States Angle for Ways to Tax Internet Sales

Published April 1, 2009

The tough economy and corresponding decline in tax revenue have increased pressure on states to collect sales taxes on goods sold over the Internet—a move critics say is unconstitutional and will harm a segment of the economy crucial in leading the nation to recovery.

Twenty-two states are participating in the Streamlined Sales Tax Project (SSTP), an effort to simplify the nationwide patchwork of sales tax rates. The goal is to convince Congress to pass legislation allowing states to force businesses that don’t have a physical presence in a state—such as online retailers Amazon and Overstock—to collect sales taxes and send them to the states’ treasuries.

“No doubt the states are looking for ways to balance their budgets,” said Jerry Cerasale, senior vice president for government affairs for the Direct Marketing Association in New York.

But the goals of SSTP run smack into a 1992 U.S. Supreme Court case, Quill Corp. vs. North Dakota, in which the court ruled a state’s attempt to impose sales taxes on out-of-state retailers violates the Commerce Clause of the Constitution.

Use Tax Ignored

Another wrinkle in the debate is the little-known “use tax,” which requires taxpayers to report the products they buy out of state and use at home.

The self-policing nature of the tax, however, means little is ever collected. Some states enforce collection on some items, such as vehicles, by, for example, not issuing license plates until the use tax form is filed with the state taxing authority. Overall, though, enforcement has been weak.

“Trying to step up enforcement of the use tax during the time of a recession is probably a bad idea,” said Daniel Ballon, a technology policy fellow at the San Francisco-based Pacific Research Institute.

Collection Complications

Sales taxes for purchases over the Internet have proven difficult to collect, thus the press for SSTP. Sales tax collection is a relatively simple process for bricks-and-mortar retailers, but online retailers with operations in multiple states would need new systems to collect and remit different sales taxes from different jurisdictions.

Cerasale notes many businesses selling products on the Internet are small firms that don’t have the personnel or technology to collect and remit sales taxes for the nearly 7,500 different tax jurisdictions in the United States.

The rules can be complicated even within a particular jurisdiction. For example, in one jurisdiction a chocolate bar could fall under one set of tax rules but a candy bar with nuts would be considered “food” and taxed another way.

“There is no way for [Internet retailers] to know this,” Ballon said.

“This idea is anything but streamlined,” Cerasale said. “There’s no centralized registration. There can be as many as 45 individualized audits in one state—and some states don’t even charge a sales tax.

“Direct marketers would have to hire entire tax departments just to handle this,” Cerasale said. “There’s no computer program to do this. It would be a huge cost for direct marketers.”

Passing on Costs

Those costs would not be absorbed by online retailers—the burden would be transferred to those making the purchase, analysts note.

“This cost burden on direct marketers would be passed on to consumers through higher prices,” Cerasale said. In addition, “Each of these jurisdictions determines what is and isn’t taxable. This plan comes very close to constituting taxation without representation.”

Jeff Kagan, an independent telecom analyst based in Atlanta, said the relatively tax-free Internet should remain so for the benefit of consumers and the growth of the overall economy.

Customers Expect No Taxes

“This is an argument we have been having for over a decade,” Kagan said. “When retailing on the Internet was young we wanted it to grow, so we delayed taxing sales. The question was less if and more of when the taxing would begin.

“Now customers are used to [there being] no tax on the Internet. Taxes are one of the reasons consumers buy on the Internet,” Kagan said.

“I think as long as pricing on the Internet is still below [bricks-and-mortar] stores, then the Internet will not be hurt,” Kagan added. “That means the low-cost sites should still do fine. The other sites that charge the same as retail stores, and [currently] save customers on tax, may suffer more.”

Proponents of the streamlined sales tax plan have discussed a small business exemption, but there’s no specific definition of what businesses would qualify for it, Cerasale said.

Rejecting Top-Down Approach

Kristina Rasmussen, director of government affairs for the National Taxpayers Union in Alexandria, Virginia, said another concern is the top-down approach of SSTP.

Taxing the Internet would begin via federal legislation, Rasmussen notes, and probably a federal sales tax. Then the states would join in, and eventually all the various local municipalities would do so as well.

“The way it stands, states would implement it, then counties and cities,” Rasmussen explained, adding that such an approach further complicates issues.

While states and other taxing jurisdictions might see such a tax as a way to fill budget holes, a better approach is to find ways to grow local economies and to benefit from that growth, Rasmussen said.

“Adding a sales tax—or more strictly enforcing the use tax—in difficult economic times is the wrong answer to the government deficits,” Rasmussen said.

Phil Britt ([email protected]) writes from South Holland, Illinois.