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updated 3/12/2005 12:40:48 PM ET 2005-03-12T17:40:48

The forces of Internet taxation are beginning to muster themselves once again in the statehouses of America. Right now ground zero in the fight is in Madison, Wis.

That's where Gov. James Doyle, a Democrat, thinks he's solved his state's budgetary shortfall in part by levying a tax on the goods Wisconsin residents purchase over the Internet.

Under his proposal Wisconsin residents would be required to pay the state's 5 percent sales tax on anything they buy over the Internet, which would include books and CDs from Amazon.com or songs on Apple Computer's iTunes Music Store. The estimated return to the state's coffers? A measly $3.2 million over two years.

That seems hardly worth the effort to add the extra cost that businesses will have to eat in order to come into compliance with the law. And if Doyle gets his way, other states may seek to follow his example and start a new offensive in their long fight over "tax equity" between Internet and brick-and-mortar businesses.

Technically speaking, when you buy something on the Internet, you owe the same amount of money in sales and use taxes to your state and local government as you would if you had bought them on Main Street. The complication — and cost — comes in keeping track of those taxes. States have no real means to do it, and so they leave it to the businesses, most of which ignore it if they can.

If you're buying something online from a company with a physical presence in your state, you will likely pay sales tax. But some vendors get around this by creating separate subsidiaries. You can thank a 1992 Supreme Court decision, Quill vs. North Dakota, for that.

Accounting nightmare
The federal government has so far prevented states and cities — Wisconsin being an exception — from imposing new taxes on Internet sales. This prevented state and local authorities from collecting some $8 billion in taxes in 2003 and could prevent them from collecting $12 billion to $18 billion by 2008, according to economists at the University of Tennessee, who wrote an oft-cited study on the matter. That's the kind of money that gives tax collectors a funny twitch.

But imagine the accounting nightmare — not to mention the cost — of having to keep track of the tax rates of some of some 7,500 tax-collecting jurisdictions.

That's exactly what the multi-state "Streamlined Sales and Use Tax Agreement" is supposed to address. Forty-two states are involved in the efforts to set uniform standards on how Internet and catalog transactions can be taxed. Once the rules are simplified, the thinking goes, states and cities will be better able to convince Congress to lift the ban on new Internet sales taxes and thus tap into a new revenue stream.

But is it really that simple? Apparently not. Another University of Tennessee study looked at the potential revenue impact of the "streamlined" rules on all of that state's 95 counties and 382 cities.

Mixed bag
The results were a mixed bag. The new "streamlined" rules change the way sales taxes are assessed: You pay based on where the goods end up, instead of where the transaction takes place. Buy a TV in a neighboring town, and you pay the tax rate of the town where you have it delivered.

Local governments in 83 counties would have received a total of $44.7 million more in sales taxes in 2003 had the new rules been in place. But governments in another 12 counties would have seen their revenue decrease by a total of nearly $15 million. For small towns and sparsely populated counties, that's real money.

Or rather, it would be if there were a reliable way to get consumers and businesses to cough up on their Internet purchases, which there isn't. This brings me back to Gov. Doyle in Wisconsin, whose administration admits there's no reliable way to enforce the proposed change to the law. Most businesses won't bother to collect, and most consumers won't pay.

Smokers targeted
This can lead to stupid behavior on the part of taxing authorities. Take the case of smokers in New York City who ordered cigarettes online to avoid paying local tobacco taxes. The city — citing a federal law from the 1940s — is now cracking down and hitting those consumers with bills for back tobacco taxes that in some cases amount to thousands of dollars.

As reported this week in USA Today, New York has targeted 3,700 people who ordered smokes online and thus ducked local taxes. Of those 2,010 had paid up to the tune of $680,000, a little more than half of what's owed. That's a rounding error in a city that will collect $29 billion in taxes this year.

This makes me wonder if all this effort to collect taxes on Internet purchases is worth it. As huge a force as e-commerce may seem, it's still only a small part of the U.S. retail economy, accounting for $18.4 billion or 2 percent of the $938.5 billion in retail sales in the fourth quarter of 2004, according the Commerce Department.

If Internet sales are ever going to amount for a bigger slice of the economy, irritating tax schemes — no matter how "streamlined" — aren't going to help.

© 2012 Forbes.com

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