Taxing Online Sales: A State Deficit Fix?

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NEW YORK (MainStreet) — The vast majority of states are projected to have budget deficits for the 2012 fiscal year, forcing some to consider fixes ranging from hiking income taxes to rethinking pension and health care plans for public employees. But one new study argues states could significantly reduce their deficit just by imposing an online sales tax.

If every state in the country taxed online sales, it would raise $10 billion nationwide and cut the average state’s budget deficit by 17%, according to a report from Extrabux, a price comparison website. And for some states, the gains would be even greater.

Iowa, which is projected to have a budget deficit of $186 million next year, could bring in about $113 million by imposing an online sales tax, cutting its deficit by 61%. Likewise, Indiana could bring in $230 million from online sales and reduce its deficit by 85%.

“It’s important to recognize that taxing online sales at the national level wouldn’t just fix a small percentage of the budget deficit – 17% is a very big number,” said Jeff Nobbs, co-founder of Extrabux. “It may not be the best thing for websites like ours to have all online sales taxed, but it’s the fairest thing to do and it would make a big difference.”

Indeed, several states have begun to tack on sales tax for online purchases in the past few years, including North Carolina, Rhode Island and most recently Illinois, with the goal of raising revenue and making it easier for bricks-and-mortar businesses to compete with e-commerce sites.

But even in these states, there is generally a big gray area for online sales taxes because many of the biggest online retailers like Amazon are located out of state and can’t be taxed directly. Instead, states resort to taxing e-commerce companies who partner with affiliate commerce sites in the state to promote their products. Unfortunately, this usually just leads to big retailers like Amazon breaking their ties with these smaller affiliate companies to avoid the tax, only to focus their efforts on other states. Meanwhile, much of the sales tax revenue continues to go uncollected.

For this reason, Nobbs argues that tweaking the sales tax policy can’t be done on a state by state basis, and must instead be imposed at the national level. And given Washington’s current emphasis on finding cures for the state and federal budget problems, the numbers in the Extrabux report could prove enticing to some legislators.

In order to come up with this, Extrabux analyzed the sales data from about 2,000 big and small retailers that partner with the site, and paired this with data on how much of a market share these sites have online to estimate the total U.S. online sales in 2010. The researchers at Extrabux then combined this with the most recent census data breaking down the sales tax revenue that each state collects relative to the nation as a whole, and multiplied this percentage by the total online spending to estimate how much each state might generate from e-commerce revenue.

In total, Extrabux found that consumers made $118 billion in online purchases that were not taxed at all last year, which could have generated $10 billion in additional revenue if states extended their existing sales tax rates to online purchases.

What’s more, Extrabux predicts that the lost revenue will only increase in the coming years as consumers continue to make more and more purchases online. If online sales increase at their current rate, Extrabux estimates that the total uncollected online sales tax revenue would hit $10.9 billion by the end of next year and more than $15 billion by 2015.

Of course, the downside to imposing a sales tax on online purchases is that it could potentially reduce the number of purchases that consumers make by removing the powerful incentive of avoiding having to pay a sales tax. But Nobbs rejects this idea.

“When you look at Amazon.com, they have a presence in all 50 states, and really, they don’t have any less of a presence in the states that charge sales tax,” Nobbs said.

Even if consumers shifted away from doing their shopping online, they’d still end up having to shop offline, which means the state would get the additional revenue one way or the other. After all, consumers have to shop somewhere.

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