Corporate Finance

Is Sales Tax on the Internet Around the Corner?

For now, online retailers are still enjoying the benefits of a moratorium on most Internet state and local sales taxes put in place when Congress p...
Lisa YoonJanuary 1, 2000

For now, online retailers are still enjoying the benefits of a moratorium on most Internet state and local sales taxes put in place when Congress passed the Internet Tax Freedom Act in 1998. But the tax-free party that helped draw so many customers to the web could be coming to an end. Along with the moratorium, which ends in 2001, the Act established the Advisory Commission on Electronic Commerce (ACEC), which was given eighteen months to recommend to Congress a plan for the taxation of Internet sales. This March, the ACEC will hold a final meeting before its April deadline, and many spectators expect the commission will come down in favor of ending the moratorium and extending state and local sales taxes online.

So far, the Commission, which includes heads of major Internet companies, state and local representatives, and interest groups like Association for Interactive Media (AIM), has been tight-lipped on its leanings. But to many, the battle looks to be a losing one for opponents of the taxes. While the anti-tax camp argues that sales taxes will hamper the growth of E-commerce, many experts believe the case for taxation is growing stronger.

“There’s not a good case for treating [Internet] taxes differently from other sales taxes,” says Steve Kafka, an analyst at Forrester Research in Cambridge, MA. For one, he doesn’t expect the taxes to slow the spiraling growth of the medium. “Consumers are not going to click away and sink the Internet,” says Kafka. People ultimately shop online for convenience, service, and selection, he says, not to avoid sales tax.

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Then there’s the difficulty of charging geographically determined taxes in the borderless environment of the Internet. Many web retailers claim it is difficult to determine when to collect tax and how much, given the myriad state and local tax jurisdictions throughout the country. But Kafka says the technology exists to handle that, too. Indeed, this year Taxware International, Inc., will unveil a transaction tax server that will support most state and local tax jurisdictions.

Yet anti-tax advocates remain steadfast. AIM executive director Ben Isaacson insists that even though tax software exists, implementing it would be extremely time consuming and labor intensive for web businesses. “People think prices are low in the Internet because it’s easy to set up a Web shop. That’s just not true. It’s just as costly, takes just as many resources, and in order to comply with the existing tax software, each business would have to write its own code [to make its systems fit into the software’s framework].”

Opponents of the taxes also point a study by University of Chicago economist Austan Goolsbee, which shows online spending could decrease as much as 30% if sales taxes were levied.

Isaacson believes the outcome of the ACEC meetings will be the continuation of the “status quo”—meaning no collection of sales taxes by localities. (Though not included in the Congressionally declared tax moratorium, which applies only to new taxes, most sates are leaving already existing online sales taxes uncollected until the moratorium expires in 2001.) According to the current nexus requirement, vendors must collect sales tax from customers in localities where the vendors have a physical presence. But what constitutes nexus continues to be nebulous in the virtual world. Isaascson says that until a consensus is reached concerning the definition of physical presence, there is no reason for the current state of non-taxation to change.

Still, those observing the debate from the sidelines are not convinced. Jonathan Zittrain, a Harvard Law School professor who co-authored a report on Internet taxation with Goolsbee, says it’s only a matter of time. “From a tax fairness standpoint alone, it simply isn’t fair to require a physical merchant to collect tax,” while an online vendor is absolved of that duty. Electronic vendors will be subject to constant pressure, and ultimately, he says, “The forces of nature will prevail.”