Clicked Off Over Internet Taxes

Charles Crumpley
Editor of the Los Angeles Business Journal

The California Legislature’s decision a few weeks ago to make Internet retailers collect sales taxes may have seemed a simple and straightforward way to raise $200 million or more in tax revenue. But it’s already become a contentious mess that promises to get expensive for the state.


Oh, and one other thing: The state may get little or no additional tax revenue from it.


Why? Because it’s easy for out-of-state online retailers to sidestep the sales tax. All they have to do is end their so-called affiliate relationships. Those are the in-state companies or even individuals who get a commission when a visitor to their website clicks on an out-of-state retailer’s link and buys something. Without those in-state affiliates, most online retailers have no official, legal presence in the state, and therefore aren’t obligated to collect sales taxes for the state.


In the past couple of weeks, affiliate relationships have been dropping faster than European sovereign debt ratings. Think about that for a moment. That means the affiliates – who are in-state folks – will lose commissions. That’s a loss of income, which could result in a loss of income taxes for the state.


“I guarantee you they won’t raise $200 million,” said Joseph Henchman of California’s goal of raising money from the Internet sales tax. He’s a policy analyst who has studied the Internet sales tax for the Tax Foundation, a Washington think tank that describes itself as nonpartisan and independent, but tilts conservative. “They may well raise nothing.”


This could be dismissed as unfounded predictioneering, except that Henchman does offer up a few Petri dishes in which the Internet sales tax has been cultured.


North Carolina and Rhode Island, for example, have seen no windfall from their Internet sales taxes. In fact, one affiliate trade group believes Rhode Island has seen less tax revenue because of the loss of affiliate income.


And Illinois, at least anecdotally, has seen an outflow of Internet-related businesses after that state passed an Internet sales tax.


This doesn’t portend well for California. It may fail to realize much new income from the law. And it may rack up expenses. Amazon.com has vowed to qualify a referendum that would let voters decide whether to keep the tax. And there may be legal challenges to the law. How much do you suppose all of that may cost the state?


Indeed, what began as a simple way to raise tax revenue may become a messy net loss.


• • •


When it comes to Internet sales taxes, in-state retailers use the fairness argument. And they should. After all, by escaping the burden of adding sales taxes, Internet sellers enjoy a nearly 10 percent price advantage if you include all the sales levies in high-tax areas such as Los Angeles.


But Internet sellers have a fairness argument of their own. It goes like this: Sales taxes are used to help support state and local infrastructure and government services that retail shops need – sewers, roads, fire and police protection, etc. Since out-of-state Internet retailers don’t use those local amenities (except for roads to deliver their goods), why should their customers pay those taxes?


Another issue: Brick-and-mortar retailers generally assess sales tax rates that are pinpointed to the store’s location. That’s simple. But Internet sellers are expected to pay where each customer is located. That’s complicated. There are about 8,000 different sales tax districts in the United States, and they aren’t contiguous with ZIP codes.


Internet sellers say that merely figuring a customer’s sales tax rate is a burden that’s vastly greater than a retail shop’s, and that makes it unfair for them.


Before the Internet sales tax issue goes on too long and gets too expensive for California, the state would do well to suspend the whole idea and come up with a better plan.

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