IF YOU BOUGHT ANYTHING over the Internet this holiday season, chances are you're a tax cheat. That's because online retailers from Amazon.com to Yahoo! rarely include sales taxes in the prices their customers pay. As a result, most buyers don't realize they're supposed to remit the tax themselves to the state in which they live.
States, of course, tend not to enforce this part of their tax codes, a fact mail-order retailers and their customers have taken advantage of for decades. The Supreme Court ruled in 1992 that while states can certainly levy taxes on their residents' purchases, they have no authority to force companies outside their borders to collect them.
This sleepy corner of the law is becoming contentious again, thanks to the rise of online shopping. Though less than one percent of retail sales now takes place on the Internet, everyone expects the amount to explode. Revenue-hungry states, naturally, are as eager as anyone to participate in the growth of e-commerce. And sales taxes are only one of the many potential sources of revenue now lumped under the umbrella of Internet taxation -- a suddenly hot topic in the New Hampshire presidential primary and sure to figure high on Congress's agenda next year.
The Internet Tax Freedom Act that Congress passed in 1998 established a three-year moratorium on new access taxes -- a fee just for connecting to the Internet. Left unresolved was the question of how and whether to tax online sales. Instead, Congress created the Advisory Commission on Electronic Commerce to study the complexities of current tax law and formulate a recommendation to Congress. That report is expected in April.
Last week in San Francisco, the 19-member commission, chaired by Virginia governor Jim Gilmore, held the third of four meetings. State and local government officials, led by governor Mike Leavitt of Utah, stressed fairness to traditional retailers in making the case for applying sales taxes equally to online and "real world" merchants.
Gilmore has emerged as a rebel among Republican governors by pushing a ban on all taxes on Internet commerce. He would also make permanent the current moratorium on access taxes and eliminate the federal excise tax on telecommunications. At the same time, he would allow states to levy a 1 percent telecom tax -- a third of the federal tax but still some $ 1.7 billion a year for state governments, increasing to $ 3.4 billion in ten years. Gilmore sees that final proposal as a way to mollify his fellow governors, who are worried that tax-free Internet shopping will eat into their sales tax revenue flows.
Commission members are split on Gilmore's proposal. And with politicians aligned against one another, the business community's representatives on the panel have become increasingly influential. David Pottruck, president of Charles Schwab, acknowledged a consensus on the issue of banning Internet access taxes and told the other commissioners he personally favored eliminating the telecom tax. The sales tax issue, he said, "is not a problem today," with e-commerce sales still relatively small and state treasuries flush with revenue from a booming economy. He noted wide-spread agreement that the existing system of sales-tax collection and administration is too complicated and burdensome to business. Ted Waitt, CEO of the computer maker Gateway, similarly urged the commission to address the question of "our total strategy for taxation in the 21st century."
The issue of Internet taxation has cropped up in the last presidential campaign of the 20th century for a couple of reasons. John McCain favors a permanent moratorium on Internet access taxes as well as an end to online sales taxes. In September he introduced a bill in the Senate to do just that. George W. Bush, caught between Texas's dependence on sales taxes (Texas, like New Hampshire, has no income tax) and the demands of anti-tax conservatives, has hedged his bets by proposing a three- to five-year extension of the current moratorium on access taxes but has so far refused to voice an opinion about online sales taxes before the e-commerce commission makes its final recommendation.
McCain's eagerness to act will surely appeal to Granite State voters. A recent study by pollster Frank Luntz found that New Hampshire has the highest per-capita level of high-tech employment in America and boasts the fifth highest percentage of adults online. Meanwhile, the conservative Manchester Union Leader has voiced its opposition to any taxes on Internet commerce. McCain spokeswoman Nancy Ives says keeping the Internet tax-free will be McCain's number one priority in the Senate next year. Likewise Mark Buse, staff director of the Senate Commerce Committee, which McCain chairs, said the senator "will do everything in his power to kill any proposed new taxes."
That's the hurdle self-styled fairness advocates must overcome. With McCain leading the charge against any plan for tax-equalization, local officials and bricks-and-mortar retailers must generate a groundswell of support for taxing transactions that currently escape scrutiny. National Governors Association executive director Ray Sheppach, who thinks McCain and Gilmore are "making a decision to give a clear advantage" to online businesses, believes the tide in Congress can be turned only by a concerted effort led by traditional retailers. They must convince members of Congress that exempting online purchases from taxation will "devastate small-town America." James Goldberg of the North American Retail Dealers Association says retailers and their allies must "keep hammering home the point . . . that we are not talking about new taxes." Rather, the question is "all about fairness and equity."
Gilmore, on the other hand, will continue to lead his commission secure in the knowledge that a friendly Congress will ultimately decide the fate of Internet taxes. A philosophically aggressive opponent of taxation, Gilmore told the commission, "I don't start from the assumption that everything in America ought to be taxed." The governor fends off suggestions that exempting online purchases from taxation is a significant advantage for Internet merchants. "It is an advantage," Gilmore told the commission, but "there are other advantages all throughout commerce," including new roads that favor large retail outlets and public money spent on sports complexes. Furthermore, Gilmore insists states won't be losing that much money anyway. He points to an Ernst & Young study indicating that states lost less than $ 170 million in 1998 -- or one-tenth of one percent of total sales tax revenues for the year -- due to consumers avoiding taxes on their online purchases.
Gilmore's numbers are significantly lower than the National Governors' Association estimate of $ 10 billion a year in lost revenue by 2003. But his argument will certainly appeal to online shoppers looking to maintain a clear conscience on tax day. The effect of his proposal, Gilmore insists, would be "to decriminalize all those illegal people out there." An effect voters are sure to appreciate.
Edmund Walsh is a staff assistant at THE WEEKLY STANDARD.