States Look to Enforce Internet Taxes to Close Budget Gaps

State governments across the country are laying off teachers, closing public libraries and parks, and reducing health care services, but there is one place they could get $23 billion if they could only agree how to do it: Internet retailers such as Amazon.com.

That's enough to pay for the salaries of more than 46,000 teachers, according to the U.S. Bureau of Labor Statistics. In California, the amount of uncollected taxes from Amazon sales alone is roughly the same amount cut from child welfare services in the current state budget.

But collecting those taxes from major online retailers is difficult.

Internet retailers are required to collect sales tax only when they sell to customers living in a state where they have a physical presence, such as a store or office. When consumers order from out-of-state retailers, they are required under state law to pay the tax. But it's difficult to enforce and rarely happens.

That means under the current system the seller is absolved of responsibility, buyers save 3 percent to 9 percent because they rarely volunteer to pay the sales tax, and the state loses revenue.

With sales tax revenue slumping more than 30 percent in most states between 2007 and 2010, lawmakers across the country are grasping for ways to collect those unpaid taxes. Retailers and lawmakers in several states have proposed ways to solve the problem, some with more support than others.

"The problem is that some out-of-state e-retailers openly flaunt the law, arguing that it doesn't apply to them," said Texas state Democratic Rep. Elliot Naishtat, who has offered a bill to require more Internet sellers to collect Texas sales tax. "It's about potentially generating hundreds of millions of dollars for our state."

Texas cut $24 billion in state services to cover its revenue shortfall. That included decisions not to fund the expected growth in the number of public school students and the expected growth in the caseload for Medicaid, the health care program for the poor and disabled.

Internet retailers cite a 1992 U.S. Supreme Court decision involving catalog sales, Quill Corp. v. North Dakota, which ruled that states could require only companies that had a physical presence within the state to act as tax collector.

To get around the ruling, some states are expanding what it means to be physically present. For example, an online retailer hiring a marketing firm or owning a subsidiary inside the state would qualify under definitions adopted in some states.

In February, the Texas comptroller demanded that Amazon.com pay $269 million in back sales taxes because a subsidiary operated a warehouse near Dallas. Amazon is appealing the order.

Last year, New York enacted a law that said Internet retailers' practice of paying commissions to marketing agents based within the state constituted a presence. Arkansas, Colorado, Illinois, Rhode Island and North Carolina quickly followed with similar laws.

Bills are pending in Arizona, California, Florida, Hawaii, Massachusetts, Minnesota and Pennsylvania. Texas lawmakers passed such a measure, but Gov. Rick Perry vetoed it. Now legislators are trying to resurrect the bill by attaching it to a larger budget measure. The matter is now before a conference committee.

California estimates it loses at least $200 million a year in uncollected tax from online sales, $83 million from Amazon.com alone. A bill that has passed the state Legislature would force Seattle-based Amazon and others to collect that tax from California residents.

Amazon, Overstock.com and other big Internet retailers cite the Quill decision as their primary defense against collecting sales taxes, but they also argue that collecting tax in the District of Columbia and the 45 states where a sales tax exists would be extremely complex and expensive.

"There are over 8,000 taxing jurisdictions in the United States," said Jonathan Johnson, president of Overstock.com, which has offices only in Utah. "We think it's wrong that states are trying to cause out-of-state retailers to be their tax collectors."

After all, Johnson said, these retailers do not use any state services where they don't have offices.

To avoid having to collect sales tax, Amazon threatened to close its warehouse in Texas, cut off marketing affiliates in Illinois and North Carolina and sued New York claiming the law there is unconstitutional.

Earlier this month, Amazon severed ties with website affiliates in Connecticut after the governor signed into law a state tax on online purchases that is expected to raise $9.4 million.

The movement by states to force online retailers to collect sales taxes is more than just an attempt by government to get more money. It also highlights a rift in the business community.

Traditional retailers are complaining loudly to their elected officials, saying the current structure creates an unfair playing field.

Wal-Mart, Target, Best Buy, J.C. Penney, Sears and other traditional retailers have formed The Alliance for Main Street Fairness to push for more stringent tax laws on Internet retailers. Brick-and-mortar stores saw sales plunge 9.1 percent between 2007-2009, while online merchants saw sales rise 4.8 percent, according to the latest data available from the U.S. Census Bureau. Wal-Mart's comparable store sales were down nearly 1 percent in 2010.

The alliance is pushing to expand the definition of physical presence, state-by-state, to force big online retailers to collect state sales tax.

When Texas lawmakers took up such a bill, most of the testimony came from owners of small businesses. Gregg Burger, the general manager of Austin's Precision Camera, complained that customers come into his store to inspect the products, but then go online to buy them to avoid the sales tax.

"We get people all the time who come in, talk to a salesman for 15 minutes to half an hour ... and then go, and we know they are going to buy it online because they can save money. In theory, they are stealing our time," Burger said. "We're losing at least 15 percent to online, out-of-state, so we're losing anywhere between $3 million and $5 million a year in business."

While state laws would help, Burger said he would like to see a national solution.

"We should be picking on everyone who ships into every state," he said.

But local Internet marketers that link to major Internet retailers complain the laws would hurt them. In Illinois and other states where such laws have passed, Internet retailers cut their ties with local web sites.

Johnson, of Overstock, said the traditional retail giants are just getting a taste of their own medicine.

"Local retailers complained that the big-box stores were coming in and taking their business, and the Wal-Marts of the world said they had a better business model and the world has changed," Johnson said. "Today, the business model has changed and we can take cost out of the supply chain by doing business the way we do on the Internet. And for Wal-Mart, of all people, to be saying it's not fair that Amazon and Overstock can't be forced to be tax collectors is ironic."

Representatives for Wal-Mart and Target declined to comment for this story.