Internet Taxes a Touchy Issue in Legislature

Tom Ahern is no anti-technology Luddite.

To stock the shelves at his Latitude 33 Bookshop in Laguna Beach, where Sophocles outsells Danielle Steel, the former computer programmer engages in e-commerce with New York’s biggest publishing houses, ordering books with the click of a mouse.

He believes--strongly--in the power of technology to improve the lives of ordinary Americans and revolutionize the way we shop.

He also believes in taxes--Internet sales taxes to be exact. And when he sees the big boys at Borders and Barnes & Noble setting up Web sites to siphon away more of his business--Web sites that are immune to the California sales taxes that his customers must pay--it makes him rant.

“If they were regular competitors, OK, there is a big pie out there. But these guys are fairly predatory,” Ahern said. “Why should they be getting a tax advantage on me when they have stores a few blocks away?”

That is a question under fierce debate these days in the California Legislature, where lawmakers are struggling to balance the interests of their golden goose of the moment, Silicon Valley, with the economic well-being of small businesses and the local communities they represent.

Because of the property tax ceiling imposed by Proposition 13, California government is highly dependent on a sales tax base that could be significantly eroded by Internet commerce in coming years.

Though such business accounts for just 1% to 2% of total retail sales worldwide, that number is expected to rise to 15% by 2003. One-third of California’s budget coffers and of overall city revenues in the state, come from sales and user taxes.

But as with many issues relating to the so-called new economy, tax-free Internet shopping has become sacrosanct in Sacramento. Efforts to tackle the tax inequities it has exposed are considered political dynamite. Democrats and Republicans are jostling to appear friendlier than their enemies to the new economic gods. And Republicans in particular are warning that any efforts to “tax the Internet” will force business to flee the state.

Most loudly of all, moderate Democratic Gov. Gray Davis has declared the Internet off limits to California sales taxes for the near future. After a meeting with President Clinton and the nation’s governors in February, Davis said technology-driven growth was already generating record revenues for government.

In a large sense, the nation already has a hands-off policy on the issue. The Internet Tax Freedom Act passed by lawmakers in Washington imposed a temporary ban on new Internet sales taxes, and Congress is considering whether to extend the moratorium to 2006.

Nevertheless, the protests of small-business owners such as Ahern, the president of the Laguna Beach Chamber of Commerce, are spurring consideration of several Internet tax-related bills in Sacramento this year, including one by Assemblywoman Carole Migden (D-San Francisco) written specifically to reap tax dollars from the Barnesandnoble.coms of the world.

Legislation by state Sen. Jim Costa (D-Fresno) attempts to push California to work with other states on a unified system of collecting sales taxes, one of the main challenges to Internet taxation. A bill by state Sen. John Vasconcellos (D-Santa Clara) seeks to reexamine the state’s entire tax structure in light of the changing 21st century economy.

Across the ideological divide, Assemblyman Steve Baldwin (R-El Cajon) and state Sen. Ray Haynes (R-Riverside) were working to permanently ban Internet sales taxes, but met with resistance in the Democrat-controlled Legislature. And some Republican lawmakers are arguing that California will eventually have to examine killing sales taxes altogether if it hopes to truly level the playing field and sort out the tax mess.

Migden and Assemblywoman Dion Aroner (D-Berkeley) insist that their bill, AB 2412, is not an attempt to impose a new levy on e-tailers. Rather, they say, it is an effort to make clear that some of them should already be paying.

“It is not an expansion,” Migden said during a debate last week. “It is simply a clarification of who should and who should not be paying taxes.”

Republicans beg to differ. They contend that the bill is clearly a tax increase and should have required a two-thirds vote of the Legislature. After it barely cleared the Assembly, 41 to 30, GOP lawmakers immediately signed a petition protesting the vote.

“Her solution goes the wrong way,” said Assemblyman Bill Leonard (R-San Bernardino). It is “a massive tax increase on the people of California,” said Assemblyman Keith Olberg (R-Victorville).

The dispute goes to the heart of California’s arcane and antiquated sales tax law, shaped in part by a series of high court decisions.

Retailers are now required to collect sales taxes here only if they have physical, brick-and-mortar presences in the state, such as a store or sales office. If they exist in California only through mail order catalogs or cyberspace, they generally do not have to pay the taxes.

To exploit that distinction and avoid the tax hook, Barnes & Noble and Borders have established Web sites that they deem to be independent from the traditional stores they operate. Numerous retailers, from music stores to clothing manufacturers, have done the same.

But amid their spacious aisles and cappuccino counters, the parent bookstores prominently promote the Web sites as an alternative way of shopping for the latest New York Times bestsellers. And if a customer seeks to return a book from Borders.com, critics contend, he is told to visit the nearest Borders outlet. The Migden-Aroner bill would essentially declare such arrangements hollow here, forcing the retailers to collect sales taxes from California customers.

“We have a physical store, we have a Web site, and when it went up, there was no question in our mind that we should pay sales taxes,” said Karen Pennington, a manager of Kepler’s bookstore in Menlo Park and president of the Northern California Independent Booksellers Assn. “We find it unconscionable that Barnes & Noble and Borders are not.”

Rich Fahle, manager of site content for Borders.com, said the company is secure after consultations with lawyers that it is a separate entity that should remain exempt from having to collect taxes from California customers.

Nevertheless, he finds the Migden-Aroner bill troubling because he said it shows that California lawmakers are looking at simplistic solutions to the Internet’s tax problem--solutions that could further handicap competition.

That is because Amazon.com, the massive e-tailer that led all the mega-bookstores into cyberspace in the first place, has no stores or warehouses in California, and thus would remain immune from taxation if the legislation became law.

“The Barnesandnoble.com customer is not going to respond to this bill by getting into his car and going to the local bookstore,” said Assemblyman Tom McClintock (R-Northridge), one of the most tax-unfriendly members of the Legislature. “He is more likely to go to Amazon.com.”