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'iPod tax' planned for music downloads?

States grapple with how, or if, to tax online movies and music such as songs purchased from Apple's iTunes.

Legislators in Wisconsin are mobilizing against a proposal they call the "iPod tax," in a battle over online music and movies that could soon spread across the United States.

At issue is whether consumers need to pay tax on digital downloads such as movies or songs purchased from Apple Computer's iTunes store. In a few states, those who don't voluntarily pay a few extra cents of tax on their 99-cent downloads are already technically breaking the law.

Wisconsin Gov. Jim Doyle now wants his state to start collecting taxes on digital music, videos and software. Key Republicans in the GOP-dominated legislature say they will block the proposal, but administration officials say they're just trying to make things fair.


What's new:
Wisconsin and other states are grappling with how, or if, to tax digital downloads such as music and movies purchased online.

Bottom line:
Some economists say taxes on digital goods could hamper the growth of a vibrant new marketplace; others say that having taxes only on offline versions of the same goods distorts the operation of free markets.

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"It's an issue of tax equity," said Jessica Iverson, a spokeswoman for the Wisconsin Department of Revenue. "If you go into a Main Street business and purchase a CD, you are paying tax."

That issue of "leveling the playing field" between Internet and offline businesses has dogged e-commerce from its inception, creating a complicated maze of rules that is now extending to the world of digital downloads.

Economists are split, even across right-left divides, as to whether adding these kinds of taxes is a good idea. Some say that taxes on digital goods will hamper the growth of a potentially vibrant new marketplace, while others say that having taxes only on offline versions of the same goods distorts the operation of free markets.

Many states already impose what is often called a "use tax," which is essentially a sales tax applied to goods purchased from out of state businesses such as through a catalog, a 1-800 number, or online.

For the most part, states can't force the vendors to collect that tax unless they have a physical presence in the state, however. That means that consumers themselves are often technically required to tally up how much they've spent during the year and pay the tax voluntarily.

Predictably, the compliance rate for this is extremely low, although some states have pursued high-profile efforts to collect the tax by contacting online vendors--most notably when Michigan subpoenaed online cigarette sellers for the names of state residents earlier this year. Wisconsin officials estimate that just about 1 percent of people actually pay this kind of "voluntary" tax at the end of the year in that state.

In the case of digital downloads, the issue has been almost wholly invisible.

In at least a few states, however, consumers who don't pay taxes on these songs, or on other digital download services, are in the category of tax scofflaws.

A representative for South Dakota's Department of Revenue said that state's sales tax laws already apply to digital downloads. In Utah, too, iTunes shoppers who aren't paying tax aren't following the rules.

"It works like anything else that's from mail order or a magazine," said Scott Smith, deputy director of the auditing division of Utah's State Tax Commission.

"It's an issue of tax equity...If you go into a Main Street business and purchase a CD, you are paying tax."
--Jessica Iverson, spokeswoman, Wisconsin Department of Revenue

In practice, neither state pursues individual consumers for taxes that would amount to just a few dollars. South Dakota does have a compliance program in place that pursues businesses that make large purchases online, such as antivirus software, however.

Other states, such as California, say digital downloads are simply not taxed.

The issue may change over time as a group of states called the Streamlined Sales Tax Project extend their work to digital goods. Wisconsin policy-makers say their proposal comes out of discussions in that 20-state group, although it has not yet adopted a final policy on digital downloads.

Wisconsin state Rep. Scott Jensen, a key member of the state Assembly's Finance Committee, said he'll work to kill the proposed tax on downloads, however.

"Even if it does pass, it's unlikely that there would be much compliance," Jensen said. "But I think it is unlikely that the governor's proposal for the iPod tax will make it though the Legislature."