States, Software Makers Link on Online Tax Issue

As lawmakers near a decision about whether to extend a moratorium on new Internet taxes, Silicon Valley may have found a way to eliminate a major obstacle to their collection.

For years, opponents of Internet taxes have maintained that the existence of more than 7,000 different taxing authorities throughout the country made it too cumbersome for merchants to efficiently collect sales taxes from online purchases.

But in recent weeks, about two dozen states--including Utah but not California--have been working in cooperation with such companies as IBM Corp., Taxware International Inc. and Esalestax.com to develop technology that can identify online sales on which taxes are due, collect that tax and distribute it to the states to which it is owed.

Their approach relies on software that keeps track of the sales tax rates among jurisdictions and adjusts for quirky rules such as those in New York, where until a few years ago, sales taxes were imposed on large marshmallows as snacks but treated small marshmallows as nontaxable food items.

The technology would require the participation of merchants, who would transmit shipping and product information to a database that would calculate and collect sales taxes based on the credit card address of the buyer. If retailers balk, the system could also be implemented through state legislation or agreements among participating states. In any event, supporters say federal action would not be needed.

“It’s definitely part of a viable solution,” said Frank Shafroth, director of state and federal relations at the National Governors’ Assn., a Washington trade group. “When you buy an airline ticket online, software is important in figuring out what federal taxes are owed on the airline ticket. . . . That’s the kind of thing we’d like to do.”

States with sales taxes have the authority to collect the levies on online purchases despite a three-year moratorium on new Internet taxes. But until now, enforcement has been problematic.

The federal moratorium, which ends October 2001, bars state and local governments from imposing taxes specifically on Internet service or commerce. But sales taxes that are not targeted at online commerce--such as those on companies that also offer catalog sales--are allowed.

The Advisory Commission on Electronic Commerce, a 19-member panel created by Congress last year to study the tax issue, is scheduled to vote Monday and Tuesday whether to continue the moratorium or make other changes.

A recent study by Forrester Research estimated that about $525 million in online sales taxes go unpaid, compared with between $1.5 billion and $1.7 billion in unpaid taxes on mail-order catalogs. Forrester estimates that online shortfall could rise to as much as $5 billion by the year 2004.

Sales taxes are the single largest source of revenue for most states and local governments--about $189 billion in 1998--and experts say the skyrocketing growth of online sales could take a huge bite out of state and city budgets--though probably not for another six to 10 years.

Opponents of Internet levies say keeping e-commerce tax-free would help the economy continue expanding. But Main Street merchants fear that e-commerce may force them out of business.

The most avid proponent of online sales-tax collection software, Taxware International, initially drew little response when the company demonstrated the technology in December at a meeting of the Advisory Commission on Electronic Commerce.

But since then, state officials have become intrigued.

They initiated talks with several vendors--including IBM Corp., Vertex Inc. of Berwyn, Pa. and Esalestax.com of Englewood, Colo.--to gauge their interest in modifying their software products to facilitate sales tax collection. And they have rounded up support from as many as 25 states to modify their sales tax laws to accommodate the new technology, said Duncan, of the Federation of Tax Administrators.

Still, other software developers remain leery about becoming embroiled in the Internet tax debate, saying technology alone won’t solve the problem.

“The technology is there . . . but there’s way too much sensitivity around the discussion for us to take a position,” said John Sappey, a spokesman for Vertex. “It’s not at all clear that [technology alone] is going to solve the issue. . . . There is going to have to be a political solution.”