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January 26, 2003

So Many Online Sales, So Little in Tax Revenue


STATE officials across the country have been keeping their eyes on two sets of numbers, and it is sometimes difficult to tell which is growing faster. One is their projected budget shortfalls. The other is online retail sales, which they would like to tax to help fill the gaps.

Forecasters say the states may come up short next year by as much as $80 billion, which would create the biggest state budget crisis since World War II. A merry holiday season in cyberspace, meanwhile, has pumped up the receipts of online retailers to $78 billion last year, according to Forrester Research, an increase of more than 50 percent over 2001.

That does not count the larger categories of business-to-business online sales and catalog sales, for which sales tax is generally not collected. A study by the University of Tennessee estimates that sales tax is not collected on $234 billion in online business-to-business commerce. And tax on most of what the Direct Marketing Association estimates at $125 billion in annual catalog sales is not collected, either.

The states cannot currently impose the tax because the Supreme Court has ruled that their multiple tax systems would impose an unfair collection burden on retailers that do not have a physical presence in their buyers' various states. Online buyers are actually required to pay sales taxes directly to their states, but they rarely do.

If the states can simplify and coordinate their sales tax systems, they may be able to convince Congress or the courts that collecting the levy will not be an unfair burden.

"Collection of online sales tax could plug 30 to 50 percent of state budget deficits this year and next," said Frank Shafroth, director for state and federal relations at the National Governors Association.

An effort to overcome the Supreme Court's objections made headway last November when 33 states agreed to narrow the differences in their sales tax rules and to provide retailers with software to collect taxes.

"We have developed a simplified process for collection of sales tax that meets the criteria of the Supreme Court and the Congress," said Gov. Michael O. Leavitt of Utah, a leader in the states' effort.

Maybe so. But it is not enough in the eyes of business interests that are lining up against online sales tax collection. Anti-tax groups, direct marketers and online sellers have long opposed efforts to collect online, but new opposition has emerged from broad-based business groups that want concessions on other tax issues in return for their support for the collection changes.

"Before Congress authorizes a mandatory system for sales tax collection, they need to resolve some outstanding issues," said Vincent Randazzo, director of public policy for the Business Roundtable, which represents the chiefs of 150 big companies.

The states are expected to seek a Congressional mandate to collect sales taxes after they win legislative approval for their new tax system in at least 10 states that represent at least 20 percent of Americans who pay sales taxes.

Governor Leavitt said that as many as 25 state legislatures would begin considering acceptance of the new system early this year. Neal Osten, a lobbyist with the National Conference of State Legislatures, said Congressional legislation could be introduced this spring.

Expecting a lobbying showdown, the Business Roundtable has already begun "to touch base with the big players in Washington," said Mr. Randazzo, who declined to specify the chief lobbying targets.

Business groups fret that state officials will use the information they gather from collecting online sales taxes to become more aggressive in seeking income taxes from corporations that have sales but no physical presence within their states.

"Once you have a system in place for identifying out-of-state sales," Mr. Randazzo said, "the states will have all this information they can turn over to their revenue departments and say: `They did $25 million in sales here we'll collect income tax.' "

Some state officials see the linking of the issues as part of a lobbying strategy by big business. "They want to get their pound of flesh, and they see this as an opportunity," said Mr. Shafroth of the governors' group.

Opponents of online sales taxes have other complaints. participated in the deliberations that created the states' plan but is not satisfied with the results. "There's not enough simplification," said Richard Prem, Amazon's director for global indirect taxes.

Christopher M. Kelley, a Forrester analyst, said collecting sales tax would have a minimal effect on Amazon and other online retailers. He said they could compensate for the higher cost to customers by expanding free-shipping offers, though that would cut into already thin profit margins.

OST large bricks-and-mortar retailers support online tax collection, but Frank G. Julian, operating vice president and tax counsel for Federated Department Stores parent of Bloomingdale's and Macy's, which sell through stores and over the Web said the collection process was still too complicated.

Sponsors of the tax-simplification process wanted a single tax rate for each state, but that idea was opposed by local authorities and some local businesses that were unwilling to forfeit tax breaks. Some states, for example, exempt "essentials" like food and clothes from the sales tax though the definitions of exempt catagories varies from state to state, with some areas including goods like candy and belts while others do not. Some states, like California and New York, also let local governments impose sales tax surcharges that only apply in their jurisdictions. The proposed compromise allows three rates per state.

Multiple rates make collection difficult, Mr. Julian said, noting that Federated already spent "tens of millions of dollars" to collect $1 billion a year in sales taxes.

But retailers that have stores virtually everywhere see universal online collection as a matter of fairness. "We're required to collect it," said Wayne Zakrzewski, an assistant general counsel for taxes at J. C. Penney. "Our rivals should also collect it."

Tripp Funderburk, policy director for the e-Fairness Coalition, which represents big retailers like Target, Wal-Mart and Circuit City, as well as real estate interests, said that retailers' profit margins are so thin that "when you give someone a 6 to 8 percent price advantage, that's the government favoring one sector over another."

As online sales eat into sales tax collections, local authorities will have to make up the difference, Mr. Funderburk added, and many are already raising property taxes.

The information technology industry has been very effective in its Washington lobbying, and it is not about to forfeit a tax break that has bolstered both e-commerce and the computer, communications and software sectors that support it.

Walter Hellerstein, a professor at the University of Georgia School of Law, said the simplification camp would have little trouble lining up 10 states Illinois, Wisconsin and North Carolina should be among the first but he said they would need "roughly half the states" to overcome lobbying opposition in Congress.

Opponents of the drive for online sales taxes worry that the states may bypass Congress and simply take nonpaying corporations to court, arguing that they have met the Supreme Court's objections and are now allowed to collect.

"Congress has never been willing to stick its foot into the sales tax nexus issue, and I don't see anything that's about to change," Mr. Shafroth said.

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