A blueprint for streamlining sales taxes: an agreement on how to simplify sales taxes across state lines has been reached. Now it's up to legislatures to concur.

We'd been in so many hotels over the past two or three years," remembers Oklahoma Senator Angela Monson. "The same people, the same hollow square table, the same milling around, the same hallway conversations.

"Then, that morning last November, we took the vote and it was over. For me, at least, it took a few minutes to sink in. All of these people, from all of these states had just agreed to reform their sales tax systems. No one had ever done that before. wholesale tax reform even in one state is rare. Doing it in 10 or 20 or more states at the same time is absolutely unprecedented. But we had done it--or, at least, had taken a gigantic step in that direction," she says.

What Monson and 99 other state legislators, legislative staff, state revenue officials and representatives of the private sector did was to vote to approve the Streamlined Sales and Use Tax Agreement. This action of the group known as the Streamlined Sales Tax Implementing States culminated a critical phase in a three-year project to allow states to collect taxes on remote sales--for example, Internet sales. Their decision sets the stage for consideration of the streamlined sales tax agreement during the 2003 legislative sessions.

"I was rushing through the Chicago airport following the meeting," continues Senator Monson, who now co-chairs the implementing states group, "and the enormity of what we had accomplished hit me. State officials had just approved a drastic reform of state sales tax systems.

"After a few seconds of euphoria, though, I realized that the first three years were easy. Now comes the really hard part-actually implementing the agreement in state legislatures," she says.

Forty-five states and the District of Columbia use sales taxes. No two systems, though, are exactly alike. They are, in fact, quite complex. The most obvious variation is in rates. The sales tax rate in Hawaii and several other states is 4.0 percent. In Missouri, though, the state rate is 4.225 percent. Rhode Island and Mississippi have a 7 percent rate. In a dozen states, there is only one rate. In the others, there are local sales taxes in addition to the state rate.

Some states tax food and drugs; others don't. In some states, snacks--like pretzels and potato chips--are not considered food, so they are taxed. In others, snacks are defined as food, so they are exempt. Some states have used sales tax holidays, for example, on children's clothing for a week or two before school begins in the fall. States also use many different sales tax return forms and employ various audit procedures for retailers.

SUPREME COURT CASES

It is this complexity that caused the U.S. Supreme Court, in two important cases, to rule that a state cannot require an out-of-state retailer to collect the sales tax on an item sold to one of its residents. Utah cannot force L.L. Bean, a catalogue and Internet seller based in Maine, to collect the Utah sales tax when a Utah resident buys a pair of boots online. The consumer owes the tax, according to the Court, but the Utah revenue department cannot force L.L. Bean to collect it and send it to the state. University of Tennessee economist Bill Fox estimates that, by 2006, states will lose $45 billion a year in uncollected taxes on Internet sales.

The National Conference of State Legislatures and other state and local organizations have worked since the late 1980s to reverse or mitigate the effects of the two Supreme Court decisions--first, National Bellas Hess vs. Illinois and later Quill vs. North Dakota.

These joint efforts initially, but unsuccessfully, sought relief in Congress. More recently, they have focused on interstate cooperation in simplifying state sales taxes.

NCSL formed a task force on taxation of electronic commerce in November 1998. Co-chaired by Illinois Senator Steve Rauschenberger and Tennessee Representative Matt Kisber, the task force developed the model legislation in January 2000 that led to creation of the Streamlined Sales Tax Implementing States.

The group is composed of representatives from 34 states and the District of Columbia that passed model legislation during their 2001 and 2002 sessions. The im-plementing states met monthly for a year to hammer out a comprehensive proposal for simplifying state and local sales taxes. Legislatures began considering this agreement last month.

VOLUNTARY SYSTEM

"The key to the interstate agreement," says Senator Rauschenberger, "is that it is voluntary. States will voluntarily join by adjusting their sales tax laws. Remote sellers--companies that make sales over the Internet or through catalogues--will volunteer to collect the sales tax for the states that have simplified their sales tax systems."

To participate, state sales tax statutes must conform with the provisions of the agreement. The hallmark of the agreement is its emphasis on uniformity, standardization and simplification.

"Sales tax systems vary because states vary," says Texas Senator Leticia Van de Putte, new co-chair of NCSL's task force. "When legislatures define food in a certain way or set the rate at a certain level, it's a decision not made in a vacuum. They are reflecting the political forces and the political cultures in their states. What we have to do now--to respond to technology, and to the national and international marketplace--is forgo this complexity and make our sales taxes more uniform and simpler."

30 STANDARDS

The agreement includes at least 30 standards that states will have to meet to participate in the system. These provisions cover the major elements of state sales tax laws.

Some of the greatest complexities in sales tax laws occur in how they define items subject to the tax. When, for example, is a candy bar not food? Thirty states have chosen not to tax food. However, many of those states tax candy. These states currently use different definitions of candy. Some tax Twix bars, which contain flour; others do not. The proposed agreement says what candy is--and, by the way, excludes Twix bars from the definition. The agreement does not tell states they must or must not tax candy. In fact, it goes out of its way to say that the agreement "shall not be construed as intending to influence a member state to impose a tax on or provide an exemption from tax for any item or service." However, if a state chooses to tax an item-say, candy-then it must use the agreement's definition of candy.

The agreement does not say whether a state should tax drugs. If the state elects to tax drugs, then it must use the agreement's definition. It does not say clothing should be taxed, but it lists what is to be considered clothing. Belts, for example, are clothes, but belt buckles, sold separately, are not.

Several of the agreement's provisions have this "on-off" feature. The agreement does not tell a state it can or cannot use sales tax holidays. If a state elects to use sales tax holidays, though, it must comply with several requirements established in the agreement. For example, it must provide notice to retailers at least 60 days before the first day of the quarter in which the holiday will take place.

SOME REQUIREMENTS STRICTER

Many of the agreement's requirements are not so permissive. For example, a state and its local jurisdictions must tax the same things. In tax talk, that means they must have the same base. (The exception to this is an allowance the agreement makes for states, such as Illinois and Missouri that currently allow local jurisdictions to tax food, even though the state does not.) Sales tax administration will have to be done by a state body.

The agreement establishes requirements for uniform tax returns and for remitting funds to the state from sellers. It provides for greater notice to sellers concerning rate changes and changes in local tax jurisdiction boundaries. It has a clearly defined set of requirements for sourcing a purchase-in other words, for determining which state or local sales tax applies. It has a detailed section on deducting for bad debts and another on protecting privacy and confidentiality.

Tennessee Senator Bill Clabough, a member of NCSL's task force and of the implementing states, says that the agreement is the "result of many large and small compromises.

"Much of the time," he says, "the tensions were between state revenue officials and legislators. The tax administrators, to their credit, were trying to construct an ideal system. The legislators were constantly thinking about how the system would work in their state and what it would take to get it passed."

The lawmakers who helped develop the agreement are strong advocates for it and are working to get it passed, Rauschenberger says. "NCSL just completed a survey of the legislators on its task force and those involved with the implementing states. All of them said they were introducing the agreement in their states and were working to get it approved."

IT'S THE MONEY

The agreement's advocates offer different reasons for their support. Some start with the money. "It's really as simple and as complex as the money," says former Ohio Senate President Richard Finan. "We estimate that Ohio lost $448 million in sales tax revenue last year because of Internet sales. We are a fiscally conservative state with a fiscally conservative legislature. But we also have services to provide, and we have to balance our budget. Losing $448 million in taxes that are legally owed means we either have to cut services--education, health care, child care, economic development--or find the revenues somewhere else."

Rauschenberger puts the money argument into federalism terms. "For 45 states, the sales tax is a substantial portion of the revenue mix. The erosion of the sales tax because of remote sales weakens state governments and threatens their sovereignty. The consequence of letting a major revenue source become obsolete is that the states will revert to being dependents of the federal government."

Oklahoma Senator Monson adds that devolution makes the need for resources even more imperative. "Throughout the 1990s, state governments assumed responsibilities for many programs, such as welfare and children's health. Most state legislators felt this was the right thing to do-the right thing for federalism and the right thing for our constituents. Those responsibilities take resources. For many of us, the sales tax is a significant source of revenue-one we need to protect to make devolution successful."

FAIRNESS FOR MERCHANTS

Some supporters of the agreement point also to fairness. They argue that Main Street retailers are at a disadvantage because they are required to collect sales taxes and remote sellers are not.

Maureen Riehl, vice president for the National Retail Federation, says the Supreme Court decisions require retailers with stores in a state to collect the tax. "That means," she says, "that big retailers like Sears and Target--as well as mom-and-pop stores--have the playing field tilted against them. They're collecting sales taxes, and Internet sellers are not. The so-called brick and mortar stores don't have anything against Internet sellers. In fact, many have their own Internet operations. It's just a question of being treated fairly."

Consideration of the agreement in state legislatures is generating attention from various interests on both sides of the question. Among the supporters are local governments, traditional retailers, telecommunications companies, shopping centers and realtors. Lined up in opposition are anti-tax groups and Internet sellers.

VARIED SUPPORTERS

Mayors, county executives and other local officials support the agreement because, like the states, local governments have seen sales tax revenues eroded by remote sales. They believe declining revenues force them to reduce services or become more reliant on property taxes, the public's least favorite tax. Traditional retailers--family companies selling shoes on Main Street or office supply chain stores such as Staples--are among the agreement's strongest advocates, says the retail federation's Riehl. They see it leading to fairer competition between companies that collect the sales tax and those that, so far, have not. Shopping center owners want to make sure the retailers who rent space are healthy and are not put out of business by unfair competition from Internet sellers. Realtors have the same motivation. They want to make sure there are retailers to rent or buy shop space along Main Street, Broadway or Park Avenue. Telecommunications companies, including AT&T, Verizon and Bell South, are in favor of th e agreement, primarily because it simplifies certain kinds of telecommunications taxes.

OPPOSITION FROM THE NET

Opponents in the private sector primarily are so-called "pure" Internet retailers--companies that sell only over the Internet and have a physical presence in only one state. (The Supreme Court rulings require sellers to collect sales taxes in states where they have "nexus.") Although Amazon.com, a large retailer that sells only over the Internet, has not opposed the agreement, many other pure Internet retailers do. They worry about losing a competitive advantage. Some, especially smaller companies, are concerned about the cost of software they would need to calculate sales taxes owed.

The antagonism of anti-tax groups, such as the National Taxpayers Union, is consistent with their philosophical opposition to taxes. They express concern about the burden placed on Internet sellers to collect the tax and the potential for loss of tax competition among states.

10 STATES MUST ADOPT

"No one expected the states to succeed in developing a streamlined system," says Rauschenberger. Like Monson, though, he notes that the hard work is just beginning. The agreement does not take effect until 10 states representing 20 percent of the population have adopted it. "A few states need to make only minor adjustments to comply," he says. "They should be fairly easy. It's some of the bigger states, with complex sales tax systems, that will struggle with this."

He's not sure how the current fiscal crises will affect consideration of the streamlined agreement. "Our budget problems could make many legislators and governors more supportive of these reforms. On the other hand, because the system is voluntary, no one is going to see a lot of immediate revenue from this. I also worry that the budget crises are so severe that legislatures will not really have time to focus on anything else this year."

What happens when the agreement begins to operate? Senator Monson outlines three scenarios. "One is that the interstate agreement proves to be successful as a voluntary system. Over time, more states would join and more companies would volunteer to participate. A second is that Congress would use the streamlined agreement as the basis for federal legislation that would authorize states to collect taxes on out-of-state sales. And some folks believe that the agreement, by reducing the burden on interstate commerce, could persuade the Supreme Court to overturn its rulings in Bellas Hess and Quill.

"Those options are all down the road a bit," she says. "Right now, the important thing is to make sure that this critical experiment in cooperative federalism continues and that legislatures and governors give it fair and thorough consideration over the coming months."

RELATED RICLE: WHAT THE CRITICS SAY

Illinois Senator Steve Rauschenberger has been co-chair of NCSL's task force on taxation of electronic commerce since it was created in 1998. Although he is one of the country's staunchest advocates for the streamlined sales tax agreement, he also recognizes that it has critics who have raised important arguments against it. Senator Rauschenberger responds here to some of the major concerns.

Q. How do you respond to critics who say this state effort to collect sales and use taxes on Internet sales is really just a way of imposing a new tax on consumers?

A. Of course, it isn't a new tax. The U.S. Supreme Court acknowledges that consumers owe the tax whether they walk down the street to buy something or purchase it from an out-of-state company. What the Court says is that states cannot force the out-of-state retailer to collect the tax for them, because the cost of doing that is simply too high. The streamlined agreement takes that as a cue. We've drastically reduced the complexity in sales tax systems and, therefore, have minimized the burden on the sellers.

Q. Is it possible that the agreement will encourage states to expand their sales tax base?

A. There is language in the agreement saying that it should not be interpreted as endorsing taxation of a particular item. It doesn't say you have to tax food. It just says if you do, do it this way. That could mean a slight expansion of the base in some states. But the intention is not to expand the base or create revenue. The intention is to make these sales tax systems simpler. It is one of countless trade-offs the implementing states agreed on.

Q. Some economists note there is a value in tax competition among states. Won't the agreement's emphasis on uniformity eliminate this competition?

A. The most important part of tax competition among states is about rates. If my state raises the sales tax rate, does that mean consumers will go to Wisconsin to buy a DVD player? Would a company view that as contributing to an unfriendly business climate? Those are legitimate concerns, but the streamlined agreement should not have an effect on that. It doesn't say that sales tax rates have to be uniform from state to state. The agreement has on-off switches. There's no reason to think that a state that has had a switch off for decades suddenly will turn it on. The lobbyists who worked to turn it off before will work to keep it off when the legislature approves the agreement.

Q. Will the agreement hurt the five states that do not have a sales tax?

A. No. According to the agreement, an out-of-state company collects the tax of the state of the consumer. If someone in Oregon, which does not have a sales tax, buys that proverbial pair of boots from L.L. Bean, the company would not collect a tax. A business in Oregon, however, that sells on-line would have to collect the tax for Missouri, say, if a Missourian bought something from that Oregon company.

OUTLINE OF THE STREAMLINED SALES AND USE TAX AGREEMENT

The interstate agreement that has been sent to legislatures for consideration is a comprehensive and detailed approach for achieving uniformity and simplification in state sales taxes. The agreement is not a model act. Rather, it is a set of standards and provisions with which a state must comply to enter the voluntary system. Its major provisions are:

* Central administration of state and local sales and use taxes.

* Limits on state and local rates and rate changes.

* Limits on state and local rates after Dec. 31, 2005.

* Local jurisdictions limited to a single rate.

* States limited to a single general rate with an option of a single additional rate that could be zero on food and drugs.

* Central seller registration.

* Uniform sourcing rules.

* Telecommunications sourcing.

* Uniform procedures for exemptions.

* Uniform tax returns.

* Uniform definition of food and related items.

* Uniform definition for clothing.

* Uniform administrative definitions.

* Uniform definition for tangible personal property.

* Uniform definition for software.

* Uniform definition for drugs.

* Uniform definition for medical equipment.

* Uniform definition for leasing.

* Standardization of sales tax holidays.

* Elimination of caps and thresholds after Dec. 31, 2005.

* Privacy clarifications.

* Privacy protections.

* Amnesty for participating voluntary sellers.

* Outline of models for participation through technology.

* Outline for monetary allowances based on technology models.

* Uniform rounding rule.

* Customer remedy procedures.

* Requirements for direct pay procedures.

* Provisions for governance of the agreement that ensure legislative participation, certainty for sellers and procedures for resolving disputes with nonbinding, third-party arbitration.

YOU CAN'T TELL THE PLAYERS WITHOUT A SCORECARD

Numerous public and private groups have been involved in development of the Streamlined Sales and Use Tax Agreement. A thumbnail description of them and a listing of their Web sites are:

* Streamlined Sales Tax Implementing States. Thirty-four states and the District of Columbia passed model legislation that authorized them to develop an interstate agreement to simplify state sales taxes. State legislators, revenue officials and private sector representatives were appointed to the implementing states. Thirty states and the District of Columbia voted unanimously to approve the Streamlined Sales and Use Tax Agreement in November 2002. (Two of the implementing states did not send representatives to the meeting and officials from two other states abstained.)

* NCSL Task Force On State and Local Taxation of Telecommunications and Electronic Commerce. NCSL's Executive Committee created this task force at the end of 1998 to provide a forum for legislators and staff interested in the issues associated with sales and telecommunications taxes. It has overseen NCSL's work on these issues ever since. www.ncsl.org/programs/fiscal/tctelcom.htm

* Streamlined Sales Tax Project (SSTP). NCSL's task force endorsed model legislation in January 2000 that directed state revenue departments to enter into multistate discussions to simplify sales taxes. Thirty-two states joined SSTP. The project's product--and a similar one developed by NCSL's task force--led to additional model legislation that created the implementing states group. www.geocities.com/streamlined2000/

* National Retail Federation. An association of major retailers, including Sears, Target, Target, JC Penney and Staples, that has supported development of the streamlined agreement. www.salestaxfairness.com/index.htm

* Council on State Taxation. Created in 1969 through the Council of State Chambers of Commerce, COST comprises more than 500 companies that do business across state lines. A COST staff member serves on the implementing state's group as a representative of the District of Columbia. www.statetax.org/index.html

* E-Fairness Coalition. This coalition includes other trade associations, such as the International Council of Shopping Centers and the National Realtors Association, and certain companies, including WalMart and Radio Shack. www.e-fairness.org

* Federation of Tax Administrators. An association of state revenue department officials. It has provided staff support to the Streamlined Sales Tax Project and the implementing states. www.taxadmin.org/

* Multistate Tax Commission. An organization of state tax officials that has provided staff resources to the Streamlined Sales Tax Project and the implementing states. www.mtc.gov/

Carl Tubbesing is NCSL's deputy executive director. Neal Osten, NCSL's expert on the Streamlined Sales Tax Agreement, contributed to this story.