A Break in the E-Tax Impasse?

Key senators are close to a deal that would let states impose sales taxes on Net purchases, while extending the general moratorium til 2006

By Howard Gleckman

The U. S. Senate may be about to take a major step toward resolving the long-standing controversy over Internet taxes. BusinessWeek Online has learned that Senate Commerce Committee Chairman John McCain (R-Ariz.) and Senators Byron Dorgan (D-N.D.) and Ron Wyden (D-Ore.), who have sponsored competing e-tax measures, may be close to agreement on a compromise. It would, for the first time, allow states to require online retailers to collect sales taxes, but only after the states drastically simplify those levies. It would also continue until 2006 the congressional ban on new taxes on the Internet itself. The moratorium is now due to expire in October.

Under existing law, states are barred by the Supreme Court from requiring out-of-state retailers to collect tax on goods purchased online or though mail-order. But in a series of decisions, the high court has said Congress has the power to authorize such collections. The existing moratorium on Internet taxation doesn't apply to sales taxes, so if Congress gives states the authority to impose such levies, it would be a significant step.

If the lawmakers can nail down the agreement, the Commerce panel could act on the compromise as soon as Thursday, May 3, sources say. The issue has been hung up in the committee for a year, and until now, Wyden and McCain have been implacable foes of taxing e-sales. Dorgan has pushed for a uniform sales-tax regime.


  A deal -- which still hasn't been finalized -- would dramatically shift the landscape on e-taxation, says Lisa Cowell, executive director of the e-Fairness Coalition, a business group that backs equal taxes for online and Main Street sales. "The bottom line is that Congress is going to pass legislation this year that is going to grant states the authority to require collections," she says.

However, a Dorgan-Wyden compromise would still leave a number of issues unsettled. One of the biggest involves the details of what states would have to do before they could require e-tailers to collect taxes. One version of the compromise would give states the green light once 25 legislatures adopt a simplified system, which would include uniform definitions of taxable goods and services and sharply reduced reporting and audit rules. But the most controversial version would allow only one sales tax rate within each state.

That could torpedo any simplification effort, since it would be fiercely opposed by cities and counties, many of which set their own sales-tax rates. State and local governments are "not thrilled" with this idea, says Jeffrey Friedman, a partner with accounting firm KPMG.

Another provision would allow Congress to give its final approval before states could actually require retailers to collect levies. Governors fear that such a vote would allow Capitol Hill to effectively renege on its promises, even after states achieve simplification.


  The tentative agreement also recognizes, but does not yet resolve, the tax treatment of services that are bundled with Internet access. While monthly access fees themselves would remain tax-exempt until at least 2006, states want to tax products that are bundled with the basic charge, such as news services or long-distance Internet telephone calls. According to sources, Dorgan and Wyden have agreed that such bundled services should be taxed, but they haven't yet worked out how.

Finally, some business groups are worried about whether collecting sales taxes would subject online businesses to other state levies. Increasingly, states are trying to impose so-called business-activity taxes on companies that operate in their jurisdictions. The compromise would attempt to protect businesses by guaranteeing that merely collecting sales taxes for purchases by residents of a state would not make companies liable for other levies. But some business groups are seeking a broader exemption from such taxes.

Even if a Dorgan-Wyden bill clears the Commerce panel, it still has a long way to go. The Senate Finance Committee, and eventually the full Senate, still must approve it. The measure would then have to pass the House, which has taken a much stronger antitax stand. And it would need to win the approval of the White House, which has been sending mixed signals of its own. During his Presidential campaign, George W. Bush said he backed a five-year extension of the freeze on new Internet taxes. But last month, Vice-President Dick Cheney told an industry group that he backed a permanent ban. Neither expressed a view on sales taxes.

The bottom line: Don't expect a final deal until shortly before the existing e-tax moratorium expires in October. But the willingness of both Wyden and McCain to accept the idea that states have the right to collect taxes on e-sales is a huge step. It could help spur state and local governments to clean up the current muddle of sales tax laws. And most important, it could lead at last to a system where all purchases are taxed equally, whether they take place on the Net, on the phone, or on Main Street.

Gleckman is a a senior correspondent in BusinessWeek's Washington bureau. Follow his views every Tuesday in Washington Watch, only on BW Online

Edited by Douglas Harbrecht

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