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Bolster State Finances by Stopping Internet Sales Tax Evasion

Taken on a state by state basis, the losses incurred to the U.S. from the loss of out-of-state sales taxes are staggering. Alabama expects to lose $1 billion in sales and use taxes during the next five years; Arizona won't pocket $210.7 million over the next decade; Indiana's hit is $40 million to $114 million annually; and in 2012 alone, Pennsylvania may lose $250-400 million. Michigan lost over $400 million in 2010. And so on.

All told, states and localities lose about $24 billion a year in revenue from untaxed Internet sales, according to National Retail Federation. These losses are growing at a time when public workers, including many school teachers, are being laid off in record numbers. And it's not just money that is lost: brick-and-mortar stores, like bookstores, are disappearing from communities as consumers buy cheaper products online, untaxed.

How did this happen? A big, fat, costly loophole in Quill Corp. v. North Dakota, a 20-year old Supreme Court decision:

North Dakota sent a notice to Quill Corp. that it owed use tax (a companion tax to the sales tax) payments for purchases that North Dakota residents had made through Quill Corp.’s catalogue. Quill responded that it did not have nexus in North Dakota because it had no physical operations or employees and hence did not have to collect North Dakota use tax on sales made to North Dakota customers.

The Supreme Court sided with Quill, ruling that a taxpayer must have a physical presence in a state in order to require collection of sales or use tax for purchases made by in-state customers. Physical presence means offices, branches, warehouses, employees, etc. The existence of customers alone (i.e. economic presence) did not create sufficient nexus under the Commerce Clause for North Dakota to impose a sales tax collection burden on Quill Corp.

The exemption from sales tax has particularly been a boon for Amazon, founded two years after the decision, and the 800-pound retailer is understandably trying to hold on to this advantage. Last June, after Connecticut Governor Dannel Malloy "signed a budget bill that includes a so-called 'Amazon tax,' which aims to raise $9.4 million by forcing online retailers to collect sales taxes through affiliates," Amazon informed the Department of Revenue Services that "the company is not obligated to abide by the law because it does not have a physical presence in Connecticut." Those two words, physicial presence, is what separates Connecticut from a windfall.

Other states all around the country, hungry for revenue, are also trying to collect the Internet sales taxes owed to them -- and also running into legal obstacles.

Which brings us to the good news. Last year, a pair of U.S. representatives introduced legislation to close the loophole. The bill, National Journal reported, "would authorize states to force retailers to collect sales taxes, even online firms, and even when their customers reside in states where the companies have no physical presence." That's why last week's news -- that the Consumer Electronics Association, which has 2200 member companies, has thrown its weight behind Senate legislation to close the loophole -- is so heartening:

CEA Chairman Randy Fry, co-founder and president of California-based Fry's Electronics, is in Washington this week to press for action on a bipartisan Senate bill offered by Sens. Mike Enzi, R-Wyo., and Dick Durbin, D-Ill., that would let states require online retailers to collect sales taxes from out-of-state customers. There would be one caveat - states would have to simplify tax structures or sign on to a tax-simplification project launched in 1999 by a group of states.

The hope is that CEA can replicate the success they enjoyed earlier this year, opposing the Stop Online Piracy Act the Senate's Protect IP Act.

One thing is clear: Right now, there is probably no easier way for Congress to help strapped state and local governments than to empower them to collect billions in sales taxes that are rightly due to them.