States, Cities Split Over Online Taxes

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States, Cities Split Over Online Taxes

A congressional bill intended to curb online taxes has created a public-policy gap between regions either rich or poor in information technology companies.

States such as California, New York and Massachusetts have moved to curb taxation of the small but fast-growing electronic commerce sector, arguing that a reduced tax will promote faster economic growth and greater tax revenues for state and local governments.

In contrast, lobbyists for many states, cities and counties are fighting to stop members of Congress from freezing state-imposed taxation on the Internet business, saying it will cut their tax revenues and business base.

In Congress, legislators, staff members and lobbyists have rewritten the industry-backed tax freeze bill several times since its introduction last summer by Sen. Ron Wyden, D-Ore., and Rep. Chris Cox, R-Calif.

Senate photo Sen. Ron Wyden, D-Ore.

So far, these objections have delayed consideration of the bill. Neither the House nor the Senate is expected to approve a version before the congressional recess in November. Both the Senate and the House have drafted different versions of the legislation, which establish multiyear moratoriums on online taxes and require industry and government executives to draft a compromise tax plan within seven years.

But if the bill passes, business will shift away from Main Street stores to online merchants, depriving local governments of much-needed tax revenue, said Harry Smith, mayor of Greenwood, Miss., a town of 1,900. "You will see stores close, people lose jobs and there will be less money for public safety and education," said Smith, whose town receives half of its $3.8 million budget from sales taxes generated by stores throughout the state and stores within the boundaries of the town. On Oct. 29, Smith joined lobbyists with the Washington-based National League of Cities to lobby Congress against the bill.

The bill "creates a discriminatory system out there where Main Street business owners will have to pay taxes ... and those who are wealthy enough to afford a computer and hookups with the Internet will be able to purchase their goods and services on the Internet free of taxation," said Larry Jones, a vice president at the Washington-based U.S. Conference of Mayors.

A critical issue is "nexus," which is a legal term defining whether a business has a tax obligation to a local government. Under a Supreme Court ruling, out-of-state businesses without an office or store in a state don't have to collect sales taxes for that state. This decision annually costs local governments at least $3.5 billion in sales taxes that is never collected by mail-order firms, and will cost more as online commerce grows, say opponents of the Cox-Wyden bill.

Executives from the online industry favor the current nexus rules, which free them from monitoring and collecting sales taxes levied by thousands of state and local governments. "We should be encouraging this new medium to continue to develop and thrive and not get caught up in a web of thousands of state and local taxes before anyone has taken a comprehensive look" at the overall tax situation, said David Seldin, a spokesman for Wyden.

Jones, Smith and other state and local officials hope to collect enough data during the Christmas break to show the bill would have a harmful impact on state and local governments. These lobbyists hope to kill the bill or amend it to preserve other taxes - such as franchise taxes or gross-receipts taxes - which they say would be reduced by the Cox-Wyden bill.

"We have gone to great lengths to make sure that the bill makes explicitly clear that it is not intended to affect taxes other than those specifically directed at Internet users," said Seldin. "We are very close [to a final version]. ... We have a good chance of getting the bill marked up in committee before the end of the year," said Seldin.

"The momentum [for final passage] is there. ... Perhaps the most important measure right now is how far we have come as well as what the final stretch looks like," said Jeff Richards, executive director of the industry-funded Interactive Services Association, Silver Spring, Md.

The bill has already won the support of governors from four technology-rich states - New York, California, Virginia and Massachusetts - while legislators in six states have passed laws curbing taxation of online commerce. These six states include New York, California and Massachusetts.

Instead of taxing online commerce, local leaders should be thinking about ways "to make a region as friendly as possible to the Internet," said Peter Harter, policy chief for Netscape Communications Corp., Mountain View, Calif.