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Collecting E-Commerce Taxes Door-to-Door

by Brian McConnell
08/05/2004

For about a decade now, we've successfully avoided the subject of taxing electronic commerce, for good reason. Sales tax has traditionally been the domain of state and local government. Forcing electronic storefronts, especially small mom-and-pop operations, to collect and submit taxes to dozens of different tax collection agencies would be an unreasonable burden. With this in mind, regulators gave online stores a free pass, which has lasted nearly a decade now.

For the most part, online stores have been treated the same way as mail-order catalogs, which are not obligated to collect sales taxes for jurisdictions where they do not have a physical presence. This was one of the drivers behind the growth of mail-order catalogs and their electronic brethren. Consumers would net a 5 to 10 percent discount by avoiding local sales tax--not a big deal for small transactions, but for purchases such as a computer, it amounts to a substantial discount.

The rationale for taxing e-commerce is essentially one of fairness. Storefront businesses are expected to collect local and state sales taxes, with few exceptions. Many of these businesses are small, locally owned shops that also do not benefit from the economies of scale afforded by centralized warehouses and supply-chain automation. Giving online stores a tax-free pass effectively discounts everything they sell by 5 to 10 percent.

The objection to taxing e-commerce, apart from the tech industry's generally libertarian bent, is also based on fairness. Large businesses can hire experts to write code to automate the process of calculating, collecting, and disbursing sales taxes to an arbitrarily large number of tax agencies. For small, locally owned web stores, many of which serve specialized niche markets, that would be an unreasonable burden. Those businesses would be forced to either spend inordinate sums of money on customized software development, or to hire outside service providers to handle the task for them. In both cases, this further increases their cost of doing business and tilts the scales even further in favor of larger businesses.

Some have argued for a national e-commerce tax that would be levied on all e-commerce transactions. This nationally collected tax would then be disbursed to states based on a variety of formulas. The idea has not been welcomed warmly, in part because it overrides what has traditionally been a decision of local governments, and in part because of the fear that a national e-commerce tax will morph into a national sales tax on everything. The federal government is not exactly the most efficient or responsive entity in the world. People are right to be wary about granting it more authority than it already has.

However, there might be a simpler, cleaner solution, which is simply to require delivery services to collect local taxes and to embed this cost in their delivery fees. This is not a new idea; DHL has been in the business of expediting international shipments for many years. From 1996 to 1998, my old company PhoneZone sold a lot of telephone systems and components to customers overseas. I still remember shipping one Altigen system (a Windows NT-based phone system) to Ulan Bator, Mongolia. We never had to worry about calculating and paying tariffs in advance. DHL handled it, and it collected those fees from the customer. All we had to do was declare the type of goods and their value, and the courier did the rest. Without this service, there was no way we could have done substantial international business, which at one time accounted for about 50 percent of our revenue.

Couriers could play a similar role in collecting sales taxes on goods shipped within the United States and the NAFTA free-trade zone. The delivery business is now dominated by a handful of highly automated companies that already deal with complicated logistics. Asking them to collect local and state sales taxes is something that would be relatively easy for them to do, and relatively easy for tax agencies to police.

One of the benefits of such a system is that, apart from being straightforward to implement and making life simpler for web stores, this policy is naturally enforceable. Didn't pay the tax on an item? No delivery until you pay it (and in most cases, the tax would be embedded in your shipping charges). Tax collectors could easily detect fraud by spot-checking stores to see whether they were understating the sales price to couriers.

When I was running PhoneZone, one of our biggest headaches was calculating sales tax on intrastate purchases within California. Each county has a slightly different tax rate. At the time, the highest rate was 8.5 percent. We got tired of trying to calculate the tax for each county (zip codes worked most of the time, but not always). So we just charged everybody in California the highest rate. That way we wouldn't come up short when the tax man came around to collect his piece of the action. I would have happily signed up for a shipping service that freed us from dealing with this, just as I signed up for a payroll service that took care of all the various payroll taxes and their associated paperwork.

If you think about it, a system like this makes a lot of sense. Virtually every web store is dependent on couriers to deliver products to customers. Couriers deal with much more complicated logistics problems, such as calculating the most efficient routes for deliveries (the so-called traveling salesman problem). One simple rule would solve the e-commerce tax problem: simply taxing the recipient based on the local taxes at the point of delivery.

Of course, there will be ways to cheat the system. Web stores could systematically understate the value of products (and risk being caught and fined in spot checks by regulators). More likely, customers who live close to state boundaries would have shipments sent to friends across the state or county line. For example, someone in Maryland might have deliveries made to a friend in Delaware to save a few bucks (just as people in "dry counties" drive across county lines to buy booze). This makes sense only if the amount of money saved justifies the time and gasoline spent to travel to pick up the goods. Usually it won't make sense to do this, especially for low-cost items like books, nor will it make sense for heavy, bulky items.

Some people argue that electronic stores already pay a hidden tax in the form of shipping charges. You can drive over to your local store and avoid courier charges. Or so it seems, except that the goods you pick up at your local store had to be delivered. The shipping charge to the store is simply embedded in the local store's price, which when combined with local taxes makes the local store look even more expensive compared with its electronic competitors.

In the end, this is about fairness, particularly for small, independently owned businesses, which are already at a disadvantage compared with large, multinational firms. It is difficult to stay in business when you are competing with companies that can undercut your prices by 10 or 20 percent and that offer what amounts to a 5 to 10 percent discount courtesy of the government. Having been a small-business owner for more than a decade, I am an ardent believer in free markets and minimizing government interference in commerce. However, the money for local government has to come from somewhere, and if I am forced to collect sales taxes, I don't see why much larger companies that can already undercut my prices should be given de facto tax-exempt status.

This might not be a perfect solution, but at some point we will need to treat e-commerce equally compared with other businesses. Perhaps this is an option that should be considered. The government was wise to give e-commerce a free pass from taxes for many years. This allowed the industry to develop free from regulation and taxation. However, e-commerce is a maturing industry and is no longer a fragile, nascent market in need of protection.

Brian McConnell is an inventor, author, and serial telecom entrepreneur. He has founded three telecom startups since moving to California. The most recent, Open Communication Systems, designs cutting-edge telecom applications based on open standards telephony technology.


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