an unfettered Internet is key to the growth of an information-based economy
Politicians and tax collectors are salivating over off-the-chart forecasts of e-commerce revenues, but California Gov. Gray Davis didn't take the bait. Instead, he took some political heat and may have saved his state's growing share of the new economy.

To his credit, Gov. Davis recently vetoed a bill that would have imposed a sales tax on Internet sales by Web-based companies that happen to have brick-and-mortar outlets in the state.

The bill was intended to close a perceived loophole in the law. The U.S. Supreme Court held in 1992 that a state can't compel an out-of-state Internet or mail-order company to collect sales taxes from local residents unless the retailer has a tangible presence in the state. To avoid collecting sales taxes, some brick-and-click companies simply run their physical stores and their online stores out of separate subsidiaries, and see to it that their online operations are totally out-of-state.

Supporters of the California bill fear that if some retailers can legally refuse to collect taxes on their online sales, even as they add stores around the state, they'll gain an unfair advantage over other businesses. And those that don't qualify for the tax break may bolt the state, taking jobs and tax revenues with them.

A growing number of Chicago and suburban officials have voiced the same concerns. They are huddling to deter consumers from e-shopping or to find a way to tax those who do, lest tax-free online sales cut into business at stores with a physical presence, those that collect taxes to fund municipal services such as police, fire protection and public works.

The tax revenue challenge is real, but Gov. Davis is right. He sees that an unfettered Internet is key to the growth of an information-based economy. And, since California is a proving ground for public policy, his vision bodes well for Illinois.

E-commerce retailers would have a dramatically tougher time meeting the burdens of sales tax compliance than their in-state competitors. While an old economy store collects a tax at only one rate and remits it to a single state agency, Internet-based businesses would need to compute and collect the taxes that apply to all of their customers' billing addresses and send them to hundreds, if not thousands, of different state and local governments. The costs of compliance could easily sabotage local economies by driving e-tailers away, along with the skilled jobs that they control.

The Internet empowers people in all kinds of ways, affording them anonymity, mobility and free choice. Studies already show that people living in states with high sales taxes are much likelier to shop online.

When a German resident purchases a CD from a store in Berlin, she pays a value-added tax of 16%; if she buys the same CD from a Chicago-based Web site that sends it to her by mail, she'll probably pay no tax because tax collectors simply don't open every package that enters a country.

Software, music or videos downloaded from the Net will probably never be taxed either, because they're impossible to track. Businesses operating online can set up shop in any tax-hospitable state or tax-haven nation they please. If the U.S. is to compete effectively in a digital, global marketplace, it may well face increased tax competition and be forced to justify its tax rates and compliance requirements.

Congress knows what American business is up against. For another year, federal law bans states and localities from imposing taxes on Internet access or discriminatory taxes on electronic commerce.

The raging controversy over Internet taxation may be the very catalyst we need to simplify our fractured and outmoded sales tax rules.

About the Author

Marc Lane is a business and tax attorney, a Master Registered Financial Planner, a Registered Financial Consultant, and a Certified Investment Specialist. Marc is the author of 30 books on business organization, taxation, and personal finance. His newest book, "Advising Entrepreneurs: Dynamic Strategies for Financial Growth" draws from his experience working with those who have successfully built their businesses. Marc is an Adjunct Professor of Law at Northwestern University and an Adjunct Professor of Business at the University of Illinois. His practice areas include Individual Taxation, Corporate Tax Planning, Business Tax Planning, Estate Planning, Investments, Retirement Planning,Elder Law, International Trade, Business Law, and Wills, Trusts and Estates. Additional articles, case studies, and a free email newsletter are available at www.marcjlane.com.