How to Implement a National / Internet Sales Tax

This is a subject I’ve talked about before, but this time I want to dig into possible solutions and posit a solution that might actually work. The problem, of course, is that municipalities, cities and states are missing out on billions in tax revenue because of online stores that don’t charge sales tax because they don’t have what’s called a “nexus” in the biz, a physical brick-and-mortar location in that particular state.
It’s insidious: if I can buy a book for $20 at the local independent bookstore, I’d also be contributing (for lack of a better word) 8.31% sales tax, $1.66, split across the city, county and state. Multiply that by millions of transactions every day and it’s a huge amount of money. If I instead used the handy Amazon.com app on my phone and bought the book online, that $1.66 wouldn’t make it into the city coffers, etc.
Just focusing on Colorado, our state sales tax rate is 2.9%, and “in addition to its own sales tax, the state collects sales taxes for many Colorado cities and counties and several special districts.” There’s also an existing Consumer Use Tax that’s intended for when a regular sales tax isn’t collected (like those online purchases). The state consumer use tax rate is the same as the sales tax rate: 2.9%.
There are approximately 43,000 zip codes in the US, so let’s assume that each zip code has a different taxation rate (I’m sure it’s easier than that, though) and that each zip code uniquely describes a unified sales tax zone, factoring in cities, counties, special taxation districts, and all the other complexities of taxation.
Sounds like a lot. 43,000 tax zones. But that’s why we have computers, right? So here’s what I suggest for fairly calculating and distributing an Internet-based sales tax:
Internet sales tax should be calculated at 5.00% of aggregate transaction value, based on billing zip code.
That 5.00% would be split 50/50 between regional and Federal coffers, so if I buy a $2000 HDTV from Amazon.com, I’d be charged a 5% online sales tax by the merchant, and they would then make monthly payments to a federal Internet sales tax agency. That agency would analyze and divide out the money and issue payment to each state proportional to the number of aggregated billing zip transactions for that time period. Each state would then split out its payment to each of the specific zip code regions.
In the case of my mythic HDTV, that $2000 purchase would have $100 tax added on, all of which would be sent to the Feds. They would keep half ($50) and send the other half to the State of Colorado, which would probably split it again in half, sending $25 to the department of revenue in my community and keeping $25 for the State budget.
Easy enough and we could then do away with the goofy “consumer use tax” which I suspect a tiny percentage of people are even aware of, let alone pay diligently each year.
By pushing the burden onto the merchant, it also frees up audits and dramatically increases the percentage of transactions overall that actually produce tax revenue when they file their taxes.
Can it work? Let’s dig into it a bit with some sales data that a local online merchant shared with me, aggregate sales data by transaction amount and zip code…
The data has 11,962 records, representing 6,652 unique zip codes and an aggregate transaction amount of 118,167.75. That means we’re talking about lost Online Sales Tax revenue of $5,908.39, or $2,954.19 in Federal sales tax. If we assume that those 6,652 zip code zones represent an uneven split of 40 states, that means that, roughly, each state also missed out on about $75 in revenue from this individual merchant.
Not a lot of money, I grant you, but multiply it by a few thousand — or more — and you start to see how much of an impact this simple proposal could have on city, state and Federal budgets. It really could be the difference between city centers collapsing from lack of retail sales tax to cover infrastructure costs and cities doing well.
It also levels the playing field between brick-and-mortar (the lifeblood of every economy worldwide) and the upstart online sites, an important factor to consider as we move further into the 21st Century.
There’s no going back. I’m not rallying for a return to an offline world as we had in the 1950s, or even further back before Sears Roebuck changed the dynamics of an expanding West by introducing catalog shopping. On the other hand, like it or not, sales tax and usage taxes are the grease on the machine of our economy and form of government. Watching it dry up is just creating a greater economic disparity between the “haves” and the “have nots” and crippling our infrastructure services like firefighters, police, street maintenance, and parks and recreation.
But that’s just my view, and my proposal. What’s your take on this, dear reader?

10 comments on “How to Implement a National / Internet Sales Tax

  1. How would you handle states that don’t have taxes? There is no sales tax in Alaska unless a municipality chooses to have one. Only a few do. Personally I would object to paying taxes online when I don’t pay them locally and the federal government already gets a lot of my money.

  2. Why not push it even further back…since you cannot take payment online without a merchant account or paypal…etc…why not make those institutions (that have the money to cover the overhead) responsible for capturing and paying the sales tax? They could aggregate the data too. This way, it takes the burden off the small business owner who is just trying to get his/her new online store off the ground have to jump through another hoop of reporting and paying each individual transaction to the government. People often think of big companies like amazon or best buy when they consider stuff like this, but what about the person who’s just trying to sell some T-shirts (or something) through their website?
    5% would be a decent rate though. Part of the challenge of adding too much sales tax is that typically, what you don’t pay for in tax online, you often pay for in shipping…so if you make the tax too high, you actually end up punishing online businesses.
    One other thing to think about. What about if I buy something from Canada? What if someone from Canada buys something from me here? Just things to think about.

  3. This is why it’s an interesting conversation: it’s not as easy as it seems to do something that’s fair and Constitutional (remember that clause about no taxation without representation? yeah, I assume it’d apply to a region w/ no sales tax suddenly having to pay a national sales tax too).
    Judi, if you buy something from BestBuy.com or Target.com, companies that have a retail presence (and therefore tax nexus) in Alaska, they already know not to charge you an online sales tax, right? That being the case, it’d be easy enough to isolate and identify those zip code groups that represent regions that currently do not pay sales tax and retain their status.
    Adam, I like the idea of Paypal and related gateways collecting the tax, but the problem I foresee is how they know who should or shouldn’t actually pay tax? Also, to whom do they send the tax collected?

  4. Adam has a great idea, I’m surprised I haven’t heard it before! I’ve long been an opponent to Internet sales tax, primarily because although most people say it’s “simple” programmatically, the “simple” things never turn out that way, somehow. It would be a lot like PCI compliance… it’s very expensive and I bet a lot of small merchants still aren’t compliant, even though they can be fined into the stoneage if they are caught.
    Small e-commerce merchants (including myself) use third party software. For us to be able to manage this tax affordably, all third party e-commerce software companies would have to implement these changes. Then we’d have an additional labor cost and overhead associated with running the reports, filling out and filing the paperwork, etc.
    I already have a hard time just managing one state sales tax, much less all 50.
    And that doesn’t even address the actual fundamental problem with the national Internet sales tax… typically a “sales and use” tax is mean to compensate a local and state government for the “use” of their roads, utilities, fire and police protection, and other municipal services while shopping in said locale. Internet purchasers never visit that location, or use any of their services.
    Catalog retailers have always been exempt from paying sales tax outside of any state they operate, and so far Internet retailers have been afforded the same protection. I honestly don’t see a difference.

  5. I am a very unhappy SkyMall Vendor, and one thing I am curious about is……..how can they charge sales tax for every item sold, if they are based ONLY in Phoenix……and my product is shipped out of California? Shouldn’t they only be able to charge the tax for Arizona sales—if they are legally considered the seller—or California tax, if I am considered the seller????
    thanks.
    Jo Anne

  6. Thanks for addressing this topic — it’s great to hear someone point out just how much money states are losing because sales tax isn’t collected on online purchases. And I couldn’t agree more that we have to level the playing field between bricks-and-mortar retailers that have to collect sales tax and online retailers that don’t.
    But I think you’re making the solution much too difficult. Here’s why:
    – Sales tax is managed by the states, so there is no reason to create a federal agency to deal with online sales tax and no reason to send half of sales tax revenue to the federal government.
    – There are actually just over 13,000 tax jurisdictions in the U.S., not 43,000. That’s still a lot of jurisdictions, of course, but the Streamlined Sales Tax initiative has already developed a way to reduce the costs and complexities of collecting sales tax for multiple states. Online retailers that are collecting sales tax for Streamlined member states are able to use standard definitions, reporting procedures, and sales tax data — it really makes it much easier to collect sales tax for multiple states.
    – There are comprehensive sales tax management services available for online retailers. I actually work for a company, FedTax.net, that provides one: TaxCloud. TaxCloud handles every aspect of sales tax management for retailers — from calculation to collecting to remitting, and including handling any audits and preparing state-by-state returns — and it’s available at no cost to retailers.
    In other words, all the systems are already in place to make it easy for online retailers to collect and remit sales tax. All that’s needed is federal legislation allowing states to require them to. That legislation, the Main Street Fairness Act, is likely to be introduced in Congress soon. So if you agree that online retailers should collect sales tax, please support the Main Street Fairness Act!

  7. @Brandon Eley, I don’t know what third party software you’re using now, but with TaxCloud you wouldn’t have to worry about creating reports, filing returns, etc — it does all that for you. We’d be glad to work with you and/or your shopping cart system to implement TaxCloud (and in fact, it’s already pre-implemented with many shopping carts) so that you don’t have to worry about any of this. Even if you just want to collect for a single state, we can take care of all the administration for you — for free.
    Also, to correct a small misunderstanding in your comment: Online sales tax is “destination-based,” which means that the sales tax goes to the region where the item is shipped, not where the online retailer is based. So if you live in California and buy from an online retailer based in Oklahoma, if the retailer collects sales tax, it would be at the California rate and would be remitted to California. So the tax you’re paying is ultimately being used for the roads, utilities, etc. that you’re using.
    And, sorry, one more thing: You mention that you don’t see a difference between catalog retailers, which have always been exempt from paying sales tax outside of their home state, and online retailers. I agree that catalog and online retailers should be treated the same. However, the dramatic increase in remote sales due to the rapid growth of online shopping has resulted in two things: 1) more sales tax is going uncollected, and 2) technology has advanced to the point where both catalog and online retailers can collect sales tax for any state easily and affordably. It’s just not overly burdensome anymore.

  8. I don’t think you’re quite right with that, Erin, because tax is based on the billing address, not the shipping address. To wit: if I live in California but send something to someone in Alaska as a present, I still have to pay CA sales tax if the merchant has a tax nexus in the state. Right?

  9. A) If sales tax is based on billing, and if zip codes that currently don’t have any sales tax charged will maintain their free ride (see Alaska comment earlier) , then I bet there would be a load of people changing their billing address on their credit card to some Alaskan zip code. I know I could do it today on my capital one card – 1) I have paperless billing, 2) there is no “proof” of residence needed to change. Billing addresses are sort of trivial nowadays.
    Just another wrinkle that will need to be worked out.
    B) I’m with Adam on his idea – it would be easier to just increase the monthly bill I pay to my gateway provider or (though I hate to say it, because they get enough money) even easier to just let Visa/MC/Paypal take out the tax and handle it all. No offence TaxCloud, but why do I want to go through the hassle of adding more middleman software to my cart? Sounds like more things that can break.

  10. I’d argue for the FairTax plan where the ONLY tax is sales tax. It replaces income tax etc… there’s a good Wikipedia article about it… But it’s been discussed for years with no progress.

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