E-commerce raises question of sales tax fairness

Smith was edged out before he could reach the finish line, but the retired Army Ranger felt he’d been in a fair fight. He doesn’t say the same for the small-store business climate to which he returned and relies on for his livelihood.

Smith contends his outdoor-gear store in this central Illinois college town is forced to play by unfair tax rules that compel him to add almost 8 percent in sales tax to a customer's bill, but exclude his online competitors from the same burden.

“I have people come in here all the time who tell me they can get their gear cheaper online,” Smith said. “When I have to add on that sales tax, it isn't tough math to do.”

Smith is among a growing chorus of bricks-and-mortar small businesses protesting what they see as tax law inequities driving them to the brink by requiring they collect and remit sales taxes while their electronic counterparts prosper through tax-free goods and services.

Studies show more than 1 of every 4 dollars in purchases covered by sales taxes go uncollected in the U.S. because of online transactions, adding up to an estimated $12 billion annually in lost revenue, according to the Center for Business and Economic Research at the University of Tennessee.

The biggest beneficiaries are Amazon, eBay, Overstock and other giant online retailers that operate almost entirely in cyberspace. But there are also a multitude of smaller Internet businesses that reap the rewards of tax-free commerce. They object to collecting sales taxes because of the varied rates and exemption rules across the country.

And they are protected by a 1992 Supreme Court ruling that mandates retailers to collect and remit sales taxes only in those states where they have a physical presence such as a store or headquarters. The decision came about in a test case involving catalog sales but the principle was extended to Internet sales as e-commerce evolved.

Bricks-and-mortar stores, including big-box operators Walmart and Target, didn’t say much at first, but now they’re ratcheting up the pressure on politicians to close the sales tax loophole for online retailers, and close it in a hurry.

The Supreme Court left open the door for Congress to enact a national solution, but there had been little interest in doing so until revenue shortfall caused by the persistent recession had state and local governments hunting tax dollars wherever they can find them. The push for a remedy is also driven by the accelerated pace of e-commerce and its negative impact on Main Street businesses.

The U.S. Census Bureau, for example, projects online retail sales in the U.S. will hit the $200 billion mark in 2012, up from $135 billion in 2009. Online sales for the upcoming holiday season are expected to surpass last year’s record-breaking $32 billion.

Forty-five states and scores of municipalities levy sales taxes, with various exemptions for essentials such as food, clothing and medicine. Consumers in those jurisdictions are legally obliged to keep track of their tax-free online purchases, and account for the uncollected taxes when they submit their annual tax returns.

This honor system is called a “use tax” and few people pay attention to it. Nor do the states and municipalities do much to enforce it.

U.S. Sen. Dick Durbin, D-Ill., understands the competitive disadvantage faced by bricks-and-mortar stores. He also calls the loss of billions of bucks in sales tax revenue “real money” for cash-strapped states that have cut funding for schools, police, libraries, roads and social services.

In July, Durbin filed federal legislation to compel online retailers to start collecting sales taxes. Dubbed the Main Street Fairness Act, it creates a national framework for simplifying and streamlining a sales tax system complicated by the various tax jurisdictions.

In October, Reps. Jackie Speier, D-Calif., and Steve Womack, R-Ark., filed a similar bill in the House, calling it the Marketplace Equity Act. It gives the states more flexibility than Durbin’s proposal in setting up a collection and enforcement structure.

Back in middle-America Normal, where one-third of the town budget is funded with sales tax receipts, Mayor Chris Koos feels the crunch of eroding revenue. He said sales tax receipts there are down about 40 percent.

“We're on a bare-bones budget as it,” said Koos. “But I have citizens asking me all the time: ‘Why can't the town provide more services’?”

Durbin traveled to Normal recently for a press conference where Smith, a self-described “small government Republican,” declared his support for the Democrat's big-government solution.

“I don't like the federal government telling business what to do, but right now we've got a tax code that's creating winners and losers,” Smith said. “All I want is a level playing field.”

The big online retailers argue they're not standing in the way.

Amazon, the e-commerce behemoth with $35 billion in sales last year, has offered conditional support for Durbin's bill while locked in battle with a handful of states that have passed laws requiring online businesses to collect and remit sales taxes.

But Amazon also disputes the notion that no-tax sales give it a competitive edge.

The company cites studies like the one released in July by Chicago investment firm William Blair & Co. It found Amazon's prices are 5 percent to 6 percent less than store prices, even when the sales tax is added. “As analysts have noted, we offer our customers the lowest prices regardless of whether the sales tax is charged,” Amazon spokeswoman Mary Osako said.

E-commerce merchants also like to point out that online sales aren't exempt from the sales tax; that the burden to pay it falls on consumers through the use tax requirement.

That argument doesn't carry weight with Durbin. At his press conference in Normal, the Senate Majority Whip admitted he'd failed to pay his use taxes until last year, when his accountant advised him to do so.

Durbin's confession drew a laugh, but it illustrates his point: Taxpayer compliance in every state is woefully low – less than 5 percent in Illinois – which only heightens the need for online retailers to take on the role of tax collector.

“This is a mature, growing industry that needs to accept its social responsibility,” Durbin said.

In Normal, the issue is playing out on several fronts. The mayor worries about dwindling tax revenues, and the sustainability of his running-shoes store that’s losing customers to online retailers.

His shop, across the street from Smith's store, is located in an aging retail district being revitalized with a $200 million infusion of private and public funds. The district's success -- and the town's ability to pay back some of that money -- depends on keeping merchants who can lure paying customers into their stores.

One of those merchants is bookseller Brian Simpson, who stocks used and collectible books. Customers still wander his store aisles but more than half his sales are made online, many through “third-party seller” agreements with online retailers, including Amazon. “My online customers help me keep my storefront open,” said Simpson.

That means Kristen Gianaris, a 20-year-old college student, can still browse for books in Simpson's store. She discovered it after the Borders bookstore chain shuttered its storefronts. “My mom used to bring me to bookstores when I was a kid,” Gianaris said. “I just like the feel of them.”

But she also knows cheaper online prices helped push Borders over the cliff and she admits she buys her textbooks online from an Internet retailer that doesn't collect the sales tax. She's a frequent enough shopper on Amazon's website that she qualifies for their no-cost shipping.

Consumers like Gianaris are so used to buying goods without paying taxes that they resist efforts to change the system, viewing efforts to add a sales tax to online purchases as another government attempt to impose a new tax. A Rasmussen Reports poll in April found more than 60 percent of Americans don't want an online sales tax in any form.

For his part, Simpson worries about the cost of collecting and remitting taxes to the multitude of states where his books are sold. “I don't object to collecting an online sales tax," Schneider said. “But somebody needs to come up with a way for me to do that (and remit the tax).”

In neighboring Indiana, Republican State Sen. Luke Kenley (R-Noblesville) says he's found a way. He's president of the Streamlined Sales Tax Governing Board, a coalition of 24 states that have been lobbying Congress for a decade to enact a uniform sales tax for all retailers.

Five years ago, Kenley supported a legislative deal in his state – similar to those cut in Tennessee and South Carolina – that gave national online companies a break by agreeing not to go after them on the sales tax if they would locate their distribution centers in Indiana.

Intended to lure investment and jobs, it worked: Amazon quickly opened three distribution centers in Indiana, creating 1,700 jobs.

Kenley doesn't regret the deal, but admits his concerns over lost sales tax revenue are mounting. Almost half of Indiana's $13 billion annual budget is paid for with sales taxes. Last year, Kenley chaired the state's budget committee that cut $300 million in school funding to make up for a revenue shortfall.

"Nobody likes paying taxes," said Kenley. "But everybody recognizes you need some taxes for government to provide essential services.”

The best taxes, he added, “are the ones that are fair and even-handed and don't create unfair competition in the marketplace."