State and Local Sales and Use Taxes and Internet Commerce

In theory, state sales and use taxes are consumption taxes based on the destination principle.The destination principle prescribes that taxes should be paid where the consumption takes place.Sales taxes collected at the point of sale achieve this if consumption takes place near the point of transaction.In contrast, consumers pay a use tax on products purchased out-of-state and used in their home state where consumption likely takes place.Under current law, states cannot reach beyond their borders and compel out-ofstate vendors (without nexus in the state) to collect the use tax owed by state residents.The Supreme Court has ruled that requiring remote vendors to collect the use tax would pose an undue burden on interstate commerce.States are concerned because they anticipate gradually losing more tax revenue as the growth of Internet commerce allows more residents to buy products from vendors located out-of-state and evade use taxes.Recent estimates put this loss at approximately $8 billion in 2003.For this report, "Internet taxes" are existing use taxes and taxes on Internet access services.States that rely more heavily on the sales and use tax will likely lose more revenue than states less reliant on the sales and use tax.Congress is involved in this issue because commerce conducted by parties in different states over the Internet falls under the Commerce Clause of the Constitution.Currently, the "Internet Tax Moratorium" prohibits (1) new taxes on Internet access services, and (2) multiple or discriminatory taxes on Internet commerce.This moratorium was created by the Internet Tax Freedom Act (ITFA) of 1998 and had expired on October 21, 2001.Congress extended the "Internet Tax Moratorium" through November 1, 2003, with P.L. 107-75, enacted on November 28, 2001.The moratorium was extended for an additional four years, through November 1, 2007, by P.L. 108-435, enacted on December 3, 2004.The moratorium is related to the use tax collection issue, but is not the focus of this report.The degree of further congressional involvement is an open question.Congress could do nothing and end the moratorium and not address the use tax issue.Or, Congress could: (1) extend the moratorium (or make it permanent) and/or (2) address the use tax issue.Opponents of remote vendor use tax collection responsibility would support a permanent moratorium and a clearer definition of nexus for use tax purposes.Many state officials are opposed to a permanent moratorium and would like Congress to change the law and allow states to require out-of-state vendors without nexus to collect state use taxes.Simplification and harmonization of state tax systems are likely prerequisites for Congress to consider approval of increased collection authority for states.This report will be updated as legislative events warrant.