Ducking sales tax is great for Web shoppers but a killer for local governments that are losing out on billions in revenue.
If I want to buy the hot new videogame Mass Effect 3 and have it delivered to my home in New Jersey, I have a few choices. I can go to Amazon.com and pay $59.99. Or I can go to BestBuy.com and pay $59.99, plus New Jersey sales tax of 7%, for a grand total of $64.19. Almost no one would choose to shell out the extra $4.20 that Best Buy (bby) is charging, and therein lies the problem for traditional retailers.
It's the dirty not-so-little secret of online and catalogue shopping: Buy from a retailer that doesn't have a physical presence in your home state, and you avoid state and local taxes on your goods at the time of purchase. Technically, if I buy Mass Effect from Amazon (amzn), I'm required to send my $4.20 to New Jersey's coffers on my own. Yeah, right. Plenty of people don't even realize they're supposed to be sending that money in -- I didn't before I wrote this column. (Amazon collects taxes in only five of the 50 states.) Ask any tax expert or economist what percentage of these taxes is ever collected from consumers, and he will tell you it's virtually zero.
It's a great bargain for shoppers but a huge, unfair advantage for the online retailers, which have been beating up their brick-and-mortar counterparts for years. And it's a double whammy for state tax coffers: Not only do the online retailers not collect sales taxes on what they sell, but they are helping put chains like Borders and Circuit City out of business, shutting off what was once a spigot for state and local revenue.
This brawl over the collection of local taxes has been brewing for more than a decade, but it matters now more than ever. Online sales are expected to total about $226 billion this year and soar to $327 billion by 2016. States and municipalities are losing out on about $25 billion a year in uncollected tax revenue, the National Retail Federation estimates.
That's money the states desperately need right now. The heyday of ever-growing real estate valuations that used to fund local budgets is over. States are getting squeezed, and so are towns all across America. And with a national deficit of $1.3 trillion and counting, they can look forward to getting less and less money from the federal government down the road.
Online and catalogue retailers have been the beneficiaries of a Supreme Court ruling that declares it an undue burden for them to have to navigate the mass of fiefdoms clamoring for their share of your spending money. The Justices have a point. Right now there are 9,600 sales tax jurisdictions in the U.S., and that number grows by about 300 to 500 every year, according to the Tax Foundation. "Tax law can be more than a little confusing," says Joe Henchman, a policy analyst for the group. To wit: Kit Kats are taxed at different rates than Twix bars. (Apparently, Henchman explains, one qualifies as a "grocery item," and one is just candy.)
But there's a simple way to bridge the tax gap. Congress could act to require online retailers to collect one rate for each state so that retailers would be dealing with only 50 different tax rates. Then the states would be responsible for divvying up their piece of the pie with their local municipalities.
When budgets are tight and deficits get big -- as they are right now -- governments inevitably start looking for new ways to raise revenue. It's happened time and again in the U.S. Just look back at IRS documents from the 1940s, and you get a sense of how World War II was financed -- with special victory taxes, new tax brackets, and so on. Today phrases like "paying our fair share" have become part of our daily lexicon, and bureaucrats are scrounging for more money. But before we go creating a whole new class of levies, tolls, and tariffs, we should look for inequities in the current code. I'd suggest we start with the Amazon exemption.
This story is from the April 9, 2012 issue of Fortune.