Taxing the Internet, One Bagel at a Time

Published December 1, 2006

In Rhode Island, policymakers have been haggling over how to tax bagels, which is different from how rolls are taxed. In Vermont, Joe Six-Pack will start paying a tax on beer next year.

These are the kinds of discussions policymakers in most states have been having because of the Streamlined Sales and Use Tax Agreement (SSUTA), which is designed to help states charge sales taxes on Internet and mail order purchases. States that are party to the agreement have been trying to make their tax structures match up with those of the other states in the agreement.

Threat to Autonomy

Competition is the key to healthy state and local economies, but the Streamlined Sales and Use Tax Agreement threatens states’ autonomy to shape their own tax policies, costs each state’s economy jobs, and devastates their technology sectors.

Formed in 2002, the Streamlined Sales Tax Project, as the SSUTA was originally called, was created to push Congress toward taxing the Internet. Because two Supreme Court decisions (most recently 1992’s Quill v. North Dakota decision) have ruled that requiring remote sellers to collect state sales taxes is an undue burden on interstate commerce, a state cannot require sellers to collect its sales tax unless they are physically located in the state.

Supporters of Internet taxation claim SSUTA will “simplify” and “streamline” the sales and use tax system. Critics say implementation of SSUTA would preserve many of the current complexities of calculating and collecting sales taxes and would force merchants to comply with thousands of different tax rates and exceptions.

The real motivation of SSUTA is to target businesses that are not physically located in the customer’s state and to export a state’s tax burden.

Possible Tax Cartel

Several states have looked at ways to reduce compliance costs to lower local jurisdictions’ liability regarding tax collections. Taxpayer advocacy groups express concern that this will reduce competition among local jurisdictions to attract businesses and homeowners and increase the likelihood of a tax cartel in which counties, cities, and towns are subject to the special interests of another nationwide tax collector.

SSUTA would destroy incentives to keep tax rates moderate and foster competitiveness, and inefficient local retailers and governments would be artificially shielded from competitive forces. The pressures to raise taxes in the nation’s 30,000 state and local tax jurisdictions would lose their counter-balance.

As of August 1, only 13 states qualified as full “member states” in the SSUTA.

These states–Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, New Jersey, North Carolina, North Dakota, Oklahoma, South Dakota, and West Virginia–have agreed to comply fully with the rules and definitions of the agreement. Overall, 44 states have taken steps toward compliance with the agreement.

Rhode Island, categorized by the SSUTA as an “implementing state,” has faced challenges with complying with the agreement’s definitions. In 2004, some Ocean State bakeries owed the state thousands of dollars in uncollected sales tax because they were unaware of a change in the state’s definition of prepared food.

Toasted vs. Untoasted

As toasted bagels are considered prepared food while untoasted bagels are not, confusion and even reports of bakeries closing followed the tax change.

This year the debate returned, with questions on how to tax bins of olives with and without added spices, and what category of baked goods the Italian dessert called cannoli should fall into.

Beer drinkers in Vermont are other recent losers due to SSUTA. Starting next year, Vermont will tax beer, delivery or shipping charges, and telecommunications services in order to move closer to compliance with the SSUTA. Although Vermont could have met the “simplification” guideline by removing the tax on wine rather than imposing the tax on beer, the decision was made to seek even more revenue from taxpayers.

Taxpayer advocacy groups point out that increasing taxes should not be easy. All efforts to reform tax collection should ensure that competition among states and localities is protected and encouraged, they say.

Elizabeth Karasmeighan ([email protected]) is state government affairs manager at Americans for Tax Reform.