California's missing online money

Californians pay the nation's highest sales taxes, yet by one measure they still don't pay enough. Unless taxpayers come forward on Wednesday in an outpouring of guilt or good citizenship and send the Franchise Tax Board last year's 7.25% sales tax on almost everything they bought over the Internet from out-of-state sellers -- and if the past is any guide, most won't -- California will again be shorted by more than $1 billion in sales taxes owed. That's a significant chunk of the state's budget.

There is a widely held misapprehension that the Internet is a tax-free zone. The proof seems to come at the end of every online shopping session, when the items in the imaginary cart are tallied and the only added charge is shipping. No sales tax. Shoppers who are spooked by the current recession and by the precipitous increases in sales tax rates at stores on April 1, to be followed in Los Angeles County by another increase that will bring the sales tax to a total of 9.75% on July 1, are likely to seek escape in the cyber-mall to an even greater extent.

But they're kidding themselves. Every book or appliance bought through, every autographed Manny Ramirez jersey or Hannah Montana lunch box bought from a vendor on EBay, carries the same tax obligation as if the item were purchased in a brick-and-mortar shop down the street from the buyer's desktop. It has nothing to do with the Internet Tax Freedom Act, which blocks states and local governments from taxing Web access but doesn't touch sales and use taxes on goods.

Here's how it works: Sellers located in California add sales tax to purchases made by Californians, and that's the case regardless of whether the purchase is made in person, by phone, through the mail -- or over the Internet. Sellers outside of California don't. The tax liability remains, but responsibility for calculating it and remitting it to the state shifts to the buyer, who is supposed to add up all Internet and other out-of-state purchases made over the year and add a "use tax" in an amount equal to what the sales taxes would have been had the purchases been made here.

The use-tax line on the Franchise Tax Board's income tax form doesn't explain much. So Californians who buy over the Internet from out-of-state sellers end up feeling like either suckers or cheats -- suckers for "voluntarily" adding use tax, because state tax collectors probably would never know about the purchases, or cheats for not adding the tax.

Libertarian visionaries describe a day in which the Internet makes state and local governments obsolete, along with all their taxes, services and regulations. But that day isn't here. Even if buyers abandon shopping districts for the cyber-world, the costs of maintaining, cleaning, policing and managing cities and states remain the same. Collecting taxes on sales from out-of-state sellers makes a certain (although perhaps lesser) degree of sense because use taxes are broad-based, relatively easy to collect -- andneeded. As collections drop, so must basic government services -- or the state, counties and cities must look elsewhere for revenue.

That's why California must modernize the way it collects taxes. The state provides education, water systems, transportation, policing and other services based on tax revenues produced by a 20th century economy that emphasized retail goods sold in the same neighborhood in which they were consumed. Things have changed; it's now a service economy, and goods purchased here may be sold anywhere in the world. California has to either downsize the scope of protections and services for its residents, or update what and how it taxes. The Commission on the 21st Century Economy is studying the dilemma and is to recommend changes in the state's tax structure by July 31.

Other states are in a similar predicament. Last year, New York Gov. David Paterson signed into law what's become known as the "Amazon tax,” requiring online sellers to calculate and remit sales taxes on goods sold to New York residents instead of relying on the shoppers' very spotty record of sending in their use taxes. sued, arguing that the law runs afoul of a 1992 U.S. Supreme Court ruling that bars such requirements for mail-order firms that don't have in-state operations. Amazon lost but is appealing, so lawyers continue to argue, for example, whether in-state computer servers are sufficient contacts.

Sellers don't dispute that the tax is owed, but they fiercely resist the obligation to calculate and remit it, noting the cost and administrative headaches of dealing with 45 different state tax schemes (a handful of states have no sales tax). One response has been the Streamlined Sales Tax Project, which seeks to reach uniform taxes and rules among the states. Most states have joined; California has not. Online sellers are divided on the project, and there is good reason to believe that some sellers prefer the status quo because they enjoy the advantage of charging no tax, and buyers remain unaware that they owe it.

Attempts by states to collect taxes that have long been owed but seldom paid can seem like heavy-handed government grabs that hit otherwise law-abiding citizens. But Californians owe it to themselves to be aware of the consequences of their tax laws. What they don't pay out of one pocket may have to be paid out of another, unless we're ready to ask government to do less. But that too can carry costly consequences.