Taxman stalking elusive customers Shoppers who buy via catalogs, Internet aren't paying now

WASHINGTON — WASHINGTON -- Budgeting for a new computer? Calculating the cost of a new seasonal wardrobe? Don't forget the sales tax -- 5 percent in Maryland, and more elsewhere.

Unless, that is, you happen to buy via a catalog or the Internet. The sales-tax exemption for mail-order and Internet commerce tends to delight consumers.


But it is the bane of states and cities that rely on sales taxes to pay for roads, parks, police and other services.

The localities say they are victims of archaic tax laws, written at a time when buyers and sellers had to be in the same place to complete a transaction.


Now, with mail-order and especially Internet trade beginning to boom, states and localities are trying to plug the potentially gaping hole in their revenue bases.

On one front, they are fighting a bill that would impose a moratorium on new taxes on Internet trade. At the same time, they are seeking a way to persuade mail-order and Internet-based companies to collect existing sales taxes.

Mail-order and Internet-based companies argue that the local governments' efforts to require them to collect sales taxes would create a huge administrative burden. These companies fear it would be nearly impossible to keep track of the nation's 30,000 tax jurisdictions, each with its own tax rates and rules.

"If each of the tax authorities tries to tax the Internet, we will have a patchwork approach to taxation which will dramatically slow growth of Internet commerce," said Brian O'Shaughnessy, head of public policy for the Interactive Services Association.

States, in particular, rely heavily on the retail sales tax, which amounted to about one-third of their total tax revenue in 1995, according to the Center for the Study of the States in New York.

Normally, states and municipalities require that businesses collect sales taxes from customers. There is one exception: when the business and the customer are in different states.

That exception is the result of a 1992 Supreme Court ruling that a state could compel a business to collect sales tax only if the company had a physical presence -- "nexus" -- in the state. L. L. Bean, in Freeport, Maine, for example, must collect sales tax only from Maine customers.

Technically, sales tax is due even on out-of-state purchases. In reality, however, customers who order over the phone or the Internet have usually been able to sidestep the tax. Most states, like Maryland, audit businesses to determine the sales tax they owe. But it is too cumbersome to enforce the law for individuals.


"It's very difficult to collect" the taxes, said Eben Moglen, a professor of legal history at Columbia University, "and no state collects them effectively."

The federal government, which has authority to regulate interstate commerce, could amend the laws that determine nexus but has not done so. A bill proposed two years ago would have required direct marketers to collect out-of-state sales tax. The measure died.

The sales-tax exemption has grown from a minor irritant to a potentially debilitating problem for localities as advances in telecommunications have made long-distance commerce routine.

A study by the WEFA Group, a consulting firm, projects that Internet sales will soar from nearly $2 billion this year to more than $31 billion in 2002. The study also predicted that mail-order catalog sales would reach $107 billion in 2002, up from an estimated $78.6 billion this year.

Randy Arndt, a spokesman for the National League of Cities, says that, without a way to tax Internet and mail orders, states and localities may "have to raise taxes or cut services."

But the nature of online commerce makes the physical presence of a purchase difficult to determine. Sales taxes are based on the buyer's location; the location of an online transaction is hard to define because the buyer, the seller and the Internet service providers (America Online, for example) that make the purchase possible are all in different locations.


Further, some goods, such as software, can be sent to an e-mail address, not to a physical location.

"The implications of technology are so complex and so hard to understand that it is not clear that we can impose a tax," said Gary Cornia, a business professor at Brigham Young University.

Fears of tangled tax laws and technical obstacles have led some members of Congress to propose a bill that is expected to be considered by the House and Senate next year. The bill, sponsored by Sen. Ron Wyden, an Oregon Democrat, and Rep. Christopher Cox, a California Republican, would place a moratorium of at least five years on new Internet taxes, to give governments time to develop a workable plan for the collection of sales taxes.

State and municipal officials have already won some concessions from the bill's sponsors. The moratorium, for example, would not affect existing Internet taxes. Local governments could still impose new taxes if the same transaction would be taxed if it did not take place via the Internet: If newspaper subscriptions are currently taxable, so, too, would online subscriptions be.

Yet even if the bill passes, it might not allay the concerns of its sponsors. The moratorium would still allow for the collection of existing taxes or taxes that are not Internet-specific. As a result, say advocates of Internet commerce, localities might be tempted to try to bend their existing laws -- even those written before the Internet existed -- in hopes of squeezing revenue from the new medium. For example, some governments are already treating Internet service as a telephone service, which is subject to tax in most states.

"How broadly they interpret them will be subject to a lot of scrutiny, but [the legislation] lends itself to a tremendous amount of confusion," said Eric S. Tresh, an Atlanta-based tax consultant with Arthur Andersen.


Given the complexities of legislative solutions, local officials are also trying to work with corporate leaders to try to develop a tax-collection system that would not overly burden businesses. Some business leaders say they would be willing to collect sales taxes if the task was manageable.

"A no-tax approach is greedy," said O'Shaughnessy, of the Interactive Services Association. "We don't need special treatment. But if there is going to be tax, it should be fair and equitable."

The Direct Marketing Association, which represents mail-order and Internet-based companies, has met with local government officials in hopes of developing a system by which businesses could choose -- but not be required -- to collect sales tax for all states. Local governments might be expected to simplify the administrative process by, for example, standardizing the number of times a year that a business would have to file sales-tax returns.

Even so, some expect conflicts ultimately to end up in the courts.

"We don't have any clear guidance," said Doug DeRito, a partner at Arthur Andersen who predicted that judges would have to establish precedents for handling Internet commerce. "It's one big state of confusion right now."

Pub Date: 11/30/97