The County Line - March/April 2001

Collecting Internet Taxes Not As Easy As Planned

Yep, it is about as interesting as watching grass grow. But the issue of collecting taxes on transactions from Internet and remote sellers is at the very heart of the financial future of the state of Alabama and its counties.

For everyday, more and more retail transactions move to the Internet and with them go the easy-to-collect sales tax revenue. In their place is left a perplexing set of questions, constitutional hurdles and political brick walls for the state revenue collector. A solution, however, is too important not to get our attention.

It is so important, in fact, that the Association proposed that the National Association of Counties alter its position on this issue during the recent conference in Philadelphia. We were unsuccessful in securing a change in the organization's policy, but we were able to get some people thinking about the pitfalls of the program that is being proposed on the national level.

The problem stems from a bevy of constitutional issues that essentially block a state from requiring a business to collect sales taxes from its customers unless the business is located or has a physical presence in the state that levies the tax. If you are confused, maybe this real world example will help:

Right now, somewhere in Alabama, someone is on the Internet ordering some product from Yahoo or one of the other popular Internet sites. This product will be delivered into Alabama and will be used in Alabama. The product WILL be subject to Alabama's sales and use tax laws. However, Alabama has no power to require the Internet company to collect the tax and remit it on behalf of the consumer.

And in the absence of a requirement that Yahoo collect this tax, the state -- and its cities and counties -- are left with a rather difficult route to the collection of this revenue from the purchaser. This difficulty in collecting the tax is, as one might imagine, a growing problem that has government officials across the county scratching their heads. As more and more retail transactions move into the "Internet" arena, the problem becomes more difficult to contain.

A solution might have been a bit easier to achieve six or eight years ago. But today, the Internet is such a powerful communication tool that it can be used not only to sell everything imaginable, but also to motivate the voters to oppose any change in the nation's approach to taxing Internet transactions.

And just in case you think this thing isn't complicated enough, there is yet another player in this confusing dance -- your local retailers. Because the local retailers are required to collect sales taxes (often on the same merchandise that can be purchased on the internet without paying the tax) they are demanding a level the playing field. These retailers, a powerful lobbying force in Washington, are working hard to create a method that will subject Internet sales to some type of tax collecting program.

The solution -- although it is hard to view this proposal as a way to solve the problem -- proposed by the retailers is something called the Streamline Sales Tax Project. As with most things in Washington, it is hard to understand and even harder to explain.

Here's the idea in a nutshell. The retailers propose that every state in the country adopt the same set of rules, definitions, exemptions, collection procedures, penalties and regulations for taxing transactions that occur WITHIN their borders. In exchange for this "streamlining," the remote and internet sellers will be given the opportunity to voluntarily collect taxes on their transactions and remit those voluntarily-collected taxes to the state where the purchaser resides.

If this deal sounds one-sided to you, then you understand why the Association believes the National Association of Counties should not support this project. It simply is not in the best interest of states and counties to change everything about their taxes in exchange for a voluntarily program of Internet tax collection. That is not an equal swap.

But it is difficult to make people understand that the idea is not a good one. We made this pitch to NACo's Finance, Taxation and Intergovernmental Relations Steering Committee in Philadelphia and it fell on deaf ears.

A couple of committee members did tell us after the meeting that our view was correct, but they were not willing to support us with their vote. The only committee member who did speak during the meeting conceded that our concerns might be legitimate, but said it is in the best interest of counties to do whatever it takes to collect taxes from remote sellers.

That view is extremely shortsighted. And I'll explain with another real example.

While at the NACo conference, we learned that both the states of Pennsylvania and New Jersey do not collect sales taxes on the purchase of clothing. Each state, however, has its own definition of "clothing," which establishes what will and what will not be exempt from each state's separate tax. In other words, items such as Halloween costumes or belts might be exempt from taxes in one state but subject to the tax in the other state.

The streamline project, however, has its own definition of "clothing" that must be used by any state that wishes to either exempt clothing from taxation or levy a separate tax on clothing. This national definition will, obviously, impact revenue in BOTH New Jersey and Pennsylvania because the states will shelve their current tax code and move to this national definition of "clothing".

Now, in order for this Internet collections scheme to generate any new money for New Jersey and Pennsylvania -- and any other state that has its own set of rules -- the states must first recoup enough new Internet tax money to fill the gaps generated by these changing definitions. We don't know how big these gaps will be, but we know that those gaps must be filled before we can even reach the "break-even-point" with this scheme.

The other major flow in this proposal is that there is no requirement that the Internet companies participate by collecting taxes on items they sell. So we could all agree to change our entire tax code and then the Internet companies could still continue to refuse to collect the tax.

Again, this is not a deal that government should be willing to accept. If we work hard enough we can find ways to ensure that the Internet companies participate. And counties should withhold their support until such a way is found and added to the streamline proposal.

To do any less is to weaken the already weak position we have today.

It is clear that a solution to this problem will not come without considerable work. But it is worth the effort, because in the time it has taken you to read this column someone in Alabama has purchased something on the Internet and we sit here without a workable plan for how to collect that tax.