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Days numbered for tax-free Net sales

Governors and state legislatures push for online sales taxes, and Democratic control of Congress could help them.

The halcyon days of tax-free Internet shopping may be about to end.

A powerful alliance of politicians, including key U.S. senators and the National Governors Association, is arguing that out-of-state retailers must be required to charge sales taxes on purchases. At the moment, for instance, companies like Seattle-based Amazon.com are not required to collect sales taxes on shipments to millions of its customers in California.

This is hardly a new debate: officials from the governors' association have been pressing Congress to enact such a law for at least six years. They invoke arguments, which have been unsuccessful so far, like saying that reduced sales tax revenue threatens budgets for schools and police.

What has changed, however, is the political dynamic. While its precise contours are difficult to map, a Democrat-controlled Congress is seen as more likely to agree to the idea than one controlled by Republicans.

"When you have a Democratic majority in Congress, that Congress will be more friendly to imposing new burdens on business if it means additional tax collection," said Steve DelBianco, executive director of the NetChoice coalition, which counts as members eBay, Yahoo and the Electronic Retailing Association and opposes the sales tax plan.

Another factor that could tip the scales in Washington in favor of the pro-sales tax forces is a concept called the Streamlined Sales Tax Agreement, invented in 2002 by state tax officials hoping to straighten out some of the notorious convolutions of state tax laws. If that happens, they believe, it will be easier to convince Congress to make sales collection mandatory for out-of-state retailers.

"Without any doubt, Congress will eventually approve legislation to give states that comply with the (agreement) mandatory collection authority for out-of-state transactions," said Neal Osten, federal affairs counsel for the National Conference of State Legislatures. "We expect that the legislation will be introduced shortly in this Congress."

So far, 22 states have signed onto the project by enacting legislation to simplify their tax codes, Osten said. "We believe that with the system operational, with software and online collection available, sellers volunteering and revenues being collected, Congress will consider the legislation and indeed approve it," he added in an e-mail message.

Sticky debate over "candy" definition
A simplification effort is key because of the dizzying complexity of state tax laws. One example is the Streamlined Sales Tax Project's "

Flour as an ingredient became a sticky point. In 2003, a representative of Indiana, James Turner, noted that a proposed definition of candy would have taxed the Milky Way Midnight candy bar but not the original Milky Way bar. But further investigation showed that Turner's counter-proposal would have treated "certain flavors of Pop Tarts" and Cookies and Twix Crunchy Cookie Bars as candy--but not Cookies and Snickers Crunchy Cookie Bars. Peanut butter Girl Scout cookies would be candy, but Thin Mints or Caramel deLites would be classified as food.

Bizarre distinctions like this, coupled with the existence of more than 7,000 different tax agencies, explain why the U.S. Supreme Court ruled, in a 1992 case called Quill v. North Dakota, that out-of-state retailers generally couldn't be obligated to collect sales taxes unless Congress changes the law. The justices noted: "Congress is now free to decide whether, when, and to what extent the States may burden interstate mail order concerns with a duty to collect use taxes."

One exception to that is a legal concept called "nexus," which means a company can be forced to collect sales taxes if it has a sufficient business presence. A second exception is cigarette sales, which are covered by the Jenkins Act.

Of course, online purchases from sites like Amazon and eBay only seem to arrive tax-free. Legally speaking, however, purchasers are required to pay their own state's sales tax rate--the concept is called a "use tax"--and then voluntarily report the amount owed at tax time.

California residents, for instance, are burdened with a sales and use tax of at least 7.25 percent. State law is strict: if Californians travel to a state with a 5 percent tax and shop there, the law requires them to cough up the 2.25 percent difference when they return. Online purchases are taxed as well.

But compliance is spotty at best. California's Board of Equalization estimates the state lost $1.34 billion in 2003 because residents aren't paying use taxes--and attributes $208 million of that to online purchases.

Pro-sales tax lobbyists say the losses nationally are far higher. A 2004 report from the National Governors Association and the National Conference of State Legislatures puts the figure at $15.5 billion in lost e-commerce revenue nationwide.

David Quam, director of federal relations for the National Governors Association, says mandatory sales tax collection will help retailers and tax collectors alike by simplifying the system. "It does mean the ability to collect the taxes that are due and owing, and more importantly, it's a simplification of definitions and your tax base and making more sense out of the tax codes," he said. "Those are all net positives."

A rift among business groups
The governors have found allies among large retailers like Staples and Wal-Mart Stores that have physical presence virtually everywhere--and therefore already

What remains unclear is whether the big-business-and-state-politician coalition will be able to muster enough support in a Democratic Congress to enact a law making sales tax compliance mandatory. Osten, from the National Conference of State Legislatures, said: "There will be members of both parties supporting the passage of this legislation.

While it's not a traditional left-right issue--the pro-sales tax legislative proposal is being co-authored by Republican Sen. Mike Enzi of Wyoming and Democratic Sen. Byron Dorgan of North Dakota--it does have some partisan overtones.

Statements from members of federal commission on electronic taxation in 2000 indicated that the Republicans tended to be more skeptical of mandatory sales tax collection. James Gilmore, the Republican governor of Virginia at the time, said that "no sales or use taxes should be imposed on interstate business-to-consumer transactions." Grover Norquist, a Republican insider and operative, blasted fellow panelists for engaging in a stealth campaign to raise taxes on Americans.

They largely took the side of online-only retailers and Silicon Valley companies, which argue that state politicians' claims of lost revenue are inflated (PDF), and say that even a simplified sales tax system will impose additional compliance costs that will be passed on to consumers.

Dallas Mayor Ron Kirk, a Democrat, protested (PDF), however, that "small Main Street retailers are severely handicapped by the absence of a level playing field vis-a-vis e-tailers."

Neither Dorgan and Enzi, who have introduced a mandatory sales tax collection bill in previous years and are drafting a revised version right now, would say when to expect the new version of their legislation.

"As more states continue passing laws securing the collection of this tax and as the amount of revenue being lost by states and municipalities increases, there will naturally be more emphasis on and support for Sen. Enzi's bill," said Elly Pickett, Enzi's deputy press secretary. "When that support will hit critical mass and we will be able to pass the bill is hard to determine, but Sen. Enzi is continuing to work on the issue."

This is unrelated to the debate over the Internet tax moratorium, which only limits taxes on access charges such as DSL or dialup connections. Congress renewed the ban in 2004, and it expires this November.