Why Taxing Internet Sales Makes No Cents or Sense

As the April 15 deadline to pay personal income tax approaches, momentum is building to force a new group of people onto the <?xml:namespace prefix = st1 ns = “urn:schemas-microsoft-com:office:smarttags” />Illinois state tax rolls.These potential taxpayers do not own tangible property in Illinois, nor are they entitled to vote in the state.Who are they? They're merely companies that sell their products over the Internet.Internet taxation is a daunting scenario that Illinois e-commerce companies may soon face if Sen. Steve Rauschenberger (R-Elgin) gets his way.Contrary to popular belief, federal law doesn't prohibit all Internet taxation. It merely prohibits states and localities from imposing multiple and discriminatory taxes on Internet sales and prevents states from imposing taxes on Internet access. States are therefore free to impose taxes on goods purchased through the Internet.Rauschenberger has seized on this opportunity and has been working with a task force of the National Conference of State Legislators task force. The legislators drafted model legislation for states to collectively streamline and simplify their sales- and use-tax systems to make it more “e-commerce friendly.”With more than 7,000 taxing jurisdictions nationwide—from state governments to mosquito abatement districts—streamlining and increased efficiency is desirable. But the current system has been in place for decades, so what is the real impetus?Answer: a new tax on e-commerce, just at the time when most state budgets are deeply in the red.  Illinois alone is facing a two-year deficit variously estimated between $7 billion and $10 billion.Currently, e-commerce sales account for barely more than 1 percent of aggregate retail sales nationwide, but states fear an increasing loss of tax revenue to Internet sales at a time when state budgets face a fiscal crisis.U.S. Supreme Court precedent requires that a sufficient nexus exist between the taxing authority and the taxed entity. Retailers are not required to collect taxes when their only connection with customers in the taxing state is by common carrier (package delivery companies) or U.S. mail. This precedent has long exempted mail-order companies from collecting sales taxes from buyers living outside the retailer's home state.Current case law considers this a Constitutional issue: Congress has wide latitude to regulate interstate commerce, and states are prohibited from unduly burdening interstate commerce. This is where the states see their opening: By simplifying their laws, they hope to persuade Congress to allow them to impose Internet sales taxes.This effort is misguided. It is extremely difficult to reconcile various state and local interests. For example, taxes on sales of general merchandise within suburban Hanover Park vary by county. Sales tax in the Cook County portion of the village is 8.25 percent, while in the DuPage portion it is 7 percent. In addition to the tax rate, another consideration is what gets taxed. Only about 40 percent of sales are taxed, the rest exempted for various reasons. Food, medicine, clothing—each is viewed as a staple by different communities.Placing the burden of collecting sales taxes on out-of-state sellers doesn't make sense. These retailers use none of the state's resources; they should not be burdened by the state's tax collection efforts. Only a few states allow companies to keep a portion of those collections to offset administrative costs. In states like Illinois that do provide a retailer's discount, the amount is hardly sufficient to cover the administrative burden.If there must be a tax, what makes sense is an origin-based tax, under which a company's domicile would be the company's principal place of business as defined by the Uniform Commercial Code. This has many advantages over a destination-based tax: It would require no new federal legislation; compliance would be simple, and it protects each state's right to establish its own tax rates, exemptions, and revenue projections. It also protects the privacy of the buyer, as the seller would have no need to determine his or her location.We already have origin-based sales taxes for physical stores. A purchaser of a novel at a bookstore in Wisconsin pays the Wisconsin sales tax even if he or she lives in Illinois.If new legislation is forthcoming, consumers from all states would win if virtual stores were to all play by the same rules.<?xml:namespace prefix = o ns = “urn:schemas-microsoft-com:office:office” />