Subj: Internet Sales Taxes: Perspectives of IPI: Center for Technology Freedom From: Bartlett Cleland Institute for Policy Innovation To: Internet Caucus Advisory Committee Sales Taxes The primary focus of attention for Internet tax proponents is an e-commerce sales tax that would require vendors to collect a sales tax when someone purchases something online. Whether some items such as food or prescription drugs would be excluded, as many states currently exclude them under the states' sales taxes, is still up for debate. In addition, it isn't clear whether services such as legal, medical or financial services sold over the Internet would or should be taxed. Sales tax proponents are currently considering two basic approaches. One approach—a version of which has been proposed by Sen. Ernest Hollings (D-S. C.)—would impose a uniform Internet sales tax nationwide so that all vendors operating within the U.S. would have to collect the tax on all qualified sales. There are several advantages to this type of approach. Currently, there are some 7,548 taxing jurisdictions within the United States. Knowing which tax level to apply to whom and on which purchases—since states can vary on what items they tax—could be difficult. In addition, there is a growing interest among states, especially in light of so many states having budget surpluses, in exempting for limited periods of time certain items that would normally be taxed—that is, vendors do not collect sales taxes either on certain days or on certain items. For example, the state of Texas recently implemented legislation that bans sales taxes on certain back-to-school items on designated days in August. A uniform federal sales tax would solve the problem of multiple jurisdictions and the limitations placed on states by the Commerce Clause. Congress would have to set the level of the tax and determine what would and would not be taxed. The sales tax money collected by the businesses could either be sent to Washington, which would redistribute it based on some formula, or could be sent directly to the state or other taxing authority in which the vendor resided. The downside of this approach is that it would create a huge new opening for the federal government to oversee and regulate taxes at the state level, imposing a real threat to federalism. The states should think very carefully about giving up that much power and control. The other and more popular approach would require online vendors to collect sales taxes based on the residence of the purchaser, not the vendor. This approach has the advantage of simply using the existing tax structures within the states and local communities. Congress would not be creating a new tax. However, it would require some type of waiver in the Commerce Clause which currently prohibits requiring such collections, or it would require some type of mutual agreement among the states, similar to the one the NGA is proposing, that did not run afoul of Article I, Section 10 of the Constitution which says "No state shall, without the consent of Congress, enter into any agreement or compact with another State . . . ." One problem is that it would create an administrative nightmare knowing how much to tax whom. Proponents of the tax argue that the software that would calculate the correct tax based upon a purchaser's residence is already available and can be purchased for as little as $1,000. However, even if software can immediately determine which tax is appropriate for each sale, actually getting the money to the taxing jurisdictions would be difficult. Can you imagine, say, 20 million vendors trying to transfer money to 7,500 different taxing jurisdictions? Perhaps more importantly is the privacy concern—the sales tax would require some method of collecting the information about the purchaser and what he purchased. If a purchaser buys something in a retail store, there is little need for the vendor to get personal information such as where the customer lives, unless the customer is having the product shipped to his home. And even that is largely non-problematic, since outside entities don't have access to that information. As a result, there is little possibility of someone examining people's purchasing habits—especially by the government—or for that information to be used against the purchaser at some time in the future. Although credit cards leave a trail, that information can be difficult to access without going through the proper channels. Not so with online purchases subject to a sales tax. Not only will vendors need an address in order to know where to ship the item, they need an address to know which of the 7,500 taxing jurisdictions the customer lives in so they know how much tax to charge. Were vendors able to send the appropriate government bodies a check for the tax as discussed above, that might create an administrative headache, but not a real privacy problem. But high-sales companies could end up writing tax reimbursement checks to all 7,500 jurisdictions. As a result, proponents of this approach are looking for a third party that would receive the tax money from vendors who would in turn distribute it to the taxing jurisdictions. Databases created by such third parties are a real source of privacy concerns—someone, including the government, will know who you are and what you buy. Of course, if all states decided to tax Internet sales at the same rate, many of the accounting problems would be solved. One seldom-discussed solution to the problem of the multiple-taxing authorities would be to require online vendors to impose the sales tax appropriate for its place of business, rather than the residence of the purchaser. That is, an online vendor located or incorporated in Texas would charge Texas' sales tax on all sales, regardless of the location of the buyer. And each vendor would turn those taxes over to its respective state. This is, in effect, the way the sales tax works when someone from one state purchases something while in another state. In this case the nexus applies to the seller rather than the buyer, just as when a customer travels to another state and purchases something from a retail outlet (as discussed by Dean Andal below). If Smith purchases something while in another state, the vendor charges Smith the state's sales tax. The vendor doesn't ask or care whether Smith is from another state or not. This method of taxing Internet sales might also require statutory changes to deal with the Commerce Clause, but at least it simplifies the method of taxation and eliminates the concern that the government would be gathering information on customers and their purchases.