With their coffers running dry, state governments are eyeing billions of dollars in potential tax revenue on Internet sales. Laying aside traditional concerns over sovereignty and other issues, a growing number of states are joining an initiative to create uniform tax laws and codes, paving the way for collection of sales taxes on Internet purchases.

As of April 2003, seven states joined the Streamlined Sales Tax Project (SSTP) and adopted legislation to simplify the sales tax system. This was done by creating uniform definitions for taxable items from orange juice to clothing. In the past, orange juice was defined as a beverage in one state and a fruit in another state.

Studies estimate governments forfeit anywhere from $3.2 billion to $45 billion by not collecting sales taxes on various forms of e-commerce. Widespread state revenue shortfalls have rekindled the policy debate over whether states should have the power to require companies to collect taxes on remote sales made via the Internet.

Although SSTP is gaining momentum, states face a challenge in gaining congressional approval for their efforts. Congress, through the Interstate Commerce Clause of the U.S. Constitution, has the power to regulate interstate commerce, and it is up to federal lawmakers to ultimately pass legislation that compels retailers to collect and remit sales tax on remote purchases to states.

SSTP members hope to convince congress that it is possible to get states to agree to uniform definitions of taxable goods, and that retailers are not opposed to the idea of collecting sales taxes. The SSTP has set its first benchmark: enlisting 10 states that have a cumulative population amounting to 20 percent of the population of all states that collect sales taxes. Hitting that benchmark would prove to Congress that the states are serious.

When and if the SSTP hits this benchmark, member states plan to ask major online retailers in those 10 states to voluntarily collect and remit sales taxes on sales made to residents of those states. SSTP proponents hope this will convince Congress that collecting the taxes is not a burden on retailers and that retailers are willing to shoulder the responsibility.

If Congress refuses to support the plan, it is conceivable that a member state could serve as a guinea pig by requiring retailers to begin collecting and remitting the sales taxes. This could set in motion a lawsuit, which could force the Supreme Court to rule on the constitutionality of the state's requirement.

The Power to Tax

The number of states joining the SSTP is growing steadily. SSTP advocates hope to hit the 10-state benchmark this year, and ask Congress for the power to force remote vendors to collect sales taxes on member states' behalf.

But the remote sales tax issue has vexed state and local governments for decades. Before consumers used the Internet to buy goods, they shopped from mail order catalogs. States have long sought the power to require companies selling goods via mail order to collect taxes on those sales and remit those taxes to states.

Two key U.S. Supreme Court rulings -- National Bellas Hess, Inc. vs. Department of Revenue of the State of Illinois (1967) and Quill Corp. vs. North Dakota (1992) -- denied states that power.

As the Internet rapidly penetrated American consumers' homes, electronic commerce became the new mail order business, and states watched more buying occur in an environment beyond the long arm of their tax laws. Besides e-commerce, growing use of the Internet created other sticky challenges to tax laws.

Should online services, such as the electronic purchase of downloadable software or digital entertainment, be subjected to sales taxes? If a business Web site is hosted on a server located in a particular state, does that state have tax jurisdiction over that

Shane Peterson  |  Associate Editor