In Search of a Simple Sales Tax.

The complexity of 46 very different sales tax systems and the loss of tax revenue to Internet and catalog sales around the country have led the cry for simplification and uniformity.

Representative John Hines is a rancher from northeastern Wyoming. He's been a member of the Wyoming House for 16 years and chaired the revenue committee there for eight years. Hines is soft-spoken and unassuming. He may even appear to be a bit taciturn, but he sports an occasional wry smile.

In February, Representative Hines established himself as a pioneer in a new tax movement that is taking hold in legislatures throughout the country. He moved his bill, HB 259, through passage during Wyoming's 40-day session, then watched on March 1 as Governor Jim Gehringer, a former legislative colleague, signed it into law.

With Representative Hines' leadership, Wyoming became the first state to approve a model act intended to simplify state sales tax systems. The action bucked a decades-old trend that had seemed irreversible. "Most state sales tax systems are complicated, convoluted and unfathomable," says Tennessee Representative Matt Kisber, another leader in the movement toward simplification. "It's not just that there are over 7,000 separate sales tax jurisdictions," he continued. "It's the variations in definitions, in rates, in forms and audit procedures. Consumers don't understand it. Retailers barely do. And state revenue departments almost despair at administering it."

Utah, led by Senator Lyle Hillyard, passed a different version of the legislation a few days after Wyoming's groundbreaking action. And, with 20 or more other legislatures considering the model during 2001, it is safe to say that the movement toward streamlining sales tax systems is serious and gaining momentum.

These model laws set up a structure and a timetable for states to come together to finalize a simplified sales tax system. The models address every aspect of sales and use taxes. "It is impossible to overestimate how sweeping and fundamental these reforms could be," says Illinois Senator Steve Rauschenberger, who, along with Representative Kisber, chairs NCSL's task force on taxation of electronic commerce. "Forty-five states plus the District of Columbia have sales taxes. That means that, right now, there are 46 very different sales tax systems in the country. Legislatures that pass the model will exchange complexity for simplification," he says.

SALES TAX COMPLEXITIES

Most consumers are only vaguely aware of the complexities and variations in sales taxes. A shopper at Shaw's Supermarket in Falmouth, Maine, probably knows that he pays sales tax on a bottle of Tide, but he doesn't pay it on a box of Cheerios. A resident of Philadelphia knows she can visit the mall across the state line in Delaware and probably avoid paying sales tax on a new diamond ring. And a farmer in Michigan calculates the sales tax when he's buying a pickup truck, but doesn't have to when he springs for that new tractor.

Some states tax food, and some don't. Some tax clothing, and some don't. Some tax farm machinery, and some don't. Consumers know that. But they may not know that the definitions of food, clothing and other items vary from state to state. Are potato chips food or are they a snack? Is a scarf decorative or worn for protection?

The variations that consumers face are relatively simple compared to the complexities confronted by retailers, especially those doing business in more than one state. Most prominent are rates. The sales tax rate in Utah is 4.75 percent. The rate in West Virginia is 6 percent. In Connecticut, and a handful of other states, there is only one rate. In Colorado, though, there are 49 home rule cities with the authority to impose sales taxes on top of the state rate of 2.9 percent. In addition, retailers have to keep track of changes to the rates. They have to be aware of sales tax holidays and different audit procedures. They must comply with different consumer privacy laws and variations in laws governing returns and remittances.

"Companies like Sears are committed to being responsible corporate citizens. We believe in supporting local and state governments," says Russ Davis, national director of government affairs. "We are very encouraged that state legislatures are moving toward simplicity and transparency in their sales tax systems. The sooner the states achieve simplification, the sooner we can move toward a level playing field for all retailers."

Representative Kisber observes that legislatures created these complexities in response to legitimate public policy concerns that vary from state to state. "Twenty-eight states exempt food from the sales tax. They've done that primarily to mitigate the regressive nature of the tax. But they don't all define food in the same way. That's just the way the legislative process worked in those states." In his estimation, "States like Wyoming and Utah that pass the model act are saying, 'We are willing to forgo complexity and sacrifice some of our responsiveness to achieve two or three broader policy objectives.'"

TWO MODELS UNDER CONSIDERATION

State legislatures are actually considering two different, yet complementary versions of a package designed to simplify state and local sales tax systems. Each contains both a model act and an accompanying agreement. In each version, the model act establishes the framework for completing a multistate streamlined sales tax system. The second document--that is, the agreement--offers the criteria that states would have to meet to enter into an interstate streamlined sales tax compact. One version was developed by the Streamlined Sales Tax Project (SSTP), a group of 32 state revenue officials. The other version, endorsed by NCSL's executive committee, is based on the streamlined project's work, but differs from it in several important respects.

The SSTP model spells out the requirements for definitions, rounding rules, sales tax holidays and bad debt procedures; while the NCSL model defers decisions on these sections until state officials begin meeting after their states have passed the model act. Another major difference deals with who those state officials will be. The SSTP model says revenue departments. NCSL wants a larger board that could contain legislators.

Rauschenberger notes that legislatures contemplating sales tax simplification have three primary options. "They can just pass the NCSL-endorsed model act. Or they can pass the NCSL act and the NCSL-endorsed agreement. The third alternative is to approve the SSTP model act and agreement.

"Passing either version of the model act is the key," he asserts. "That sets the stage for the hard work of getting a simplified sales tax system up and running."

SIMILARITIES IN SUBSTANCE

The SSTP and NCSL versions are identical in many ways. They attempt to achieve as much simplification and uniformity as possible in sales tax structure and administration. For example, current state laws range widely in the amount of notice they give to retailers about changes in rates and other sales tax requirements. Retailers complain that in some states they have little time to adjust computer software to accommodate a new rate or a change in definition. The models would require states to provide retailers "with as much advance notice as possible" and would limit the effective date of a rate change to the first day of a quarter.

The popularity of catalog and Internet sales has exacerbated the problem of determining what sales tax rate to apply. Does a consumer in New Jersey pay the New Jersey rate of 6 percent when she buys a parka from Land's End? Or does she pay 5 percent, which is the rate in Wisconsin where Land's End is based? The models establish a set of uniform decision rules for making this determination.

Thirty-six of the states allow local jurisdictions to have their own sales taxes. In some of these, the state administers the local tax; in others, the local jurisdiction does it. In some, the state collects the local tax and remits it to the local government. In others, it is up to the local jurisdiction to collect the tax owed. Retailers, who add the tax to the amount of a purchase, find this confusing and cumbersome. The NCSL and SSTP models would require that the state administer the sales tax for local jurisdictions.

Both models anticipate that computer software will be an indispensable element of the new streamlined system, especially for retailers who sell in numerous states. Several companies have developed software that automatically calculates the sales tax owed--whether the consumer is standing at the modern equivalent of a cash register at The Gap store in Manhattan, Kan., or whether he is ordering the same item over the Internet. Several retailers, for example Sears and Wal-Mart, have developed their own software that does the same thing. Both models establish standard ground rules for certifying these different software systems.

Other common features of the two models include uniform audit procedures, uniform tax returns, a central registration for sellers and uniform privacy protections for consumers.

DEFINING THE DIFFERENCES

A primary difference between the two models centers on governance and who will represent a state in the next round of discussions. The streamlined project's model says that the state revenue director will be the representative. NCSL amended that provision to allow a legislature to designate up to four representatives that could include legislators, revenue officials, local officials and members of the private sector.

"Our task force simply felt that the next phase of the discussions among the states needed both the technical expertise of our revenue departments and the policy and political perspective of elected officials," says Tennessee Representative Kisber.

NCSL's electronic commerce task force, which developed the organization's model act and agreement, had lengthy debates over definitions, vendor compensation, rounding rules and bad debt. The question of uniform definitions of goods to be taxed was particularly nettlesome. Should soft drinks or candy be treated as food? "The controversy that these issues stirred up threatened to derail the whole project," recalls Rauschenberger. "The task force feels strongly that these questions have to be resolved. But including them at this point easily could have stalled the legislation in several states that otherwise are ready to participate. Deferring this until later buys time to work toward consensus."

Also troublesome for the NCSL task force was the question of how much a state should compensate a retailer for collecting the sales tax. The current range is from a low of no compensation to a high of 5 percent of the amount of the transaction. The SSTP model specifies a process for setting this rate for participating states. The NCSL task force finessed the issue by adopting the SSTP recommendation while calling for a study of the actual costs that vendors incur. The results of the study will be used to review the level of vendor compensation in the future.

FORCES DRIVING THE SIMPLIFICATION MOVEMENT

Four primary forces have driven the sales tax simplification movement:

* A pair of Supreme Court decisions.

* The revenues that state and local governments are losing because of catalog, Internet and other remote sales.

* The cries from some retailers to "even the playing field" between local merchants and out-of-state sellers.

* The possibility of federal legislation.

In many ways, the drive toward sales tax simplification began in 1967 with a U.S. Supreme Court decision. In National Bellas Hess vs. Illinois, the Court ruled that a state cannot require an out-of-state seller to collect sales tax on an item sold to one of its residents. A consumer in Missouri owes the tax, say, on a pair of boots bought through the L.L. Bean catalog, but the Missouri revenue department cannot force L.L. Bean to collect the sales tax and send it back to Missouri.

State legislators, governors and local officials made a big push in the late 1980s to persuade Congress to pass legislation that would correct the Bellas Hess decision. North Dakota Senator David Nething was in NCSL's leadership at the time. "We came really close a couple of times," he remembers, "but we just couldn't get it done."

The growth of catalog--and, later, Internet--sales eroded state revenues. A late 1980s study placed revenues lost to catalog sales as high as $3 billion. A recent University of Tennessee study estimates that states will lose $10.8 billion by FY 2003 if they are unable to collect taxes on remote sales.

As catalog and Internet sales increased, state officials worried about meeting their responsibilities in a rebalanced federal system and satisfying rising demands for services from their constituents. But they also discovered natural allies among certain members of the private sector. "We've talked about 'leveling the playing field' for so long, it's become a cliche," says Nething. "But it still describes the problem. Local merchants--the shops you see on any town's Main Street--were at a disadvantage to the catalog companies, who weren't collecting the sales tax."

Rauschenberger puts it this way. "I chair the Appropriations Committee, so I have a responsibility to make sure Illinois has a fair, equitable and dependable revenue system. But I also represent hundreds of independent merchants. They operate on such close margins, it doesn't take much to put them out of business. Losing customers to the catalog and Internet companies could just do it--and it has."

In 1992, state officials in North Dakota, hoping for a reversal of the Bellas Hess ruling, brought another out-of-state sales tax case to the Supreme Court. The Court, though, in Quill vs. North Dakota, affirmed its earlier decision and offered additional justification for its position. The complexity of state and local sales tax systems, the Court said, constitutes an undue burden on remote sellers--Land's End in Wisconsin selling to a customer in New Jersey or Amazon.com shipping a book to an on-line consumer in Nebraska. The complexity of the systems and the costs they impose on out-of-state retailers, in turn, are a burden on interstate commerce. Forcing the remote seller to collect and remit sales tax, therefore, would be a violation of the Commerce Clause of the U.S. Constitution. The exceptions to this, the Court said, are companies that have nexus--that is, a physical presence--in a state. Thus, a customer in Kansas buying from the JC Penney catalog must pay the sales tax because there are Penney's s tores in Kansas.

After several fruitless years of continuing the fight for relief through congressional legislation, several state legislators and governors embraced a new interpretation of the Quill decision. They came to view the ruling not as an insurmountable obstacle, but rather as a road map to show state and local governments what they would have to do in order to collect taxes on catalog, Internet and other out-of-states sales. They reason that the high court's concern in Quill is with complexity and the costs that retailers have to bear to comply with 46 different sales tax systems. If state governments reduce the complexity and eliminate the costs, then it follows that the Court could say the burden is gone and allow states to require retailers to collect sales taxes--whether they are in-state or out-of-state.

"It was the sales tax equivalent of 'I could have had a V-8,'" remarks Senator Rauschenberger. "We were all defending an anachronistic, 70-year-old system. The answer, it became clear, was to fix the system."

The simplification movement has also been driven by the possibility of federal legislation--of two opposing types. Some members of Congress prefer to make the Internet a "tax-free zone" and have introduced legislation that would prohibit taxation of any Internet activities. The threat of that kind of legislation imposes urgency on the state simplification movement.

"States have progressed so far in such a short period of time. But, we have to keep moving to head off something really draconian emerging from Congress," Representative Kisber argues.

There are other members of Congress--in the Senate especially--who are crafting legislation that would build on the states' simplification efforts. North Dakota Senator Byron Dorgan, Ohio Senator George Voinovich, Wyoming Senator Michael Enzi and several others have introduced a bill that would authorize states to collect taxes on out-of-state sales once 20 or more of them have simplified their sales tax laws. Kisber points out that "state legislators leading the simplification efforts want to give impetus to the Dorgan bill by showing that states are serious about streamlining."

Opposition to efforts to collect sales taxes on Internet sales and to the simplification movement comes from several sources. They range from the philosophical to the nitty gritty. Arrayed at the philosophical end are elected officials such as Virginia Governor James Gilmore and anti-tax advocates such as Grover Norquist, who heads Americans for Tax Reform. They view efforts to tax remote sales in the context of their overall opposition to taxes.

Gilmore chaired the now defunct federal Advisory Commission on Electronic Commerce. He included a personal statement as an addendum to the commission's final report: "I was guided by the philosophy that no taxation should be presumed necessary. To the contrary, the presumption should favor the right of individual citizens to keep their own hard-earned money."

Another group of opponents includes elected officials and representatives of the private sector who believe taxation of sales and other activities over the Internet is a threat to the viability of the various industries associated with it. Stanley Sokol, a lobbyist for companies that conduct business over the Internet, was also a member of the federal Advisory Commission on Electronic Commerce. "The wonderful thing about the Internet--its instant market access--also makes state tax designs potentially devastating to Web businesses," he noted in the statement he attached to the commission's final report.

The specifics of the simplification proposals have generated controversy, much of it from various private sector interests who believe they are benefited or damaged by components of the model acts and agreements. For example the soft drink industry, which otherwise has not opposed simplification, has raised concerns about language in the definition section of the SSTP model agreement that could affect the tax status of soft drinks.

Finally, there are those who feel the simplification proposals have not gone far enough. Frank Julian, representing Federated Department Stores, testified before the U.S. Senate Commerce Committee calling the SSTP model "simplification lite" and the NCSL model "simplification ultra-lite. "The burdens of collecting the sales tax are very real," he said. "The sales tax must be simplified if it is to survive."

WHAT'S AHEAD

"There may be only one thing better than playing inside baseball," says Senator Rauschenberger, "and that's playing inside the sales tax code. There are so many details to master, so many opportunities for missteps. What impresses me is how much progress we have made in such a short period of time. Proposals for such fundamental change are bound to generate controversy. The controversy is worth it, though. The consequence of letting a major revenue source become obsolete is that the states will revert to being dependents of the federal government."

Representative Kisber agrees. "This could be our last opportunity to keep the sales tax from imploding and to prevent the states from being irreparably weakened in the process."

Carl Tubbesing, NCSL's deputy executive director, heads the Washington, D.C., office.

COMPARISON OF NCSL'S AND THE STREAMLINED PROJECT'S APPROACHES

The NCSL task force based its simplification recommendations on the work of the Streamlined Sales Tax Project represented by 32 states and co-chaired by Diane Hardt and Charles Collins, state revenue department officials from Wisconsin and North Carolina.

COMMON FEATURES

NCSL's version and the SSTP version move states toward the same goal of an interstate agreement that would streamline administration of state sales and use taxes. Much in the two formulas is the same:

* Single, one-stop registration for sellers.

* State administration of both state and local option sales taxes.

* Consistent electronic filing procedures.

* Uniform sourcing rules to determine which jurisdiction is entitled to tax a sale.

* Uniform audit procedures.

* Uniform administration procedures for exempt purchases and purchasers.

* Simplified tax returns.

* Uniform state and local tax bases.

* Protection of consumer privacy.

UNRESOLVED ISSUES

There are a few items included in the SSTP model that the NCSL model defers for final resolution by a new governing body made up of states that pass the model act. The task force feared that including these unresolved issues in the model at this stage could slow the progress of the legislation in state legislatures. The items awaiting final resolution are:

* Uniform definitions.

* Uniform rounding rule.

* Uniform bad debt provision.

* Uniform treatment of caps, thresholds and sales tax holidays.

DIFFERENNT APPROACHES

There are two issues on which the models differ.

GOVERNANCE

* Each state may send up to four officials (picked by the legislature) to represent it in the next phase of discussions with the other participating states.

* States passing the model act alone or the model act and legislation to comply with the terms of the agreement will be allowed following rights in the interstate discussions to follow States passing the models act alone have until July 1, 2003, to approve the accompanying agreement.

SSTP

* Each state is represented by its revenue director.

* States must pass both the model act and the accompanying agreement to be able to vote or changes to the agreement.

UNIFORM BASE

* The model requires local government to have the same tax base as their state by Dec. 31, 2005, but it allows the state to establish a rate of zero on items such as food clothing, electricity and gas that the state does not want to tax, but is willing to let local governments tax. Each state would have its own uniform base--that is the things it taxes--but local governments would not lose revenue on items they currently tax and the state doesn't.

SSTP

The model requires local governments to have the same tax base as the state by Dec. 31, 2005. For example is the state of does not tax food then Local government cannot tax food either.

Graham Williams, NCSL

SIGNIFICANT DATES IN THE HISTORY OF THE SALES TAX

1930

Mississippi enacts the nation's first state sales tax to shift reliance from property taxes in the face of widespread property devaluations brought on by the Great Depression. By 2001, 45 states and the District of Columbia have a sales tax, accounting for roughly one-third of all state revenues.

1967

The United States Supreme Court rules in National Bellas Hess, Inc. vs. Illinois Department of Revenue that states cannot compel remote sellers to collect and remit sales taxes on sales shipped into their state.

1992

In Quill vs. North Dakota, the United States Supreme Court upholds the Bellas Hess ruling, citing the complexity of sales tax structures from state to state as an undue burden on remote sellers and on interstate commerce.

Oct. 1998

President Clinton signs into law the Internet Tax Freedom Act (ITFA). The law establishes a three-year moratorium on state taxes on Internet access and on multiple or discriminatory taxes on transactions made over the Internet. The act creates the Advisory Commission on Electronic Commerce to present recommendations to Congress on tax issues related to electronic commerce.

Nov. 1998

NCSL establishes the Executive Committee Task Force on State and Local Taxation of Telecommunications and Electronic Commerce.

June 1999

The Advisory Commission on Electronic Commerce, chaired by Virginia Governor lames Gilmore, holds the first of six meetings, but, in the end, fails to achieve a two-thirds majority on any proposal related to sales tax on goods sold over the Internet.

Jan. 2000

The NCSL task force endorses model legislation that directs state revenue departments to enter into multistate discussions to develop a simpler, more uniform, and fair system of sales and use tax collection. By March 2001, 32 states join as participating members in the Streamlined Sales Tax Project (SSTP), either through the NCSL model act or executive order.

Feb. 2000

University of Tennessee Professor Bill Fox releases a study that estimates that states would collectively lose $10.8 billion by FY 2003 if existing taxes on sales over the Internet were not collected.

Jan. 2001

The NCSL task force and the Streamlined Sales Tax Project endorse different, but complementary versions of a model sales tax simplification act and an accompanying agreement.

March 1, 2001

Wyoming becomes the first state to enact sales tax simplification legislation.

--Graham Williams, NCSL