Internet Purchases and Current Law

If 7,500 jurisdictions with sales and use taxes were to apply their own tax collection regimes to the Internet, America would experience tax pandemonium. This is largely what has logjammed the effort to tax the Internet in the first place: Current law does not provide a clear idea how to go about it.

(Imagine, by the way, what collection chaos would ensue if all 87,453 units of government in America were to adopt sales or use taxes—all 3,043 counties, 19,372 cities, 16,628 townships, 13,726 school districts, and 34,683 special districts—and then tried to impose those taxes upon each other whenever residents made Internet purchases from outside their respective jurisdictions!)

This is why, in 1998, Congress passed the Internet Tax Freedom Act (ITFA), which instituted a national, three-year moratorium on "multiple" and "discriminatory" taxes directed at electronic commerce.

The U.S. Supreme Court has ruled that states cannot require out-of-state companies to collect taxes for them, since this would interfere with interstate commerce. Under the ITFA and Supreme Court precedent, states and localities may only require companies with a "substantial physical presence" or "nexus" in their state to collect sales taxes. For example, a company with facilities in Florida may be required to collect taxes on sales to Floridians. But a Montana company with no "nexus" in Florida cannot be required to collect taxes on the goods it sells to Floridians.

This situation is extremely frustrating to state and local government officials constantly on the lookout for new sources of revenue. It creates a virtual tax-free zone for consumers. But bear in mind: State and local officials are not upset because they are "losing" revenue. They are upset because they are missing out on a new source of revenue: Internet sales. Like anyone, they appreciate anything that makes their jobs easier or brings them more money, and are frustrated when they cannot have it.

Ron Nehring of Americans for Tax Reform gives the example of, an online consumer electronics vendor based in Oregon, a state with no sales tax. The company has no presence in any other state. As a result, 100 percent of purchases from are free of sales tax collection. Consumers in states with sales taxes are technically responsible for reporting their purchases to their local taxing authority and paying a "use tax." This is, of course, rarely if ever done.

"Many state and local politicians detest a system which allows consumers to avoid paying sales taxes by going online or, as is more common, purchasing from a catalog," says Nehring. That is why nonprofit lobbying groups representing government officials have converged on Washington in recent years: to fight for the extra revenue they believe Internet commerce has deprived them of.

With the Clinton administration on their side, state and local officials succeeded in establishing, as part of the deal for passing the ITFA, the Advisory Commission on Electronic Commerce (ACEC), which has been holding meetings across the nation and will make its recommendations before its statutory April 21, 2000, deadline. Instead of examining the issue objectively and questioning whether the Internet ought to be taxed at all, the Commission's goal has been, in Nehring's words, to "change the law and institute a national sales tax collection system for all Internet and catalog remote sales."