Stateline Story

Internet Taxation Issue Divides Policy Makers

The Internet is fast evolving into a vast electronic shopping mall where virtually anything under the sun can be had with a mouse-click and a credit card number. But the growth of this potentially limitless new economy raises complex tax issues that cut across state, legal and political boundaries.

The debate focuses on goods shipped by out-of-state Internet retailers. These items escape state and local sales taxes, depriving states of $5 billion in sales tax revenue last year, according to pro-tax forces. They warn the situation will only get worse as e-commerce continues to grow, unless corrective action is taken.

Taxation foes counter that the Internet has the potential to be an awesome economic engine, so long as it's not weighed down by a complicated web of state and local taxes. Furthermore, they argue, most states are in great fiscal shape thanks to the country's economic boom, so why do they need to bother e-commerce anyway?

Underlying the squabbling is a crucial fact: Forty-six states collectively get 48 percent of their revenue from sales and gross receipts taxes, according to the National Governors' Association. In other words, don't look for the struggle over Internet taxation to quietly go away.

If anything, it promises to grow more raucous as both sides marshal their most convincing arguments why e-commerce should, or shouldn't, be treated as just another source of state sales tax revenue.

Hands Off!

There are two major reasons why states haven't already gone after remote Internet sales.

The first is a ban that's codified -- sort of -- in federal law. The Internet Tax Freedom Act (ITFA), enacted in 1998, established a three-year moratorium on special, multiple and discriminatory taxes on e-commerce. The law makes no specific mention of state and local sales taxes.

Even so, ITFA has helped erect a force field between remote Internet sellers and states dying to tax them. The IFTA moratorium expires Oct. 21, 2001.

The other factor having a cooling effect on states is legal precedent.

A 1992 U.S. Supreme Court case, Quill Corp. v. North Dakota, blocked North Dakota's bid to impose a sales tax on a Delaware mail order firm. The court's rationale was that North Dakota raised a barrier to interstate commerce in violation of the Commerce Clause of the Constitution.

The high court had made a similar ruling in 1967, in National Bellas Hess, Inc. v. Department of Revenue Illinois.

When e-commerce takes place entirely within a state's borders, the situation is cut-and-dried. If Washington-based Amazon.com sells a book to a customer in Seattle, for example, Amazon.com has to collect a Washington sales tax.

However, in Quill, the court hinted it might be receptive to congressional revisions in the tax treatment of remote sales. This explains why a steady stream of governors and tax experts have paraded before Congress to examine various sides of Internet taxation.

Economic Impact On States

In 1998, the tax loss stemming from Internet sales was about 0.1 percent of overall sales tax revenues, according to University of Chicago economist Austan Goolsbee.

If e-commerce grows as predicted, that number could grow to 1.4 percent of sales tax revenues by 2003, University of California at Berkeley professor Hal R. Varian says.

The National Governors' Association estimates that three years from now, states will be losing $10 billion in annual sales tax revenues if they're not allowed to tax cyber sales. The Center on Budget and Policy Priorities, which concentrates on policy issues affecting low-income citizens, puts the loss at $15 billion by 2003.

Of course, no one ultimately knows where e-commerce will be three years from now. One thing is certain -- state officials don't want to be caught flat-footed if Internet sales take off beyond anyone's wildest dreams. It's a fiscal gamble they can't afford to lose.

This is especially true for Florida, Nevada, South Dakota, Tennessee and Washington, states where sales tax revenues account for more than 50 percent of collections.

Who Passes The Hat?

The question of how and by whom state sales taxes are collected is one of the thornier issues associated with Internet taxation. It's prompted major teeth gnashing and grandstanding from state and federal politicians.

With an estimated 6,000 taxing jurisdictions in the United States, the collections issue takes on nightmarish dimensions. NGA has proposed that government and e-commerce businesses come up with a simplified sales tax system. It would also like Congress to pass a law requiring remote sellers to collect taxes for states that go along with the plan.

But during a recent U.S. Senate hearing on Internet taxation, Democratic Oregon Sen. Ron Wyden said any collection mechanism would amount to "bureaucratic water torture."

There doesn't appear to be much enthusiasm on Capital Hill for helping states collect sales taxes. Why should Congress put itself in the position of being pilloried over a tax it can't spend?

For what it's worth, Gateway computer CEO Ted Waite, a member of the Advisory Commission on Electronic Commerce, says it's possible to come up with a sales tax collection system that would work.

The Fairness Argument

Arguments over the fairness of keeping the Internet tax-free generally follow two lines. The first has to do with retailers who sell goods from stores and other physical locations.

Those favoring Internet taxation argue that `brick and mortar' merchants are at a tremendous disadvantage to their Internet counterparts, because consumers with computer access will gravitate toward tax-free Internet sales.

Taxation opponents argue that Internet consumers already pay shipping costs on their purchases, so it wouldn't be fair to saddle them with state sales taxes, too.

The other part of the fairness argument centers on haves and have-nots. Advocates for the poor contend that middle-class consumers are more likely to have computers, and thus enjoy the benefits of buying merchandise tax-free over the Internet.

"The burden of the sales tax will shift more and more to low-income people, because upper-income people will be able to opt out of the system," says Michael Mazerov with the Center on Budget and Policy Priorities.

Final Analysis

A bill now pending in Congress would make the Internet tax moratorium permanent, instead of a three-year deal.

"Tax collectors have been trying to get around the Constitution to tax remote sales ever since Sears Roebuck mailed its first catalogue," says Sen. Wyden , one of the bill's co-sponsors. "A permanent moratorium will ensure that consumers and small (Internet) businesses will be saved from an onslaught of haphazardly thrown together new, discriminatory taxes."

Nearly half of the nation's governors -- 20 -- say they're undecided on the issue. Among those with firm opinions, 16 want to levy sales taxes on e-commerce, while 10 want to shield the Internet from taxation. Four governors were hesitant to make any comment, one way or the other.

Meanwhile, lobbyists on both sides of the issue are bending ears in statehouses and on Capital Hill. Heightening their sense of urgency is the October 2001 tax moratorium expiration date set by the Internet Tax Freedom Act.

Whether it's possible to craft a solution that makes everyone -- or anyone -- happy is anybody's guess. As Massachusetts Gov. Paul Cellucci, a staunch opponent of Internet taxation, archly notes, "Who knows?"