End of the Beginning: Internet Sales Tax

By Roy Mark

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Efforts to impose an eventual Internet sales tax reached the end of the beginning phase Tuesday when representatives from 32 states approved model legislation designed to create a system to tax Web sales.

Spearheaded by the National Governors Association (NGA), the Streamlined Sales Tax Project (SSTP) would require participating states to have only one tax rate for personal property or services effective by the end of 2005. Included in those services would be online sales.

Currently, sales and use taxes are owed on all online transactions, but states are prohibited from requiring remote sellers to collect and remit those levies. A 1992 U.S. Supreme Court decision said states can only require sellers that have a physical presence or "nexus" in the same state as the consumer to collect so-called use taxes.

The court ruled that the current patchwork of roughly 7,500 taxing jurisdictions across the country is too complex and burdensome for online retailers to charge and collect sales taxes. In order to collect the taxes, the court ruled, states would need to first simplify the existing system.

Tuesday's vote represents the first step in that simplification. The coalition of states voted to require participating state and local governments to have only one statewide tax rate by 2006 for each type of product taxed.

"This is a 21st century system that will dramatically improve the morass that currently exists," said Utah Gov. Michael Leavitt.

The NGA launched the STTP in 2000 with the long-term goal of presenting Congress and the courts with a system that would allow the states to collect sales taxes on online sales and catalogue purchases.

Under the SSTP model legislation, states will develop uniform product codes and sourcing rules, uniform definitions of what is taxable, and simplify administrative policies. They would then provide software free of charge to retailers that would calculate, collect, and remit the taxes owed on remote sales.

If at least 10 state legislatures approve the provisions of the agreement, court and congressional approval would then have to follow. The effort, if successful, would be the first overhaul of the nation's sales tax policy in 40 years, and the first time states had acted together to significantly restructure the system.

Although the process still faces many state and federal legislative pitfalls and, if successful, is still at least two or three years away, the prize for the states is well worth the wait. A report by the University of Tennessee last year estimated that all 50 states could collectively lose more than $45 billion in Internet sales tax revenue in 2006.

The study , commissioned by the Institute for State Studies and prepared by the University of Tennessee with data collected by Forrester Research, shows the revenue impacts for states are significant. Nearly half of state revenues come from sales taxes and more than 40 percent of state spending is dedicated to education, law enforcement, and transportation projects.

According to the study, in 2001, inability to tax e-commerce likely cost state and local government revenue a loss of $13.3 billion. By 2006, the loss will more than triple to $45.2 billion; and in 2011 the loss will be $54.8 billion. The cumulative total of losses between 2001 and 2011 is $439 billion. The report also shows how much each individual state will lose from uncollected sales and use taxes.

The Internet Tax Freedom Act passed by Congress only prohibits states from taxing consumers on the use of Internet service providers. The current moratorium does not apply to sales taxes, nor to federal taxes.