After two years of shadow boxing, the battle between Congress and the states over whether to tax Internet sales is about to turn into a full-blown brawl. The outcome will turn on who gets to write the rules. Will it be state and local officials, who want the right to tax e-commerce? Or will it be Washington lawmakers who see the Internet economy as the future source of economic prosperity?
The National Governors' Assn. (NGA) is landing the first blow. On Nov. 16, it will propose a radical system in which states would collect taxes for online and mail-order sales. The plan would at first be voluntary but ultimately would be universal, says Governor Michael O. Leavitt (R-Utah), the plan's chief backer. "The existing system is such a mess that it demands complete transformation," says Leavitt, who chairs the NGA.
DEADLOCK. Critics of e-taxes are already swinging. On Nov. 9, Virginia Governor James S. Gilmore III, head of a congressionally named panel studying e-taxes, said he opposes all Net levies. The next day, two senior Ohio Republicans, House Budget Committee Chairman John R. Kasich and Representative John A. Boehner, proposed new federal legislation to bar sales taxes on e-commerce. And Senator Ron Wyden (D-Ore.) may try to extend an existing freeze on new taxes, due to expire in 2001. "State and local governments are clinging to their old tax base like a horse and plow," says Boehner.
The governors' plan terrifies the anti-tax crowd because it encourages states to forge ahead without waiting for congressional approval. Gilmore's panel, which can only make recommendations, seems hopelessly deadlocked. And states can bypass the freeze, which only blocks new taxes but doesn't prevent collection of existing taxes from online buyers.
Under the NGA proposal, states would pay third-party companies to calculate, collect, and remit sales taxes on e-commerce and mail-order purchases, based on the delivery address of the buyer. The intermediaries would handle any tax returns. And they, rather than the e-tailer, would be subject to audit. Today, IBM is developing a similar system to collect value-added taxes for businesses in Europe.
One plus for business would be simplified sales taxes. State and local governments would still set their own rates. But rules for what is taxable and who is exempt from paying levies would be more uniform. NGA officials expect that at least a half-dozen states will enact the plan next year.
But once the proposal hits state capitals, it will touch off fireworks. Anti-tax groups and some online businesses will argue the levies are tax increases, since few buyers pay them now. They'll also insist that the Internet should be a tax-free zone. "State and local governments must change their tax regimes to fit the New Economy," says Stan Sokul, a member of the Gilmore Commission and a lobbyist for mail-order companies.
Governors and local officials say they're just collecting taxes that have been on the books for decades. And they'll have the support of Main Street businesses and even some big e-tailers, who already must collect the levies. "The challenge of [the Internet] is great enough for retail businesses," argues Michigan Treasurer Mark A. Murray. "We don't need to add a price differential to the challenge."
Expect a slugfest. But the real importance of the NGA proposal is that it will force states to confront a key issue: Are they willing to radically reform their sales taxes in the new world of e-commerce? If not, states will have to find another way to pay for schools, roads, and other critical services.