As of August, 21 states, including North Carolina, had passed legislation that brought their sales and use tax laws into alignment with each other, so merchants in their states could collect levies on purchases made on the Internet.

Online retailing has flourished in recent years, and because merchants don’t have to collect sales taxes for states outside of where they maintain their physical presence, governments say they are losing revenue. They say consumers are shopping less at local “brick-and-mortar” stores, in favor of the convenience of browsing the merchandise at home.

Now most states, pressed by traditional retailers, are poised to get all vendors to help them collect taxes on Internet transactions, but first they need an act of Congress in order to enforce their Streamlined Sales and Use Tax Agreement.

Unenforceable use tax

Because rates and laws vary greatly among states and their local governments, collecting taxes based on where customers live would be too heavy a burden for sellers, according to two rulings by the U.S. Supreme Court. Internet retailers, for the most part, don’t bother to charge for their customers’ local sales tax, causing what brick-and-mortar retailers say is an unfair competitive advantage.

In most states, when a transaction’s out-of-state sales tax is uncollectable, consumers typically must pay a use tax on the items they purchase. Citizens are required to pay the tax on their end-of-year tax returns, but state revenue officials and tax experts consider the collection of such use taxes as unreliable and unenforceable.

According to a report released in 2001 by the Institute for State Studies, state and local governments’ annual losses attributed to e-commerce sales will rise to $45.2 billion in 2006 and $54.8 billion in 2011.

In order to “stop the bleeding,” representatives from several states and businesses began to develop a system in early 2000 that would simplify, or “streamline,” the sales tax system so states that conform could collect levies on online purchases.

In late November 2002, after almost two years of negotiating, 34 states and the District of Columbia agreed to stipulations in the Streamlined Sales and Use Tax Agreement. Soon thereafter states began introducing and passing legislation that changed their sales and use tax laws to conform to the particulars of the interstate pact.

Creating a streamlined system

Since there are about 7,500 state and local taxing jurisdictions in the country, streamlining their codes for retailers was no easy task.

For example, members of the SSUTA need to apply a uniform definition for products that are sold, in order to determine whether they are taxable. Designers of the agreement determined, for example, that items such as aprons, baby receiving blankets, costumes, disposable diapers, and ear muffs would be considered “clothing” for consistent tax purposes. On the other hand, belt buckles, costume masks, patches, and sewing materials would not be defined as clothing items. Meanwhile, whether “goggles” qualify as protective equipment for work or for sporting purposes is up to the retailer.

SSUTA members also must apply consistent sourcing rules to determine under which jurisdiction a sales tax would apply. For items purchased at a store, the tax rate at that business location applies. But if a customer purchases an item in one jurisdiction and it is thendelivered to another jurisdiction, the delivery address is the taxable source. The latter case applies whether the purchase is made over the Internet, on the telephone, or in a brick-and-mortar location.

But uniformity rules are not carried over to the tax rates among the states and localities. States may have as many sales tax rates as they have jurisdictions.

How does that make the collection of sales taxes simpler, or “streamlined,” for Internet retailers? SSUTA’s supporters say that the agreement standardizes tax bases, rules, administration, and collection, while technology takes care of applying the appropriate rates. Under the agreement, online sellers would adopt technology provided by a SSUTA governing board, which would calculate the appropriate sales tax based on the customer’s zip code. According to the National Conference of State Legislatures, once the agreement is in place, “all merchants that collect sales taxes using the state certified technology would be held harmless for any miscalculations.”

Competition or collusion?

Critics of the SSUTA say the deal, and its governing board, would discourage tax policy competition and strip states of their sovereignty. Veronique de Rugy, a fiscal policy analyst for the Cato Institute, a free- market think tank in Washington, D.C., calls the agreement “OPEC for politicians.”

“This project is really about creating more sources of revenue for the states by allowing them to start taxing income earned outside of the borders of their state,” she wrote in a November 2002 article.

If Congress made the SSUTA mandatory for all participating states, states could coerce merchants outside their boundaries to collect and remit taxes, and be subject to penalties, audits, and lawsuits. Legislation with bipartisan sponsorship is pending in committees in both the U.S. House and the Senate.

“Make no mistake: Under the cover of the [SSUTA], states and local governments are asking Congress to lift the restriction that forbids them to tax extraterritorial income earned by remote sellers,” de Rugy wrote. “The extension of sales-and-use taxes to out-of-state sales, no matter how simplified and harmonized, represents a huge threat to taxpayers and economic prosperity.”

Opponents say the SSUTA applies an archaic system for sales and use taxation and applies it to the modern, technology-driven economy. “Simplifying” it doesn’t seem possible, they say.

“Even if this claim is taken at face value,” wrote Adam Thierer, director of Cato’s telecommunications studies, “it is important to understand that the simplification process which these groups advocate is, in reality, an attempt to create a collusive multi-state tax cartel.

“Such a result would betray the Founding Fathers’ intended model of competitive federalism and would greatly discourage tax competition between the states. In that sense, such ‘simplification’ proposals can be seen as little more than an attempt to create an Articles of Confederation-style tax system for e-commerce.”

SSUTA raises questions about overall taxation on the Internet as well, Thierer said, such as whether it is the consumer or the seller that is being taxed. He suggested four guiding principles for Internet tax policy:

• No redundant or discriminatory taxation: no taxes on the service itself, nor levies that overlap each other.

• No taxation without representation: “companies should only be required to pay taxes in those jurisdictions where they have a substantial physical presence or ‘taxable nexus’”

• Promote tax competition, not collusion: “state and local governments should not be allowed to establish collusive tax regimes which discourage vigorous interstate tax competition”

• Protect consumer privacy: tax collection systems should not trace electronic transactions.

A conspicuously absent state

Not surprisingly, one of the few states avoiding the SSUTA (as of September, 40 states had signed on to some degree or another, while five states have no sales tax) is Colorado, which is known for the most stringent tax expenditure limit in the country, the Taxpayer’s Bill of Rights. By most measures Colorado’s TABOR has been the most effective tax or expenditure limitation in the nation, successfully restraining the growth of government and returning excess tax revenues to its citizens.

Colorado’s Gov. Bill Owens, who has been TABOR’s biggest cheerleader inside and outside his state, has also become one of the most recognized critics of the SSUTA.

In June 2003 Owens released a report through a think tank he founded, the Center for the New American Century, which raised nine problems with taxation on Internet sales.

Chief among Owens’s complaints about the SSUTA are that it is essentially a tax increase, and that despite its “simplification” claims, the agreement “foists national sales tax collection obligations upon each merchant in America while preserving for each local government in the country its own distinct tax rate.”

Based on a study by two University of Tennessee professors, the SSUTA could collect an additional $440 billion over the next 10 years if it is implemented over all e-commerce.

“Because [SSUTA] takes a broad view of taxable goods,” Owens wrote, “additional hidden tax increases could lurk in the esoteric details of the [agreement]. States that currently exempt certain goods from taxation could be forced to extend sales taxes to currently untaxed products, as an example. And all caps that limit sales tax liabilities would be eliminated.”

Owens also says that the effort to streamline, or simplify, across thousands of tax jurisdictions presents inherent conflicts with efforts to preserve state and local sovereignty over tax policies.

“…A merchant will have to calculate up to 7,500 different tax rates on transactions to consumers,” Owens wrote. “An Internet or catalogue merchant that opts to perform tax collection functions itself will be subject to 46 different audits…each year to ensure the merchant is properly collecting and remitting its taxes.”