Massachusetts comes around to supporting an Internet sales tax

A pair of boots from L.L. Bean. The latest bestseller from A diamond engagement ring from Blue Nile. Every day, more and more consumers are buying items like these over the Internet. According to the most recent estimates, nearly 100 million Americans bought something using the Internet in 2003, with about 7 million buying online for the first time. Internet sales nationwide totaled about $100 billion, according to Cambridge-based Forrester Research.

The steady growth in online retailing is the one bright spot remaining in Internet commerce following the dot-com collapse. It’s also a growing worry for struggling state governments, which see a growing loss of sales-tax revenue from purchases made by modem. But if a new bill proposed in Congress by US Rep. William Delahunt and backed by a bipartisan group of legislators becomes law, Internet retailers will be required to collect sales taxes and remit them to the consumers’ home states–including Massachusetts, which has only lately joined the push to collect taxes on online sales.

The reason the Bay State has jumped on the Internet tax bandwagon is the ongoing fiscal crisis now working its way down from the state to municipalities. “Our state and local governments are laying off teachers and firefighters, and we are eliminating programs in our public schools,” says Delahunt. The Quincy Democrat believes that Massachusetts’s commitment to limiting property-tax increases, by means of Proposition 2H, will be sorely tested if the state continues to lose sales-tax revenue. “There will be pressures to seek more and more Prop. 2H overrides, or to see it amended or even repealed,” he says.

In 2002, the state lost $240 million in tax revenue because of online sales.
With its many tech-savvy citizens, Massachusetts has been hard hit by the shift to Internet purchasing. In 2002, the state lost $240 million in tax revenue because of online sales, and by 2011 that figure is expected to jump to $830 million, according to the Salt Lake City­based Institute for State Studies. Massachusetts counts on the sales tax for about a quarter of its tax revenue; $3.7 billion was collected in sales taxes last year.

But taxing Internet transactions is easier said than done. In a 1992 decision, Quill v. North Dakota, the Supreme Court ruled that state governments could not force out-of-state retailers to collect sales taxes. (Technically, consumers are expected to pay that sales tax themselves, in the form of a “use” tax, with their state tax return, but they generally ignore the requirement, and states do little to enforce it.) Because state and local governments impose multiple sales taxes, at varying rates, the high court determined that making these retailers collect for the more than 7,000 local and state taxing jurisdictions in the country would be an excessive burden. That is, the court said, unless the states could agree to streamline their disparate taxing systems and convince Congress to sign off on the plan.

In 1998, Congress passed the Internet Tax Freedom Act, which prohibits states from taxing access to the Internet, or from taxing online sales more heavily than those made by brick-and-mortar retailers or catalogers. But the bill never prohibited states from taxing online sales. As a result, Web retailers must now collect sales tax on purchases made by consumers living in the store’s home state, just as catalogers do., for example, must collect sales tax on purchases made by residents of Washington and North Dakota, where the Internet retailer maintains offices.

In 2000, state officials from across the country organized the Streamlined Sales Tax Project in order to meet the court’s challenge in the Quill decision. Under the proposal they developed, each participating state would be allowed to set one primary sales tax rate, with the option of a secondary rate for food and pharmaceuticals. Each local jurisdiction with a sales tax would be allowed to add one more rate into the mix. In addition, states would adopt a set of definitions for all consumer products, grouping the products in categories. Now, for example, some states tax baseball hats as sporting goods, whereas others consider the hats clothing and don’t tax them. Under the proposed plan, states could choose to tax or not tax either sporting goods or clothing, but they would have to agree on which category each item belongs to. Participating states would pay for software that enables out-of-state retailers to collect the correct tax for all jurisdictions and would agree to limit or eliminate audits of retailers that use the software. Businesses would no longer have to file tax returns with each local jurisdiction that levies a sales tax. Rather, there would be in each state a central point of administration for sales tax collection that would also distribute the proceeds to cities and towns.

The plan would “simplify the collection of taxes,” and in that sense “reduce the burden on businesses,” says Delahunt. “It forces states to come together and say, ‘Let’s make sense out of this hodgepodge that we have.'” Some 20 states have passed legislation adopting this streamlined tax system. Eighteen other states, Massachusetts included, have passed legislation supporting the concept of streamlining sales-tax collection.

For Massachusetts, this represents something of a change of heart. Two previous Republican governors, Paul Cellucci and Jane Swift, refused to take part in the effort, taking the stance that Internet sales should remain tax-free for out-of-state purchasers. But Gov. Mitt Romney approved a budget rider last March authorizing the state to join the tax-streamlining compact. “For us it’s a matter of enforcement,” says Eric Fehrnstrom, director of communications for Romney. “We already have a use tax that applies to transactions over the Internet. These taxes go [mostly] uncollected. We would prefer to collect the tax directly from the retailer.”

In 2003, for the first time, Massachusetts included a line on its state tax return requesting that consumers report and pay the use tax. Fehrnstrom says between 11,000 and 12,000 people voluntarily paid about $1.2 million. But if the Streamlined Sales Tax Project comes up with a better method, he says, Romney will support amending the state tax code to conform to it.

In making this policy shift, Romney has broken ranks with a local high-tech industry that, despite the absence of major online retailers here, is dead set against taxing any Internet sales. “What suffers is economic growth, because there is a new layer of uncertainty and administrative tax bureaucracy,” says Christopher Anderson, president of the Massachusetts High Technology Council, a business trade group. “It will dampen the full potential of the Internet.”

In this, the state high-tech group echoes the stance of national trade associations. George Isaacson, counsel for the Washington, DC­based Direct Marketing Association, which represents Internet and catalog retailers, says that the states are looking to cash in on Internet taxes without actually doing much to streamline their tax systems. Indeed, when state officials working on the project “were confronted with the difficult task of surrendering the unique features of their state and local tax systems, they repeatedly retreated from proposals for real tax reform and consistently rejected, or diluted, provisions that would have produced true uniformity,” Isaacson said in congressional testimony last fall.

In addition, he said, retailers would still have to juggle different tax rates for thousands of local communities; in some cases, two different rates within the same state (one for food and drugs and one for other items); and various product categories being treated differently from state to state. To date, the states have not produced software that can handle the job, he asserted.

Industry complaints about the unwieldiness of managing the collection burden are undermined, in part, by the many retailers that have brick-and-mortar stores around the country and also sell products over the Internet. Earlier this year, several of these major retailers, including Wal-Mart and Toys “R” Us, agreed to collect sales tax on all of their online sales, even in states where they do not maintain a physical presence.

Another countervailing force is the traditional retail industry, which sees the sales-tax free ride of Internet sellers as an unfair competitive advantage. Thus, the National Retail Federation, a trade group for major retailers, supports the streamlined sales tax proposal, and some retailers have proven to be aggressive advocates for the new system. Jack Vanwoerkom, executive vice president of the Massachusetts-based office supply store Staples, for example, says that taxing Internet sales by all retailers is simply a matter of fairness.

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“A sale is a sale no matter how it is made–in-store, online, by phone, or by mail,” says Vanwoerkom. He adds that Staples is already required to collect taxes in myriad jurisdictions, employing 30 full-time staffers and spending about $30 million on tax compliance each year. Consider, he says, the state of Colorado, which imposes a 2.9 percent state sales tax. Seven Colorado counties impose additional sales taxes to pay for mass transit, subsidize cultural events, or fund a new football stadium for the Denver Broncos. In addition, more than 200 cities and towns in the state tack on their own sales tax. The streamlined sales tax proposal, he says, would be an improvement.

Ultimately, the fate of Delahunt’s bill may come down to regional interests, rather than partisan differences. States with lots of online or catalog retailers, which would also come under the streamlined sales-tax scheme, are likely to resist the proposal, while states that don’t have such retailers will support it. Currently, Delahunt’s bill has 20 co-sponsors, including several Republicans, as well as three of his House colleagues from the Massachusetts delegation: Michael Capuano, Barney Frank, and John Tierney. But apart from the Bay State, Delahunt has found few allies from states with large high-tech industries.