their tenuous commercial vitality as a reason for Congress to stay away from taxation, the downturn in the economy gives states fresh ammunition, too: Economic slides translate into shrinking revenue for states.

Action on e-commerce taxation will start fast in Congress this year, and the battle will be pitched. Conservatives simply want to pass the three-year moratorium the House endorsed, and President-elect Bush would like to see a five-year extension. Moderates and liberals, on the other hand, are listening to state and local government arguments that they are losing huge tax revenue that, technically, they are due.

Indeed, most states are due tax revenue from online purchases. The kicker, however, is that the U.S. Supreme Court in the 1967 National Bell Hess Inc. vs. Department of Revenue decision, and then again in the 1992 Quill Corp. vs. North Dakota decision, ruled that while states are owed taxes from the sale of remote goods, the sales tax system in the U.S. is so complex that it would be unfairly burdensome to require people who sell goods remotely — through catalogs, telephones and now the Net — to determine what level of taxation the sale required.

As a result, states cannot demand remote sellers to collect their taxes unless the sellers have "nexus," or a physical presence, in the state. The tax collecting burden was shifted instead to consumers themselves, who are supposed to remit to their state departments of revenue the sales taxes from the purchase of any taxable good bought remotely.

This twist makes most people who buy online scofflaws, of course, because few people are actually aware that they are supposed to send taxes from remote sales to their states.

Forrester Research earlier this year released a report showing that of the nearly $13 billion in taxable retail goods that were sold online in 1999, only 20 percent of the purchases were taxed by the states. According to the study, states raked in $140 million in taxes from online purchases, but $525 million in taxes that should have been collected were left on the table. California lost $73.8 million, and Texas lost $51.9 million, for example.

To deal with the sales and use tax issue as the government and retail advocates want, in return for an endorsement of the moratorium against "new and discriminatory taxes" — the sales and use taxes are neither new or discriminatory — Congress must give states the authority to collect taxes from remote sales, something the U.S. Supreme Court was unwilling to do. Key to any congressional action — or to the alternative of trying to get the U.S. Supreme Court to overturn the Quill decision — is a successful effort by states to make the dizzyingly complicated network of state and local sales and use taxes more uniform.

Earlier this year, states started the Streamlined Sales Tax Project, which aims to coordinate state efforts to iron out the nations sprawling system of sales and use taxes. In addition, the National Conference of State Legislatures is pushing states to adopt model tax language that the conference drafted earlier this year. The hope is that state legislatures will pass tax-simplifying measures promulgated by these bodies, and that these will ultimately lead to a simpler national structure.

There are thousands of individual tax regimes in the U.S., from city sales taxes to differing definitions in various states about whether, for example, unpopped popcorn is a "food" or a "snack," and whether it should be taxed. States have wrestled for decades with the growing complexity of the sales tax system, and coalitions of states have made stabs at leveling their differences. To date, however, the system is hopelessly convoluted.

Jeffrey Friedman, a partner at consulting firm KPMGs e.Tax Solutions division, champions the states willingness to wrestle with the complex and usually divisive issue of taxes. "As a state representative said to me recently, Simplifying and improving the sales tax system is doing Gods work," Friedman says. "It needs to be done. Everybody knows it. The system is broken today, and its embarrassingly complicated."

An economic slowdown, he predicts, will force states to finally get it done. "I think to some extent the healthy economy and the healthy state coffers have given us the luxury of being able to discuss these issues thoughtfully, and not rush to judgment," Friedman says.

Others, however, remain doubtful.

"The states are never going to adopt [the uniform laws]," says Sokul, who was a member of the Advisory Commission on Electronic Commerce. "The state legislatures are either not going to adopt it, or they will change it. So the system is going to be adopted, if at all, differently by the states, which dramatically undermines its purpose."

Private Lives

Lawmakers struggled with a bevy of privacy bills in the last Congress, passing a few that addressed the privacy issues swirling around financial information and health information. Last year, too, the federal government for the first time implemented a privacy law aimed specifically at Web sites, the Childrens Online Privacy Protection Act. But the overall message from the Hill was: Were interested, but were not ready for sweeping legislation yet.

In part, lawmakers inability to have any serious debates about broad privacy legislation stemmed from timing: The past two years, when the issue of privacy grew particularly hot, was the tail end of a key election cycle, and legislators were reluctant to wade into such a contentious issue.

By the end of the 107th Congress, in the fall of 2002, Congress may finally pass some comprehensive privacy legislation, the CDTs Berman predicts.

"Privacy is going to be front and center," he says. "The election portends that privacy will be important. You had a tie in the presidency, a tie in the Congress and two candidates running toward the middle. Everything points towards gridlock or bipartisan efforts. And privacy has had a ton of bipartisan efforts. While it is a contentious issue, it doesnt cost a lot of money and I think [members of Congress] will say we can get something done . . . As the clock ticks into the second year [of the Congress], the pressure will be very high."

Berman cautions, however, that the same arguments being used to thwart e-commerce taxation will be used for other issues, including privacy. "This is the goose that is supposed to lay the golden egg," Berman says, "so if it is having problems, which it is, there will be less of a tendency to impose considerable regulatory or cost burdens, and that may spill into privacy."

It was a big year for privacy advocates such as Berman. Hearings on privacy issues became front-page news. So did stories about how Web sites and Internet advertisers were surreptitiously collecting personal information from unsuspecting Web surfers. Privacy-concerned organizations sponsored numerous workshops and symposia on Capitol Hill, and lawmakers paid attention.

Of the large-scale privacy bills, the Consumer Internet Privacy Enhancement Act, sponsored by Sen. John McCain, R-Ariz., and John Kerry, D-Mass., seemed to have the most momentum, and McCain and Kerry are sure to revive the bill in the next Congress. As chairman of the powerful Senate Commerce Committee, McCains support for privacy legislation is important.

The McCain-Kerry bill would require companies to reveal who is collecting information about consumers, what kind of information is being collected and whether consumers must divulge personal information to get access to the site. It would also force Web sites to ensure the security of harvested consumer information; demand that Web sites let consumers limit how their personal information is used for marketing purposes; and levy fines of $22,000 for each violation, up to a maximum of $500,000.

"It is imperative that we act because of the myriad of different solutions being devised in state and local governments across the country," says Rep. Billy Tauzin, R-La.

Tauzin and Rep. Mike Oxley, R-Ohio, are battling to replace Rep. Tom Bliley, R-Va., who has retired, as chairman of the House Commerce Committee, which is the committee, along with the Judiciary Committee, that debates and votes on the most important cyberspace legislation. "If we are going to have a ubiquitous e-commerce for this country, we need some common standards on privacy," Tauzin says.

The battle will rage — as it did in the last Congress — between industry-oriented folks and civil liberties advocates. The industry forces champion "self-regulation" as the only acceptable approach to deal with privacy, meaning privacy rules and their enforcement will be left up to industry. The free market, so the logic goes, will punish those with poor privacy policies and reward those with consumer-friendly practices. The civil liberties advocates are calling for, at the very least, baseline legislation to buttress any self-regulatory regimes installed by industry.

If the civil liberties groups get their way and sweeping privacy legislation is enacted, it would threaten to undermine the Information Economy, says Harris Miller, president of the Information Technology Association of America. "The self-regulatory model is working well," he says. "Government regulation will only be harmful to the Internet and to the consumers themselves."

Given the stakes and the energy behind both sides, the issue "is going to be on the front burner this year," Miller says.

Telecommunications: Tough Act To Follow

Telecommunications has long meant war on Capitol Hill, where the battlefield is thick with the bloodied vanquished and celebratory victors. The problem is, they keep changing places. Battle has become life to many telecom partisans, and this Congress promises to be brutal.

If Tauzin takes over as Commerce Committee chairman, as is expected, he says he "absolutely" plans to revisit the Telecommunications Act of 1996, an enormous piece of legislation that by itself created a small industry of people whose worlds spin around knowledge of the arcana of the act.

"Its time for us to see if we cant make the provisions of the 96 act more real, to implement them more quickly," Tauzin says. "The competition that was supposed to have happened by now in local and long-distance is being hampered. The idea of freeing up the [baby] Bells to compete in broadband is getting hung up on the Bells not being able to do long-distance."

Tauzin is deeply critical of the Federal Communications Commission, and says FCC reform will top his agenda as Commerce Committee chairman, if he gets the job. "Weve got a new act, the 1996 act, that predicts a converged, marketplace-driven, competitive telecommunications structure, and yet is being regulated by a 1930s organization that has a mindset to regulate monopoly service," he says. "Thats all changed. We need to reform its mission. Its whole mission was protection against monopoly. Now it needs to foster competition."

This is not sweet music to Robert McDowell, vice president and assistant general counsel at the Competitive Telecommunications Association, an organization with a deep adversarial relationship with all things baby Bell. Unfortunately for McDowell, Tauzin is much more sympathetic toward the baby Bells than Bliley, the outgoing Commerce Committee chairman, was.

"Our competitive carriers, who are collectively spending about $1 billion a month building out broadband networks, are very concerned that the ground rules laid out in the Telecommunications Act of 1996 may change in 2001," McDowell says. "Most of our members stock prices are in the toilet now, and some are almost on their knees as far as their survival. If you change the fundamental rules of the game when they are in a fragile state, that will exacerbate their problems."

In the last Congress, Tauzin introduced a bill that would let incumbent local exchange carriers, such as Verizon Communications and BellSouth, offer high-speed data services outside their local markets. Among other things, the bill would drop requirements that ILECs open their broadband networks to competitive local exchange carriers.

Since the arrival of the influential Tauzins legislation, McDowell says, "We have seen a tightening of the capital market for most telecommunications." Tauzins legislation, he says, is "very dangerous," because it will help the baby Bells "extend their monopolies into as many areas as possible."

The performance of telecom stocks, McDowell says, can serve as an object lesson on how legislation can concretely affect industry. "Certainly, we are in a normal business cycle, but itll be harder for entrepreneurial telecom firms to bounce back if there is hostile legislation going through Congress," he says. "Every industry goes through a business cycle, but some can be held down if the government acts against them, and that is whats happening here."

Tauzin, McDowell and the armadas of other telecommunications warriors are suited up and ready to fight. And they will.