A few years ago, when state coffers were flush with cash and online retail sales seemed headed for the stratosphere, state officials pushed the taxation of online sales as a fairness issue. “We figured if you had two identical people making identical purchases, but one buys downtown and the other buys online, someone is not paying their fair share of the cost of their government,” says Scott Peterson, director of the Business Tax Division in South Dakota’s Department of Revenue.
What a difference a few years and a sharply changed economy can make. Today, faced with mounting state budget deficits, the issue is no longer fairness-it’s the balancing of state budgets. “Back in March 2000 everyone had money and a positive budget balance, and some states were even giving money back to taxpayers. Now, this is one of our top issues, because sales tax is a huge portion of almost any state’s budget,” says Peterson, who co-chairs the Streamlined Sales Tax Project, a multi-state effort to lay the groundwork for the mandated collection of online sales taxes across state borders.
Perhaps no state illustrates the new push better than California. Two years ago, Gov. Gray Davis vetoed a bill that would have imposed sales taxes on online purchases. Now the proposal has a new life in the State Assembly and, facing a budget shortfall of $35 billion, Davis is looking more favorably upon the $1.75 billion that a sales tax on online purchases could bring in.
What happens in California could have a strong impact on building support for Internet taxes in other states. “It would cause a ripple effect throughout the country,” Peterson says.
Peterson and other state officials say they are nearing their goal of forcing online retailers to collect and remit sales tax for most states from which they receive orders from customers-whether or not the retailers have a physical presence in those states, the current stipulation under which they’re supposed to collect sales tax. In February, Wal-Mart Stores Inc., Target Corp. and other major retailers agreed to start collecting sales taxes for purchases in 37 states and the District of Columbia in return for an amnesty on any back taxes that the retailers might owe.
The sales tax issue now has popped to the top of state lawmakers’ list of critical issues. Pointing out that two-thirds of states must cut their budgets by more than $25 billion in aggregate before the end of June to balance their fiscal 2003 spending plans-after having already cut $49 billion-the National Council of State Legislatures has ranked online tax among its Top 10 issues for this year, right up there with homeland security, education reform and health care issues. On top of that, the group says states are already facing a shortfall of $68.5 billion for fiscal year 2004.
The NCSL, noting that the University of Tennessee reports that states and municipalities lost an estimated $13.3 billion in 2001 - a loss projected to reach $45.2 billion in 2006 - in sales and use tax revenue due to online sales of products and services, is pressing for fast relief. “States have taken the lead in developing a blueprint for streamlining sales and use tax collection across the country, a move that would help local retailers stay competitive with online businesses,” the NCSL said in naming its Top 10 issues. Now it wants more action from the retail industry and the federal government, which must approve a multi-state tax collection plan before states can mandate tax collection across state borders. The University of Tennessee says its estimates of lost sales tax revenue are intended as a useful guide but will likely differ from actual numbers. “There’s a lot of approximation in these figures,” says Dr. Don Bruce, one of the study’s co-authors.
The Direct Marketing Association, contending the Tennessee study uses vastly inflated estimates of e-commerce activity, says states lost about $1.9 billion last year, not $13.3 billion. State officials say the DMA overlooks the actual growth of online activity.
For years, efforts to force online retailers to collect sales tax have lumbered along, facing steadfast resistance from pure-play online retailers, disorganization among states and a lack of wholehearted support from the federal government. Many opponents of online sales taxes contend that the tax would unduly stifle the development of a young industry that still accounts for only a tiny though growing percentage of overall U.S. retail sales. “Having to deal with multiple tax jurisdictions in each state would be onerous and expensive,” says Shannon Stowell, vice president of business development and co-founder of Altrec.com, a 4-year-old company that specializes in online sales of outdoor sports gear. “Online business is still struggling to get on its feet and is less than 4% of all retail.”
Consumers don’t care
Recent research indicates, however, that forced collection of sales tax may not harm retailers as much as they’ve expected. In a February report, “Sales Tax: Avoidance Is Imperative to Few Online Retailers and Ultimately Futile for All,” Jupiter Research reported that only 46% of online consumers it surveyed in November 2002 were aware that they could avoid sales tax by shopping online. And of that 46%, more than half don’t look for online retailers that don’t collect sales tax.
Some retailers have been collecting sales tax across multiple states without a problem. Williams-Sonoma Inc., for instance, has been collecting sales tax on web sales since it launched its first e-commerce web site in 1999, whether or not it has a physical presence in customers’ states. Another e-retailer, which uses special software to organize different state and local tax rates, has been collecting sales tax on catalog sales since 1989 and web sales after that for states where it has a physical presence. “We haven’t noticed an impact on sales,” says the retailer’s vice president of e-commerce.