States Approve Sales-Tax Pact

Is a Hershey's chocolate bar a candy or a food? A group of 34 states that want to levy sales taxes on Internet and catalog purchases took a big step forward in November when they settled upon an answer: candy. This and dozens of testy sales-tax issues were addressed, clearing the way for the next step in tax simplification: approval of the simplified rules by state legislatures.

It took three years for state revenue officials to hammer out their simplification plan. The motivation was there: e-commerce is eating up as much as $14 billion a year in state and local revenues. Technically, when consumers buy online they owe sales or use taxes, but states can't always make retailers collect the tab. The U.S. Supreme Court has said the taxes are too complex to administer nationally--some 7,600 jurisdictions each have their own rates and rules. In simplifying the system, states are wooing retailers and a skeptical Congress into letting them collect.

The states' 70-page agreement spells out common definitions for goods from candy to clothing; states and localities still decide for themselves whether or not to tax a category of items. States would pick one tax rate--the same goes for local governments--although both would be allowed a different tax rate for food and medicine.

Nothing takes effect until 10 or more states pass laws bringing their tax systems in line with the agreement. Moreover, those states must represent at least 20 percent of the population of the 45 states that levy sales taxes.

It won't be easy. The sales taxes took on complexities as states poked holes in the tax code as favors to powerful home-state business interests. "This is the hard part," says Neal Osten, who follows the issue for the National Conference of State Legislatures. "All the complexity--the exemptions, the definitions--occurred over 70 to 80 years of sales-tax history. It's going to take some work."

Simplification will create winners and losers in every state--and any business or industry that suspects it may lose can be expected to fight it. The agreement could also wreak political havoc in other ways. Maryland and Ohio, for example, would both lose revenue simply because they would have to start rounding numbers down, rather than up. New York, Massachusetts, Connecticut and Vermont would have to give up "thresholds" whereby consumers pay no sales tax on, say, the first $100 or so of clothing. Local governments in Alabama, Arizona, Colorado and Louisiana would have to hand over responsibility for administering their local-option sales taxes to their state governments. In Arkansas, North Dakota and Tennessee, local governments may collect more sales taxes when local tax limits go away.

State officials involved in the sales-tax project predict 20 to 30 legislatures will debate the agreement this year. They hope 10 to 15 states pass it. "Having state budgets in the poor condition they're in adds some weight to the effort," says Scott Peterson, director of business taxes in South Dakota. "It's going to be an interesting year."