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National Tax Journal Vol. 53 no. 4 Part 3 (December 2000) pp. 1273-1286

Remote Vendors and American Sales and Use Taxation

Remote Vendors and American Sales and Use Taxation: The Balance between Fixing the Problem and Fixing the Tax Abstract - The remote vendor problem challenges the sales tax as a revenue producer; even more critical, though, is damage to economic balance, efficiency, and fairness. Congressional relief from the physical presence rule—rendered obsolete by uncertainty about what presence means and by “click and brick” affiliates—requires no undue burden for multi–state enterprises. State adoptions of a burden–reducing common tax structure would be virtually impossible because states have substantially different shares of their tax systems at stake in the sales tax and because they start from unique sales tax structures designed for their own economies and politics. Congress could handle the problem by requiring registration for large remote vendors, but only for states affording vendor–friendly compliance (no local use taxes and reasonable collection compensation).

INTRODUCTION

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John L. Mikesell School of Public and Environmental Affairs, Indiana University, Bloomington, Indiana 47405–1702 National Tax Journal Vol. LIII, No. 4, Part 3

he inability of states to consistently collect sales tax on sales by remote vendors (including but not limited to those operating through the Internet) to customers within their borders presents a watershed for state government finance. The idea that making a purchase by means of the Internet (or through a telemarketer, a catalog, or any other non–physical mechanism, for that matter) should relieve a customer from sales or use tax liability, either by law or by prevailing practice, when the same purchase would be taxed if made from a local storefront seems ludicrous and patently unfair. However, that is the shape of the current legal environment. That has been the situation for decades, but it has become more severe with technologies that have made remote vending easier and more accessible for the customer and less expensive for sellers. Certainly revenue loss is a concern, but even more important is damage to basic economic balance, economic efficiency, and competitive fairness among vendors (Bruce and Fox, 2000). The prevailing situation clearly is at odds with how retail sales taxes—defensible as the American approach to indirect consumption taxation—ought to operate. Sales tax structures, as outlined by Due (1957, pp. 41–2) ought to 1273


NATIONAL TAX JOURNAL meet three requirements: (i) uniformity of burden distribution by commodity or service to avoid discrimination against individuals according to preference; (ii) neutrality with respect to methods of production and channels of distribution; and (iii) ease of administration for both tax authorities and taxpaying firms. A sales tax structure that fails to conform to these requirements will not perform well against broader expectations of revenue policy— and the present sales and use tax treatment for remote commerce clearly runs afoul of each of these requirements. Remote vendors protest against the registration and collection requirements needed to balance treatment of their operations with requirements placed on local vendors because of the compliance burden associated with the huge array of sales taxes a multi–state vendor could face. A truly national vendor would encounter 45 states, the District of Columbia, and thousands of local taxing jurisdictions. At the extreme, an Internet merchant cannot keep from offering its wares to the entire nation, thereby becoming exposed to responsibility in each jurisdiction, but the same difficulty would apply to some degree to any remote vendor. This concern is legitimate and, as discussed later, the burden from complicated multiple–jurisdiction responsibility presents a critical barrier to balancing tax treatment of local and remote vendors. There are two general approaches to remedying the undue compliance burden that prevents integration of remote vendors into the sales and use tax compliance system. (i) Fix the sales and use tax structure. National sales tax simplification, rationalization, and restructuring with constraint on local sales tax authority would reduce compliance burden by giving remote vendors a near uniform sales tax landscape. There are severe political and practical

problems with such a program, particularly if there must be a speedy outcome from the state legislative processes. Attaining consensus across states on what the rationalized model will be and then getting individual state legislatures to adopt that “reform” structure would promise a long struggle—and would radically change how state and local tax policy is designed in the United States. (ii) Fix the problem. A second approach to attacking the burden is to simply fix the problem at hand; in other words, to eliminate the compliance burden placed on remote vendors by the thousands of local taxing jurisdictions. As later sections will describe, this problems can be resolved in a direct way that does not even interfere with state ability to allow local sales taxes. Before examining the approaches in detail, earlier sections will consider the variation in sales taxes across state revenue systems, the structural causes of the remote vendor problem for states, and some factors that make fundamental sales tax restructuring particularly difficult. SALES TAXATION IN GOVERNMENT FINANCE: IMPORTANT REVENUE, DIVERSE PRACTICES State and local governments in the United States rely on sales taxes for financing the services they provide. The taxes have typically yielded about one–third of state tax collections (far more than the contribution for any tax other than the personal income tax), around 10 percent of local government tax revenue (a distant second to property taxes but more than twice the revenue from any other tax), and about one–quarter of combined state and local tax revenue (U. S. Bureau of Census, 2000). From fiscal 1947 to fiscal 1998, gen-

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Remote Vendors and American Sales and Use Taxation eral sales taxes produced more revenue than any other state tax. However, the $159 billion they produced in fiscal 1998 was roughly two billion dollars less than was produced from individual income taxes. 1 Through the mid–1990s, sales tax had lead by roughly $7.5 billion per year. Was this reversal produced by erosion of the sales tax base to remote vendors? Probably not. Sales tax yield grew at an annual rate of around 5.7 percent, only slightly below the 5.9 percent growth of national personal income—but individual income tax yields grew at a rate of 8.7 percent from 1995 to 1998 and increased by 11.1 percent in 1998 alone. 2 The revenue performance of state sales taxes would be hard to fault, except in comparison with the remarkable growth of individual income tax revenue. The picture is what the relative revenue elasticities of the two taxes would be expected to produce.3 This recent dynamic does not diminish the importance of general sales taxation to both state and local government. The sales taxes provide a significant and widely exploited revenue option that contributes to the feasibility of the American federal understanding that the government spending ought to have considerable responsibility for raising that revenue. General sales taxes are the source of choice in many states, as Table 1 data on the percent of tax revenue collected from general sales taxes in each state dem1

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onstrates. However, not all states rely on sales and use taxes to the same degree, which is a reflection of the fiscal autonomy that is at the heart of American federalism. While the median across the 45 sales tax states is 33 percent, five (South Dakota, Florida, Tennessee, Texas, and Nevada) raise more than half of their tax revenue from the tax while three (Massachusetts, New York, and North Carolina) raise only about one–quarter from it. And, of course, Alaska, Delaware, Montana, New Hampshire, and Oregon levy no state sales tax. This diverse reliance means that states have different stakes in insuring that their sales taxes continue to be productive sources—much more of the state revenue structure is at risk from sales tax problems in, for instance, Texas or Florida than in Massachusetts or New York, making it extremely difficult for states to orchestrate a single voice in discussions about the tax. A second fundamental complication in sales taxation is that there is no standard state sales tax in the United States and no federal tax to use as an initial template. States reach considerably different conclusions about what transactions to tax and what transactions to exempt. Significant choices about which there are major differences of legislative opinion, expressed in individual state sales tax laws, include: (i) the extent to which services will be added to the tax base (virtually all service coverage is selective at best, so differences

State sales tax collection data for 1998 from unpublished U. S. Bureau of Census state tax collection data graciously supplied by the Governments Division of the Bureau of Census, supplemented with data from state revenue departments and state comprehensive annual financial reports. The reported sales tax data are adjusted for statutory differences across states and for the special conventions of Census reporting to provide a measure that is as consistent and as faithful as possible to the concept of sales taxation across all states. Adjustment procedures are discussed in greater detail in Mikesell (2000). U.S. Department of Commerce, Bureau of Economic Analysis data, as reported in Federal Reserve Bank of St. Louis electronic database (www.stls.frb.org/fred/). Remote commerce might be blamed, except the growth of sales tax collections has not lagged economic activity. Furthermore, the differential growth rate between general sales and individual income tax collections is not new and certainly is not merely a vestige of the continuing current economic expansion. Bureau of Census data show the rate increase for the national total of state individual income tax collections to have been greater than that for state general sales tax collections not only for 1995–8, but also for 1990–8, 1980–98, and 1970–98. The same is true for each decade: 1990–8, 1980–90, and 1970–80. Individual income tax collections were bound to catch and pass general sales tax collections with that record!

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NATIONAL TAX JOURNAL TABLE 1 AN INTERSTATE COMPARISON OF SALES TAX REVENUE, RELIANCE, AND BASES, FISCAL 1998

State NEW ENGLAND Connecticut Maine Massachusetts Rhode Island Vermont Mean Median MIDEAST Maryland New Jersey New York Pennsylvania Mean Median GREAT LAKES Illinois Indiana Michigan Ohio Wisconsin Mean Median PLAINS Iowa Kansas Minnesota Missouri Nebraska North Dakota South Dakota Mean Median SOUTHEAST Alabama Arkansas Florida Georgia Kentucky Louisiana Mississippi North Carolina South Carolina Tennessee Virginia West Virginia Mean Median SOUTHWEST Arizona New Mexico Oklahoma Texas Mean Median

Implicit Sales Tax Base to Personal Income

Adjusted Sales Tax Revenue ($Million)

Reliance On Sales Tax (%)

3,031.7 830.8 2,962.5 525.7 957.7

32.3 35.1 20.4 29.5 32.2 29.9 32.2

0.409 0.484 0.293 0.282 0.403 0.374 0.403

2,672.2 4,766.2 7,922.5 6,313.1

29.1 30.5 21.9 30.6 28.0 29.8

0.347 0.288 0.344 0.326 0.326 0.335

5,743.7 3,166.7 7,670.2 5,531.2 3,047.4

32.6 32.5 35.4 31.4 27.3 31.8 32.5

0.318 0.442 0.501 0.391 0.463 0.423 0.442

1,528.8 1,619.2 3,696.0 2,627.8 915.2 366.4 437.9

31.8 34.8 32.1 32.0 34.8 34.0 52.5 36.0 34.0

0.445 0.502 0.435 0.468 0.444 0.529 0.688 0.502 0.468

1,652.7 1,513.7 12,923.6 3,970.7 2,348.1 2,258.2 2,034.8 3,272.8 2,178.3 4,027.8 2,682.9 993.9

28.8 37.3 57.4 34.3 33.0 37.1 46.8 23.6 38.3 57.6 25.4 33.0 37.7 35.7

0.432 0.632 0.557 0.517 0.461 0.636 0.556 0.449 0.531 0.523 0.423 0.485 0.517 0.520

2,556.4 1,551.9 1,912.3 14,994.5

36.8 43.4 36.1 60.9 44.3 40.1

0.473 0.893 0.674 0.485 0.631 0.579

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Remote Vendors and American Sales and Use Taxation TABLE 1 (continued) AN INTERSTATE COMPARISON OF SALES TAX REVENUE, RELIANCE, AND BASES, FISCAL 1998

State ROCKY MOUNTAIN Colorado Idaho Utah Wyoming Mean Median FAR WEST California Hawaii Nevada Washington Mean Median

Reliance On Sales Tax (%)

Implicit Sales Tax Base to Personal Income

1,530.8 652.8 1,277.1 335.4

26.0 31.7 36.9 39.2 33.5 34.3

0.446 0.504 0.607 0.751 0.577 0.556

21,301.9 1,266.9 1,772.0 4,982.7

31.5 39.9 54.9 42.2 42.1 41.0

0.394 1.013 0.570 0.480 0.614 0.525

Adjusted Sales Tax Revenue ($Million)

159,675.4 TOTAL 35.7 0.495 Mean 33.0 0.473 Median Source: Calculated from reports to the Governments Division of the US Bureau of Census and data collected from individual states. Sales tax collections adjusted for census reporting peculiarities, nonstandard rates, and special excises levied in lieu of expanded sales tax coverage in some states.

will arise as states pick and choose their coverage); (ii) exemption of household purchases of goods (grocery foods, non– prescription medicines and equipment, clothing, and items subject to selective excises are the sources of the greatest variation); (iii) utilities (taxation varies across type of utility, type of purchaser, and, sometimes, how the utility is used); (iv) treatment of exempt organization purchases and sales; and (v) completeness of exemption of business input purchases.4 Legislation spawned in each state establishes what its sales tax will be and, thereby, the extent to which the tax will encompass economic activity in the state. State policy and state politics differ across the states and so too will the state tax bases coming from the legislative process. 5 Table 1 demonstrates the impact of these choices by presenting the ratio of the implicit sales tax base to personal income 4

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in each state (the same base adjustment and standardization protocols were used as in the prior calculation of sales tax reliance rates). Where coverage is broad, the ratio will be high and where it is narrow, the ratio will be low. In 1998, the states with the broadest coverage—Hawaii, New Mexico, Wyoming, South Dakota, and Oklahoma—taxed on average 80.4 percent of state personal income, while those with the narrowest coverage— Rhode Island, New Jersey, Massachusetts, Illinois, and Pennsylvania—taxed an average of 30.1 percent of personal income. Coverage in the broadest tax states thus amounts to 2.67 times that of the narrowest. While capacity to export certainly influences the measured ratios (Hawaii, for instance, enjoys great potential to tax tourists), statutory breadth choices clearly matter. None of the narrow coverage states fully tax grocery food purchases,

Due and Mikesell (1994) discuss the general nature of these differences. Handbooks by Research Institute of America (2000) and Commerce Clearing House (1999) provide good sources for current details on state sales tax structure. Where states permit local sales taxes, those bases usually follow state definitions—but not always. That adds yet another base difference across the nation.

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NATIONAL TAX JOURNAL none provide significant coverage of consumer services, and four provide substantial exemption of clothing purchases. All the high ratio states fully tax grocery food purchases, purchases of clothing, and four also include extensive taxation of services. Overall, the variation and range of sales tax bases reflect differences in legislative choices about each sales tax base. If one assumes that the tax base chosen by each state generally reflects the will of that state’s citizenry, then the problem of reaching a single, uniform base for all states is clear. The structures are different because of policy intentions, not because of uninformed legislative accident or its disdain for the public.6 However, the problem is fiscal as well as political. At any given statutory tax rate, the legal coverage of the broadest taxes will yield about two and two–thirds as much revenue as will the narrowest rates. Coming to a consensus, a uniform state sales tax base for all states cannot avoid creating major impacts in individual state revenue systems—any standard base, either modeled after the existing base levied by any state or designed to be a simplified ideal, will engender significant changes in yields and burden distributions within the states— conflicting with decisions that have emerged in the political process over the years. This would not be an uncomplicated and easy legislative process. THE PROBLEM AND SOME UNPROMISING OPTIONS State sales tax revenue does not yet show a discernable impact from the inroads of electronic or other remote commerce.7 Sales tax collections have recently been growing at roughly the same rate as 6

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growth in the economy—and no state has so far been sufficiently concerned to raise its statutory tax rate or to expand its legal sales tax base to recoup revenue losses from the switch of local brick–and–mortar storefronts to remote vendors. The average state rate at the start of 2000 is the same as it was in 1995, while the implicit sales tax base remains about the same percentage of state personal income (from 1995 to 1998, the median across states went from 48.1 to 47.3) (Mikesell, 2000). Earlier patterns of base decline and escalating statutory rates seems to have stabilized; the long economic expansion has provided considerable relief for states. There is no fiscal panic among states. The unfairness and competitive imbalance is clearly in place, however, even without any apparent revenue impact—and consequences will grow as vendors see the simplicity of tax avoidance and the competitive advantage associated with easily available electronic storefronts. The problem is that economic and technological change has made untenable the physical presence rule that National Bellas Hess, Inc. v. Department of Revenue (386 US 753 (1967)) and Quill v. North Dakota (112 S Ct 1904 (1992)) established to determine when remote vendors must register as sales and use tax collectors. The difficulty is two–fold. First, the rule fails to establish the types and frequency of contact that creates physical presence: “. . . exactly how much physical presence is sufficient to support state taxing jurisdiction in this context remains elusive.” (Kulwicki, 1994) The imprecision applies to all manner of remote commerce, electronic and otherwise, although more is probably known about the boundaries for mail order enterprise than for electronic selling. Physi-

This is not to say that there is a robust, positive theory of why some states rely heavily on sales taxes and others do not. Of course there is copycatting, but—as Table 1 shows—there are significant differences in base coverage even within regions. More is known about what drives the adoption of state lotteries—a relatively minor revenue source—than what drives state reliance on significant taxes. Cline and Neubig (1999) estimated the fiscal 1998 loss to be less than 0.1 percent of sales and use tax collections for fiscal 1998.

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Remote Vendors and American Sales and Use Taxation cal presence is clearly the requirement; what is less clear is what establishes that presence in the current commercial environment. Second is the problem of defining the relationship that would allow attribution of nexus when a remote electronic vendor has brick–and–mortar local affiliates. The legal fiction that corporations are separate entities, distinct from their shareholders and from corporate affiliates, establishes the standard now, although even that is not clear.8 Affiliates can operate electronic and brick–and–mortar storefronts that sell the same product line and use a common name; can direct customers to the closest brick–and–mortar (affiliate) location from the electronic storefront; and can promote electronic storefront operations from the brick–and– mortar locations without causing the electronic storefront to have a use tax collection responsibility where the business has brick–and–mortar locations. Because electronic storefronts are simple and inexpensive to create for an established retailer, the tax can become voluntary with the physical storefront serving as a display window for sales flowing through the untaxed electronic remote9—and mall operators (not the mall stores—orders from the store would be taxable) are starting to install Internet kiosks to allow avoidance transactions under the single mall roof. 8

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Under current standards, transactions can easily flow from local brick–and–mortar vendors to their electronic affiliates, thus converting the transaction from one taxed under the entirely collectable sales tax to one taxed but only marginally collectable under the accompanying use tax.10 Regardless of primary revenue impact, such a tax would not be an acceptable component of a modern fiscal system; it could not be justified as a general indirect tax on household consumption.11 The Quill physical presence line may be “bright” in the eyes of the judiciary, but the new forms of remote commerce have blurred the line enough to make it an unreliable standard if the sales and use tax is to be fair, non–distorting of channels of commerce, and productive. The tax can continue to yield revenue with the current standard because much commercial activity will flow through local vendors and the sales and use tax on motor vehicles (a large component of the existing sales tax bases) can still be collected through the registration process—but its fundamental justification as a general tax on household consumption, though, is badly eroded and it creates substantial incentives for changing how commercial transactions occur. It could be worse. Proposals to make the Internet a tax free zone—the intent of the Internet Tax Elimination Act—could promise an end to sales and use tax revenue, going well beyond the problems of

There is no national rule (Bricker, 1995). Businesses rely on several state rulings and interpretations from non– electronic remote commerce, including from California, Current, Inc. (No. 938248, California Superior Court, San Francisco, February 9, 1993); from Ohio, SFA Folio Collections v. Tracy (625 N. E.2d 693, 1995); from Connecticut, SFA Folio Collections v. Bannon (585 A. 2d 666, 1991); and from Pennsylvania, Bloomingdale’s By Mail, Ltd. V. Commonwealth of Pennsylvania Department of Revenue (567 A 2d 773, 1989). The presumed barrier is that the physical storefront of the affiliate cannot accept returns of merchandise purchased from the remote partner, but there has been no authoritative test of the presumption. A purely electronic storefront is expensive to create from scratch because of the cost of developing order fulfillment systems, of advertising to build the brand, of developing administrative structures, and so on. An electronic affiliate of a established brick–and–mortar company (a “brick–and–click” operation) can avoid much of this initial cost. States do make various efforts at direct collection of use taxes from individual consumers. Some states have linked that collection effort with their individual income taxes, but revenues are modest (Mikesell, 1997). State sales taxes encompass many business–to–business transactions. These elements of the modern sales tax are not justifiable either.

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NATIONAL TAX JOURNAL the current physical presence rule. Along with continuing the moratorium on “taxes on Internet access, unless such tax was generally imposed and actually enforced prior to October 1, 1998” and “multiple or discriminatory taxes on electronic commerce,” the legislation would also prohibit “Any sales or use tax on domestic or foreign goods acquired through electronic commerce.”12 The devastation to the sales and use tax results because virtually all business activity involves, at some stage in the purchase process, acquisition through electronic commerce. The problem can best be understood by parsing out the several operations that constitute an ordinary transaction between a final (non–business) customer and a vendor.13 The various elements include (Gunnerson, 1999): shopping (window shopping for brick–and–mortar enterprises, surfing or browsing for the Internet), ordering (communication between shopper and the vendor, over the counter or by hitting the “buy” button), payment verification (vendor validates credit card or check with clearinghouse), wholesaler contact (vendor contacts wholesaler or distributor to fulfill order or to replenish inventory), and delivery of purchase (wholesaler arranges delivery to the customer, customer takes purchase home from storefront). The Internet represents a normal commercial channel for every one of these transactions for product or service sales, the exception being delivery—which requires that the sale involve something that can be digitized. And even payment—the actual transfer of (non–currency) funds— typically flows through dedicated electronic networks, although usually not the Internet (Weiner, 1999). How much of the 12 13

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commercial transaction would need to be electronic for the purchase to be necessarily free of sales and use tax? If only delivery, then there is no significant problem— most of consumption expenditure is not subject to digitization and cannot be delivered electronically.14 States have been reluctant to include intangible property and services in coverage of the sales tax, so in relative terms, not much would be lost from missing this component of consumption and to attempt an aggressive campaign to add these previously omitted transactions to the sales tax base now would not be politically advantageous. If the Internet is, however, to be fully sales and use tax free, then every store– to–customer transaction will have been an Internet transaction at some stage of the flow of commerce and hence not subject to taxation. With strictest definition, the sales tax base falls to zero—not even the purchase of a motor vehicle would be taxable—and states and localities will have a major fiscal problem. At a minimum, the law would require massive interpretation to determine what is and what is not enough connection with the Internet to make it tax free. Neither outcome would seem to be acceptable under normal ideas of sound tax policy. REFORMS TO SIMPLIFY, RATIONALIZE, AND REVISE TO PRESERVE SALES TAXATION States may require individuals and enterprises within their jurisdiction to accept responsibility for compliance with taxes —including sales and use—that the state levies. However, the Commerce Clause, as reflected through National Bellas Hess and reaffirmed in Quill, prohibits “undue

H.R. 3252, the Internet Tax Elimination Act, 106 th Congress, 1 st Session (November 8, 1999). If intermediate business–to–business transactions before final sale are included, the reach would be even greater. Around three–quarters of household consumption expenditure would be difficult to digitize—barring development of Star Trek “transporter” technology (Mikesell, 1998).

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Remote Vendors and American Sales and Use Taxation burden” on interstate commerce—thereby providing the physical presence standard previously considered. How much burden might be undue? The Quill decision left that to Congress, which must “decide whether, when, and to what extent the States may burden interstate mail order concerns with a duty to collect use tax,” a responsibility that is presumed to extend beyond mail order to all remote commerce. Unless compliance responsibilities are reduced and multistate businesses can be provided a less burdensome state and local tax environment, particularly relief from claims from the thousands of local jurisdictions that a national vendor could face, Congress will not provide relief from the physical presence requirement. Simplification, rationalization, uniformity, and reduction in numbers are discussion topics and have been the concern of more than one task force, but nothing has yet moved Congress—even with convincing evidence that Congress does have power to legislate in this area (Hellerstein, 2000). A number of public policy organizations have proposed a “zero burden” remedy—a “technofix”—that hinges on voluntary agreement, development of “trusted third party” contractors, and no change in the current nexus law.15 Participating state and local governments would pay a “trusted third party” (TTP) to handle compliance for all participating vendors. Participating vendors will transmit necessary customer order information to the TTP, the TTP will do the appropriate sales or use tax calculations for that order, the TTP will arrange with the appropriate credit card company to add the appropriate tax to the bill, and the TTP will arrange that remittance will go to the

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proper government or governments. Ultimately the system could apply to all vendors, local or remote. State and local governments would pay for the services of the TTP so that burdens of sales tax compliance would fall on the general revenue system, not vendors alone. Given that only certain sectors of the economy are sales and use tax collectors, this change is probably reasonable. However, it is not clear that this would be an improvement over providing meaningful compliance compensation to those firms who act as tax collectors now. The program also speaks of the objective of uniform state and local sales tax laws, with the intent that agreement be reached on uniformity within six to eight years. That could be an excellent idea—a poorly designed uniform structure certainly would not likely be an improvement over the current structures—but there is no particular reason to expect that such uniformity would emerge, certainly not based on the behavior of states and localities over the years. 16 As an earlier section showed, the states now have significantly different ideas about what they want in their sales tax base and great differences in the extent to which they rely on that tax for financing state services. The choices shaping the current patterns of sales taxation almost certainly are not random, so getting uniformity of structure and administrative rules, first in multi– state negotiations and then through all the relevant state legislatures, would be an exceptional accomplishment. Even without the difficult problems of achieving uniformity, the zero burden technofix holds little promise. The technofix offers the remote vendor with-

“Streamlined Sales Tax System for the 21st Century,” (1999 State Tax Today 228—18) endorsed by the National Governors’ Association, the National Conference of State Legislatures, the National Association of Counties, the National League of Cities, the U. S. Conference of Mayors, the International City/County Management Association, and the Council of State Governments. The proposal also envisions a consensus board to screen and approve changes in state sales taxes, but to be created in a longer–term horizon.

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NATIONAL TAX JOURNAL out physical presence no inducement for participation, even if the state paid the TTP for compliance. Why would a remote vendor with no physical presence participate in the system? There would be costs associated with the link between the vendor and the TTP and lost economic advantage from tax avoidance. Under current law, which would remain in place with the techofix, escaping nexus is simple for any large enterprise—as noted previously—and gaining a price advantage is certainly something that any vendor would enjoy. Staying outside the TTP system offers zero burden for the enterprise —plus affords the remote vendor a price advantage over brick and mortar competitors.17 In light of existing information technology and remarkable geographical information system databases, it might be possible to induce greater voluntary registration from remote vendors by offering them more attractive compensation for use tax collection, thereby affording them the profit from this governmental service, rather than directing the money to the TTP. That would give the enterprise an economic reason for voluntary participation—if a TTP could profit from providing the service, surely larger remote vendors could as well and thus would have reason to register. States haven’t shown much interest in reasonable compensation for vendors, however, and remote (electronic) vendors have shown little interest in voluntary registration even with states having no intra–state variation in the sales and use tax and uncomplicated taxation of the product being sold. The physical presence standard bars an equitable, efficient, and balanced treatment of remote and local consumer pur17

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chases under the sales and use taxes—and the minimum requirement for the Congressional action to change the standard is simplification of compliance requirements for remote vendors, particularly in regard to dealing with thousands of local taxing jurisdictions. States should use the challenge as an opportunity to rationalize and simplify their sales and use taxes, an action that is long overdue.18 It would be wrong to expect swift creation of such a rational tax—or even to expect that all states would ultimately agree to the negotiated structure. Governors might break two centuries of American tradition and negotiate a single unified tax structure for every state, something like the tax structure standards of the European Union, but what the executive has negotiated, the legislature must adopt. To get all governors to agree on a single, sensible, simple, and reformed sales tax structure stretches the imagination; getting all legislatures to then accept that proposal would be even more difficult. Most importantly, even if states were to reach agreement, there is no guarantee that the physical presence bar will be lifted. The most important need is to establish a national structure that will not: (i) place unrealistic compliance requirements on remote vendors who sell at retail to the full national market; (ii) make those retailers economically whole as they perform sales tax collection tasks; and (iii) eliminate the easy avoidance that the physical presence standard permits. Sufficient simplification to meet the needs of remote vendors will not arise quickly, if at all, from independent state action. Relief from the physical presence standard requires Congressional action—as does

The technofix proposal also offers those using TTP immunity from audit. This is extremely weak tea, in light of the low audit rates that characterize state tax departments and the fact that the enterprises can easily and legally avoid sales and use tax responsibility by simply staying remote. The objective should not be the simplest possible tax—a turnover tax on every transaction would be that — but rather the simplest tax within the idea of taxing household consumption expenditure. And that clean system turns out to be much simpler for compliance and administration than the structures that now are in application. (Mikesell, 1999).

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Remote Vendors and American Sales and Use Taxation some change in structure and compliance requirements to constrain cost and burden. Congress could handle all elements in a straightforward fashion with a minimum of interference in state and local fiscal autonomy and without preemption of state and local taxing authority through legislation to require use tax registration for all retailers with sales exceeding a national threshold, but only with states that had acted to reduce burden on remote vendors for tax compliance responsibilities (in other words, the laws were “vendor–friendly”). First, vendors with retail sales above a national threshold would be required to register as use tax collectors for states with vendor–friendly use taxes. The threshold would need to be large enough to prevent uncompensated burden on small enterprises but small enough to discourage businesses from breaking into affiliated companies for competitive advantage. This balancing is not impossible, even if the first Congressional effort turns out to be too small or too large. The important change is to the registration requirement: Congress should provide a use tax registration requirement that is not based on the obsolete and imprecise concept of physical presence, but rather on two clear tests: retail sales volume of the firm and whether the state had passed a vendor– friendly use tax law. Second, the legislation would establish prohibition of local use taxes as one criteria for being a vendor–friendly state. By itself, an end to the physical presence standard would confront businesses marketing to the entire nation with the immense compliance burden of collecting for all states and localities that levy sales and use taxes and keeping track of thousands of 19

rates and bases. Imposing a single statewide sales and use tax rate—some type of blended rate—would provide comparable relief from complexity to the local use tax prohibition, providing state and local bases are uniform, but Cornia and colleagues conclude from detailed investigation in several major local sales tax states that “adoption of a single rate would in general be difficult and simply infeasible in many if not most states” (Cornia et. al., 2000) They reach this conclusion because the single rate for local governments, regardless of how determined: (i) would significantly reduce local fiscal autonomy by constraining local choice on the tax rate; (ii) would interfere with covenants that pledge local sales tax revenue for debt repayment and substantially complicate other revenue earmarking; and (iii) could not both be revenue neutral and hold all localities harmless from revenue loss. This prohibition of local use taxes would have the same effect as a single rate for remote vendors, but would have no meaningful revenue impact on covenants and earmarking, would not interfere with local fiscal autonomy, and would not have the hold harmless/revenue neutrality conflict. With that prohibition, remote vendors would encounter only one use tax rate and base per state (the state rate and base), while local governments would have whatever sales tax authority their states elected to offer them with no impact on remote vendor compliance responsibilities. In 19 of the 45 sales tax states, remote vendors now face but a single statewide use tax rate, either because local governments lack taxing authority (11 states) or because, while localities may levy sales taxes, they may not levy use taxes (eight states). 19 That is also the case for the 46 somewhat state–like jurisdiction, the Dis-

Furthermore, in a few other states, local use tax coverage is so limited—less broad than their companion sales taxes—as to be irrelevant for remote vendors. A number of observers seem unable to understand that not all localities that levy a general sales tax have a compensating use tax (Cline and Neubig, 2000, for instance). Because large numbers seem to be important to the discussions, there are well over 1,000 localities that levy a general sales tax without a compensating use tax.

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NATIONAL TAX JOURNAL plus several recent state tax reform studies), but state legislatures and governors move slowly at best. Even as commissions and task forces have preached the need for simplification and rationalization over the past three or four years, states continue adding complications (for example, tax holidays for clothing and personal computer purchases and new grocery food exemptions). The strong message of rationalization and simplification that household consumption spending should always be taxed and that business purchases should always be exempt, provisions that are completely consistent with good tax policy, has not carried the day in the past and it is not clear why legislatures, acting independently, would quickly change their pattern now. And states clearly do not appear to be paying attention as the remote vendor–sales tax simplification argument swirls about.

trict of Columbia. This approach to the single rate/base per state objective is simpler, much more effective, and less intrusive to American principles of fiscal federalism than other approaches that would ban or constrain local sales taxation. It deals only with the problems of interstate vendors, the principal Constitutional concern of Congress, and leaves localities and in–state vendors generally to deal with the tax structure of their own states. Third, the legislation would require vendor–friendly states to compensate remote vendors for their collection work. Both remote and local vendors act as intermediate tax collectors when they collect sales or use tax from their customers and remit those collections to the state; this work is a privatized governmental function and should be compensated at a reasonable rate, so that vendors have a reason to be faithful agents of the state. Indeed, a reasonable compliance program —10 percent of collections would not be unreasonable as a first effort––should reduce the extent to which larger vendors would even want to be outside the program. Whether vendors choose to contract with others to handle this compliance or whether they do the work themselves ought to be up to the vendor, just as they decide whether to do accounting, legal, or janitorial work inside or outside the firm. The sales and use tax systems should be restructured so they more closely follow the ideal of an easily administrable indirect tax on consumption expenditure, but the restructuring needs to be done for the benefit of each state’s own citizenry and local enterprises and without demanding swift reform to the same sales tax structure in each state. 20 There are good models for simple and rational sales tax structures available (Due and Mikesell, 1994; McLure, 1997; and Mikesell, 1999, 20

CONCLUDING OBSERVATIONS The primary current issue is whether the task is to relieve remote vendors of excessive compliance burden or to restructure sales taxes into a simpler, uniform, and more rational system. Remote vendors need to enter the compliance scheme for sales and use taxes to continue as an acceptable approach to indirect consumption taxation. These vendors point to the burdensome complexity from the huge number of local taxing jurisdictions—and Congress uses this special burden on interstate commerce as reason for continuing the physical presence rule that keeps such vendors outside the compliance scheme. The important task for sales tax preservation is to address the compliance burden issue and, as previous sections have shown, that can be done without the far more difficult general sales tax restructuring.

It would be hazardous to involve Congress in aggressive restructuring—these are the people responsible for the Internal Revenue Code and even after 90 years of experience, the Code fails to meet many normal standards for a simple, efficient, and effective tax on income.

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Remote Vendors and American Sales and Use Taxation Gunnerson, Gary. “Behind the Scenes.” PC Magazine 18 No. 22 (December 14, 1999): 12–4. Hellerstein, Walter. “Federal Constitutional Limitations on Congressional Power to Legislate Regarding State Taxation of Electronic Commerce.” National Tax Journal 53 No. 4, Part 3 (December, 2000): 1307–1326. Kulwicki, Laura. “Continuing State Trends in Nexus Enforcement After Quill: The Struggle to Define ‘Substantial Nexus.’” State Tax Notes 6 No. 6 (February 7, 1994): 345–51. McLure, Charles E., Jr. “Electronic Commerce, State Sales Taxation, and Intergovernmental Fiscal Relations.” National Tax Journal 50 No. 4 (December, 1997): 731–49. Mikesell, John L. “Administering Use Taxes for Direct Collections Through Income Tax Reports.” State Tax Notes 12 No. 21 (May 26, 1997): 1603–6. Mikesell, John L. “Retail Sales Taxes and Electronic Commerce: Is There Hope?” State Tax Notes 14 No. 12 (March 23, 1998): 903–7. Mikesell, John L. “Simpler Sales Taxes for Remote and Local Vendors—Some Principles Plus a Minimalist Remedy for E–Commerce.” State Tax Notes 17 No. 20 (November 15, 1999): 1291–5. Mikesell, John L. “State Retail Sales Taxes, 1995—1998: An Era Ends.” State Tax Notes 18 No. 8 (February 21, 2000): 583–95. Research Institute of America. 2000 Guide to Sales and Use Taxes. New York: Research Institute of America, 2000. U. S. Bureau of Census. 1998 State Tax Collections. Online, 2000. Census Bureau Available at: http:// www.census.gov/ftp/pub/govs/www/ statetax.html. Weiner, Stuart E. “Electronic Payments in the U. S. Economy: An Overview.” Federal Reserve Bank of Kansas City Economic Review 84 No. 4 (Fourth Quarter, 1999): 53–64.

The best hope is for the minimal Congressional action outlined here to fix the problem and then to leave states with the slow process of fixing the sales taxes. That is a simple approach that does little violence to American federal principles of state–local fiscal sovereignty, while it levels the competitive balance between alternative storefront formats. REFERENCES

Bricker, Robert C. “Agency and Affiliate Nexus for Sales and Use Tax.” Journal of State Taxation 13 No. 3 (Winter, 1995): 61–9. Bruce, Donald, and William F. Fox. “E–Commerce in the Context of Declining State Sales Tax Bases.” National Tax Journal 53 No. 4, Part 3 (December, 2000): 1373– 1388. Cline, Robert, and Thomas Neubig. “The Sky Is Not Falling: Why State and Local Revenues Were Not Significantly Impacted by the Internet in 1998.” State Tax Notes 17 No. 1 (July 5, 1999): 43–51. Cline, Robert, and Thomas Neubig. “Masters of Complexity and Bearers of Great Burden: The Sales Tax System and Compliance Costs for Multistate Retailers.” State Tax Notes 18 No. 4 (January 24, 2000):5 297–314. Commerce Clearing House. 1999 U. S. Master Sales and Use Tax Guide. Chicago: CCH International, 1999. Cornia, Gary, Kelly D. Edmiston, Steven M. Sheffrin, Terri A. Sexton, David L. Sjoquist, and C. Kurt Zorn. “An Analysis of the Feasibility of Implementing a Single Rate Sales Tax.” National Tax Journal, 53 No. 4, Part 3 (December, 2000): 1327–1350. Due, John F. Sales Taxation. Urbana, IL: University of Illinois Press, 1957. Due, John F., and John L Mikesell. Sales Taxation, State and Local Structure and Administration. Second Edition. Washington, D.C.: Urban Institute Press, 1994. 1285
