The Future of Internet Taxation

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, November 14, 1999

Copyright 1999 Robert L. Sommers, all rights reserved.

Part 3 of a 3-part series.

The Future of Internet Taxation

Current state and local tax systems numbering nearly 7,500 throughout the US are notoriously parochial when it comes to defending their jurisdiction. Yet, these numbers could be significantly increased if states and local jurisdictions were allowed to tax e-commerce.

Businesses would be buried in costly paperwork attempting to comply with often-conflicting tax clauses. That is precisely why the Commerce clause in the Constitution prohibits taxes which would cause an undue burden on interstate commerce.

Aside from state and local tax authorities and traditional brick-and-mortar businesses, which complain they are at a competitive disadvantage because they must collect sales taxes, there is little pressure – or enthusiasm -- for internet taxation. According to a Gallup Poll, 73% of active internet users oppose an internet sales tax, compared to 14% in favor.

Are the States’ Concerns Overblown?

Although state and local tax officials express grave concern that e-commerce will decimate the ability of states and localities to levy taxes on these transactions, this response may be overblown. Currently, the Commerce clause prevents states and localities from taxing remote sellers, unless they have sufficient nexus with the state. E-commerce merely extends the practice to avoid taxes by engaging in remote selling without a physical presence.

Most services, food and medicines are not currently subject to sales taxes anyway. In California, services, such as legal, accounting, and medical, are not subject to sales taxes. Neither are food or medicine. Obviously, e-commerce involving these transactions will not cause an erosion of the tax base.

Problems Achieving a Uniform Tax Rate:

The Commission on Electronic Commerce, created by the Internet Tax Freedom Act legislation, has been unable to make any headway in the taxation debate, although several members have voiced support for Internet taxes, provided it is simple for businesses to calculate. This could mean a uniform tax rate agreed to by all states, or technological advances that would allow businesses to calculate the sales tax simply, without a large investment in time and resources.

Purchasers and Self-Assessment of Use Taxes

So, the answer to e-commerce taxation in particular and remote selling in general may be to require a state or locality's resident to self-assess and pay the tax (called a "use tax" – as opposed to a "sales tax" -- since the consumer is paying a tax for the use of the property) that would have been collected by the remote seller. There is no constitutional prohibition against the use tax; the problem lies in enforcement.

Therefore, although e-commerce prevents states from forcing remote sellers to collect and remit sales tax, the ultimate tax liability is not affected since in-state consumers already are saddled with that tax liability to self-assess and pay the tax. While few consumers may realize this, they are responsible for paying a "use tax" through self-assessment.

Congress could pass legislation requiring common carriers (FedEx, the post office) to provide information reporting to the states on purchases by residents, similar to the IRS reporting form 1099. Since common carriers know the vendor, purchaser and date of transactions, they could transmit that information to the appropriate state taxing authorities. Then the state’s residents would be more likely to self-assess and pay the tax because this information has been reported.

Obviously, this method would avoid any undue burden on out-of-state venders transacting business via e-commerce, mail order or telephone solicitation. The common carrier’s costs of transmitting tax information could be subsidized by the states. Intangible sales over the internet, however, would still not be captured under this approach.

Congress could require vendors to provide a copy of the sale receipt to a centralized tax agency, describing the items, cost, vendor and purchaser. It is unlikely this would burden commerce. Depending on the political climate, state taxing authorities would then decide whether to tax their residents on the purchase.

Use of an Electronic Trace to Identify Parties and Transactions

If government could control e-cash so that an electronic trace could be placed on purchase and sales transactions, then the identity of the seller, buyer, goods and costs of goods could be determined and traditional sales tax rules could be applied.

Also, if Congress required e-commerce to be channeled through "toll-booths" which levied a tax on the purchase and sale transaction, then taxes could be assessed and collected as transactions moved through the system.

Lack of Privacy Issue

Since these alternative approaches involve notice to the government concerning private purchase transactions in order to tax the recipient, citizens would be understandably concerned about privacy issues. While these methods may not unduly burden the out-of-state vendor under the Constitution’s Commerce clause, they may cause an unacceptable intrusion into consumer privacy. In short, governments will likely have a difficult time justifying the taxing of e-commerce.


It is clear that a fundamental restructuring of our current sales-tax laws is needed to deal with the increasingly integrated economy of e-commerce.

Perhaps the biggest practical hurdle to taxation is whether e-commerce transactions, flying around the internet through multiple jurisdictions at the speed of light are susceptible to taxation when both the location of seller and purchaser are unknown and the medium of payment could very well be untraceable. The real question is whether governments can keep pace with technology as newer, faster and different forms of commerce emerge.


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