Focus: LAW

Taxes uncollected on remote purchases

Posted 2/2/09

A local consumer has a number of options if she wants to buy a copy of, say, Malcolm Gladwell’s new book, “Outliers.” Her choices include the Barnes & Noble store in Warwick for $19.59; buying it online at Amazon.com for $15.39; or buying it online at BarnesandNoble.com, again for $19.59.

However, when this theoretical customer checks out, she would see the price differential widen further – because, whether she buys the book online or in person, Barnes and Noble would charge her sales tax of $1.65, while Amazon would charge no sales tax at all. And that discrepancy is making lawmakers in Rhode Island and across the country increasingly unhappy.

What has them upset is the legal thicket surrounding taxes on “remote sales,” a category that includes purchases made online, as well as through catalogs and other direct mail vendors.

In a 1967 decision that was reaffirmed in 1992, the U.S. Supreme Court ruled that businesses without a physical presence in a state are not required to collect that state’s sales tax. The court reasoned that merchants would face such a headache trying to navigate America’s crazy quilt of state and local sales taxes that it would pose an unconstitutional barrier to interstate commerce.

In practice, that has meant Barnes & Noble collects sales taxes online because it has bricks-and-mortar stores here, while Amazon.com does not.

To make matters more confusing, consumers technically owe taxes on every purchase they make online, because Rhode Island, like other states, says residents must pay a “use tax” on all purchases. In practice, however, those are almost never paid.

In response to the court’s concerns, Rhode Island and a number of other states have created the Streamlined Sales Tax Project to simplify and unify the sales tax collection system across jurisdictions.

As of last August, 22 states, including Rhode Island, were in full compliance with the project’s recommendations, which also include an amnesty for merchants that agree to collect sales taxes. The states also have petitioned Congress to ease restrictions on taxing remote sales, though so far to no avail.

“I am very concerned about the lack of taxes collected on all remote sales, including those over the Internet and catalog sales,” Rep. Steven M. Costantino, chair of the House Finance Committee, told Providence Business News in an e-mail. “We hope that the federal government can assist states in aggressively pursuing these lost tax opportunities, which would ultimately benefit Rhode Island’s existing businesses.”

In December, Costantino, along with House Speaker William J. Murphy and House Majority Leader Gordon D. Fox, wrote to the state’s congressional delegation and pleaded with them to pass legislation allowing the states to collect sales taxes on e-commerce. Rhode Island faces a long-term budget imbalance even after the current recession ends, they wrote, and the “single largest threat is a declining sales-tax base.”

“Nearly 50 years of federal inaction on the remote-sales issue continues to put Main Street businesses and state governments in jeopardy in Rhode Island and other sales tax states,” they added.

Some states are finding ways around the federal restrictions. The most aggressive moves have been in New York, where lawmakers passed a bill requiring that any online store with third party affiliates in the state must collect sales taxes — a category that includes Amazon.com, because it pays commissions to the owners of Web sites that link to its product pages.

In April, Amazon took the state to court over the law — but the following month, Amazon also started collecting New York’s 8.375 percent sales tax from all Empire State customers. Last month, the New York State Supreme Court rejected Amazon’s claim that the law was unconstitutional.

States are also facing new questions about what items should be taxable. In New York, Gov. David Patterson has recommended that sales taxes be levied on digital downloads, a proposal that has been nicknamed the “iTunes tax.”

It is hard to know exactly how much revenue states are losing to uncollected sales taxes on e-commerce, but the number is certainly significant. Online retail sales were expected to top $200 billion in 2008, according to Forrester Research.

In 2004, Donald Bruce and William F. Fox, two University of Tennessee economists, estimated that Rhode Island would lose as much as $110.3 million in tax revenue to remote sales in 2008, $58.5 million of it from e-commerce.

In an interview, Fox said he is currently updating the estimates at the request of the states. “E-commerce has grown faster than we were projecting” in 2004, he said, but that may be offset somewhat by the fact that more online vendors are paying sales taxes. “It will still be a big dollar amount – whether it’s as much as we said before, it may not be, because of better collection,” he said.

Fox also noted that business-to-consumer sales make up only about 10 percent of e-commerce – the vast majority of sales are business-to-business. “If Dell sells a PC to another firm, in many cases that’s a taxable transaction, and Dell may not be collecting for many of those situations,” he said.

Michael Mazerov, a senior fellow with the Center on Budget and Policy Priorities, a Washington think tank, said the remote sales tax issue raises fairness concerns, both because reduced sales tax revenue limits funding for social services and because higher-income Americans are more likely to avoid paying sales taxes by making purchases online.

Mazerov told a budget conference organized last year by The Poverty Institute that Rhode Island was “not minimizing sales tax losses from Internet sales.” He recommended that the state pass a law similar to New York’s to target Amazon.com and other vendors with affiliates.

“Policymakers in a number of states who are aware of this issue were waiting to see how the Amazon litigation would turn out, and now that [the state] won the first round … it may give states more confidence” to pass similar laws, Mazerov said in an interview last week.

Mazerov also said the state should step up enforcement efforts against retailers like Sports Authority, which have bricks-and-mortar stores in the state yet still do not collect sales taxes from Rhode Islanders who purchase from the company online.

As federal lawmakers look for ways to help states deal with the economic downturn, one way they could help is by dealing with the remote sales tax issue, Mazerov said. “This is something the federal government could do, at no significant cost, … to help the states avoid budget cuts in this downturn.” •

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