State Efforts to Collect Taxes on Internet Commerce

December 12, 2011

As states attempt to address budget shortfalls, many have been tempted to take a second look at an old problem: the taxation of interstate commerce.  While the original commerce clause of the Constitution discussed the topic explicitly, the increasing amount of consumption that takes place over the internet has left states eager to be able to exact state sales taxes.  However, current law clarified by the U.S. Supreme Court has left states with only a vague set of principles to guide them in this regard, says Joseph Henchman, a policy analyst with the Tax Foundation.

Those principles are:

  • Nexus: a sufficient connection between the state and the taxpayer.
  • Fair apportionment: the state cannot tax beyond its fair share of the taxpayer's income.
  • Nondiscrimination: the state must not burden out-of-state taxpayers while exempting in-state taxpayers.
  • Fairly related: the tax must be fairly related to the services provided to the taxpayer.

Within the confines of these ambiguous principles, states have employed a number of tax frameworks to attempt to take advantage of the growing commercial traffic online.  However, those that are employed often result in extensive litigation costs due to the ambiguities involved and the complicated interactions of federal and state laws.

In order to address the current situation and attempt to pull financial benefits out of the system while simultaneously leveling the playing field, governments on both levels should consider an origin-based system of taxation.  Within such a system, purchasers would pay taxes based on their geographic location.  This resolves the issue of forcing online retailers to be aware of their tax liabilities throughout the United States' approximately 9,600 tax jurisdictions.

Also, such a system allows brick-and-mortar retailers and those that operate online to compete on the same level.  Finally, such a system would grant to the states the ability to tax the increased consumption flow that takes place online, augmenting state revenues and reducing budget shortfalls.

Source: Joseph Henchman, "Assessing Federal Action on State Efforts to Collect Sales and Use Taxes on Internet Commerce," Tax Foundation, November 30, 2011.

 

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