The Other Face of E-Commerce: Can the Sales Tax Survive Cyberspace?

• Author: Mackey, Scott

The explosion of e-commerce is making states nervous about the future of their sales taxes. This article discusses the origins of the Internet taxation problem and possible solutions to it.

Editor's note: This article originally appeared in State Legislatures, December 1999, and is reprinted and adapted with permission. Copyright retained by the National Conference of State Legislatures.

It was a neighbor who first alerted Ohio Senate President Richard Finan that the Internet might pose a threat to the future of his state's sales tax. "A moving van pulled up to his house one day, so I asked if he was moving. He said, 'No, I just bought new furniture over the Internet-and I didn't have to pay any sales tax.'"

For years, the Supreme Court has prevented states from requiring out-of-state sellers to collect sales and use taxes legally due from buyers. But now, with many experts predicting that the Internet will revolutionize retailing, states are beginning to get very nervous about the viability of their sales taxes in the electronic commerce environment. Some experts are even questioning whether the sales tax is viable in a 21st century economy.

This is a high visibility issue not only in state capitals but in the nation's capital as well, and it has all the elements of high drama. The players are:

* a federal commission chaired by a governor who has questioned the viability of the state sales tax;

* members of Congress who want to preempt state tax policy without regard for the impact on state finances;

* state legislators and governors who see electronic commerce as a powerful economic development tool, but who also understand that education and infrastructure (often funded by sales taxes) are key building blocks in high-technology growth;

* consumers who see Internet buying as a way to "beat the system;"

* CEOs who must balance the need for skilled workers with the desire for low taxes; and

* a powerful telecommunications industry with the means to provide candidates with needed cash just as the 2000 election cycle is heating up.

What makes this such a daunting issue is that its ultimate resolution depends on so many interrelated factors: Will electronic commerce grow exponentially, as analysts are predicting? Will electronic commerce revolutionize marketing, distribution, and retailing? What will the federal advisory commission studying this issue recommend to Congress? Will Congress act during a presidential election year? Where do the presidential candidates stand? Will governors and legislators pass legislation to reduce the administrative burdens imposed by the sales tax?

Ultimately, the states must live with the consequences of the decisions, many of which they have no control over. "This may be the most important issue that states have faced in a generation," says National Conference of State Legislatures (NCSL) Executive Director William Pound. "How Congress and the states resolve it will influence the balance of power between the federal government and the states for decades to come."

An Old Problem...

The origins of the current Internet tax debate can be traced back to another era of major economic change in the United States: the Depression. State and local governments, which relied primarily on property taxes, suddenly faced a collapse of property values across the country. Many states turned to sales taxes to replace the failing property tax. In 1930, Mississippi became the first state to levy a general sales tax. By the end of the decade, 23 other states had followed suit. Today, only Delaware, Montana, Oregon, and New Hampshire lack a state or local general sales tax.

These "new" sales taxes were designed in an era when citizens bought goods at the local store. The local merchant could, without much trouble, collect a few pennies on the dollar and send the money to the state once a month. And because retailers were present in the state, there was no question that states had the authority to require them to collect taxes on their behalf.

Fast forward to the 1950s and 1960s. The improvement of our national highway system opened up many opportunities for multistate selling. Major national retail chains emerged; consumers became increasingly mobile and had the ability to shop across state lines.

To protect in-state retailers from competition from out-of-state vendors, states turned to "use" taxes. Use taxes require residents who purchase...