Background

State and local governments depend on the retail sales tax to provide services police, fire, education, transportation, health, and environmental quality to citizens and businesses. The sales tax is the single largest source of state tax revenue ($1.47 billion in 1997) and is a critical component of thousands of local revenue systems in 25 states. From a federalism perspective, the existing sales tax system works well: citizens and the officials citizens elect to deliver state and local services make the decisions about state and local sales tax revenues.

Internet commerce is a huge, important, and fast-grooving segment of the U.S. economy. Business-to-business electronic commerce, a significant portion of which is subject to sales tax, is growing at an astonishing rate and is projected to reach $1.3 trillion by 2003. Business-to-consumer on-line retail sales are growing rapidly as well. By 2003, it is estimated that six percent of all U.S. retail dollars or $108 billion will be spent on-line.

As the result of court decisions and Congressional inaction, most Internet vendors and other remote sellers currently are not obligated to collect sales taxes from consumers. The tax-free status of these electronic commerce transactions violates the principles of tax neutrality by taxing identical goods differently based solely on the location of the seller, puts local merchants at a competitive disadvantage, and threatens the long-term viability of the sales tax as a key source of state and local government revenue.

The gap between those who use the Internet and those who don't is widening. According to a recent report of the U.S. Department of Commerce, the Internet revolution is bypassing the poor, minorities, and those who live in inner cities or rural areas. Personal computers are present in 80 percent of homes in which families make $75,000 a year or more but in fewer than 16 percent in which families make less than $20,000. Falling computer prices have had no impact on this "digital divide," and the chasm between the Internet haves and have-nots is creating growing social divisions based on class and race. The poor who most often buy goods and services in cash from local merchants, are unable to take advantage of the increased choices, competitive prices, and convenience that on-line shopping provides. Because they pay sales taxes on their purchases to local retailers, the poor also pay more for some goods and services than high-income individuals who can avoid the sales tax by shopping on-line.

While there are approximately 7,400 jurisdictions that currently impose a sales tax, the technology exists today to collect such taxes with a minimum of effort. Numerous software companies have tax compliance systems that can accommodate the existing diversity' in our nation's state and local sales tax systems.

The Future

The Advisory Commission on Electronic Commerce has the opportunity to address the sales tax equity problem before the disparities between remote sellers and bricks-and- mortar retailers permanently distort the marketplace, forcing state and local governments to raise taxes in other areas to offset sales tax shortfalls. State and local governments strongly support technology advances and the opportunities offered by electronic commerce, and urged the Advisory Commission on Electronic Commerce to endorse the following principles and actions:

Competitive Neutrality - All sales transactions should be treated equally, whether that transaction is done in person, on the telephone, by mail, or on the Internet. Remote sellers should not be a "protected class" among retailers and should not receive a business advantage and preferential tax collection treatment at the expense of local merchants. Any benefit, advantage, or cost savings an individual or business receives from use of new technology should be provided by the technology itself and private enterprise, not through discriminatory policies imposed by government. Tax fairness is important not only to establish a level playing field among businesses, but also to promote social equity' among the fill] range of American consumers and to preserve investments in communities.

Expanded Duty to Collect - Using its authority under the Commerce Clause. Congress should authorize states and local governments to require remote sellers without a physical presence in the state to collect use taxes on goods and services sold into the state and remit those taxes to the purchaser's state.

Federalism - The federal system should not be weakened by denying state and local governments the revenue they need to serve citizens and carry out important national responsibilities. No federal action should preempt the authority of state and local governments or their ability to determine their own tax policies.

Tax Simplification - While the technology exists today to administer even the most complex sales tax systems easily and fairly, the Commission should encourage states and local governments to continue their cooperative efforts to reduce the complexity and compliance burdens posed by existing sales and use tax systems on remote sellers. Through voluntary programs, state and local governments may wish to investigate and test approaches that promote greater simplicity and uniformity in sales tax base definitions, provide incentives for voluntary seller participation through vendor collection credits and other means, and otherwise reduce the burdens of tax collection.

Submitted to:

Advisory Commission on Electronic Commerce

Submitted by:

Council of State Governments, International City/County Management Association, National Association of Counties, National Conference of State Legislatures, National Governors' Association, National League of Cities, U.S. Conference of Mayors.

Date Submitted:

September 9, 1999