Attention Net Shoppers: Cybersales Taxes Loom

SAN FRANCISCO (03/06/2000) - I ran up plenty of bills shopping online this holiday season; I didn't miss the sales tax. That said, I don't want to lose speedy response times from my local fire and police departments, reasonably prompt repaving of my local roads (this century, please), and other local services.

Unrelated issues? No. Increased online spending by consumers has state and local governments worried that a significant drop in a major source of revenue--local sales taxes--will prevent them from delivering the services we all expect. And many government agencies are clamoring to end the ban on interstate Internet sales taxes that we've enjoyed for the past few years.

But taxing the Net will literally take an act of Congress. A 1992 U.S. Supreme Court ruling held that it would be too burdensome for businesses if states enforced sales taxes for out-of-state purchases. The 1998 Internet Tax Freedom Act put a three-year moratorium on Net access taxes (but not on sales taxes).

And it created an advisory committee to study electronic commerce and recommend action on various issues, including online sales tax; the committee is due to give its final report April 21.

A Piece Of The Pie

Here in the United States, we spent about $20 billion on cyberpurchases last year, according to Forrester Research, more than double the figure for 1998.

Projections for the future vary, but nobody doubts that online spending will continue to grow--and state and local governments want a piece of the fiscal action.

Some states aren't waiting for Congress to act. Residents of Michigan and North Carolina are getting a surprise on their 1999 state income tax forms: a line asking them to calculate how much they spent online and pay the appropriate local sales tax. Florida and other states are mulling similar action. These states are merely applying existing laws that let them recoup sales tax revenue lost to out-of-state purchases. Such laws are common; the new twist is enforcing them with consumers. Businesses have paid the fees because it's easy for states to track their purchases; consumers are another matter. Now growing cybersales are prompting some states to try.

Have you kept all your online receipts? Probably not--and you have no incentive to do so. That's one reason this approach won't work very well and why Congress may ultimately have to intervene to get money to the states.

Proponents of Internet taxation argue that the Net is the same as any other sales channel and shouldn't be exempt from sales taxes. In fact, we do pay sales tax on some Internet purchases. Laws originally created to cover catalog sales require a business to collect the corresponding sales tax if it has a sufficient physical presence, or nexus, in a state.

Why Not Tax The Net?

Not surprisingly, many Internet businesses go to great lengths to avoid nexus status in high-sales tax states. That is one reason keeps many of its warehouses in Nevada (no sales tax), instead of California (up to 8.5 percent), where more of its customers reside. It's also a reason some brick-and-mortar franchises like Barnes and Noble create separate companies to do business online. Otherwise, with stores in virtually every state, Barnes and Noble would have had to process sales taxes on all its online transactions.

Some argue that not taxing Internet sales widens the digital divide. Because the wealthier Americans make more purchases online, does forgoing cybersales tax benefit most those who don't need the break? This won't be the case for long, argues economics professor Alan Auerbach of the University of California at Berkeley. If the wealthy already shop online, where's the growth market? The middle and lower economic classes, he says; so imposing taxes now would eventually affect everyone.

But sales taxes are often the most significant source of income for state and local governments. We all rely on local services, and we will all suffer if the regional governments are not able to meet their budgets, argue proponents of Internet sales taxes, such as Republican Governor Michael Leavitt of Utah, who serves on the U.S. Advisory Commission on Electronic Commerce.

Leave The Net Alone

Advocates of a continued ban on Internet sales taxes are at least as vocal.

They include most of the presidential candidates as well as Virginia's Republican Governor Jim Gilmore, who heads the electronic commerce advirory committee. Some opponents of Internet taxes favor maintaining the status quo for a few more years; others want a permanent ban.

Those urging a complete and permanent ban argue that government regulation will stunt e-commerce growth and hamper the innovations that caused it to blossom.

Governor Gilmore argues that state and local governments suffer no significant revenue loss as a result of online sales. According to a spokesperson, Gilmore also believes that e-commerce bolsters other areas of the economy, enlarging state and local governments' take from such existing revenue sources as income and property taxes and even stimulating local economies so that offline sales tax revenues increase. And Gilmore expects such trade-offs to continue, offsetting future sales tax losses. Economist Shane Greenstein of Northwestern University's Kellogg Business School, however, considers Gilmore's view shortsighted. Tax-free online sales will eventually cut into state revenues, he says. Recent research by fellow economist Austan Goolsbee of the University of Chicago supports Greenstein's view.

Leave The Net Alone--For Now

Economists Greenstein, Auerbach, and Goolsbee agree that a permanent ban is not the answer, and given the revenue potential from Internet transactions, it is politically unlikely. They suggest maintaining the status quo for a few more years.

Hindering Internet growth would hurt the overall economy, which benefits from tech businesses. Online sales figures may seem big, but they represent less than 1 percent of all retail sales and probably won't grow much beyond 2 percent before 2004, Goolsbee says. Imposing Internet sales taxes now, before cybershopping has become widely established, could cause online sales to drop by as much as 24 percent, according to a study Goolsbee conducted.

Also, the bulk of online and offline buying--services ranging from financial transactions to dry cleaning--is already exempt from sales tax. Auerbach and Goolsbee also note that the strongest U.S. economic growth is occurring in the service sector. Taxing services will require a major overhaul of the tax system. That's not on the table--yet.

Maintaining the status quo may give policy makers a chance to examine the issue and various proposals in depth. One plan--supported by many members of the tech community--suggests creating a simplified sales tax system, likely with a single nationwide rate. That solution would streamline the collection task for business, which currently have to deal with 7000-plus tax rates in different regions. Another proposal, supported by Governor Leavitt and the National Governor's Association, would create a set of databases like those used in processing credit card orders, so all businesses could easily calculate the appropriate sales taxes for any order. Regional governments have plenty of incentive to build such databases. But either plan would take time to implement.

Net Result

The problem isn't simple, and it will only grow more complex as the economy becomes increasingly global. The e-commerce committee is deeply divided over specific proposals and will probably recommend a simple three- to five-year extension of the current moratorium--which means the issue will be left for Congress to resolve or to defer further. The candidate we vote into the White House this year will also significantly influence the course of Internet taxation. We can stall for only so long: As online sales grow, states will demand their fair share. Now is a pivotal time, before we reach a crisis.

Consumers probably have one or two more "free" Net shopping seasons left. But as the saying goes, there are only two things in life we can count on: death and taxes (even online).

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