Thinking Straight about the Taxation of Electronic Commerce: Tax Principles, Compliance Problems, and Nexus

The Internet Tax Freedom Act (ITFA), which imposes a moratorium on state and local taxes on Internet access and prohibits "multiple and discriminatory" state and local taxes on electronic commerce, has been extended until November 1, 2003, but the debate on whether and how to tax electronic commerce has not ended. This paper is intended to assist clear thinking about the taxation of electronic commerce. Under an economically neutral sales tax, all sales to consumers would be taxed, all sales to business would be exempt, and sales by local merchants and by remote (out-of-state) vendors would be taxed equally. A compliance-friendly sales tax would exhibit substantial simplicity and interstate uniformity in the tax base, legal framework, and administrative procedures. Existing sales taxes exhibit none of these characteristics. Many sales to consumers are exempt, many sales to business are taxed, and, because of the Supreme Court decision in Quill, which is based on the complexity of the system, many sales by remote vendors are not taxed. The system is extremely complex, in large part because there is essentially no uniformity from state to state. Under the Streamlined Sales Tax Project the states have recently begun serious efforts to simplify their sales taxes, by making them more nearly uniform, in hopes of gaining Congressional or judicial reversal of Quill. These efforts would substantially simplify the system, but would not achieve economic neutrality, as many sales to consumers would remain exempt and many sales to business would still be taxed. Moreover, differences in tax bases, legal frameworks, and administrative procedures would remain. Technology (lookup tables that categorize products as taxable or exempt in each state) might be able to handle differences in tax bases, but not those in legal structures and administrative procedures.