June 4, 2010, 4:24 PM

Time to Bite the Sales Tax Bullet—Part 1

The web retailing industry has one unearned cost advantage over stores—it mostly avoids collecting sales taxes on purchases. It amounts to a multi-billion dollar tax break to the e-commerce business, and it can't last.

The web retailing industry has one unearned cost advantage over stores—it mostly avoids collecting sales taxes on purchases. It amounts to a multi-billion dollar tax break to the e-commerce business, and it can’t last.

The only reason web merchants get this cost-pricing advantage is because they do not have nexis—an office, employee or other presence in a state that justifies taxes being collected  by that state. Since there is no federal excise tax imposed on sales of most web merchandise that crosses state lines, the web transaction does not generate any sales tax levy, benefiting web seller and shopper alike.

For a couple of reasons, I doubt this situation will persist much longer. First, most state treasuries at the moment are sitting under a mountain of red ink because state revenues have declined. Personal incomes have declined as have state taxes they generate.  Real estate tax bases have been shrinking for more than three years, which reduces state and local government revenue.  Total retail store sales last year dropped by 7%, which in turn narrowed that state revenue stream. And since the states do not have the federal government’s ability to finance their operations by running deficits, their budgets are being squeezed big time.

States and their municipalities have four options to deal with their fiscal crisis:  increase tax rates on their existing revenue sources (primarily taxes on retail sales and real estate), cut state and local spending, appeal to the federal government for more handouts or legislate an entirely new source of state and local public funding.

The first three solutions are problematic to say the least. With declining property values and increasing foreclosures, increasing real estate tax rates only exacerbates an already terrible situation. Who could say how severe the public outcry would be to any such effort, but the French Revolution comes to mind. Nor can states and cities easily make up revenue shortfalls by increasing sales tax rates. They have been going to that well a lot lately, and with the median sales tax rate approaching 7%, there’s very little room for rate increases for this regressive tax.

Cutting spending is even less realistic. It makes for a good sound bite on Sunday talk shows. But with their infrastructures in disrepair, the need to make investments to fix their broken education systems, and the certain growth ahead in Medicaid, states could eliminate every dime of waste and still not solve their financial crunch. Of course, they could go hat in hand to the federal government as they did to get a piece of last year’s stimulus package, but with widespread revulsion over our national debt, Congress does not appear ready to approve a stimulus sequel.

That leaves finding new sources of state and local tax revenue. Yes, of course, there’s always a steep marijuana tax to consider, but that requires legalizing the stuff first—not something most states will do any time soon. Taxing sales of web sites, however, would generate a lot more revenue for state and local governments while creating a lot less political flack. Consumers are accustomed to paying taxes on retail purchases, and an appealing argument can be made that it’s essentially unfair to tax an item sold at a store but exempt that same item from tax when it’s sold online. I’ll leave to future blogs how I think such an e-commerce sale tax might best be enacted, but the conclusion of this missive is that e-retailers had better make plans now to collect taxes on everything they sell online. With online sales growing much faster than store sales, you can bet taxes on e-commerce will be forthcoming—and soon.

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