Why We Must Tax in Cyberspace

This season, as in Christmases and Hanukkahs past, shoppers have been turning to mail order catalogues and, increasingly, to the Internet for their holiday buying. It's a trend that will explode in the coming years.

While this may be a soothing convenience for frazzled Main Street and mall shoppers, sick of crowds and long check-out lines, it is a loser for state and local tax coffers. Governors addressed this issue--shopping and taxes--in this now waning 105th Congress and so did an Institute of Politics study group on federal and state power struggles this fall. They are issues that aren't likely to go away.

Technically, consumers are liable for payment of sales taxes on all purchases, including items bought from out-of-state catalogues, but mail-order companies are required to collect sales taxes only in states where they have a physical presence--a warehouse, distribution center or store, for example. Consequently state and local governments lose up to $4 billion annually in sales taxes, according to the National Governors' Association (NGA).

While that number is high now, it is nothing compared to the expected boom in Internet sales in the coming years. Today, by NGA estimates, 90 percent of most products are sold in stores, and only one percent of sales occur over the Internet. Yet, by the year 2002, electronic commerce within the United States is projected to grow from a current $8 billion to $300 billion, and the NGA calculates this will cost states and localities between $8 billion to $10 billion in foregone revenues. This is an expensive problem: states raise 50 percent of their revenues from sales taxes--taxes that pay for everything from schools and hospitals to police services and roads, fire protection, health care and garbage collection.

The issue came to a head with the introduction of the so-called Internet Tax Freedom Act in the 105th Congress, which leaves office next month. As originally drafted it would have prohibited states and localities from taxing any business activity involving the Internet for six years. State and local governments argued the time period was too long and protested this preemption of their taxing authority, but the crux of the matter was sales tax collection on remote sales.

For years, representatives of governors, mayors, state legislators and other locally elected officials have been meeting with mail order firms in an effort to work out the tax collection problem. Mail order companies had argued that collecting the taxes was too cumbersome and was an unfair burden on them with the more than 45 state and 6,000 different local taxing authorities with varying taxing structures and items they taxed.

Governors countered that the problems could be resolved. Working with the national Tax Association, they have been developing a simplified tax system. States would have to come up with a single rate and uniform definitions of goods and services that would apply to all jurisdictions within their states, and vendors would be able to easily remit taxes to the state where the purchase was received using newly developed software.

To Congress, the governors argued that the issue wasn't that they wanted higher taxes; rather, they wanted equity. They supported development of the Internet, viewing it as a powerful tool for economic development and opposed new taxes on the Internet to foster continued business growth and electronic commerce.

Yet it is "fundamentally unfair," said Gov. Mike Leavitt (R-Utah), the lead governor on the issue, "that Main Street retailers should be required to collect a sales tax while Internet and mail order vendors can sell the same goods and not be required to collect a sales tax."

After intense gubernatorial lobbying last October, Congress approved legislation that contains a three-year moratorium or "time out" on new Internet taxes and calls for the establishment of a commission to study taxation of transactions using the Internet. The commission has 18 months from the date of enactment of the legislation to complete its work. The commission is comprised of the secretaries of the Departments of Commerce and Treasury and the U.S. Trade Representative, eight state and local representatives, and eight business and consumer representatives

Yet the governors' original optimism at the establishment of the commission has waned. Initially six instead of eight state and local representatives have been named, but ten instead of eight business representatives were. There are no representatives of consumer groups. Governors pushed Congress to make changes and one business representative was dropped for a local person. They are waiting to see what other changes might occur.

And while they wait, mail order and Internet sales increase. No solution to the out-of-state tax issue could result in the collapse of the state and local sales taxes and therefore the services they support. The result could be higher property taxes and a federal system of sales tax, and that will mean, according to Leavitt, "a massive shift in power from the local government to Washington."

Shouldn't cybervendors and mail order companies pay the same as businesses on Main Street and the mall? This is one place where Congress doesn't need to play Santa. Marguerite Hoxie Sullivan is a fellow at the Institute of Politics. She served as a cabinet member for five years under New Jersey Gov. Christine Todd Whitman (R).