Untapped Revenue Streams in E-Commerce

How should states react to the exponential growth in e-commerce transactions that largely occur without the collection of sales taxes? As states struggle to deal with the sharp drop-off in revenues caused by the Great Recession, the issues related to collecting sales taxes on e-commerce transactions continues to roil state policymakers across the country.

States continue to tussle with the fallout from the Great Recession, a downturn that caused cumulative budget shortfalls of nearly $550 billion during the 2009 through 2012 fiscal years.  But even when the national economic recovery is more robust and states begin to experience a noticeable pickup in economic activity and revenues, they will have to contend with the structural flaw in their tax systems that largely prevents the collection of sales taxes on e-commerce purchases.  This is because a 1992 U.S. Supreme Court ruling—Quill Corporation v. North Dakota—held that online retailers are required only to collect sales tax on a transaction if they have a physical presence in a the state of the purchasing customer.

In addition, the 1998 Internet Tax Freedom Act places a moratorium on any new taxes on e-commerce transactions, presenting another federal hurdle that states must overcome. For a number of years now, online-only retailers like Amazon, Overstock.com and diamond Internet retailer Blue Nile have resisted collecting sales taxes on behalf of state and local governments. The driving force behind this resistance is that applying a sales tax effectively raises the price of items, a move that would make the online retailer less competitive compared to a  bricks-and-mortar store.

While a permanent solution must involve federal legislation, states have not been sitting idly by awaiting that action.

Arkansas, for instance, passed Senate Bill 738 requiring Internet retailers like Amazon and Overstock to collect sales tax on e-commerce purchases when they do business with Arkansas-based affiliate websites.

“We have a lot of local businesses in Arkansas, both small and large companies, that collect sales tax and we are trying to level the playing field,” Gov. Mike Beebe said after signing the Arkansas bill into law.

In fact, the extreme fiscal stress states now face and the dire need for revenue has prompted a number of states to either enact or propose the following measures requiring these online retailers to collect sales taxes on e-commerce transactions:

Forming the Streamlined Sales and Use Tax Agreement, known as SSTA, in fall 1999 to simplify the rules that govern the collection of sales taxes in more than 8,000 jurisdictions across the country.  The SSTA works toward ensuring the administration of the sales tax in one state is similar to any other state given that it is applied on certain goods in one state while being exempt in another state.  As of Jan. 1, 24 states had enacted legislation complying with the agreement, though a number of the larger states—including California, Florida, Illinois, New York, Pennsylvania and Texas—had not signed on as full member states.

Enacting legislation, such as “click through” laws, requiring Internet-only retailers to collect sales tax on e-commerce purchases on sales originating on local affiliate websites.  Currently, local affiliates are offered a referral fee by the out-of-state-online retailer for every purchase that originates at the local affiliate’s site and then proceeds to the online retailer’s site.  The “click through” provision in these state laws designates that the local affiliate represents a sufficient physical presence to require the online retailer to collect sales taxes .  As of late April 2011, Arkansas, Colorado, Illinois, New York, North Carolina and Rhode Island had all enacted “click through” laws, while lawmakers in Arizona, California, Connecticut, Hawaii, Massachusetts, Minnesota, Missouri, Tennessee, Texas and Vermont have proposed similar legislation.  In response to this type of legislation, the Internet retailers terminated their affiliate programs in the states.

Forwarding tax bills to Amazon  for uncollected sales taxes. In September 2010, based on an audit of e-commerce transactions within the state, Texas Comptroller Susan Combs sent the company a bill for $269 million for uncollected sales taxes, including interest and penalties, for sales made from December 2005 to December 2009.  In response to the Texas bill, Amazon announced the closure of its Irving distribution center and desire to relocate to another state with a more hospitable tax environment.  Soon after Amazon’s decision to close its Texas distribution center, the company announced it was making preliminary inquiries into opening a distribution center in either South Carolina and/or Tennessee.

In terms of a lasting solution, regardless of the efforts initiated by states, urgent action is required by Congress.  In fact, this Congressional action will help mitigate one of the major structural flaws corroding contemporary state revenue systems and provide a more long-term solution to the vexing revenue challenges confronting every state.

View the complete version of this SLC Fiscal Alert