Losing Sales Taxes

On Black Friday, the New York Times published an editorial praising a New York state law requiring on-line retailers to collect applicable state sales tax on all purchases. The requirement, in abeyance pending court challenges, makes a lot of sense. Yet history doesn’t bode well for the new law. And states are likely to continue to lose precious revenue as on-line sales grow.

Under current law, on-line retailers—as well as other remote sellers such as catalog stores—need to collect state sales tax from buyers only when the retailer has physical presence in the state (“substantial nexus” in legal terms). That’s because a 1992 U.S. Supreme Court case, Quill Corp. v. North Dakota, found that sales tax on remote sales violated the interstate commerce clause of the Constitution and unfairly burdened retailers.

In fact, the burden falls on states that lose out on billions of dollars of sales tax revenue every year. On-line sales have grown rapidly in large part because retailers charge no sales tax on buyers outside the retailer’s home state and sellers advertise that fact. Other factors may also help lower on-line prices but sales tax avoidance likely provides the biggest kick.

Unbeknownst to most shoppers, however, most states require their residents to pay “use tax” on taxable items they purchase without paying sales tax. Virginia, for example, includes an entry on its income tax return to encourage tax filers to pay their use tax. Not many do. Some years ago, the Virginia Department of Taxation told me that only about one in a thousand returns included use tax. It didn’t help that the then governor had said in a radio interview that, if he weren’t governor, he wouldn’t pay the tax. Talk about giving license to cheat the state out of taxes owed!

For years, the Multistate Tax Commission has worked to develop a “simplified sales tax system” so states could impose a uniform set of taxes on interstate sales. The idea is straightforward: a uniform sales tax would impose no additional burden on sellers beyond what they already face from their own states’ sales taxes. If such a system were adopted, the basis for Quill would disappear. Unfortunately, the commission has yet to reach consensus and there’s no simple tax.

While the commission dithers, states continue to lose out. Forrester Research has projected that on-line sales in 2009 will total $156 billion, up 11 percent from the year before. On-line holiday sales alone have more than doubled since 2003. Even in good times, states need revenue. In the current downturn, losing taxes from on-line sales has huge costs.