Will Surfing the Web Subject One to Transient Tax Jurisdiction? Why We Need a Uniform Federal Sales Tax on Internet Commerce

• Publication year: 1999

SEATTLE UNIVERSITY LAW REVIEWVolume 22, No. 4SPRING 1999

Will Surfing the Web Subject One to Transient Tax Jurisdiction? Why We Need a Uniform Federal Sales Tax on Internet Commerce

Aaron G. Murphy(fn*)

I. Introduction

Since the 1930s, states have generated revenue by taxing business transactions, including the sale of goods.(fn1) One of the most prominent forms of state taxation is the sales tax and its complementary use tax.(fn2) A state may levy a tax on sales made within its borders (a "sales" tax) and collect the tax from the merchant. A state may complement its sales tax with a "use" tax on property used in the state as well, thereby reaching sales that took place beyond its borders but that resulted in property purchased for use within its borders.

Often a use tax must be collected from the purchaser, but the purchaser rarely pays the tax. As a consequence, many mail order or Internet(fn3) purchases from out-of-state vendors escape tax altogether. This tax avoidance has recently become a major revenue issue for states because the Internet has experienced massive growth in retail sales. Exactly how much commerce is being conducted over the Internet is difficult to say. However, it is safe to say that the figure is already very large and will continue to grow at a frenetic pace, perhaps into the hundreds of billions of dollars in the very near future.(fn4)

It is a fair assumption that the retail sales conducted over the Internet represent, to a significant extent, retail sales that once took place locally. Thus, the inability of states to tax these sales has pushed Internet taxation to the forefront of many tax policy discussions. Of central concern is that the imposition of taxes on Internet commerce may stifle the fledgling industry's growth.

If merchants must collect an Internet sales tax, the dramatic growth of Internet sales may be curbed because smaller merchants may find compliance onerous. Alternatively, trying to collect a use tax from Internet purchases may place such a great burden on states that only a minimal amount of tax will be collected.

As a reactionary measure, Congress has enacted the Internet Tax Freedom Act, placing a moratorium on many new Internet taxes, at both the state and federal levels, so that the issue can be studied.(fn5) Given the impending expiration of the moratorium,(fn6) it is likely only a matter of time before some method of taxing Internet commerce is adopted.

Although there are many possible ways to tax Internet sales, both the Commerce and Due Process Clauses of the Constitution limit state taxation of sales made through mail-order catalogues or the Internet. These constitutional impediments to state taxation will have to be addressed regardless of the method of taxation that legislatures eventually adopt. The longer we postpone legislating a tax on Internet transactions, the greater the cost for Internet industries to implement its collection.

The remainder of this Comment considers how Internet sales could be taxed if Congressional action is taken to remove the Commerce Clause impediments, which would leave only Due Process Clause limitations on Internet taxation. Though three potential solutions are addressed and analyzed for their potential treatment under the Due Process Clause, this Comment concludes that a federal uniform tax on Internet sales of goods will achieve the best balance of interests while avoiding Due Process problems. Part Two provides the reader with a basic description of the current law in the area of sales and use taxes and the problems the Internet poses for that framework. Part Three presents three possible models for taxing Internet commerce and highlights the problems each model presents, both economically and within the legal framework described in Part Two. Proceeding on the assumption that Congress has removed the Commerce Clause impediment, Part Four then applies the Due Process Clause to each model, concluding that a federal uniform tax achieves the best balance of interests while avoiding the Due Process Clause problems inherent in the other models. Part Five then discusses the federal uniform tax in more detail, including several policy issues that make a federal solution the most desirable considering the international scope of the Internet.

II. Definition of Sales and Use Taxes and Current Jurisdictional Issues

Although a sales tax is familiar to most people, a use tax is not. A "sales tax" is a tax added to the price of an item by a merchant at the point of sale to the consumer. The consumer pays the tax on top of the price of the item. The merchant then sets aside the tax and remits it to the state in accordance with the taxing state's statute.(fn7)

On the other hand, a "use tax" is a tax on the "privilege of using, consuming, distributing or storing tangible personal property after it is brought into [the] State from without [the] State."(fn8) For example, a use tax may be levied on a person who purchases a product in one state for use in the taxing state. The purchaser pays the tax, which generally equates with the sales tax the purchaser would have paid had he purchased the item within the taxing state(fn9) minus any sales tax paid in the state of purchase.(fn10) The goal of the use tax is to ensure that the consumer pays the same amount of tax on any taxable item no matter where the item is purchased.(fn11) The ultimate purpose is to make tax a neutral factor in the purchaser's decisions.

The merchant collects and remits a sales tax, while the purchaser pays a use tax.(fn12) While the two taxes are economically identical from the purchaser's perspective, because they place the same burden on the purchaser in terms of the amount of tax paid and the items to which the tax is applied,(fn13) in reality the two taxes yield very different revenues for the state because of the difficulty in collecting the use tax from purchasers who are legally required to pay it.(fn14)

From the state's standpoint it is beneficial to have merchants collect and remit all taxes related to the sale of tangible goods. States are only able to place this burden of collection on merchants physically present within the state's boundaries.(fn15) This limitation is due to historical developments in Due Process Clause and Commerce Clause jurisprudence.(fn16) The result is that a state is powerless to force an out-of-state merchant to collect the use tax owed by the state's citizens when that state's citizens venture out of the taxing state to make purchases.

The problems of sales and use tax jurisdiction can be best demonstrated through the following hypothetical:

STATE A	STATE B
M1	M2
C

C is a resident of State A. M1 is a retailer doing business only in State A. M2 is a retailer doing business only in State B. State A levies a sales tax of ten percent on all purchases. It also levies a use tax of ten percent on its residents, but allows a credit against the use tax for any sales tax already paid on the item. State B levies a sales tax of five percent.

If C purchases a widget from M1 for $100, C pays a sales tax of $10. M1 will collect and pay the tax to State A. Under this traditional sales tax, State A has the power to tax C and burden M1 with the collection duty because both are physically present within State A.(fn17) Additionally, C would also be liable for remitting the use tax to State A; however, C would get a credit for the sales tax already paid, which would reduce the use tax to zero. It is in this manner that use taxes are effectively only applicable to out-of-state purchases.(fn18)

If C makes the same purchase in State B for $100, C pays a sales tax of $5. M2 will collect and remit this tax to State B. If C uses, consumes, distributes, or stores the widget in State A, C must remit the appropriate use tax to State A. In this case, the use tax is $10 minus the $5 credit for the sales tax paid for a total use tax of $5. The total tax burden on C is $10 either way.(fn19)

When the sales and use taxes work properly, they reduce the shifting economic effects inherent in most tax schemes. That is, the imposition of the taxes has no effect other than to raise revenue. A shifting economic effect is a collateral effect of taxing a transaction; the most common effects will be a consumer's decision to purchase elsewhere, or a vendor's decision to either reduce prices or move to a lower tax jurisdiction.

The practical problem with a theoretically pure tax scheme is that when C returns to State A, C is unlikely to remit the use tax and State A is unlikely to have any knowledge of C's purchase in State B. This results in a disadvantage to M1 who cannot compete with M2's effectively lower prices because of the higher tax placed on Mi's sales. The fundamental purpose of the use tax is to correct this problem.(fn20) Of course, the efficacy of this solution diminishes the closer a merchant is to the border of a lower tax jurisdiction. When traveling to the lower tax jurisdiction is no longer a significant burden on the purchaser, it is likely that a merchant required to collect a higher tax will have to lower its prices and ultimately bear some of the sales tax itself to remain competitive.

States, lacking the resources to chase down every consumer liable for the...