The Internet tax trap

No discussion of Internet taxation gets very far without someone using the phrase, "a level playing field." Sure enough, the recent decision by retail behemoths Wal-Mart, Target and Toys R Us to start collecting sales taxes for online purchases is being touted by tax proponents as a move toward parity. It's anything but.

Retailers with a physical presence in a state are required to collect sales taxes in those states. Wal-Mart, Target and Toys R Us, which have retail outlets nationwide, simply agreed to do something they already were supposed to be doing. This is a self-serving deal, with the stores playing nice on the condition that the states don't pursue them for years of tax evasion.

On some level, we can sympathize with the plight of brick-and-mortar companies. They're trying to stay competitive with online-only retailers like Dell or Amazon.com, which don't have buildings in very many states and therefore don't have the same tax-collection burdens as Toys R Us or Target.

But forcing Dell to collect sales taxes where it sells products instead of where it's located doesn't make the playing field level. It makes the playing field unlevel in a different way. Dell, which has no retail outlets, would be forced to master the tax laws of 7,600 state, county and city jurisdictions with different and constantly fluctuating rates and reporting requirements.

Which brings us to what's really going on here. Deferring to the Supreme Court Quill decision, federal law forbids, say, Colorado from forcing a merchant in Florida to collect taxes on Colorado's behalf. The burden on the remote seller is too high, said the Court. And besides, why should a retailer in Orlando collect and remit sales taxes to support the police department and public schools in Denver? But governors, cash-starved and desperate for fresh veins of tax revenue, are hellbent on getting the law changed. Convinced that Congress will see things their way if only they can bring some coherence to their tax structures, dozens of states have joined the Streamline Sales Tax Project. The effort is being led by folks like Utah Governor Mike Leavitt and the National Governors Association, whose plan is to get a critical mass of states to simplify their tax systems and then ask Congress to overturn Quill.

We're all for tax simplification and would encourage it for its own sake. But states could be more candid about what they're really after. The governors talk a lot about what they're "losing" in online sales tax revenue, but that's not where the money is (yet, anyway), and they know it. Internet sales approached $80 billion last year, which is a twofold increase over 2001. But that figure still amounts to only about 3% of all retail sales. The states stand to gain much more from catalog sales, which they've been eager to tax for decades.

What really makes Mr. Leavitt and other governors drool, however, is the Pandora's box of levies that a change in law would open. Online retailers and catalog companies fear (with good reason) that states won't stop at a sales tax remittance requirement. Other "business activity" fees - a corporate income tax, a franchise tax, a business licensing tax, a gross receipts tax, etc. - could follow in every state where an online business has customers. It's telling that the governors refuse to rule this out.

Although big, rich companies like Dell might be able to comply, chances are most Internet retailers will not have the means. The result is that many small businesses will be taxed out of the market, and many more will never enter due to the prohibitive costs of tax-law compliance. Fewer choices will lead to higher prices for products.

This may not concern giants like Wal-Mart and Target, but it does concern their competitors. And Congress will want to keep that in mind when the states come knocking.

-- The Wall Street Journal