This document summarizes the history of taxation of internet and cloud-based businesses. It discusses landmark Supreme Court cases from 1944 to 1967 that established whether a state could collect sales tax from out-of-state businesses. The courts determined that a state can tax a transaction only if the business has a physical presence or "nexus" within that state. Recent technology has allowed businesses to operate remotely without a physical presence, challenging traditional tax structures. States and local governments must now consider new approaches to ensure they can collect appropriate taxes as more commerce moves online.

1. THE Heinz
JOURNAL
Volume 13 | Issue 2 | November 2016
ARTICLES
Thinking About How to Properly Tax Inter-
net and Cloud Based Businesses
Tepid Optimism in Sino-American Rela-
tions: Pragmatism and Policy Rationales
When Democracy Hurts: America’s Ill-Fat-
ed Policy in the War on Terror
Erik Goepner
1
21
27
Tyler Gund
Emma Northcott
Kimberly Schwicke
Niles Guo
Rodolfo Scannone
Web Manager
Allison Bott
Joseph Babler
Joe Carusso
Joseph Marren
Jocelyn Meehan
Clayton Oeth
Robin Park
Leah Scott
Rekha Vaitla

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5. journal.heinz.cmu.edu 1Fall 2016
Properly Tax Internet and Cloud Based Businesses
Thinking About How to Properly Tax Internet and
Cloud Based Businesses1
“There is nothing more revolting if the grounds upon which it was laid down have vanished long
since, and the rule simply persists from blind imitation of the past.”
Oliver Wendell Holmes, Jr.2
Introduction
This paper provides an analysis of how new technology-based business models, such as Uber
and Airbnb, are disrupting the ability of state and local governments to collect taxes from once
to the loss of tax revenue allowed for by the development of new mobile applications and other
web-based businesses that escape traditional taxation. To conclude the discussion, this paper
details best practices for jurisdictions seeking guidance on how to respond to this recent evolution
Political analysts have recognized the immediacy of the problems posed by cloud-based business
as evidenced by a Governing.com article which named ridesharing a top ten legislative issue for
2016. According to the article, “[as] cities have seen a surge of app-based driving services, in-
cluding Uber, Lyft and Sidecar.... many mayors have issued cease-and-desist orders to the new
companies, but a handful of tech-friendly localities have revised local regulations to welcome
them.”3
Although, thus far, states have left regulation up to the discretion of city leaders, this trend
1 The term “Cloud” refers to hosted data storage and processing capabilities made possible via the internet. Thus,
all cloud issues are internet issues, but not all internet issues are cloud issues. Therefore, understanding the inter-
taxation. As Ernst and Young, LLP has recently articulated in a white paper: “Software sold through smartphone app
stores actually consists of just the display and user interface components of sophisticated applications that mostly
-
derless commercial transactions conducted over a virtual network (e.g., the internet) in which goods or services are
as a service (PaaS). These, in turn, are being joined by hybrid and specialized services, such as business process-,
with the enterprise market for public SaaS and IaaS alone estimated to be growing from $18.3 billion worldwide in
2012 to $31.9 billion in 2017.” See http://www.ey.com/ Publication/vwLUAssets/EY_- _Cloud_taxation_issues_and
_impacts/$FILE/EY-Cloud-taxation-issues-and-impacts.pdf, p.7.
2 O.W. Holmes, Jr. “The Path of the Law,” Harv. L. Rev. 10, (1897): 457, 469.
3 “2015’s Top 10 Legislative Issues to Watch,” Governing.com, Accessed April 12, 2016, http://www.governing.com/
topics/politics/gov-issues-to-watch-2015.html

6. The Heinz Journal
journal.heinz.cmu.edu2 Fall 2016
may not persist. Just last year, Colorado joined
California as the second state that “[established]
statewide rules for ridesharing companies,” not
do so by statute.4
Legislative activity up to this
point in time indicates that states will take a va-
riety of approaches to regulation.5
Some states,
like Illinois and Michigan, will consider pre-
empting local oversight by converting rideshar-
ing into an entirely state-regulated enterprise.6
Other states may look to the District of Colum-
bia (D.C.) model which “permits ridesharing but
also deregulates taxi meter fares when passen-
gers order rides online -- a concession meant to
make the taxi industry more competitive.”7
Before proceeding too far with the conversa-
tion on local cloud taxation, it is necessary to
examine how federal and state laws and their
governments to address their loss of tax reve-
nue. This paper builds on that discussion to de-
tail the relevant policies and procedures of how
regulation operates in a particular jurisdiction.
In doing so, this paper addresses the following
three subjects: state and local taxation law, in-
ternet laws, and the applicable federal regula-
tions. All three of these subjects have played a
role in the evolution of cloud taxation and in-
these cloud-based businesses. Questions re-
garding tax jurisdiction in cyberspace and the
authority to tax online transactions are forcing
a reexamination of interstate commerce and
must be answered as they arise.
As readers may now sense, there is nothing
simple about this subject. The beauty of these
cloud-based businesses is in their apparent
simplicity which ironically clashes with the de-
ceptively complex nature of the legal matter.
4 Ibid.
5 Ibid.
6 Ibid.
7 Ibid.
There is irony in that contradiction because the
beauty of these cloud-based businesses is their
apparent simplicity. Consumers utilize these
services because they are intuitive, easy to use,
New Paradigms of Public Policy Evolving Out
of the Digital Economy
A variety of approaches have emerged in re-
sponse to the growth of the digital economy.
Some local governments have bought into par-
ticipating in this new economy. For instance, cit-
ies like Los Angeles have made it their primary
tax incentives to cloud-based businesses that
relocate to their jurisdiction. Alternatively, some
governments resist changes due to a desire to
protect the old brick and mortar manufacturing
and service-based economy as illustrated by the
-
er localities, like the City of Detroit, have resist-
ed change despite being under severe pressure
to raise public revenues after years of economic
downturn.
Local governments’ response to fast-paced
technological developments is reactionary and
therefore slow regardless of a given jurisdic-
tion’s political stance. Cities which pride them-
selves as being on the cutting edge of technol-
ogy, such as New York, San Francisco, and San
-
ences in their ability to respond to technological
change. It does not matter if a particular locality
embraces the evolution of the digital econo-
my since most localities will still encounter dis-
ruptions as they struggle to integrate the new
businesses with the old taxation schema. Even
is in their best interest to understand the new
dynamics so that they can get a fair chance to
tax these endeavors. The City of Flint, MI, might
be an example of this type of jurisdiction.

7. journal.heinz.cmu.edu 3Fall 2016
Properly Tax Internet and Cloud Based Businesses
Crossing the Chasm of Public Policy Adop-
tion to address the Cloud Tax Issue
seminal book entitled Crossing the Chasm:
Marketing and Selling High-Tech Products to
Mainstream Customers. The text is a marketing
strategy guidebook of sorts for high-technology
startups. Dr. Moore emphasizes the need for
early stage companies to focus on niche cus-
tomers in order to outlast the depletion of the
company’s investment capital. Such a notion is
relevant here because Dr. Moore’s bell curve il-
lustration of product adoption is, in many ways,
applicable to governments and other similar
consumers.
The distribution curve informs those launching
new products how most markets will likely re-
spond. Approximately 5% of all potential cus-
tomers are the innovators of new technology.
This group of market participants is represent-
ed by the green segment of the curve. These
individuals seemed more enthusiastic about
new technology and are willing to take risks to
adopt new products, or in this case, policies.
New technology would never be scalable with-
out the early adopters as customers and advo-
cates. Early adopters are the people that wait
for days outside the Apple store in anticipation
of the newest product release. As it relates to
policy innovation, early-adopting cities include
New York, San Francisco, and San Jose. The next
market segment is the early adopters who com-
-
ket share. These individuals do not want to be
risk tolerance. Nonetheless, early adopters are
compelled to participate once they see others
successfully innovate. Cities like Los Angeles,
course, people may disagree as to what market
demographics particular cities fall under.
Widespread product endorsement by ear-
ly adopters is followed by the entrance of the
early majority into the marketplace. The early
majority includes people that like new things,
but whose risk aversion must be quelled by
a well-established precedent of success evi-
denced by case studies and publicity from rec-
ognized leaders. This segment of the market
constitutes approximately thirty percent of the
total market. The early majority is followed by
the late majority which is comprised of individ-
uals who would rather completely avoid change
if not for a sense of obligation to that often does
not develop until several years after the new
technology has become integrated into soci-
ety. The late majority makes up approximately
-
graphic includes people that refuse to change
until it is an absolute necessity do to so.
This paper postulates that local governments
will parallel Dr. Moore’s categorization, but with
weight redistributed towards early actors. This
assumptions. Dr. Moore’s model is predicated
on government spending money to get a new
technology, whereas this paper addresses ways
for government to increase tax revenue. Gov-
ernments will likely be much more compelled to
respond to innovation than localities will be to
purchase new technology given budgetary con-
Figure 1

8. The Heinz Journal
journal.heinz.cmu.edu4 Fall 2016
not override the applicability of Dr. Moore’s bell
curve as it relates to the risk tolerance of local
-
ting up new tax systems. For example, changes
to the tax code will likely attract lawsuits from
disgruntled taxpayers and opportunistic attor-
neys. A negative court ruling may all but guar-
antee the loss of a policymaker’s career. Even
absent the threat of litigation, the administra-
tive costs incurred in establishing new tax re-
The chasm between early adopters and the ear-
ly majority is precisely where a product fails. If
a product does not demonstrate enough value
to win over the early majority, the company will
-
cy without sustained investor support. As the
chasm relates to local tax policy, there are in-
novative cities, counties, and states that will as-
sume the risks to establish new tax regimes in
order to capture the revenues enabled by new
technologies.. Some of these innovators will be
inspired by brilliant foresight, and others are
motivated by desperation. Regardless of par-
ticular motivations, new technology for cloud-
based tax policies will follow the same pattern
encapsulated by Dr. Moore’s bell curve. Draw-
ing on that analogy, this paper predicts how lo-
cal governments will evolve.
Dr. Moore’s work provides an insightful frame
for discussing local responses to the emergence
of a digital economy. This frame is especially of
interest because product innovation has creat-
ed the very need for policy innovation. Jurisdic-
tions receptive to policy innovation will develop
new paradigms as they endeavor to be more
creative.
Some of these risk tolerant jurisdictions will
not survive litigation or other resistance. These
failed tax policies will fall prey to the chasm be-
tween early adaptors and the early majority as
the former is unable to persuade the latter to
follow suit. There is only a chance that the late
majority joins the trend, if the early majority
that a respective innovation is established as a
true success and proven method.
Proposition 13 serves as an example of policy
innovation that failed to cross the chasm. Prop-
osition 13’s failure to set the standard for other
governments demonstrates this fact. Although
Proposition 13 may forever remain law in Cali-
fornia, only few states have and will ever adopt
the basic policy. Massachusetts and Oregon, for
example, passed similar, but not nearly as rad-
ical property tax regimes. In sum, one can say
that Proposition 13 has failed in the public mar-
ket place of public policy ideas.
A History of Internet Taxation
The history of internet and cloud taxation8
actu-
ally began long before the rise of the internet,
or even computers for that matter. In 1944, the
Supreme Court of the United States of America
(SCOTUS) determined under which circumstanc-
es a state could collect taxes on goods delivered
in their state, but sold by businesses located in
another state. In the seminal case
,9
a Tennessee based business took
orders for goods from an Arkansas company
via phone and mail. The Tennessee business
collected payments and delivered the goods to
common carriers10
within the State of Tennes-
see. Arkansas felt entitled to collect a sales tax
on these transactions because the goods were
delivered by common carrier for use by the
purchasing company located in Arkansas. The
Court ruled that for the purpose of sales tax,
the sale took place where the goods were paid
8 See FN1.
9 McLeod v. J.E. Dilworth Co., 322 U.S. 327 (1944).
10 -
common-carrier/

9. journal.heinz.cmu.edu 5Fall 2016
Properly Tax Internet and Cloud Based Businesses
place in Tennessee because the money was re-
ceived in-state and the goods were delivered in-
state to common carriers. Arkansas’ imposition
-
ly a tax on interstate commerce in violation of
the Constitution. Under the commerce clause,
of the amendment, interstate commerce is ex-
pressly the domain of the federal government.
Nevertheless, the Court seemingly reversed
their position when presented with a similar fact
pattern in
11
In McGoldrick, a New York City sales tax
on transactions by a Pennsylvania corporation
was upheld by the Supreme Court. The Pennsyl-
that not only sold items, but also made deliver-
ies within the state of New York. This is the key
distinction between McLeod and the present
case McGolrick; in the latter case, the company
the state imposing a tax.
In 1967, the Supreme Court revisited the issue
related to tax jurisdiction in the case
12
In this case,
a Missouri based corporation was licensed to
conduct business only in their home state and
Delaware. The only potential contact the busi-
ness had with the aggrieved state, Illinois, came
in the form of catalogues that it mailed twice
a year. Orders from these magazines were re-
ceived via mail in Missouri. The Court’s decision
hinged on the determination of whether or not
from the state of Illinois which could justify the
tax burden. The Court determined that trans-
actions conducted purely via the postal service
did not merit the imposition of a sales tax on
the out-of-state company.
11 McGoldrick v. Berwind-White Coal Mining Co., 309
U.S. 33 (1940).
12 National Bellas Hess, Inc. v. Dep’t of Revenue , 386
U.S. 753 (1967).
All three cases focused on the degree to which
the corporation made contact with the state
wishing to impose a tax. This “nexus of con-
tacts” consideration seems simple enough and
is still at play in developing internet and cloud
taxation policies. However, as a recent Ernst
and Young white paper put it:
“Business users or consumers can encoun-
ter potential new tax obligations and re-
porting burdens that vary from market to
market. And if tension has been building
between taxpayer and tax authority, the
underlying reason is simply that the cloud
is borderless and tax jurisdictions are not.
But nothing is quite that simple in these
early evolutionary days of cloud taxation.
There are no familiar, cookie-cutter busi-
ness models that tax authorities can readily
understand. The existing tax law governing
technology transactions are often per-
ceived as outdated and inconsistent. The
technology and business arrangements are
such that even identifying the taxable loca-
tion of either cloud service providers (CSPs)
or their customers can be challenging.”13
In 1992, the Supreme Court visited the issue of
state sales taxes for a fourth time in
14
In Quill, the Court focused on
the nexus of contacts between the taxing state
and the out-of-state business. The Court’s in-
quiry focused on the reasonableness for such
an entity to expect to be burdened with a tax
from contact with the outside state or protec-
tion from its laws. In doing this, the Court ap-
plied Nat’l Bellas Hess to North Dakota’s juris-
dictional reach under their long arm statutes,
13 Channing Flynn, “Cloud Taxation Issues and Impacts,”
EY, January 2015, http://www.ey.com/Publication/vwLU-
Assets/EY-cloud-taxation-issues-and-impacts/$FILE/EY-
cloud-taxation-issues-and-impacts.pdf.
14 Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

10. The Heinz Journal
journal.heinz.cmu.edu6 Fall 2016
and in light of due process rights. These due
-
cedure jurisprudence including International
Shoe Co. v. Washington15
and Burger King Corp.
v. Rudzewicz.16
The Quill Court asked if the defendant had
to expect to defend a lawsuit there. However,
the Court did not require physical presence to
establish jurisdiction. Instead, so long as the
court focused on both due process and Com-
merce Clause considerations in crafting a three-
part test. The test consists of the following three
questions: Does the party direct its sales to the
residents of a state? Are contacts of the party
-
corporation receives from the state?
The amount of in-state economic activity is a
more important factor than physical presence
therein or lack thereof. Although North Dakota
due process, it failed to satisfy the substantial
nexus requirement of the Commerce Clause.
holding that jurisdiction should not be imposed
on an entity whose only contact with a state
was by mail.
The Quill Court added that Congress should ul-
timately decide to what degree states should
be allowed to burden interstate commerce with
taxation. At that time, Congress had already
considered legislation to overrule National
Bellas Hess’ presence requirement more than
once, but proposals consistently failed to gar-
ner adequate support.
15 International Shoe Co. v. Washington, 326 U.S. 310
(1945).
16 Burger King Corp. v. Rudzewicz, 471 U.S. 462 (1985).
To reiterate, under Quill, physical presence is
not required by due process for jurisdiction, but
it is required by the Commerce Clause or else a
substantial nexus is not established. While this
ruling upheld National Bellas Hess for the sake
of stare decisis, its purpose was to send a mes-
sage to Congress that it was the legislature’s
responsibility to decide to what degree states
should be able to tax parties only conducting
business in-state by mail under their authority
granted by the Commerce Clause.
The notion, articulated by the Quill Court, that
Congress should regulate how state and local
governments can tax out-of-state vendors and
buyers is a great idea, but it is one that has yet
-
tion, it is important to note how much discre-
tion is still left to federal and state Courts to
regulate this area. For example, the Illinois Su-
preme Court ruled in 2013 that the state’s Main
Street Fairness Act, which imposed upon out
of state retailers the duty to collect sales tax
on annual sales of more than $10,000, violated
the federal Internet Tax Freedom Act. The Inter-
net Tax Freedom Act prohibits some, but not
all, types of taxes on electronic commerce.17
At
the time of the case, thirteen states had similar
taxes yet to be challenged.18
-
own legislature.19
in the state, who receive a percentage of any
sales generated by customers that click to enact
a sale through online merchants (i.e. Amazon)
the collection of a sales tax.20
However, its own
Supreme Court did not agree.
17 Sal Robinson, “Illinois Supreme Court rules against
‘Amazon tax,” Melville House, October 23, 2013, http://
www.mhpbooks.com/illinois-supreme-court-rules-
against-amazon-tax/.
18 Ibid.
19 Ibid.
20 Ibid.

11. journal.heinz.cmu.edu 7Fall 2016
Properly Tax Internet and Cloud Based Businesses
The value of this Main Street Fairness Act exam-
ple is that it begs the question: “should tax juris-
diction be left to such a seemingly random pro-
essentially the same facts before them?” When
with interstate commerce such that Congress is
compelled to mandate uniform state rules like
the Court suggests in Quill?
Drawing Parallels between Civil Procedure
and both Personal and Sales Tax Jurisdic-
tions
As has already been mentioned, supra, there
are many parallels between the jurisprudence
of federal sales tax case law and federal civil
procedure law regarding personal jurisdiction.
for a physical presence per National Bellas Hess
for the sake of due process parallels reasoning
articulated in
supra.21
In International Shoe Co., the
Court held that a person or entity may be sub-
ject to the jurisdiction of a state court, if the de-
fendant has minimum contacts with that state,
outlines the limits on states’ long arm statutes
imposed by due process as well as delineated
requirements for valid service of process. In
other words, the court detailed factors includ-
ing the who, what, when, and where necessary
to establish personal jurisdiction.
In Burger King, the district court held that Florida
had jurisdiction over a dispute between Burger
King and a franchisee because of a state statute
extending jurisdiction to anyone in breach of a
contract within the state. The Court of Appeals
reversed, ruling that, although the defendants
violation of due process.
21 International Shoe Co., 326 U.S. 310 (1945).
Burger King appealed to the Supreme Court
who reversed the Court of Appeals. The Court
ruled that defendants purposefully availed
themselves of the protection of Florida law, and
therefore were subject to its’ courts’ jurisdic-
tion. Due process was not found to be violated
because the defendants should have reason-
ably anticipated being summoned into court in
Florida for breach of contract as a result of their
longstanding relationship with Burger King
there.
The Burger King Court’s fairness test evolved
.22
-
mining whether the assertion of personal juris-
diction over a defendant violates due process is
as follows: (1) What is the burden on the defen-
dant?, (2) What are the interests of the forum
state in the litigation?, (3) What is the interest of
(4) Does the allowance of jurisdiction serve in-
of jurisdiction serve interstate policy interests?
The Court in Asahi ruled that the burden on the
defendant was severe based on both the geo-
graphic distance and legal dissimilarities be-
-
ifornia resident, which diminished California’s
nor interstate policy interests would have been
furthered by granting jurisdiction to California
over the defendant Asahi. The importance of
these parallels with federal civil procedure juris-
prudence is that the Asahi test may prove useful
in the area of sales tax legislation in justifying or
Also, this discussion shows that there is some
consistency to the Supreme Court’s reasoning.
-
ent issues with parallel logic. Accordingly, policy
formulation will not occur in a vacuum. Instead,
22 Asahi v. Superior Court, 480 U.S. 102 (1987).

12. The Heinz Journal
journal.heinz.cmu.edu8 Fall 2016
a long history of related rationales for similar
This history is critical when thinking about how
states23
should or should not be able to impose
taxes upon cloud based ventures.
The laws of civil procedure and personal juris-
diction, in the context of cyber law, have devel-
oped through cases concerning a state’s jurisdic-
tion over an online business. This paper focuses
on domestic tax issues related to new cloud
based business models which is complicated
enough it its own right. However, the matter is
-
ternational cloud-based companies. European
headquartered cloud-based businesses merit
a standalone paper with Brussels Regulation,
the Rome I Convention, and other laws serving
as the basis for discussion. These issues would
arise because many new cloud-based compa-
nies that conduct business with the U.S. are
popping up in Europe. At present, there is no
multilateral convention to resolve Internet and
e-commerce derived disputes over matters of
As mentioned, supra, every state in the U.S.
has long arm statutes which attempt to impose
jurisdiction over non-residents of the state if
they have either engaged in tortuous behav-
ior or conducted business within that state.
Some states, like California, leave its statutes
open-ended, simply expressing that it has as
much jurisdiction over people outside of Cal-
ifornia as federally or its Constitution and the
U.S. Constitution will allow. California Civil Code
23 See Hunter v. Pittsburgh, 207 U.S. 161 (1907): “Munic-
ipal corporations are political subdivisions of the state,
created as convenient agencies for exercising such of
the governmental powers of the state as may be en-
trusted to them....The number, nature, and duration of
the powers conferred upon these corporations and the
territory over which they shall be exercised rests in the
absolute discretion of the state.” 207 U.S. 161, 178.
of Procedure Section 410.10 reads, “A court of
this state may exercise jurisdiction on any ba-
sis not inconsistent with the Constitution of
this state or of the United States.”24
By contrast,
Massachusetts’ long arm statute is much more
narrow, reading in part, “a court may exercise
personal jurisdiction over a person, who acts di-
rectly or by an agent, as to a cause of action in
law or equity arising from the person’s (a) trans-
acting any business in this commonwealth, (b)
contracting to supply services or things in this
commonwealth (c) causing tortious injury by an
act or omission in this commonwealth…”25
extending jurisdiction over a person or entity
under the 14th Amendment of the Constitution.
This due process analysis was covered, supra,
regarding International Shoe and the minimum
contacts requirement valid jurisdiction over an
out-of-state party. Still yet to be addressed is
the matter of general jurisdiction. General juris-
diction is found when a party’s contacts with a
state are so extensive that they are considered
“systematic and continuous” as per the 1984 Su-
preme Court holding in
26
If a party falls within a
state’s general jurisdiction, then that state has
jurisdiction over that party, regardless of wheth-
-
tinuous” activities requirement. Usually, a court
will look to see if a party has established related
items in the state, including incorporation, bank
27
In 2003,
the 9th Circuit found that L.L. Bean, a Maine
catalog retailer, fell under California’s general
24 Cal. R. Civ. P. 410.10.
25 Mass. Gen Laws. ch. 223A, § 3, see: http://www.
lrcvaw.org/laws/malongarm.pdf.
26 Helicoperos Nacionales de Columbia. S.A. v. Hall, 466
U.S. 408 (1984)..
27
-
eral-jurisdiction/.

13. journal.heinz.cmu.edu 9Fall 2016
Properly Tax Internet and Cloud Based Businesses
jurisdiction because of the Court interpreted
the company’s website to be a virtual California
because of its extensive marketing campaign
in California and L.L. Bean’s relationships with
California vendors.28
The Supreme Court has
addressed this issue yet.
The most famous cyber law case is Zippo Man
.29
Here, the
United States District Court for the Western
District of Pennsylvania found personal juris-
diction over a California defendant providing
services within the State of Pennsylvania, via its
-
tion through typical process, the court based its
decision on a sliding scale test which related to
website function and design. The court created
a sliding scale between passive websites and in-
teractive websites. According to the court, pas-
sive websites only posted information on one
side. Meanwhile, interactive websites allowed
customers to conduct business online or oth-
-
fectively establishing a “gray zone” in between
the two. This case provides a useful analogy for
cloud taxation despite the antiquated website
design activity. In other words, one could antic-
ipate the court’s use of parallel reasoning when
addressing the issue of cloud taxation. For ex-
ample, Airbnb and Uber could be located at one
extreme of the continuum because these busi-
nesses have a physical interaction within states
through their contractors and service provid-
ers. At the other extreme, might be mobile app
games that users download onto cell phone
like Words Withwith Friends and Candy Crush.
Moreover, here is where technological advanc-
es would work in favor of the tax collector in a
paradoxical way. For instance, it would be eas-
ier to track where the mobile apps were down-
loaded because, unlike Airbnb, all smartphones
28 Gator.com Corp. v. L.L. Bean, Inc., 341 F. 3d 1072 (9th
Cir. 2003).
29 Zippo Manufacturing Co. v. Zippo Dot Com, Inc., 952
F. Supp. 1119 (W.D. Pa. 1997).
have GPS capabilities. Without that feature, it is
are located in. Nevertheless, one can still get a
fairly good idea of the rental’s jurisdiction based
on its street address, which can then be digital-
ly and automatically entered into a geospatial
matrix that informs Airbnb which jurisdiction’s
tax rate should apply. Thus, technology would
make taxing these cloud business relatively easy
in theory. However, the questions of the quan-
tity and quality of contracts within the forum’s
jurisdiction will still be preeminent in line with
the tombs of jurisprudence that framed the ap-
proach of the subject of jurisdiction. Therefore,
it is worthy to understand the way Zippo has
found or rejected jurisdiction based on Zippo’s
scale regarding business conducted in or over
cyberspace.
In the 1996 case
King, a New York Federal District court ruled that
a passive website, which only posted limited in-
formation like newspaper and magazine adver-
tisements, did not justify establishing jurisdic-
tion over an out-of-state company.30
A year later
in , the 9th Circuit
ruled that a family-owned and operated com-
to jurisdiction in Arizona.31
The court concluded
that although Cybersell’s mostly passive web-
site made sales contact information accessible
from Arizona, the company did not make spe-
nor did it have any other type of contacts with
the state. Thus, the court made it clear that the
party must have done something more than
just have a website which is accessible from the
30 Bensusan Restaurant Corp., v. King 937 F.Supp. 295
(S.D. N.Y. 1996).
31 Cybersell Inc. v. Cybersell Inc., 130 F.3d 414 (9th Cir.
1997).

14. The Heinz Journal
journal.heinz.cmu.edu10 Fall 2016
it was seeking to target residents of the state.
Notwithstanding that this decision contradicts
the case, , .
from just the previous year.32
In Inset Systems,
Inc., a federal district court in Connecticut ruled
that a website accessible within the state, which
advertised for a Massachusetts-based business
with a toll free phone number, had availed it-
self of the states’ jurisdiction. However, when
this ruling was announced, it was seen as too
expansive because it opened up the potential
for most websites to have jurisdiction in all
states in which their contact information was
accessible via a website. Though the court did
not make the distinction, it seems fairly obvious
that a business in Massachusetts could expect
to draw customers from its neighboring state of
Connecticut, and thus could reasonably expect
to be sought for jurisdiction in that state. The
court would have probably ruled against juris-
if the company and website involved were simi-
lar and from a distant state like California.
All of these cases analyze proper jurisdiction
based upon an Internet business model of one
variation or another. There are many more
such cases on this subject, but these cases es-
tablished the basic frameworks from which all
other cases draw upon in their analysis. In rea-
soning by analogy, one can see how these cas-
es could assist sales tax policy makers during
their decisions about what types of Internet
and cloud-based businesses should fall into
their sales tax jurisdiction. The one factor that
was not directly addressed in any of these cas-
es regards the volume of business that an out-
of-state party can conduct within another state.
In a long-arm sales tax context, the purpose-
ful availment might be based on the business’
gross revenues o residents within the state. Hy-
pothetically, an out-of-state purchase of a single
$10 widget from a small family does not trigger
32 Cybersell Inc. v. Cybersell Inc., 130 F.3d 414 (9th Cir.
1997).
the long-arm sales tax law. However, if the small
business operates via eBay, then the portion of
sales in that state is subject to taxation (keep-
ing in mind, there are many potential inequities
caused by this scheme which could have a cool-
business through a channel like eBay, supra).
A factor not considered in any of these cases
was the distinction between providing services
as opposed to products via the internet. , espe-
cially in the form of software in regards to the
latter. This consideration was probably absent
because of changes in technology and the sig-
the rulings.
Currently, cloud-based companies utilize a SaaS
(software as a service) business model. Before
this model, consumers would typically obtain
software by going to a store in most states and
Upon that transaction, the consumer would be
charged with a sales tax. By comparison, today
that same software can be bought online and
downloaded, most likely without a sales tax col-
for sale that users pay a fee to download via
the company’s website. This website is home to
the most up-to-date product in the cloud. This
information is accessible to users anywhere in
the world with an internet connection, except
perhaps in countries like China, which have ma-
jor restrictions on internet access. From a tax
perspective, SaaS should be viewed as a good,
even though it is referred to as a service in the
context of cloud-based businesses. Therefore,
tax authorities should focus on these goods,
which are more likely than not even on their ra-
dar, but which are very easy to track and trace
in the era of big data.
The Commerce Clause and the Dormant
Commerce Clause
A brief explanation of the Commerce Clause

15. journal.heinz.cmu.edu 11Fall 2016
Properly Tax Internet and Cloud Based Businesses
and the Dormant Commerce Clause is very im-
portant to understanding the history and con-
text of state tax jurisdiction. Article 1, Section
8, Clause 3 of the U.S. Constitution, also known
as the Commerce Clause, allows Congress the
power “to regulate commerce with foreign na-
tions, and among the several states, and with
the Indian tribes.”33
The Commerce Clause grants Congress the au-
thority to regulate interstate commerce and re-
stricts states’ power to regulate matters which
state authority to regulate interstate commerce
is known as the Dormant Commerce Clause.
This prohibition is implied, not explicit. There is
much debate about the meaning of the word
“commerce” because the Constitution does not
-
ited to trade or exchange, while others advo-
of the other factors operating, this interpreta-
tion is dispositive of your stance on the balance
between state and federal authority. How one
one sees the dividing line between federal and
state police power, even though there are other
factors in the balance.
The Commerce Clause (“Clause”) has been used
to uphold federal laws in areas that do not
seemingly pertain to interstate “commerce”.
For instance, in
, the Court took an extremely broad view
of the Commerce Clauses’ implied meaning to
encompass federal authority to regulate the
states’ interests.34
In 1995, the Rehnquist Court
limited on the Commerce Clause’s overreaching
power in , stating that the
federal Gun Free School Zones Act of 1990 had
-
33 U.S. Const. art. I, § 8, cl. 3.
34 NLRB v. Jones & Laughlin Steel Corp., 301 U.S. 1
(1937).
cal schools.35
Instead the Court argued that true
purpose of the Clause was to regulate the chan-
nels of commerce, the instrumentalities of com-
-
terstate commerce. The Court continued to cut
back federal power in ,
by stating that the Violence Against Women Act
36
Up to this time,
many thought that the Warren Court’s use of
the Clause to help the cause of civil rights was
acceptable, but this ruling made it clear that the
scope of that use would be curtailed moving
forward. In addition, this ruling established the
precedent that Congress could no longer invoke
the Clause in the preamble to a law to secure its
legitimacy.37
Two other cases regarding the Commerce
Clause are relevant to this discussion. In
, the Court stated that any
attempt by a state to regulate conduct wholly
outside of itself violates the Clause, regardless
if the commerce sought to be regulated had
38
In this case, Connecticut required out-of-state
beer merchants to show that their sales prices
to wholesalers within the state were the same
as those charged to surrounding New England
states. The Court said this law was a violation
of the Clause “on its face” for two reasons. First,
because it applied to only those engaged in in-
terstate commerce and, second, it was an at-
tempt at an illegal protectionism. One should
see how this case might be argued by analogy
when it comes to Internet commerce and cloud
taxation issues, especially with those aimed as
some form of protectionism.
In the remaining case , Mich-
35 Lopez v. United States.
36 Morrison v. United States, 529 U.S. 598 (2000).
37 For a more detailed narration and in depth analy-
sis see https://www.law.cornell.edu/wex/commerce_
clause.
38 Healy v. Beer Institute Inc., 491 U.S. 324, 336
(1989).

16. The Heinz Journal
journal.heinz.cmu.edu12 Fall 2016
igan and New York both had laws that allowed
for wineries within each respective state to sell
online to those within those states, but forbid
out-of-state wineries to do the same.39
Both
states laws were ruled to violate the Dormant
Commerce Clause by favoring in-state wineries.
online commerce albeit not the taxation of on-
line commerce. Yet, it is a relevant case to keep
in mind when thinking about the cloud taxation
issue.
The Internet Tax Freedom Act
In 1998, Congress passed the Internet Tax Free-
dom Act to encourage further growth of the
Internet and commerce via the Internet.40
This
law has evolved over time and changed some-
what since its inception, but it can be best sum-
(“CBO”) report. Besides posing “a three-year
moratorium on new federal, state, and local ac-
cess levies,” this law allowed existing taxes on
addition, it permitted governments to impose
new taxes on such sales as long as they applied
equally to sales made by other means, but it
prohibited discriminatory taxes on Internet
sales. The law did not give states and local gov-
ernments the authority to require that remote
sellers collect sales taxes.”41
This law prohibited federal, state and local tax-
ation of Internet access, certain types of online
commerce and other related potential taxes,
such as bandwidth and email taxes.42
This act
also established an Advisory Commission on
39 Granholm v. Heald, 544 U.S. 460 (2005).
40 Sal Robinson, “Illinois Supreme Court Rules against
‘Amazon Tax’”, Melville House Books, Accessed April 4,
2015.
41
Taxing Internet and Mail-Order Sales, Washington, DC,
2003.
42 Ibid.
Electronic Commerce to make recommenda-
tions about Internet taxation, including wheth-
er to require retailers to collect sales taxes on
Internet purchases.43
The Commission was re-
quired to prepare a report: (1) examining how
states and other countries tax the Internet; and
ecommerce.44
Although the law had a cooling
not prohibit taxation of online sales, as these
may be taxed similar to mail order sales.45
It
was extended several times by Congress, and
became the Permanent Internet Freedom Act in
2014.46
From the perspective of this paper, the
real lasting impact of this action by Congress is
the policy analysis that came out of the Advi-
sory Commission’s report, supra. This analysis
was part of the initial action in 1998, but it did
not make recommendations as per the pro-
tocol of the CBO guidelines.47
A similar follow
up report worthy of note was published by the
COB in 2003 entitled
,48
and the Congres-
sional Research Service (“CRS”) built upon these
reports in a report of 2013 entitled
.49
CBO 2003 Report
The 2003 CBO report did an ideal job of devel-
oping a framework to analyze the issue of the
states’ desire to tax online transactions. The re-
-
43 Ibid.
44 Ibid.
45 Wilson, Daniel. 2016. “House Votes To Permanent-
ly Block Internet Access Taxes - Law360.” Accessed
April 4, 2015. http://www.law360.com/articles/665319/
house-votes-to-permanently-block-internet-access-tax-
es.
46 Ibid.
47
Taxing Internet and Mail-Order Sales, Washington, DC,
2003.
48 Ibid.
49 Steven Maguire, State Taxation of Internet Transac-
tions, Congressional Research Service, 2013.

17. journal.heinz.cmu.edu 13Fall 2016
Properly Tax Internet and Cloud Based Businesses
tion of the report was an overview of the caus-
es and conditions leading up to the need to
address the remote sales issue. This overview
that the internet’s unforeseen consequences
were having on states budgets, inter alia, and
an explanation of the debate over how to best
collect on the billions of revenues that were be-
ing transacted tax free. These revenues would
have otherwise been collected, but for the rise
-
mote remote sellers in agreeing to collect these
sales taxes in their states, either by an act of
Congress or voluntarily, as per a MOU between
states.
The following table, per the Report, shows the
amount that each state depended on sales
-
ly each state was regarding the complexity of
overlaying a system which could equitably ad-
dress such a synthesis50
:
50 Ibid. pp. 4-5.
Based upon on the above table, the CBO noted
that the potential loss of revenue from remote
purchases had generated the proposed idea
that vendors should be required to collect use
taxes for the states. The CBO referenced Quill
in this analysis and interpreted it as: “only the
Congress can give states the authority to re-
quire remote sellers to collect use taxes.”51
In
addition, the CBO noted that the federal gov-
ernment’s only stake in the Internet sales tax
debate was as a regulator of interstate com-
merce, and that the issue had no federal bud-
-
ical issues from a policy analysis perspective,
which addressed whether Congress should iron
out the wrinkles. Two policy arguments in favor
commodities taxation causes tax-motivated
decisions about consumption and production,
and also when compliance costs increase and
are imposed on remote sellers to collect and
remit use taxes from multiple jurisdictions; and
(2) a uniform system requiring remote sellers
to collect taxes imposed by Congress would
distribute the burden of sales taxes more eq-
uitably, and it would allow for more equitable
treatment of people in comparable circum-
stances. Three policy arguments in favor of not
51 Ibid. pp. 7.

18. The Heinz Journal
journal.heinz.cmu.edu14 Fall 2016
including Congress in the matter included the
idea that it will increase the size of government
and eliminate a tax advantage that is helping
the Internet grow to its economically desirable.
The CBO then outlined issues which it considers
the crux of the matter from a policy analysis as
to whether Congress should iron out the wrin-
-
es tax-motivated decisions about consumption
and production, and also increases the compli-
ance costs that would be imposed on remote
size.52
It would also “impose a tax burden on
remote sellers who, unlike local sellers, receive
53
Finally, it
and local governments, which is guaranteed by
the Constitution, if standardization of tax bas-
es and rates is required to reduce compliance
costs.”54
The result of this analysis and delibera-
tion was the evolution of a compromise, which
did not require Congress to act in the form of
the Streamline Sales and Use Tax Agreement.55
The Streamline Sales and Use Tax Agreement
The Streamlined Sales and Use Tax evolved out
of a series of events in response to the Internet
Tax Freedom Act and a fear that Congress might
attempt to permanently prohibit states from
collecting sales tax on online commerce.56
The
Streamlined Sales Tax Project (SSTP) was creat-
ed by the National Governor’s Association and
the National Conference of State Legislatures in
1999 to address the sales tax collection issues
resulting from internet commerce.57
Leaders
52 Ibid.
53 Ibid.
54 Ibid.
55 “Streamlined Sales Tax,” Streamlined Sales Tax Gov-
erning Board Inc, Accessed March 29, 2015, http://www.
streamlinedsalestax.org/index.php?page=faqs.
56 Steven Maguire, State Taxation of Internet Transac-
tions, Congressional Research Service, 2013.
57 Ibid.
from both Associations were members of the
Advisory Commission on Electronic Commerce
during the time when the Internet Tax Freedom
Act was being formulated in 1998.58
The result
was that many states’ governors agreed to work
sales tax system. The SSTP was dissolved once
the Streamlined Sales and Use Tax Agreement
59
Today, 44
states and the District of Columbia are mem-
bers of this regime, but only 24 of these states
have passed legislation to adopt the regime as
part of their state’s law.60
The Streamline Sales
Tax Governing Board claims:
“The Agreement minimizes costs and ad-
ministrative burdens on retailers that col-
lect sales tax, particularly retailers operating
in multiple states. It encourages “remote
sellers” selling over the Internet and by mail
order to collect tax on sales to customers
living in the Streamlined states. It levels the
stores and remote sellers operate under
the same rules. This Agreement ensures
that all retailers can conduct their business
in a fair, competitive environment.”61
However, as already mentioned, only 24 of the
44 states have passed the conforming legisla-
tion. Those states which have passed the leg-
islation have a total population of 92,781,860,
representing 33% of the country’s population.62
58 Ibid.
59 Ibid.
60 “Streamlined Sales Tax,” Streamlined Sales Tax Gov-
erning Board Inc, Accessed March 29, 2015, http://www.
streamlinedsalestax.org/index.php?page=gen_3.
61 “Streamlined Sales Tax,” Streamlined Sales Tax Gov-
erning Board Inc, Accessed March 29, 2015, http://www.
streamlinedsalestax.org/index.php?page=gen_1.
62 Ibid. The following states that have passed legisla-
tion to conform to the Streamlined Sale and Use Tax
Agreement: Arkansas, Georgia, Indiana, Iowa, Kansas,
Kentucky, Michigan, Minnesota, Nebraska, Nevada, New
Jersey, North Carolina, North Dakota, Ohio, Oklahoma,
Rhode Island, South Dakota, Tennessee, Utah, Vermont,

19. journal.heinz.cmu.edu 15Fall 2016
Properly Tax Internet and Cloud Based Businesses
See map, infra.63
As the map illustrates, the full member states
are not big economic powerhouse states and
the Sunbelt states are merely advisory mem-
bers. Although the Agreement stands as a log-
the Agreement demonstrates the mass uncer-
tainty surrounding it. Part of this uncertainty
rests in the fact that this Agreement fails to di-
rectly address the cloud taxation issue. Thus,
there rests a need for policy solutions to better
clarify the details of the Agreement, thereby en-
couraging more states to adopt the regime.
Aside from a lack of clarity, many other con-
troversies exist with the Agreement. First and
foremost, compliance with the Agreement is
voluntary on the part of the sellers. Remote sell-
ers who do not comply with the Agreement pos-
sess a competitive advantage over those who
are compliant.64
Retailers with physical stores
Washington, West Virginia, Wisconsin and Wyoming.
63 Ibid.
64 Washington State Department of Revenue, “Stream-
lined Sales and Use Tax Agreement”, Department of Rev-
enue Washington State, Accessed April 4, 2015, http://
dor.wa.gov/Content/FindTaxesAndRates/RetailSalesTax/
DestinationBased/DepartmentStreamLineFAQ.aspx.
are at an obvious disadvantage as well. It re-
In 2008, the City of Chicago sued eBay and its
subsidiary, StubHub, for not charging custom-
ers with city amusement taxes on tickets sold
via the websites.65
While eBay did not have any
-
erty in the city.66
-
plaints against each company requesting eBay
and StubHub to disclose all records of sales in
Illinois.67
EBay responded by releasing a public
statement that taxing small internet business-
es would prove to be cost prohibitive for these
companies and detrimental to their sustainabil-
ity.68
This same year Amazon and Overstock.
com separately sued the State of New York
seeking to overturn a law requiring retailers
to pay taxes if they acquire New York state cli-
ents as a result of advertisements through web
links.69
Both companies argued that the law was
in violation of the Commerce Clause. Both cas-
es were dismissed in 2009, and a New York ap-
peals court upheld the dismissals in 2010.70
In
2013, New York’s Court of Appeals also upheld
the rulings stating that the companies “estab-
lished an in-state sales force” via their agree-
-
sions for posting links on their websites.71
Why
should states join the Streamline regime fully if
they can keep their systems in place and tax as
they wish? States like New York may lose more
65 Jane Mcentegart, “City of Chicago sues Ebay over
Taxes on Event Tickets”, TomsGuide, Accessed April 5,
2015, http://www.tomsguide.com/us/eBay-taxes-chi-
cago,news-1423.html.
66 Ibid.
67 Ibid.
68 Ibid.
69 Chris Dolmetsch, “Amazon, Overstock Lose Challenge
to N.Y. Web Sales Tax,” Bloomberg, March 28, 2013,
http://www.bloomberg.com/news/articles/2013-03-28/
amazon-overstock-lo,se-challenge-to-n-y-web-sales-tax.
http://www.bloomberg.com/news/articles/2013-03-28/
amazon-overstock-lose-challenge-to-n-y-web-sales-
tax.
70 Ibid.
71 Ibid.
Figure 2.

20. The Heinz Journal
journal.heinz.cmu.edu16 Fall 2016
revenue by adjusting their practices and do not
want to bank on a voluntary system which they
cannot enforce.
The states that have made the Streamline Tax
part of their legislature have not entered the late
majority segment of the market yet (if states are
marketplaces for ideas about tax policy), which
according to the Chasm thesis is essential for a
venture to thrive. Also, though they have almost
full saturation in the early majority segment of
states, the states which have adopted the re-
gime are more conservative.
Winkles Upon Winkles Upon Winkles, the
FTC, and Local Zoning Laws
of the Internet and internet-based businesses.
Though these agency regulations may be unre-
lated to taxation issues, they play a role in shap-
ing the path toward possible solutions to the
remote tax issue. One example is the FTC’s Con-
sumer Sentinel program, which has a mission
to uncover, inter alia, internet fraud schemes.72
One of the largest problems discovered con-
cerning online fraud is the sale of counterfeit
products via sites like eBay, where the buyer is
told and believes they are purchasing, for sake
of illustration, a Coach handbag, which has a
high retail price, but which they believe they
are getting for a bargain from someone who
just needs to generate some fast income. Now
imagine the wrinkle a sales tax brings into this if
the buyer not only gets cheated out of the good
they thought they were purchasing, but pays
which is a fraud. This would add insult to injury
if for example eBay collected the sales tax from
the buyer, making it easy for the sellers, here
fraudulent, not to have to collect the tax. Now,
72 Federal Trade Commission, “Consumer Sentinel
Network,” Federal Trade Commission, Accessed April 6,
2015. https://www.ftc.gov/enforcement/consumer-senti-
nel-network.
you, the buyer, have a fake overpriced hand
bag and cannot get your money back from the
fraudulent seller. However, you may be able to
collect a refund on the sales tax paid on this
the State Tax Commission via eBay. This is all
hypothetical, but one can imagine there is no
collecting taxes on these types of transactions
would have to set up a special department for
these types of problems. Consequently, the
buyer will be left with a bunch of hoops to jump
through before they can get the relatively small
sum which the sales tax on such a transaction
might engender, meaning most would likely not
pursue trying to recapture this loss. Again, this
is just an exercise of the imagination of what all
upon both consumers, states, and sellers or re-
sellers as a result of a poorly planned sales tax
regime.
In another example, imagine that the State of
California enters into an agreement with Airbnb
to have it collect the use tax from those using
the service within the state which hotels col-
lect. In exchange, the state would establish a
law prohibiting the local governments from re-
stricting their residents’ use of their properties
for short term rentals within their jurisdictions.
This idea may seem farfetched, but this would
mean billions of revenues long term, otherwise
lost to the state potentially, in exchange for tak-
ing away the local right to control land use as
short term rentals. One can see how a tax law
brokered by the state with a large internet or
cloud based business, like Airbnb, could poten-
-
foreseen or not properly planned for due to the
large sums of money at stake in lost revenues.
No Cloud dwells in the Clouds
To reiterate, the term “cloud” means that the lo-
cal pc, server, or smartphone is accessing via the

21. journal.heinz.cmu.edu 17Fall 2016
Properly Tax Internet and Cloud Based Businesses
internet to a hosted server on which the data
and software dwell. There are private clouds
which are hosted on a private, on premise lo-
cation owned or leased by the company which
owns the cloud; there are also public or shared
clouds with redundancy hosted by providers,
such as Microsoft and Amazon, inter alia. Thus,
no cloud is truly in the clouds. All clouds dwell on
a physical geography, which may trigger gener-
al jurisdiction issues. These cloud data centers
are often called farms. The location of a farm
will almost certainly subject the owner of that
farm to general jurisdiction within that state
a data center trigger regarding availment of the
cloud computing is about borderless global net-
works because the same data and software can
be located with redundancy in several coun-
tries, for example, the U.S., the E.U., and India.
Therefore, the location of a public cloud cannot
be pinpointed -- most small, medium-sized, and
even large companies use public cloud services
and do not know where the physical location of
their vendor’s hosting infrastructure is located.
Moreover, the space upon it is leased rather
than owned (the business of providing cloud
bandwidth is a SaaS in itself), which makes the
question of which state is responsible for taxing
public clouds unanswerable based on the phys-
ical location of the cloud, or at least less of a fac-
tor. There is always the small chance that a SaaS
states that it uses Microsoft or Amazon, and the
state tax collector happens to know that that
state, but this is an outlier and stretching the
boundary of minimum contacts. PriceWater-
houseCoopers (PWC) published a white paper
in 2012 entitled How Does One Tax the Cloud?
which asks a series of rhetorical question along
this line of reasoning worthy of consideration:
“If a state taxes at the point of use, what if
services are free at the point of use? If tax is
based on the location of the servers or the
providers simply move to the lowest-tax
jurisdiction? How does a provider or pur-
chaser avoid being taxed in two locations
sourcing rules for sales and use tax purpos-
es?”73
Though most states have not even begun to ad-
dress the tax issues arising out of the clouds,
some do have their heads in the clouds when
it comes to thinking about how to tax SaaS. In
taxed SaaS providers for purposes of sales and
use tax, as well as business and occupancy tax.74
In this same year, Missouri ruled that SaaS host-
ed outside the state was not subject to sales
tax based on its understanding of minimum
contacts,75
but New York determined that SaaS
hosted out of state are taxable if accessed from
a location within the state. New York stated that
SaaS is “tangible personal property, the use of
which occurs when accessed in New York, and
that access constitutes a taxable transfer of pos-
session of the software, because the customers
gain constructive possession of the software,
and gain the use of the software,” but hosting
services are exempt in New York if those ser-
vices can be purchased as software licenses.76
This already complicated process thus becomes
progressively more convoluted. In Massachu-
setts, where SaaS is taxed, a local SaaS compa-
ny that provided employment application col-
lection and selection services was deemed tax
exempt because the “customer was purchasing
the information, not the use of the software.”77
It should also be noted that, according to PWC,
many states do not tax services, and cloud com-
puting/SaaS is often considered a service -- not
73 Jennifer Jensen, “How Does One Tax the Cloud,” Price-
waterhouseCoopers, January 2012, pp 5.
74 Ibid.
75 Ibid.
76 Ibid.
77 Ibid.

22. The Heinz Journal
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a good -- in the form of a software. Though, as
the example of New York, supra, illustrates, this
can go either way.78
Again, PWC asks some good
questions for tax policy makers to consider:
“A major challenge in the taxation of cloud
-
able or nontaxable service? Is it a data
processing or information service? Is it the
sale or lease of tangible personal property?
addressed cloud services from a SaaS point
of view, very few states have addressed tax
-
point, and very few states have updated
their statutes and regulations to address
this emerging use of technology.”79
IaaS stands for infrastructure as a service, and
PaaS stands for platform as a service, both are
-
scribed in a simple manner previously, supra,
as the SaaS of SaaS, but this is not technically
simplistic explanation for those who are not
tech-savvy.
While a company might not wish to have a pri-
vate cloud due to it triggering jurisdiction within
the state where it is physically located, tax ben-
companies to locate their clouds or data farms
within their borders. However, this is a matter
to negotiate with the state and local jurisdiction
prior to committing to a location. According to
PWC, some states see private cloud services as
ripe for tax purposes, but in other states, ser-
vice transactions are not.80
However, the lease
of tangible personal property is generally sub-
ject to tax, and the State of Vermont has sug-
gested that computer memory is tangible per-
78 Ibid.
79 Ibid.
80 Ibid., pp. 6.
sonal property even though it has yet to tax it as
such. Thus, states may start taxing the hosting
or maintenance of a website on a server as a
sale, or lease, of tangible personal property.81
Furthermore:
“Of potentially greater consequence are
the possible nexus implications of leas-
ing tangible personal property in a state.
Leased property in a state may create nex-
us for both income tax and sales and use
tax in the state where the assets are locat-
ed. Using a private cloud could create an
and use tax collection responsibility for the
company. The sales and use tax collection
responsibility would apply to all the compa-
ny‘s transactions in the state, not just those
dealing with acquiring private cloud com-
puting services.”
Some states have taken steps which threaten to
tax the nexus consequences of a private cloud
within their borders.82
The State of Texas had a
regulation that made any retailer which owned
or used tangible personal property within the
state, including a computer server or software,
subject to sales and use taxes.83
However, in
2011, Texas reversed this position; this exam-
ple illustrates that states are becoming aware
of these issues.84
The state of Washington has
voiced to many software headquartered com-
panies within the state that “ownership of or
rights in computer software, including mas-
ter copies of software, digital goods, or digital
codes, stored on servers located in the state” will
not be used as factor in determining whether
a party has substantial nexus.85
Of course, this
headquartered in the state, but for their clients,
81 Ibid.
82 Ibid.
83 Ibid.
84 Ibid.
85 Ibid.

23. journal.heinz.cmu.edu 19Fall 2016
Properly Tax Internet and Cloud Based Businesses
since any physically-located headquartered
companies are already subject to the jurisdic-
tion.
States want to attract data farms. Giving tax
breaks is often the key to a state attracting big
companies to locate a data center in its juris-
diction. The states which are “the frontrunners
in a race to attract server farms and data cen-
ters through tax incentives include Alabama,
Kentucky, New York, North Carolina, Oklahoma,
Tennessee, and Virginia.”86
In 2007, the state of
Washington decided that data farms would no
longer get a tax break.87
Microsoft and Yahoo
stopped construction of their centers in Wash-
ington, and Microsoft moved its center to Tex-
as.88
As a result Washington temporarily rein-
stated the tax exemption, but the repeal of the
tax incentive has seriously harmed the ability of
the state to continue to keep and attract new
centers. The neighboring state of Oregon, on
the other hand, has attracted a Facebook data
center via generous tax incentives.89
Back to the Beginning: Uber and Airbnb
In January of 2015, the State of Virginia reported
that it had received $1.7 million in taxes from
online travel companies, such as Hotel.com,
but none from Airbnb which had around 2,500
listings in the state at the time.90
Similarly, Uber
as a result of GPS-enabled smartphones and
SaaS business models “continue to undercut
the licensed, regulated and revenue producing”
traditional industries.91
State and local govern-
ments are faced not only with the declines in
86 Ibid., 8.
87 Ibid.
88 Ibid.
89 Ibid.
90 Frank Shafroth, “Unforeseen Fiscal Challenges of
Uber-Like Services,”Governing, March 2015.
91 Conor Friedersdorf, “In an Era of Uber and Lyft, One
City’s Taxi Regulations Make No Sense,” The Atlantic,
March 23, 2015.
traditional tax revenues but issues of equity,
economic viability, and the creation of new reg-
ulations to protect consumers, while facing the
death or decline of historic industries. This new
economy has been called by many names -- dig-
ital, share, on demand, and the disruptive econ-
omy -- and it is all these things. The Internet,
SaaS-based businesses leveraging cloud tech-
nology, and smartphones have transformed
economic patterns worldwide and will continue
to change and evolve. How can state and local
governments keep up with the changes and
address them satisfactorily? What role should
the federal government play in this? There is an
ever expanding web of interwoven systems of
law, policy, and technology which serve as the
contextual backdrop of the narrow issue of how
can a city properly tax Airbnb, Uber, or other
SaaS based businesses.
Conclusion
In January of 2015, House Speaker John Boeh-
ner made a statement that Congress would re-
visit the Internet sales tax issue within the year.
Congress has been studying this issue for years.
Several bills addressing the issue have been pro-
posed but have failed to gain enough support to
pass. In 2013, the Congressional Research Ser-
vice published a report entitled State Taxation
of Internet Services, supra, which narrates the
following summary of one of the bills proposed
to address the issue in its basic outlines, later
referencing other bills with similar features,
both of which are based upon the Streamline
Sales and Use Tax Agreement, supra:
“Under S. 1452, Congress would have grant-
ed authority to states to compel out-of-
state vendors to collect sales taxes, on the
condition that 10 states comprising at least
20% of the total population of all states
imposing a sales tax have implemented
the SSUTA.The legislation also included

24. The Heinz Journal
journal.heinz.cmu.edu20 Fall 2016
additional requirements for administering
the new sales tax system after the SSUTA
adoption threshold has been achieved. The
requirements included, but were not lim-
ited to a centralized, one-stop multi-state
products and product-based exemptions;
single tax rate per taxing jurisdiction with
a single additional rate for food and drugs;
single, state-level administration of sales
and use taxes; uniform rules for sourcing
(i.e., the tax rate imposed is based on the
origin or destination of the product); uni-
-
formation service providers; uniform rules
and reasonable compensation for sellers
collecting and remitting taxes. The SSUTA
generally includes these provisions, though
legislation would have been necessary for
enactment.”92
The reason this has not passed in my opinion
is that the states do not want to give up more
power to the federal government and Congress
92 Steven Maguire, “State Taxation of Internet Transac-
tions,” 2013. Accessed March 23, 2015. https://www.fas.
org/sgp/crs/misc/R41853.pdf, p. 14.
knows this. Some states have taken preliminary
measures with the SSUTA and got mediocre
results because it is voluntary and unenforce-
able, for the most part. Ultimately, this should
be a federal solution, but such a solution could
-
isting ordinances by local jurisdictions. The an-
swer seems to be a federal law which outlines
as above who, what, where, and why internet/
-
cally giving implementation power to the states
and local governments as to all other issues af-
fected by such economic activity so that local
governance trumps. In other words, the federal
law would only preempt state and local laws as
to sales and use taxation, but not give a license
for disruption upon local customs with the force
toward a multinational reciprocal sales and use
treaty with the E.U. and other such initiatives to-
ward modern tax policy.

25. journal.heinz.cmu.edu 21Fall 2016
Tepid Optimism in Sino-American Relations
Tepid Optimism in Sino-American Relations: Pragma-
tism and Policy Rationales
Abstract:
This article reviews several United States policy alternatives in Sino-American relations. I consider
the nature of the security competition between China and the United States and review major
scholarly debates about the meaning of China’s ascendancy in international relations. I ask how
-
mines stability in East Asia and harms prospects for peace in the bilateral relationship. My argu-
ment suggests that the most reasonable approach to Sino-American relations is a policy strategy
I term “tepid optimism.”
Introduction
Since the end of the Cold War, most realist international relations scholars have written that a
-
tions.1
Some analysts have attributed the end of America’s “unipolar moment” to the impressive
rise of China’s economy, pace of trade liberalization, and growing caches of hard and soft pow-
er.2
Predictions that emphasize pessimism in bilateral U.S.-China relations argue generally that
“peace-producing mechanisms” and “stability-reinforcing factors” are impotent in the face of secu-
rity competition brought on by growing Chinese power.3
Suggesting that tension will spiral, these
accounts not only misunderstand regional relations, but also ignore mounting empirical evidence
1 For accounts that are generally pessimistic about the security problems that arise from a strong China, see, for ex-
ample, the following articles: Richard K. Betts, “Wealth, Power, and Instability: East Asia and the United States after
the Cold War,” International Security, 18.3 (Winter 1993/94) 34–77; Aaron L. Friedberg, “Ripe for Rivalry: Prospects
for Peace in a Multipolar Asia,” International Security, 18.3 (Winter 1993/94): 5-33; Charles A. Kupchan, “After Pax
Americana: Benign Power, Regional Integration, and the Sources of Stable Multipolarity,” International Security, 23.3
(Fall 1998): 40–79; John J. Mearsheimer, The Tragedy of Great Power Politics (NY, NY: W.W. Norton, 2001).
2 See, for example, two illustrative articles clarifying his standpoint that a rising China has provoked counterbalanc-
ing and increasing multipolarization in the region and in Sino-American bilateral relations: Christopher Layne, “Chi-
Christopher Layne, “The Waning of U.S. Hegemony: Myth or Reality? A Review Essay,” International Security, 34.1
(Summer 2009) 142–172.
3
2005) 41.

26. The Heinz Journal
journal.heinz.cmu.edu22 Fall 2016
of a pattern showing that a more powerful Chi-
na has not yet led to concerted counterbalanc-
ing by regional neighbors.4
Security tensions in the Sino-American bilat-
by peace-promoting mechanisms like the ex-
pansion of economic trade ties and the credi-
ble commitments that the People’s Republic of
China (PRC) has pledged through membership
in international institutions. Although a sudden
crisis in cross-straits relations between China
and Taiwan could conceivably shatter the tenu-
ous cooperation in the Sino-American relation-
ship, this possibility should not be the singular
determinant of policy prescriptions; moreover,
relationship after 2008 with the Republic of Chi-
na’s (ROC’s) election of President Ma Ying-jeou
should diminish the overall concern.
Broadly, however, it is conceivable that Wash-
ington and Beijing could be brought to blows if
either government dramatically shifted toward
a nationalistic foreign policy or embraced dis-
engagement strategies. These concerns about a
shift to a more nationalistic stance by either the
United States or China are real, but relative con-
tinuity in Sino-American relations since the end
of the Cold War suggests that tepid optimism
ought to characterize any attempt by Washing-
ton to develop regional policy. Tepid optimism
practices balanced pragmatism by engaging
China in order to prevent the type of security
competition that will unfold if full-scale contain-
ment becomes the preferred policy choice of
political elites in Washington. While a possible
confrontation between China and the United
States is possible, tepid optimism can incentiv-
-
lomatic stability in the Sino-American bilateral
relationship.
4 David Kang, “Getting Asia Wrong: The Need for New
Analytical Frameworks,” International Security, 27.4
(Spring 2003): 57–85.
Positive Engagement Prevents Zero-Sum
Outcomes
This paper embraces the thesis forwarded by
Thomas J. Christensen suggesting that when
policy decisions are made, the best approach
to understanding the Sino-American bilateral
relationship demands a synthetic view of posi-
tive- and zero-sum analytic views on the rise of
China.5
Christensen has put it this way: “Even
if straightforward and full-spectrum contain-
ment were attempted by the United States, it
would be counterproductive, not only because
it would raise China’s ire, but because it would
reduce Washington’s relative power in the re-
gion.”6
Thus, positive engagement for Chris-
tensen is the answer because it will actually
guard against zero-sum worries; this idea is
what I invoke when I suggest that tepid opti-
mism is the best approach to American foreign
policy development for the region. The last two
decades have shown that trade and mutual in-
terests in stability in East Asia have consistently
undercut the presence of competition-inducing
factors between the United States and China.
In his comprehensive consideration of various
prospects for future U.S-China relations, Aar-
on L. Friedberg tentatively commits himself to
the view that tensions will continue unabated,
will produce managed peace. He argues that an
5 Thomas J. Christensen, “Fostering Stability or Creating
a Monster? The Rise of China and U.S. Policy toward East
Asia,” International Security, 31.1 (Summer 2006): 81–
126; Thomas J. Christensen, “Posing Problems without
Catching Up: China’s Rise and Challenges for U.S. Securi-
ty Policy,” International Security, 25.4 (Spring 2001) 5–40.
While some scholars have portrayed Christensen as a
general pessimist, his approach to policy development
seems to be illustrative of comprising insights from
across the theoretical perspectives. In Fostering Sta-
bility (2006), he has revised his early statements about
how East Asian security should be structured and has
evinced a decidedly “moderate” perspective that “mixes
elements of positive-sum and zero-sum thinking” (83).
6 Ibid, pp. 125.

27. journal.heinz.cmu.edu 23Fall 2016
Tepid Optimism in Sino-American Relations
“underlying compatibility…[of] strategic inter-
ests” will mitigate the full onslaught of the se-
curity dilemma brought on by the rise of China.7
The guarded stances embodied in the views of
Friedberg and Christensen capture a pragmat-
ic vision. Comparatively speaking, this sort of
balanced pragmatism in the development of
American policy toward China is far better than
adhering to the false belief that our choices are
strictly either hubristic optimism on one hand
or stubborn pessimism on the other.
Why Pessimism Cannot Endure in the Si-
no-American Relationship
It seems misguided to embrace a strict stance of
pessimism toward the rise of China as framed
-
athan Kirshner has masterfully demonstrated
how John J. Mearsheimer’s logic “self-defeats”
on its own terms. Kirshner explains how Mear-
-
quences of “being a hegemon and bidding for
hegemony.”8
If we follow Kirshner’s dismember-
ment of Mearsheimer’s view, China’s survival as
a state is indeed “not in jeopardy if it does not
aggressively bid to dominate all of Asia,” and
the U.S. does not need to pursue policies that
will “strangle the Confucian baby in its cradle.”9
Endorsing classical realism as having more “an-
alytical purchase” than its neostructuralist cous-
ins, Kirshner suggests that the core tenets of
this approach can helpfully elucidate approach-
es to China. Classical realists, Kirshner argues,
shapes the actual world; second, how the sta-
tus quo ought not to be privileged, but instead
matter” in a decisive sense because it permits
7 Friedberg, “Future of U.S.-China Relations”, 42–45.
8
Classical Realism and the Rise of China,” European Jour-
nal of International Relations, XX.X (17 August 2010): 9,
12, 1 – 23.
9 Ibid.
learning from history.10
China, he thinks, is not
constrained by the structural conditions that
neorealism foretells, but is instead rational
enough to know that an aggressive bid for he-
gemony would not advance its core interests.
In short, Kirshner shows how structural vari-
eties of realism have certain defects; with the
-
sheimer’s view, theory has erroneously led to
exaggerated policy prescriptions about secur-
ing East Asia and providing for a peaceful rise
of China. While Kirshner sees the potential for
China to destabilize security and peace in the
region and for Sino-American rivalry to contin-
ue, he does not think a security crisis is inevi-
table. For example, he has explained how the
hegemony of the U.S. dollar in the internation-
al monetary landscape could become upset
by competition with China if unsound policy
recommendations further undermine Bretton
Woods II agreements. With dollar-denominated
reserve currency holdings at roughly $1.5 trillion
policies could make the stability of the dollar
more “shaky,” especially in light of the post-
question the dollar’s long-term value.11
Thus,
we can see how these insights might suggest
that the United States should take a pragmatic
position on reforming policy in a way that will
allow for its hegemonic leadership to continue.
For instance, the reserve status of the dollar can
be stabilized if the Federal Reserve quickly in-
that create liquid markets.12
Beckley’s Argument: American Declinist
10 Ibid, pp. 2-9.
11 Ibid, pp. 7; see also Michael Beckley, “China’s Cen-
tury? Why America’s Edge Will Endure,” International
Security, 36.3 (Winter 2011/12) 47.
12 Barry J. Eichengreen. Exorbitant Privilege: The Rise
and Fall of the Dollar and the Future of the International
Monetary System. New York: Oxford University Press,
2011.

28. The Heinz Journal
journal.heinz.cmu.edu24 Fall 2016
in its promotion of policy recommendations for
the U.S.-China bilateral relationship, it is simi-
larly reckless to believe in the invulnerability
trade interdependence and institutional en-
gagement may have subdued the direct chal-
lenge of Chinese revisionist aspirations, but this
has not put to full rest their ability to frustrate
American security interests. In his article
, Mi-
chael Beckley has recently argued that declin-
ist accounts of American power are misguided
because they do not follow a dynamic analysis
that compares the United States and China
technological, and military factors since the end
of the Cold War. He writes: “The widespread
misperception that China is catching up to the
United States stems from a number of analyt-
to draw conclusions…that compare China only
to its former self.”13
Beckley thinks that a “false
belief” in American decline has been produced
by misguided understandings of how globaliza-
tion redistributes power capabilities, resourc-
es, and human capital. Relying upon neoliberal
insights from Robert Keohane and Joseph Nye,
Beckley’s argument depends upon the view
that globalization has not recalibrated matri-
ces of power between China and the United
States, but instead, processes of global produc-
tion have tended to favor American economic
superiority and the persistence of hegemony.
The spread of technology in the new era of glo-
balization, he contends, has only widened the
the United States power-resource advantages
in wealth, innovation, and military capabilities.
the sort of predictions that Indian economist
13 Michael Beckley, “China’s Century? Why America’s
Edge Will Endure,” , 36.3 (Winter
2011/12) 43–44, 41–78.
Avrind Subramanian has made in his Foreign
China’s Dominance is a Sure Thing,” where he
denounces American economic conceit, stating
evidence that:
“…the gap between China and the United
States in 2030 will be similar to that be-
tween the United States and its rivals in the
mid-1970s, the heyday of U.S. hegemony,
and greater than that between the United
Kingdom and its rivals during the halcy-
on days of the British Empire, in 1870. In
short, China’s future economic dominance
is more imminent and will be both great-
er and more varied than is currently sup-
posed.”14
While Beckley seeks to dismiss declinist views
not only for their seeming inaccuracy in the face
of two decades of enduring American hegemo-
ny, his purpose is most critically aimed at the
“jingoistic and protectionist policies”15
that such
declinist arguments endorse. His attack centers
upon meshing hegemonic stability theory with
power transition theory in a way that produc-
es aggressive retreats from current American
foreign policy rationales that favor positive en-
gagement. He cautions explicitly against the
United States adopting neomercantilist trade
policies or withdrawing from its commitments
in East Asia and Europe.16
A reduction in U.S.
diplomatic cooperation and economic engage-
ment, in his estimation, will be costly and only
exacerbate security tensions.
Social Ideational Factors Matter to a Sound
Bilateral Policy
14 Arvind Subramanian, “The Inevitable Superpower:
Why China’s Dominance is a Sure Thing”
90.5 (September/October 2011) 69 -70.
15 Ibid, pp. 77, 41-78.
16 Ibid, pp. 78.

29. journal.heinz.cmu.edu 25Fall 2016
Tepid Optimism in Sino-American Relations
Beckley’s account explains especially well why a
sound strategic vision ought to embrace the no-
tion that continuation of American leadership
will be pivotal for structuring future Sino-Amer-
account for social ideational factors and over-
looks elements that could end systemic unipo-
larity. China has consistently sought to “delegit-
imate” and “deconcentrate” American power in
a way that could bring about a transition from
unipolarity to multipolarity.17
These combined
strategies make American primacy less durable
than it may seem on Beckley’s account, but it
does not mean that multipolarization will nec-
essarily induce full-scale war. Following the
argument of Randall L. Schweller and Xiaoyu
Pu, Chinese strategies have clearly sought to
pathways that have been geared toward “modi-
to it.”18
Just because China cannot currently
compete with the United States on econom-
ic and military grounds, does not mean that it
cannot problematize the realization of U.S. se-
China’s rise will transform regional political ar-
rangements in the upcoming decades through
a politics of contestation and resistance. If the
PRC’s revisionist impulses grow and are not
-
rangements, China could grow increasingly
more capable at hampering and obstructing
American power vis-à-vis the post-1945 regime
that was constructed in global governance insti-
tutions like the United Nations, the IMF, and the
World Bank.
Can Liberal Institutionalism Work?
17 Randall L. Schweller and Xiaoyu Pu, “After Unipolar-
ity: China’s Visions of International Order in an Era of
U.S. Decline,” , 36.1 (Summer 2011):
41–71.
18 Ibid, pp. 53, 41-71.
Liberal institutionalism and decisive advan-
tages in hard power for the United States may
extent China’s grand foreign policy strategy
continues to call for greater autonomy within
the international community. Without a coop-
erative China, the United States will have a dif-
Asian region and beyond, including: (1) halting
the Iranian and North Korean nuclear weapons
programs;19
PRC-ROC hostilities and resolving disputes sur-
rounding China’s assertion of autonomy in the
South China Seas;20
(3) bringing about the end
of humanitarian crises in Africa;21
and, (4) slow-
-
national terrorism.22
China’s search to purchase
energy resources and fuel its extraordinary
growth have frustrated American security inter-
ests, but Washington has also been blocked on
a number of key matters as a result of China’s
motivation to correct certain historical embar-
rassments like reoccurring U.S. weapons sales
to Taiwan.
As Chinese power grows, the real complexity in
American foreign policy will center on how to
gain her help in solving crucial security matters.
As Deborah Welch Larson and Alexei Sevchen-
ko have contended, China is a vital intermedi-
ary in security questions. Since China can either
19 Michael Singh, “The Sino-Iranian Tango: Why the
Nuclear Deal is Good for China” (July 21,
com/articles/china/2015-07-21/sino-iranian-tango
20 Sheldon W. Simon, “The US Rebalance and Southeast
Asia: A Work in Progress,” 55. 3 (May/June
2015), 572 – 595.
21 Luke Patey and Zhang Chun, “Improving the Sino-Af-
(December 7, 2015). Available online at: https://www.
-
ing-sino-african-relationship
22 From “Executive Summary,”
(National Intelligence Council, No-
vember 2008), pp. viii-xii.

30. The Heinz Journal
journal.heinz.cmu.edu26 Fall 2016
obstruct or facilitate the resolution of security
problems that the United States has sought to
resolve, global stability can be achieved if the
United States accommodates China’s interests
in social mobility. Based on case studies of Chi-
na and Russia since the end of the Cold War,
Welch Larson and Sevchenko use social identity
theory to explain how China can be induced to
cooperate on security issues and global gover-
nance matters if the United States recognizes
the PRC’s rising status.23
Chinese strength will
mean that American foreign policy will have to
navigate the channels of distinctive interests
that Beijing seeks. Thus, a view that only em-
phasizes American primacy does not fully ap-
preciate how Washington’s power will not be
best served by unilateralism.
Concluding Thoughts – Toward Analytical
Eclecticism in Sino-American Security
If growing power means that China will expand
her interests – as she has over the past two de-
cades – then Robert Gilpin’s counsel will come
to bear on the ability of the United States to re-
solve security interests in the way that it would
like. However, as Friedberg has advocated,
23 Deborah Welch Larson and Alexei Shevchenko, “Sta-
tus Seekers: Chinese and Russian Responses to U.S. Pri-
macy,” , 34.4 (Spring 2010) 63–95.
classical realism is not enough; any thorough-
going attempt at developing American policy
demands analytical eclecticism. This is a sound
prerogative for approaching the bilateral rela-
tionship. olicy rationales ought to be guided by
a posture of tepid optimism. Washington must
continue to positively engage China in order to
prevent the security dilemma foretold by neo-
realism. China is capable of contesting Amer-
ican security interests and has enough power
to obstruct progress in stopping the advance of
nuclear programs in North Korea and Iran, in
securing borders and stopping weapons traf-
-
an crises like those faced in Burma and Sudan.
It could also take a “nuclear option” and decide
to dump its large dollar-denominated reserve
currencies if it was pushed into a naval chal-
lenge in the South China Sea. Although unlikely,
plausible reasons exist that suggest that Chris-
tensen’s advocacy for positive engagement to
foreclose zero-sum worries is the best panacea
for realizing American interests in the region.

31. journal.heinz.cmu.edu 27Fall 2016
When Democracy Hurts
When Democracy Hurts: America’s Ill-Fated Policy in
the War on Terror
Abstract:
The U.S government aggressively promoted democracy in Afghanistan, Iraq, and the broader re-
gion as a key policy within its war on terror strategy. This paper traces how democracy promotion
came to be selected as one of the critical war on terror policies and then evaluates that decision
the time. An empirical analysis of the data suggests the policy choice has not helped achieve
U.S. objectives in the war on terror and may have inadvertently contributed to the extended civil
counter-terrorism and counter-insurgency policies, such as the evolving American response to the
Islamic State.
Introduction
On September 20, 2001, President George Bush declared America’s war on terror had begun. Af-
ter the Bush administration assessed early success in Afghanistan, spreading democracy became
one of their key policies supporting America’s war on terror strategy. Over time, the President
came to view democracy promotion as a potentially transformational change agent not only for
-
tions have emerged regarding the feasibility and sustainability of democracy in those countries.
This paper begins by tracing the decision-making process that resulted in attempts to democra-
tize Afghanistan, Iraq, and the broader region as part of the war on terror. The next two sections
available at that time. The fourth section analyzes the democratization policy choice based on the
-
-
were unlikely to take hold in either Afghanistan or Iraq. Moreover, the implementation of demo-
cratic processes and institutions in Afghanistan and Iraq may have unwittingly contributed to the

32. The Heinz Journal
journal.heinz.cmu.edu28 Fall 2016
Tracing the Decision to Democratize
Afghanistan
The decision to institute democratic forms of
government as a policy response to the attacks
of 9/11 came quickly, perhaps haphazardly, and
was initially limited to Afghanistan. Once U.S.
policymakers assessed Afghanistan as an ini-
tial success, however, they began to conceive
of democratization as a policy option that could
transform the broader Muslim world and re-
duce the underlying causes of terrorism.1
As America prepared to destroy and defeat
al-Qaeda, removing the Taliban was not a fore-
possibility that the Taliban might cooperate suf-
in power.2
Two weeks after the attacks of 9/11,
the CIA initiated covert operations in coordina-
expression of regime change appears to have
occurred after that at an October 3 meeting
of the principals. At that meeting, Secretary of
State Powell stressed the need for political lead-
by the removal of the Taliban, leadership that
represented all of the Afghan people.3
U.S. mil-
itary operations at this time focused on a light
American ground presence, utilizing Northern
Alliance ground troops augmented by limited
CIA and special operations forces, all of which
would be supported by American airpower.
Policymakers were not initially concerned with
the issue of Afghan governance. The days im-
mediately following the terror attacks of 9/11
1 Council on Global Terrorism,
, ed. Lee Ham-
ilton and Justine A. Rosenthal (Washington, D.C: Council
on Global Terrorism : Brooking Institution Press, 2006),
83.
2 Bob Woodward, (New York: Simon &
Schuster, 2003), 130.
3 Ibid, pp. 191-2.
were confusing and chaotic for all Americans.
on defending the homeland, then on attacking
al-Qaeda.4
-
wards Afghanistan that was not threat-related
came in the form of humanitarian aid, with mili-
tary-style Meals Ready to Eat (MREs) airdropped
for Afghans. What a future government in Af-
ghanistan might look like received scant atten-
tion.
The lack of attention paid to Afghan governance
resulted in part from the speed and success of
military operations. Within the initial week of
pressuring the U.S. government to slow the ad-
vance so that an interim government could be
put in place before the Northern Alliance took
Kabul.5
Despite those attempts, the Northern
Alliance did enter Kabul and establish a qua-
si-government before a broad-based, interna-
tionally recognized interim government could
be appointed.
On November 10, President Bush spoke before
the U.N. General Assembly, where he articulat-
post-Taliban government that would represent
all Afghans.6
Several days later during a meeting
between presidents Bush and Putin, both lead-
ers stressed the importance of a “broad-based
the process.7
Weeks later, President Bush deliv-
4 National Commission on Terrorist Attacks upon the
United States, Thomas H. Kean, and Lee Hamilton,
(Gov-
5 Peter Baker, Molly Moore and Kamram Khan, “Rebels
Delay Move Against Kabul; Devising Plan for New Gov-
ernment in Afghanistan Becomes Priority,”
, October 11, 2001, sec. A SECTION.
6 George Bush (United Nations General Assembly, New
York, November 10, 2001), http://georgewbush-white-
house.archives.gov/news/releases/2001/11/20011110-3.
html.
7 “National Security Advisor Briefs Press,”

33. journal.heinz.cmu.edu 29Fall 2016
When Democracy Hurts
ered a speech aboard the USS Enterprise during
which he commented on Afghan governance,
“Most of all, that country needs a just and stable
government. America is working with all con-
cerned parties to help form such a government.
After years of oppression, the Afghan people --
including women -- deserve a government that
protects the rights and dignity of all its people.”
He concluded: “America is pleased by the Af-
ghan progress.”8
Less than three months after the terror attacks
of 9/11, the U.N.-brokered talks concluded in
Bonn, Germany. The talks emphasized the cen-
tral role of Afghans, with plans for the U.N. and
international community to take a supporting
position.9
Afghans would govern themselves,
assisted by a light international footprint to help
bolster their capacity.10
read, in part, “Acknowledging the right of the
people of Afghanistan to freely determine their
own political future in accordance with the prin-
ciples of Islam, democracy, [and] pluralism…”
Hamid Karzai took the oath as interim President
of Afghanistan on December 22, 2001.
Iraq
Five years before the U.S. invaded, Congress and
President Clinton had enacted a law authoriz-
ing $97 million for opposition forces who might
remove Saddam from power and promote
democracy in Iraq.11
President Bush, though,
needed little legislative encouragement. By this
, November 15, 2001, http://georgewbush-white-
house.archives.gov/news/releases/2001/11/20011115-9.
html.
8 “President: We’re Fighting to Win - And Win We
Will,” , December 7, 2001, http://
georgewbush-whitehouse.archives.gov/news/releas-
es/2001/12/20011207. html.
9 Simon Chesterman, “Walking Softly in Afghanistan: The
Future of UN State-Building,” 44, no. 3 (Septem-
ber 2002): 39.
10 Ibid., 38.
11 Bob Woodward,
(New York: Simon & Schus-
ter, 2004), 10.
point in the war on terror, buoyed by perceived
success in Afghanistan, the president frequent-
ly articulated his conviction that America had a
responsibility to free people. To those who cri-
tiqued his position as potentially paternalistic,
he responded that freed citizens would not see
it that way; they would see it as liberation.12
In January 2003, the President met with sever-
al Iraqi dissidents. They articulated a favorable
picture of what a post-Saddam Iraq could look
like. Each spoke optimistically of democracy’s
future in Iraq, noting the technological skills of
the citizenry and dismissing assessments that
highlighted the Sunni-Shia rift. The President
engaged them in an aggressive give and take.
For most of his questions they had compelling
answers, but when asked about the possibility
of the U.S. being seen as imposing its will, they
had no response.13
Concurrently, Vice President Cheney became
concerned the State Department was failing
to embrace the President’s vision for democ-
racy in Iraq and the potential transformation
democracy could drive in the Middle East. He
believed that Secretary Powell and others at
State viewed democracy in Iraq and the region
as unattainable.14
Already somewhat marginal-
ized before 9/11, this event appears to have fur-
ther isolated Secretary Powell and diminished
Bush administration.15
Two weeks before the invasion, Doug Feith, the
Under Secretary of Defense, briefed the Presi-
dent and the National Security Council on U.S.
objectives with respect to Iraq. These objectives
included moving Iraq towards democracy, with
Iraq to then serve as a model for the region to
follow. Most of the objectives focused on po-
12 Ibid., 88.
13 Ibid., 258-60.
14 Ibid., 284.
15 Woodward, 13-14.

34. The Heinz Journal
journal.heinz.cmu.edu30 Fall 2016
litical and societal issues, rather than military
ones. 16
As the weighting of the objectives sug-
gested, the promotion of democracy was used
17
U.S.-led coalition airstrikes began on March 20,
2003.
In October 2003, during a meeting with the
Japanese prime minister, President Bush again
war on terror and World War II. He noted that,
just as America and Japan enjoyed a positive
relationship after the war, at some point in the
future the Iraqi and American presidents would
share a similar relationship.18
Eight months af-
ter the invasion of Iraq, President Bush present-
ed a “new policy, a forward strategy of freedom
in the Middle East.”19
The President’s lofty am-
bitions for the Middle East and the parallels he
drew to World War II suggest he felt a respon-
sibility to liberate the “oppressed” and that he
viewed the war on terror as a potentially trans-
formative period for the world.
In June 2004, the United States transferred pow-
Iraqi elections were held in January 2005.20
After the Elections
-
racy in the Middle East, publically promoting de-
mocracy as a cornerstone of his war on terror
16 Woodward, , 328.
17 Jeremy Sharp, “U.S. Democracy Promotion Policy in
the Middle East: The Islamist Dilemma” (Washington,
D.C.: Congressional Research Service, 2006), 1.
18 Woodward, , 419.
19 Mark N. Katz,
(Baltimore: Johns Hopkins Uni-
versity Press, 2012), 23–4.
20 Dominic Johnson and Dominic Tierney,
,
First Edition edition (Cambridge, Mass: Harvard Universi-
ty Press, 2006), 245.
strategy.21
During his second inaugural address,
he implied that the wars in Iraq and Afghanistan
were partly about freedom and, by extension,
democracy. He used the words “freedom,” “lib-
erty,” “democracy,” or some variant thereof 46
times.22
In his State of the Union addresses pri-
Bush used democratizing language an average
of 23 times per speech. In the addresses that
came after the elections, the average was 36
instances—a 57 percent increase.23
Further, he
viewed his democratization policies a success.
For example, his 2006 National Security Strate-
gy celebrated the “extraordinary progress in the
expansion of freedom, democracy, and human
dignity” that had occurred since 2002 and noted
America’s commitment to continue building on
that progress.
However, the 2006 elections that brought
Hamas to power in the Palestinian Territories
administration’s push for broader democrati-
zation. The Hamas victory, along with Islamist
inroads made in elections by the Muslim Broth-
erhood in Egypt and Hezbollah in Lebanon,
brought a chorus of criticism against the Pres-
ident.24
Researchers and political commenta-
tors suggest his administration responded by
de-emphasizing democracy promotion.25
How-
21 Raphael Perl, “Combating Terrorism: The Challenge of
-
ton, D.C.: Congressional Research Service, November 23,
2005), 4.
22 Helene Cooper, “Talking Softly About Democracy
Promotion,” , January 30, 2009, sec.
U.S. / Politics, http://www.nytimes.com/2009/01/30/us/
politics/ 30web-cooper.html.
23 Data derived from State of the Union texts, 2002-
2008, available at washingtonpost.com.
24 Steven R. Weisman, “Bush Defends His Goal of
Spreading Democracy to the Mideast,”
, January 27, 2006, sec. Washington, http://www.
nytimes.com/2006/01/ 27/politics/27diplo.html.
25 Katz, Leaving without Losing, 23–4; Glenn Kessler,
“U.S. Policy Seen as Big Loser in Palestinian Vote,”
, January 28, 2006, sec. World, http://
www. washingtonpost.com/wp-dyn/content/arti-