The battle over Internet sales tax

States on a tight budget are looking everywhere, including Internet sales, to squeeze out some extra money.

The battle over Internet sales taxes, simmering for more than a decade, is boiling over. And I think somebody bought the tea kettle on Amazon.com for $39.95. Free shipping. No sales tax. Actually, there is, but more about that later.

It is no wonder the issue is taking on a new urgency. States face a 2012 budget deficit of $125 billion and are under heavy pressure to find revenue wherever they can. In 2010, E-commerce grew by nearly 15 percent to $165 billion. And $10 billion in tax revenue is on the table. On Main Street, many retailers are getting pounded by online competition, at the cost of local jobs.

In just the past few days, lawmakers in Colorado, Minnesota, Connecticut, and Missouri have joined California and a fistful of other states in moving to make online sellers collect sales taxes. Last month, Texas—not exactly a hotbed of aggressive taxation—presented Amazon with a bill for $269 million in uncollected sales taxes.

Amazon is playing serious hardball in response. It sued New York back in 2008 over the issue. It shuttered a distribution center in Texas and it is threatening to cut ties with affiliate sellers who are located in states that try to collect sales taxes. The outcome of these legislative battles is uncertain.

Still, if this keeps up, I wouldn’t be surprised to see the whole issue land in the lap of Congress—which has been ducking the controversy for 20 years. That would be just the thing for anti-tax Republicans who’ll get squeezed between their governors and local retailers on one hand, and the e-tailers on the other.

Before we head too far down this road, let’s get three things straight. First, this has nothing to do with taxing the Internet. Access to the Web is tax free, and nobody is suggesting making it otherwise (although your smart phone contract is as heavily taxed as anything in your life).

It isn’t about raising taxes either. If you think sales taxes are too high, fine. Lobby to lower them. But it doesn’t make to tax a tea kettle purchased from one seller differently from the same tea kettle bought from its competitor.

It is also not about whether on-line buyers owe tax on their Net purchases. They do. If you live in a state with a sales tax, you’ve got to pay, no matter where you buy. If the seller doesn’t collect the money, you owe what’s known as a use tax. It is right there on your income tax form.

But, of course, almost nobody pays. And that’s where those online retailers have an unfair competitive advantage over local brick-and-mortar stores. Buyers get what looks like a 5 or 6 percent “discount” because of those uncollected sales taxes. Worse, their local competitors may end up paying higher taxes to make up for the lost revenues.

Sales tax collections by out-of-state sellers are governed by a legal principle called “nexus.” In effect, if a business has a physical presence in a state, it is obligated to collect. The states are arguing that if Amazon and other online sellers have warehouses or even affiliated businesses in their jurisdiction, they must collect the tax.

In 1992, the Supreme Court practically begged Congress to sort out the mess, noting both the complexity of these issues and the danger to business of conflicting rules in different states. In those days, mail-order firms (there was no E-commerce) argued it would be too complicated to keep track of the different sales tax rules and rates around the country.

Congress responded by creating a commission.

Technology has changed since 1992. Data miners know more about us than I want to contemplate. Keeping track of our zip code and the applicable tax rate is child’s play. Yet, the battle over Internet sales taxes drags on. For a decade, a group of two dozen states has been trying to sort this out on its own, with limited success. It is long past time for Congress to straighten it out.

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