Taxing Internet Purchases -- The Pros and Cons

The explosion of electronic commerce has fueled an ongoing debate regarding its tax implications. While unique tax issues surround access to and use of the Internet itself, this article focuses specifically on the debate surrounding the imposition of sales and use taxes on tangible products purchased over the Internet.

For companies and traditional brick-and-mortar companies alike, the Internet has opened vast new markets to sell all types of tangible products. Such on-line sales have gone largely untaxed to this point. The reason behind this unintended "tax holiday" is largely the result of constitutional nexus limitations faced by states as well as the complexity of accurately administering sales and use tax laws of each state and locality. While this issue is not a new one - mail-order companies have been around for decades -- the rapid growth of "e-retailing" has brought the issues into national focus.

Internet sales should be subject to sales/use tax because:

In the face of a long-term shift to a service-driven economy, states cannot risk losing an important source of sales/use tax revenue from purchases of tangible products.

Imposing a sales tax on Internet transactions would level the economic playing field for local retail stores.

Imposition of use tax is no longer an excessive burden on the remote seller due to technological advances, which permit accurate calculation and collection of tax.

Allowing Internet sales to go untaxed shifts the relative burden of the tax to the poor and elderly.

Internet sales should not be subject to sales/use tax because:

States will not suffer nearly as greatly as they fear; indeed, current state budget surpluses outweigh any concerns regarding lost revenues.

The competitive advantage enjoyed by on-line retailers as compared to local retailers fails to exist.

The complexity of the sales/use tax systems in virtually every state creates an overwhelming compliance burden on remote sellers that no software can possibly solve.

Any tax on Internet activity, including sales/use tax on purchases over the Internet, will threaten the technological growth of the U.S. economy.

Current constitutional nexus standards will be violated if remote sellers are forced to collect and remit sales and use tax.

In the last 18 months, national attention has focused on the taxability of the Internet. Indeed, the recent Advisory Commission on Electronic Commerce, consisting of state governors, senators and prominent industry groups, drew national attention primarily due to its contentious debate on these issues.

In addition, twenty-one states are currently participating in the Streamlined Sales Tax Project. This project is being developed by a number of national organizations of state officials to prepare states to impose sales/use tax on state residents making purchases over the Internet. The first tests of the tax collection software will begin later this year. The Multistate Tax Commission also recently passed resolutions in support of the Streamlined Sales Tax project and recommended that direct marketers provide consumers with information regarding their use tax liability on purchases.

Ultimately, state and local jurisdictions will seek to obtain the same tax revenue they already enjoy regardless of how this will be accomplished. Because state and local jurisdictions are currently denied the opportunity to force remote sellers to collect and remit sales and use tax, an intense effort by the taxing jurisdictions to force voluntary compliance by the consumers is under way. In the future, we may also see efforts by government to raise taxes elsewhere if the states' prediction of declining sales/use tax revenue is accurate.