Taxes and the Internet

Other posts about economic nexus and the use tax talked about how the Internet changed the way we interact and buy or sell goods and services. Electronic commerce is an emerging issue for states and local jurisdictions who deal with taxation of digital and out of state products. One of the main reasons governments haven’t had more dialogue on this issue is because of federal law.

The Internet Tax Freedom Act (IFTA) (Public Law105-277, Section 1100) was passed by Congress and signed by President Clinton in 1998. The purpose of the ITFA was to give the Internet some time to develop and to protect users from multiple and discriminatory taxation due to its decentralized architecture. The ITFA imposed a moratorium on state and local taxes for Internet access and banned multiple or discriminatory taxes on electronic commerce.  The law also created the Advisory Commission on Electronic Commerce, which analyzed Internet taxation and provided recommendations on dealing with this issue.

Two of these ideas included establishing “bright line” nexus standards for American businesses and placing the burden on states to simplify their own complicated telecommunications tax systems as well as sales and use tax systems to ease burdens on interstate commerce.  To address the issue of tax simplification, the National Governors’ Association and the National Conference of State Legislatures created the Streamlined Sales and Use Tax Agreement, which established a common set of definitions and tax laws regarding electronic commerce for government and businesses.  Currently, there are 24 states that have passed laws conforming to the agreement. Washington joined in July 2008 with the passage of Senate Bill 5089 - Conforming Washington's tax structure to the streamlined sales and use tax agreement.

Scott Peterson, Executive Director of the Streamlined Sales Tax Governing Board (Board), said that the consortium is recruiting mores states and seeking bill sponsors in Congress to create a national system for online sales tax collection and remittances. Remittance means sending the taxes collected to the jurisdiction of the buyer.  Businesses also like the agreement and 1,400 online retailers have volunteered to collect state sales tax. In return, Washington promises not to sue them for back taxes they might have owed.

While the Agreement is a step in the right direction, in order for there to be significant change the answer will need to come from the other Washington.  According to the Board, some studies estimate that states lose billions a year in uncollected sales tax and it could reach as much as $23 billion by this year.  Only Congress has the authority to let states require collection of this revenue.  The Agreement simplifies the complexity of this issue and as more states join, it applies pressure on Congress to act.

Unfortunately, in the current political climate in D.C. where lawmakers are willing to default on our nation’s debt for political purposes, change won’t come easy or quickly.  However, this change needs to happen. Even though the sales tax is regressive, it’s Washington’s primary source of revenue.  By fixing this issue it will help to modernize the state’s tax collection authority for a 21^st century economy.

Two States’ Competing Tax Systems

Washington and Oregon share a very unique situation: two states and one metropolitan region with an economic structure unlike any other in the country.  Oregon has one of the top income tax rates in the country, and Washington has one of the top sales tax rates, making it almost impossible for their tax systems to be any more different . 

To add an additional ripple to the fold, Washington has a controversial sales tax exemption for all Oregon residents.  Washington lawmakers believed that without an exemption, Oregonians wouldn’t shop in Washington since they could shop in their home state and pay no sales tax at all.  All it takes is an Oregon driver’s license and there’s no sales tax charged.  Not surprisingly, businesses on border cities and towns greatly dislike the exemption.  Washington State Representative Jim Moeller told Pew Center on the States, “Sixty-thousand of my constituents pay Oregon income tax and help support their parks and their roads and their health care.  When Oregonians find themselves over here and they need to pick up a shirt or a pair of shoes or whatever, they should help pay for our parks and our roads and our health care just as much as we pay for theirs.”  Oregon isn’t the only state which benefits from the exemption.  Alaska, Colorado, Montana, and New Hampshire among others benefit as well.

To complicate matters, Washington residents are required by law to pay use tax on goods or certain services when a sales tax has not been paid.  However, this practice is widely ignored in the state. See Phil’s use tax post here.

That leads us to the question--does any of this really matter?  Are residents in both Oregon and Washington traveling en masse and moving across one border to the next in order to dodge the tax burden?  Overall, experts have mixed thoughts on the issue. 

Portland-based economist, Joe Cortright believes the disparate tax structures do not play a large role in each state’s economy – even though he believes Clark County is losing $100 million annually in sales tax revenue.  Some factors which support his position are that many Washingtonians live in Vancouver yet work in Portland.  So, they are paying Oregon’s income tax and Washington’s sales tax.  One positive for this group of Washington residents is that homes are cheaper in the border area of Washington.  

Many believe that the various tax structures are not a major determinate of residents’ shopping habits.  People are going to live where they want to live, shop where is most convenient, and work where they want.

A question raised by the article by the Pew Center on the States is not whether the current tax structures of each state is hindering economic growth for the other, it’s whether or not both states are being well served by their respective tax structures.

By now, every reader of this blog should know that Washington’s tax structure, which is so heavily reliant on the sales tax, is one of the most regressive in the country.  And, given Oregon’s boom-or-bust revenue cycles reliant on their income and corporate gains taxes, they’ve got some work to do, too.  The message the authors of this blog have been trying to get across is that Washington State’s tax structure needs to be reformed so that it isn’t so heavily reliant on one particular tax – a volatile one at that.  Oregon faces the same troubles we have – they rely too heavily on one source of tax revenue.  Just like you’d want to diversify your investment portfolio, we need to diversify Washington’s tax structure so that in times of high volatility, we have something to rely on. 

One poignant quote included in the Pew Center on the States article by Randy Miller, an active Portland business leader, “Enlightened people here all feel the same: We need a sales tax.  Enlightened people in Washington feel the same: They need an income tax.  The general public?  Forget it.”

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