Charles E. McLure, Jr.*, Hoover Institution, Stanford University

I. Introduction
Being designed for a world of tangible products, the tax systems employed by the states are ill-suited for a world of electronic commerce.¹ This is perhaps most obvious in the case of the sales tax.²

The sales tax departs from widely accepted tenets of taxation in ways that will become increasingly troublesome as electronic commerce grows in importance. The most pressing problems are complexity and the resulting constitutional inability to tax interstate sales by remote vendors (those lacking a physical presence in the taxing state). Concerted efforts have been underway for several years to find a way to simplify the sales tax, but in ways that fail to address other fundamental problems, and, in fact, may even fail to achieve the corollary objective of allowing taxation of sales by remote vendors.

This article describes the problems with the sales tax and summarizes recent efforts to simplify the tax. Because I have described and discussed the problems in detail elsewhere, the descriptions and discussions presented here (in Section II) are rather skeletal; the notes contain further references. The most recent effort at simplification, which is on-going, is described in greater detail (in Section III), not only for its own sake, but also to illustrate the range of knotty problems that must be overcome in any effort to simplify the sales and use tax.

II. The Current Debate
All but 5 states (and the District of Columbia) tax sales made within the state, and almost 7,000 local jurisdictions also levy sales taxes.³ For constitutional reasons states are unable to apply their sales taxes to sales made by out-of-state vendors.⁴ Instead, they levy "use taxes" intended to compensate for this inability. Use taxes generally mirror sales taxes, being levied on the same base and at the same rate on products bought from out-of-state vendors. Much of the discussion of "sales and use taxes" that follows pertains primarily to use taxes.

A. The Focus of Debate: Two Issues
The current sales tax debate is focused on two issues: simplification and an expanded duty to collect use tax.

1. Complexity
States tax almost all sales of tangible products, with notable exceptions, such as food and prescription drugs, which are often exempted for distributional or social reasons.⁵ By comparison, they exempt almost all services and other intangible products. Although sales for resale are almost universally tax-exempt, a wide variety of goods and services bought by businesses are taxed.⁶ Purchases by non-profit organizations are also commonly exempt. The choice of what to tax and what to exempt is made on a state-by-state basis. Moreover, virtually all laws, regulations, and compliance requirements (e.g., registration, filing, payment of tax, and audit) vary from state-by-state. Thus a vendor that is obligated to collect sales or use tax in more than one state faces considerable complexity.⁷

Local sales and use taxes create additional complexity. At the very least, it is necessary to "source" the sale to the local level, in order to determine which local tax rate(s) to apply and which local jurisdiction(s) should get the revenue. (But in about a half-dozen states local governments that levy sales taxes do not impose local use taxes, usually to avoid the need to determine the destination of intra-state transactions.) In most states local governments tax the same sales as the state, which administers the tax for them.⁸ But in some states local governments enjoy considerable latitude in defining the base for local sales taxes. Finally, local governments in a few states administer their own taxes, rather than relying on state administration, adding further to complexity.

2. Nexus
Whether a state can require a remote vendor to collect use tax on its behalf is the question of nexus. Whether nexus exists depends on the relationship ("connection") of the vendor and its activities to the taxing state. Nexus is determined by application of the Due Process and Commerce Clauses of the US Constitution.⁹

Nexus under the Due Process Clause requires relatively little; that the taxpayer purposefully directs its activity into the taxing state is enough.¹⁰ The Due Process Clause thus provides little protection from a duty to collect use tax.¹¹

The Commerce Clause provides out-of-state vendors substantially more protection from a duty to collect use tax. Noting the onerous compliance burden on interstate trade created by the complexity described above, the US Supreme Court ruled in National Belas Hess¹² and again a quarter century later in Quill¹³ that a state cannot impose a duty to collect use tax on a vendor of tangible personal property that does not have a physical presence in the state.¹⁴ For this purpose a "physical presence" is not limited to employees and ownership or rental of real estate. Having agents (representatives) in the state would also trigger nexus.¹⁵ By comparison, some state courts have ruled that merely having corporate affiliates in the taxing state would not necessarily constitute nexus.¹⁶

It is unclear whether the physical presence rule of Quill would apply to remote sellers of services and intangible property.¹⁷ Stare decisis, which figured heavily in Quill ("...the Belas Hess rule has engendered substantial reliance and has become part of the basic framework of a sizable industry..."),¹⁸ would not apply to the sale of intangible products and services delivered electronically.¹⁹ Of course, the ability to deliver services and intangible products electronically is what distinguishes "pure" electronic commerce from mail order and analogous forms of electronic commerce in tangible personal property.

B. The Missing Issues: Deviations from an Ideal Sales Tax
Extant sales and use taxes satisfy none of the following four criteria for an ideal sales tax.²⁰

Sales to business, including sales of capital goods, should not be taxed.
Tax should apply equally to all sales to consumers.
Tax should apply equally to sales made by local merchants and by remote vendors.
Taxation should be as simple as possible, consistent with other objectives.

Exemption of capital goods deserves special attention. A tax that does not apply to capital goods is a tax on consumption.²¹ Unlike an income tax, a tax on consumption is neutral with regard to the choice between present and future consumption. Besides distorting this choice, a tax on capital goods exhibits the economic non-neutralities of any other tax on sales to business.

2. Taxation of all sales to consumers
Exemptions found in state sales and use taxes distort consumer choices between taxed and untaxed products and create inequities between consumers, depending on their consumption choices.²² The advent of digitized products will aggravate distortions and inequities, as products serving virtually identical needs (e.g., video cassettes and downloaded videos; music on CDs and music downloaded from the Internet and perhaps "burned" onto the buyer's CD, etc.) are likely to be taxed differently, unless laws are changed so that essentially all sales to consumers, including those in business to consumer (B2C) electronic commerce, are taxed.

3. Destination-based taxation of sales
Indirect (sales) taxation can consistently be based on either the origin or the destination of sales. Origin-based taxation requires taxation of all production, including that which is exported, and no taxation of imports.²³ By comparison, destination-based taxation requires taxation of all consumption, including that which is imported, and no taxation of exports.

Destination-based sales taxes are arguably preferable to origin-based taxes as measures of benefits of government services. This is most easily seen in the case of the excises levied on motor fuels to finance the construction and maintenance of roads and highways; few would argue that jurisdictions where refineries are located should receive all the revenues from such excises. Similar arguments can be made for the use of destination-based excises to finance health care and related costs resulting from the consumption of alcoholic beverages and tobacco products. The analogous argument is more difficult to make for revenues from general sales taxes. But I believe that consumption of goods and services subject to sales tax may a fairly good surrogate for the benefits of most public services — and certainly a better measure of benefits than production of the same products (the base of an origin-based tax).²⁴

The state sales taxes are, for the most part, destination-based levies. But they have two avoidable characteristics that are inconsistent with a destination-based system.²⁵ First, the taxation of business inputs introduces a production-tax element into the ostensibly destination-based sales tax. Thus both firms trying to export and firms competing with out-of-state producers bear a cost they would not bear under a pure destination-based tax. Second, the failure to tax most imports made directly by consumers gives remote vendors a competitive advantage over local merchants. Of all the deviations from the ideal system, the failure to tax purchases from remote vendors is perhaps the most flagrant violation of common sense,²⁶ as well as the norms of good tax policy.²⁷ From the viewpoint of both economic efficiency and fairness it simply makes no sense to tax sales by local producers and vendors and not tax sales by their out-of-state competitors.²⁸ Yet, this result is more-or-less inevitable, given the complexity of the system and the constitutional prohibition against barriers to interstate trade.²⁹

4. Simplicity
Taxation should be as simple as possible, for both taxpayers and tax administrators, consistent with achievement of other important objectives. The Supreme Court's concern with the burden on interstate commerce posed by complexity gives this quite commonplace objective unusual urgency.

5. Interaction between the criteria
Simplicity often conflicts with other important objectives of tax policy; where this is true, it is necessary to make trade-offs between simplicity and other objectives. But I contend that there is relatively little inherent conflict between simplicity and other important objectives of state sales and use taxes.

Under current law each state (and sometimes each local government) decides which items are taxable and which exempt, often drawing distinctions that defy logic.³⁰ It also decides which otherwise taxable items are exempt when bought for business use; this commonly depends on the buyer's industry and purported use of the item. Each state establishes its own tax administration and procedures for tax compliance. Statutes and regulations and their interpretation differ from state to state, even when intended to have the same effect. It is necessary to "source" remote sales to the local level, if local use taxes are to be applied. The obvious and inevitable result of such a chaotic system is substantial complexity and high burdens of compliance and administration, especially for vendors operating in more than one state.

Adoption of the first two criteria listed above would eliminate a substantial amount of complexity, as well as avoiding undesirable economic distortions. Only one rule would be needed to define the tax base: if a product is sold for business use, it is exempt; otherwise, it is taxable. (If there are to be exemptions for particular items on equity and similar grounds, they should be limited, and exempt sales should be defined uniformly in all states.)

With these rules in place it would be relatively easy to achieve substantial simplification. There would be no need to worry about how each state defines various products or criteria for exemption of business purchases. Indeed, there is little reason, aside from political territoriality and administrative inertia, that all states could not adopt a uniform sales and use tax statute, utilize nationwide registration, employ uniform administrative procedures, and conduct joint audits.³¹ A de minimis rule would limit the duty to collect use taxes to states where a vendor does more than a de minimis amount of business.³²

Adding local sales and use taxes to the mix inevitably complicates matters, because of the need to "source" sales to the local level. (I see no reason to allow local jurisdictions to deviate from the state tax base.) But it would be far easier to solve this problem under an essentially uniform system than under the archaic and complicated system that now prevails.

In short, exempting all sales to business, taxing all sales to consumers, adopting substantial uniformity in laws and administration, and providing a de minimis safe harbor would make it far more reasonable to require remote vendors to collect use taxes. With enough national uniformity, a taxpayer in San Jose, California would know the tax law of (for example) Florida, Maine, New York and Utah, simply by knowing the tax law of California; the only difference would be the applicable tax rates.

6. The limited focus of the current debate.
The current debate is far less ambitious than what was just proposed; as noted earlier, it is focused almost entirely on the last two components of an ideal sales tax, simplicity and an expanded duty to collect use tax on interstate sales. Aside from a few academics,³³ virtually no one advocates eliminating tax from business inputs, including capital goods, or taxing all consumption spending uniformly, despite the manifest simplification these reforms would make possible.

C. The Political Dimension
The debate over whether or not to tax electronic commerce, and how, has created a complex web of overlapping political issues.

1. Those who favor taxing electronic commerce
"Main street" merchants oppose granting tax exemption to electronic commerce, because they believe doing so would give their high-tech competitors in other states an unfair advantage. They believe that the tax preference for remote vendors created by Quill should be eliminated. In these views they are joined by representatives of state and local government, who fear a growing loss of revenue as business moves to the Internet, where it might be tax-preferred.³⁴ Responsible representatives of state interests, increasingly all such representatives, agree with the need for massive simplification if an expanded duty to collect use tax is not to be unreasonable — and if it is to have any chance of passing either Congressional or judicial scrutiny. While representatives of local governments share state concerns about revenue, they fear that they will lose substantial fiscal autonomy in any quest for simplicity, which many believe must involve a single sales/use tax rate in each state.³⁵

The interest of state and local governments in simplification appears to be driven almost entirely by fear of revenue loss, not by principle. In the absence of substantial simplification — and perhaps even with it, given the Supreme Court's emphasis on stare decisis — Quill stands in the way of efforts to require remote vendors to collect use taxes. Until recently state and local governments have shown little interest in simplification for its own sake, and there is still virtually no interest in creating a system that is consistent with the first two criteria for an ideal sales tax (exemption of all sales to business and taxation of all sales to consumers).

2. Those who oppose taxing electronic commerce
Arrayed against those who would subject remote commerce to the same taxation as other commerce are the sectors that would collect the taxes in question, their customers, and their suppliers. Traditional direct marketers, which over the years have proven their political ability to withstand efforts to impose an expanded duty to collect use tax, have been joined by dot.com firms, recently the darling of Congress, and the high-tech industry that supplies them. Finally there are those who dislike all taxation, largely for ideological reasons, and would hold Main Street hostage in the attempt to keep taxes down.³⁶

Even direct marketers appear to be of two minds on the question of an expanded duty to collect use tax. While they would prefer not to collect the tax, all else equal, they may prefer an expanded duty to collect over perpetuation of the current state of uncertainty, which encourages "trench warfare," in which the states employ novel theories of nexus in the attempt to compel collection of use tax and, because of the risk that such strategies may be successful, creates enormous contingent liabilities.³⁷

3. Implications for federalism
In theory, either the Congress or the US Supreme Court could place a stamp of approval on a compromise that combined simplification with an expanded duty to collect use tax. If there were enough simplification, the Supreme Court might overturn its decision in Quill. Given the Court's emphasis on stare decisis, this is not a sure bet. Congress, in the exercise of its constitutional power to regulate interstate trade, could render Quill moot, by authorizing an expanded duty to collect even where the vendor has no physical presence in a state. The historical power of the direct marketers, who are now joined by those with an interest in a tax preference for electronic commerce, also makes this a long shot. In any event, a Congressional override of Quill (like the Internet Tax Freedom Act, to be discussed below), which the states might welcome in the short run, could have unsettling and undesirable implications for fiscal federalism, as it would entail a serious and precedent-setting Congressional intrusion into the taxing powers of the states.³⁸

4. Institutional impediments to a solution
Implicit in the Quill decision is the fact that any effort at simplification must be multilateral if it is to pass judicial muster; after all, the essence of Quill is that the complexity caused by the current diversity of state and local sales and use taxes imposes an unacceptable burden on interstate commerce. I surmise that, for the Supreme Court to overturn Quill, virtually all of the sales-tax states would need to agree on a system that is substantially uniform in many relevant respects. What the Congress might require as the price of overriding Quill is even more speculative and less clear, because of the interjection of politics into the mix, but we might assume for argument's sake that it would also require virtually complete uniformity. This is a tall order.

Achieving the required degree of uniformity will be difficult for several reasons. The present system was created by the unilateral actions of 45 states and the District of Columbia, and must be reformed in the same way.³⁹ There is no institutionalized forum in which the states can take multilateral decisions. The National Governors' Association (NGA) and the National Conference of State Legislatures (NCSL) — and much less the Federation of Tax Administrators and the Multistate Tax commission — have no legislative authority.⁴⁰

State tax administrators have been involved in the Streamlined Sales Tax Project (SSTP, to be discussed below) with the blessing of their state legislatures and/or governors, but they have no law-making authority. Those who do have that authority, the individual governors and state legislators, may have quite different agendas. (See the next part of this section for evidence. Note also the role played by the ACEC chairman, Virginia governor James Gilmore, in assuring that the Advisory Commission on Electronic Commerce — the ACEC, discussed below, produced no recommendations to Congress for taxation of electronic commerce.⁴¹) Either the governors or the legislatures of a few important states might, in effect, exercise veto power over any compromise.

Finally, there is some risk that the U.S. Supreme Court would find that Congressional approval for a multistate compact that would effect the SSTP is constitutionally required.⁴² An attempt to gain Congressional approval of the SSTP Agreement would offer further opportunity for advocates of the status quo to block compromise.

5. Evidence of institutional impediments
The institutional impediments described above are playing out in several forums, among them the NCSL (which has taken charge of the SSTP) and the halls of Congress.

As described more fully below, via the SSTP, tax administrators have been attempting to fashion a system that would allow substantial simplification of compliance and administration, especially for multistate vendors, while retaining a significant amount of state autonomy. Yet, before endorsing the draft proposals of the SSTP, the Executive Committee of the NCSL made important modifications and deletions, reserving the deleted provisions for further study. Some of the deletions reflect political influences as much as principled objections. This suggests that gaining even state approval for a simplified system will not be easy.

The extreme diversity of legislation that has been introduced in the Congress during the past year indicates the breadth of opinions about the proper tax treatment of electronic commerce — and the likely difficulty of gaining Congressional agreement. At one extreme are proposals that would enact the anti-tax majority findings of the ACEC (described below); at the other are proposals to enact the minority view — essentially the NGA program that is reflected in the SSTP. Whereas the latter proposals envisage Congressional approval of interstate tax compacts, the former naturally do not.

III. The Streamlined Sales Tax Project: Contours of a Possible Solution?
It is still too early to know the details of a compromise that would combine simplicity and an expanded duty to collect use tax and be adopted by the states (and be approved by either the U.S. Congress or the U.S. Supreme Court). But the Streamlined Sales Tax Project (SSTP), a cooperative effort of almost 40 states, suggests some of the possible components of such a compromise.⁴³

A. Precursors of the SSTP
The SSTP is the third highly visible effort to deal with the taxation of sales and use tax that has been inspired by the advent of electronic commerce.

1. The NTA Project.
In the fall of 1997, the National Tax Association (NTA) created the Communications and Electronic Commerce Tax Project (the NTA Project) consisting of 16 representatives each from business and government, as well as seven "others" (representatives of the ABA, the AICPA, and the U.S. Treasury Department, plus three academics). The Project quickly identified substantial simplification and an expanded duty to collect use tax as the components of a possible compromise. The Project was ultimately unable to agree on a legislative proposal, because a three-fourths majority was required to approve any measure. But in September 1999 it approved a final report that analyzes issues and describes areas of tentative agreement and disagreement.⁴⁴ This report, which identified and discussed many needed elements of simplification, including most of those described here, served a useful educational purpose and should provide valuable input to any further deliberations.⁴⁵

2. The Advisory Commission on Electronic Commerce.
In October 1998 the U.S. Congress enacted the Internet Tax Freedom Act (ITFA).⁴⁶ Besides imposing a three-year moratorium on new taxes on the Internet,⁴⁷ the ITFA created the Advisory Commission on Electronic Commerce (ACEC or "the Commission"), which was comprised of eight representatives each from business and from state and local governments and three from the federal government. An important part of the charge of the ACEC was an examination of whether to impose sales and use taxes on electronic commerce.

Under the ITFA a two-thirds majority of the members of the Commission was required to approve "recommendations" to Congress. While this supermajority was not achieved, a majority of the Commission voted to forward to Congress a Report⁴⁸ that included the following "findings":

A five-year exemption for digitized content downloaded from the Internet and "their non-digitized counterparts." This would effectively eliminate sales taxes on music, videos, books and magazines, games, and software.

Codification of the Quill decision and provision of safe-harbors that would prevent corporate affiliation, repairs, and returns from being construed as constituting a physical presence in the state. This would allow e-commerce and mail-order companies to avoid collecting use tax, even when they have stores (which can accept returns) and provide warranty service in a state.⁴⁹

While the Commission accomplished little of direct value, it did provide an incentive for interested parties to develop proposals to deal with the issues at hand. Like the output of the NTA Project, many of these are reflected in deliberations of the SSTP. Moreover, by placing the ball directly in the court of state and local governments, the Commission's report stimulated interest in the SSTP.

B. The SSTP's Objective and Approach
The stated objective of the Streamlined Sales Tax Project is to "develop measures to design, test and implement a sales and use tax system that radically simplifies sales and use tax."⁵¹ Bringing this project to fruition, although necessary if state and local governments are to have any hope of imposing on remote vendors an expanded duty to collect use tax, will be a daunting undertaking. While legislatures and governors may desire to expand the revenue base and eliminate unfair competition for local merchants, they also wish the power to define the tax base and determine other rules of the game in the sales and use tax area. Exercise of this power is antithetical to simplification.

The SSTP envisages that each sales tax state (or enough states to make the plan effective) would adopt the model "Uniform Sales and Use Tax Administration Act" (the Uniform Act). The Uniform Act would authorize the taxing authority of the state "to enter into the Streamlined Sales and Use Tax Agreement with one or more states to simplify and modernize sales and use tax administration in order to substantially reduce the burden of tax compliance for all sellers and for all types of commerce." The Agreement contains all the myriad details of simplification and uniformity and constitutes a "contract" between signatory states on what standards must be attained and how the states will act in concert with one another going forward.

Each state participating in the Agreement must modify its own laws to bring them into conformity with the terms of the Agreement. The draft Act provides a vehicle for amending existing state laws as necessary to bring the state into conformity with the Agreement.

On December 22, 2000 the states participating in the SSTP approved the Agreement, with expectation that state legislatures would begin to debate and enact the Agreement in early 2001.⁵² The Agreement provides that the Agreement will become effective for enacting states upon its enactment in five states. After the Agreement becomes effective the SSTP will continue to work, inter alia, to develop uniform definitions and product codes and a simpler, more uniform tax return (and, of course, to undertake the further study envisaged by the NCSL Executive Committee resolution of January 24, 2001). Business interests and non-member states are to be represented on an advisory council that consults on administration of the Agreement. A pilot project is underway in four states (Kansas, Michigan, North Carolina, and Wisconsin) to test the technology-based aspects of the SSTP's proposals.

An important component of simplification would be establishment of standards for certification of certified service providers and certified automated systems and establishment of performance standards for multistate sellers; this is explained further below. This would allow a "technological fix" to many of the problems of complexity.

C. Recommendations of the SSTP
The draft Agreement approved on December 22, 2000 (and slightly amended on January 24, 2001) would require states to adopt certain provisions intended to simplify compliance, by making states sales and use tax systems more nearly uniform. In addition, the draft described approaches to tax administration that would employ modern technology to further simplify compliance and proposed that states provide monetary incentives intended to encourage adoption of such technology and voluntary registration by vendors who do not have a duty to collect use tax.

On January 27, 2001 the Executive Committee of the NCSL unanimously endorsed the Act and Agreement, but not before modifying key provisions and deleting others, which it wished to reserve for further study. As modified by the NCSL, the draft provides that food, clothing, electricity, and gas could be taxed at preferential rates, despite the weak case for such treatment on equity grounds — and the strong case against it on grounds of economic efficiency and revenue (or lower rates). The provision for uniform definitions of food was deleted, in part to mollify the candy and vending machine industry, which fear being singled out for special (taxed) treatment. (They are currently taxed in some states that generally exempt food.) Local merchants desire retention of caps, thresholds, and holidays. This reveals an interesting tension between the desire for simplicity — which is needed if out-of-state vendors are to be required to collect use tax, as well as for its own sake — and the desire to make tax-preferred sales. Financial institutions and credit card companies fear that, as originally drafted, the uniform provision for bad debts would apply only to merchants, and not to them. The rest of this section describes the most important provisions of the December 22, 2000 draft, as amended on January 24, 2001 — that is, before the modifications and deletions just listed were made — without comment where the effect and intent are clear, but with comment where needed. Footnotes indicate provisions that were deleted or modified in the NCSL draft.⁵³

1. Requirements of Participating States
The Uniform Act requires each signatory state to agree to do certain things. The upshot would be a system with the following characteristics.⁵⁴

a. State administration
Member states would administer all local sales and use taxes. Sellers would only be required to register with, file returns with, and remit funds to the state taxing authority, which would then distribute revenues to local governments. States would conduct all audits.

b. State and local tax bases
After December 31, 2005, the tax base for local jurisdictions must be identical to the state tax base, except where federal law prohibits local taxation of a transaction taxed by the state. Before then all local jurisdictions in a state must have a common tax base. This provision does not apply to sales or use taxes levied on the transfer of motor vehicles, aircraft, watercraft, modular homes, manufactured homes, or mobile homes.
Comment: The last provision (and several similar provisions described below) except these "big-ticket" items from generally applicable provisions. Application of different rates to those that must be registered to be operated legally poses no administrative problem. Modular homes, manufactured homes, or mobile homes were excepted because many states tax only a percentage of the value of such property in order to achieve rough parity with the tax treatment of conventional housing; in the latter case materials are subject to tax, but labor generally is not. Again, administration of differential rates for these products should not be onerous.

c. Seller registration
Member states agree to create an online sales and use tax registration system. A seller registering under the Agreement would be registered in all member states. An agent may register for a seller; this means that Certified Service Providers could register for sellers.

d. State and local tax levies
To reduce the complexity and administrative burden of collecting sales and use taxes, member states would do the following:

1. Lessen the difficulties faced by sellers when there is a change in a state sales or use tax rate or base by making a reasonable effort to do all of the following:
   1. Provide sellers with as much advance notice as practicable of a rate change.
   2. Limit the effective date of a rate change to the first day of a calendar quarter.
   3. Notify sellers of legislative changes in the tax base and amendments to sales and use tax rules and regulations.
      Comment: The potentially troubling words "by making a reasonable effort" are included to deal with the possible need to change rates quickly in response to a projected revenue shortfall. These words are not included in the description of the limitations on actions of the much more numerous local governments.
2. Not place caps or thresholds on the application of state sales or use tax rates or exemptions that are based on the value of the transaction or item after December 31, 2005.⁵⁵
   Comment: this provision (and the matching provision for local taxes below) would simplify compliance by allowing vendors simply to apply the tax rate to the tax base, without taking account of floors and ceilings.
3. Not have multiple state tax rates on items of personal property or services after December 31, 2005.⁵⁶ Until that date a state may continue to have a generally applicable state tax rate and additional state rates.
4. Provide that the tax rate equals the combination of the state and local sales tax rates.
5. The second and third provisions do not apply to sales or use taxes levied on the transfer of motor vehicles, aircraft, watercraft, modular homes, manufactured homes, or mobile homes.

1. There would be no more than one sales tax rate or more than one use tax rate per local taxing jurisdiction. Local sales and use tax rates would be identical. This provision and the next do not apply to sales or use taxes levied on the transfer of motor vehicles, aircraft, watercraft, modular homes, manufactured homes, or mobile homes.⁵⁷
   Comment: One rate per state would not be required. Each local jurisdiction would be allowed to choose its own sales and use tax rate.
2. There would be no caps or thresholds on the application of local sales or use tax rates or exemptions based on the value of the transaction or item.⁵⁸
3. Local rate changes would be effective only on the first day of a calendar quarter, after a minimum of 60 days' notice to sellers.
4. Where a purchaser computes tax based on local tax rates published in a printed catalog, changes in local sales tax rates would be applied only on the first day of a calendar quarter, after a minimum of 120 days' notice to sellers.
   Comment: Because of the lead time in the preparation of catalogs the notice period is lengthened from 60 days to 120 days. Catalog sales pose a particular problem, if purchasers wish to calculate amounts due vendors and pay by check or money order. (Payment with credit or debit card charges, and even C.O.D., would pose no problem, as the vendor could calculate the tax due.) It would be infeasible to implement local tax rates that vary widely, depending on the address of the purchaser. Despite their disadvantages, use of a blended rate or exemption from local use taxes may be appropriate in this limited case.
5. Changes in boundaries of local jurisdictions would be applied only on the first day of a calendar quarter, after a minimum of 60 days' notice to sellers.⁵⁹
6. The state would maintain a database that describes boundary changes for all taxing jurisdictions.
   Comment: Taxpayers have commonly borne the burden of knowing about boundary changes, even when there is no readily available source of information on such changes. Similar comments apply to the two provisions that follow, regarding applicable tax rates and assignment of addresses to jurisdictions. These provisions place the burden on the states, which must eventually provide all these databases in downloadable form.
7. The state would maintain a database of all sales and use tax rates for all jurisdictions. Identification of states, counties, cities, and parishes would correspond to Federal Information Processing Standards (FIPS) as developed by the National Institute of Standards and Technology. Identification of other jurisdictions would follow a format determined jointly by the member states.
8. The state would maintain a database that assigns each five digit and nine digit zip code to the proper tax rates and jurisdictions.⁶⁰
9. The state would participate in the development of an address-based system for assigning taxing jurisdictions that meets the requirements developed pursuant to the federal Mobile Telecommunications Sourcing Act.

Temporary tax exemptions would be allowed after December 31, 2003 only if the item exempted has been defined in the Agreement.⁶¹ (See item f below.) In state where local jurisdictions levy a sales or use tax, the state must provide notice of the exemption period at least 60 days prior to the first day of the calendar quarter in which the exemption period begins and apply the exemptions to both state and local tax bases.
Comment: State and local governments sometimes provide "sales tax holidays" (for example, to coincide with the beginning of the school year), temporarily exempting certain items (e.g., school supplies and children's clothing) from tax. These holidays, which necessitate reprogramming of computers, sometimes are enacted with extremely short notice and raise definitional issues that have no ready answer.⁶²

e. Uniform sourcing rules
Sellers would be required to source sales in accordance with the following provisions, regardless of the characterization of a product as tangible personal property, a digital good, or services (except sales or use taxes levied on the transfer of motor vehicles, aircraft, watercraft, modular homes, manufactured homes, or mobile homes, which would be sourced according to the requirements of each member state, and excluding for the present telecommunications). These provisions do not affect the obligation of a purchaser to remit use tax on its taxable purchases.
Comment: The objective is to approximate destination-based taxation as closely as possible.⁶³

1. When the product is received by the purchaser at a business location of the seller, the sale is sourced to that business location.
   Comment: This would be a normal over-the-counter retail sale.
2. When the product is not received by the purchaser at a business location of the seller, the sale is sourced to the location where the purchaser (or the purchaser's donee, designated by the purchaser) receives the product. This would include the location indicated by delivery instructions, if known to the seller.
   Comment: This provision would, where possible, source gifts to the location of the recipient, instead of the giver. While consistent with the destination principle, it produces a result that is different from that when the giver buys the gift from a local retailer and sends it to the recipient.
3. When the first two rules do not apply, the sale is sourced to the location indicated by an address for the purchaser that is available from the business records of the seller that are maintained in the ordinary course of the seller's business, when this does not constitute bad faith.
4. When the above three rules do not apply, the sale is sourced to the location indicated by an address for the purchaser obtained during the consummation of the sale. This would include the address of a purchaser's payment instrument, if no other address is available, when reliance on this address does not constitute bad faith.
   Comment:The "bad-faith" exception is intended to prevent sellers from participating in schemes to evade taxes by utilizing addresses in no-tax states on payment instruments. It presumably would not prevent the buyer's ability to use this ploy without the knowledge of the seller.
5. When none of the above rules apply, including the circumstance where the seller lacks sufficient information to apply the rules, sales would be sourced to:

   for tangible personal property: the address from which the product was shipped;
   for digital goods: the address from which the product was first available for transmission by the seller or from which the service was provided. Any location that merely provided the digital transfer of the product sold would be disregarded.
   Comment: These origin-based fall-back provisions would apply where it is impossible to implement destination-based sourcing. The wording of the rule for digital goods (as elaborated by the qualification in the second sentence) is intended to prevent domestic suppliers of digital content from evading tax by channeling transmission through no-tax states or foreign locations. Implementation of this rule would appear to be administratively demanding, given the nature of digital commerce.

f. Uniform definitions⁶⁵
The agreement does not require any state to tax or exempt any product. But states must use the definitions specified in the Agreement if it chooses to tax or exempt products covered by those definitions. In taxing or exempting products, a state must include all items specifically listed within a definition and may not vary from any definition except as specifically provided.⁶⁶ The definitions of clothing and food are the most important contained in the Agreement.
Comment: This approach forces states (and localities) to tax or exempt broad categories of products that are commonly subject to exemptions, employing uniform definitions of the categories, rather than applying exemptions or taxation to narrowly-defined products, based on definitions that may be unique to the particular state (or locality). There are no definitions of tax-exempt sales to business and non-profit organizations. It appears that the intent is to rely on audits of such entities in their capacity as purchasers to enforce compliance. While this may be appropriate for entities operating in only one state, it would appear to be problematic for multistate entities, which would be forced to comply with the laws of each state.

i. Clothing and related items
"Clothing" means "all human wearing apparel suitable for general use." The Agreement contains illustrative lists of items that are clothing⁶⁷ and of items that are not clothing;⁶⁸ neither list is intended to be comprehensive. Comment: The definitional lists (given in notes 67 to 71) demonstrate graphically the needless complexity that is created by deviating from the simple rule that all B2B sales are exempt and all B2C sales are taxed; under that rule these lists would be totally unnecessary. In addition, since the lists are intended to provide examples, and not to be comprehensive, other products will need to be classified. There is considerable risk that states will initially adopt definitions of these that are not uniform in all respects. It can be expected — or at least hoped — that the definitions and lists will be fine-tuned over time to overcome this potential frailty by becoming comprehensive.

The following definitions are mutually exclusive of "clothing" and of each other. Again, there are non-comprehensive lists of examples of each. a. "Clothing accessories or equipment" are incidental items worn on the person or in conjunction with clothing.⁶⁹
b. "Sport or recreational equipment" are items designed for human use and worn in conjunction with an athletic or recreational activity that are not suitable for general use.⁷⁰
c. "Protective equipment" are items for human wear and designed as protection of the wearer against injury or disease or as protection against damage or injury of other persons or property but not suitable for general use.⁷¹

ii. Food and food ingredients
"Food and food ingredients" means "substances, whether in liquid, concentrated, solid, frozen, dried, or dehydrated form, that are sold for ingestion or chewing by humans and are consumed for their taste or nutritional value." It does not include alcoholic beverages and tobacco, each of which is defined. Candy, dietary supplement, and soft drinks are mutually exclusive (and defined) categories of food and food ingredients. States may choose to exclude prepared food and food sold through vending machines from the definition of food and food ingredients.
Comment: Candy, dietary supplement, and soft drinks are separately defined, so a state could, if it wished, exempt them from a general exemption for food. The project would allow a state to exclude prepared food and food sold through vending machines from the definition of food for similar reasons. Defining "prepared foods" seems preferable to basing exemption on the type of premise where prepared food is commonly sold. The sale of both taxable food and non-taxable prepared food by the same establishment could cause complexity, as could the separate categories for candy, dietary supplements, and soft drinks.

iii. Sales price
The Agreement defines delivery charges, purchase price, retail sale, and sales price. It is noteworthy that "sales price" (and "purchase price, which is the equivalent for the application of use tax) includes delivery charges, installation charges, and the value of exempt property that is bundled with taxable property.
Comment: State currently differ in the treatment of delivery and similar charges and the tax treatment of bundled products. This provision would unify treatment. Inclusion of delivery charges is important to the achievement of equity and neutrality between local merchants (which implicitly include delivery charges in what they sell over the counter) and remote vendors.

h. Uniform tax returns
Member states would require only one tax return per seller per taxing period, allow Model 1, Model 2, or Model 3 sellers to submit sales and use tax returns in a simplified format, and participate in developing a more uniform sales and use tax return form that, when completed, would be available to all sellers. At their discretion they would require all Model 1, 2, and 3 sellers to file returns electronically. The member states intend that all have the capability of receiving electronically filed returns by January 1, 2003.
Comment:This provision would simplify filing tax returns, as each state now has its own forms.

i. Uniform rules for deductions of bad debts⁷²
In computing the amount of tax due, member states would allow a deduction for bad debts, as defined for federal income tax purposes.
Comment:Not all states currently allow deductions for bad debts. This provision would allow such deductions, based on a federally defined standard.

j. Uniform rules for remittances of funds
Member states would require only one remittance per return, except additional remittance could be required from sellers that collect more than $30,000 in sales and use taxes in the state during the preceding calendar year. Member state could, at their discretion, require remittances from sellers under Models 1, 2, and 3 to be remitted electronically. Information accompanying remittances would employ uniform coding.

k. Confidentiality and privacy protections
Member states' laws and regulations regarding the collection, use and maintenance of confidential taxpayer information would remain fully applicable and binding. Member states would insist on preserving the privacy of consumers by protecting their anonymity under Model 1. A Certified Service Provider would be allowed to retain personally identifiable information of consumers only in limited circumstances, notably to verify exemptions and for audit purposes.
Comment:There has been enormous concern that "trusted third parties" (the term the NGA originally used for what are called Certified Service Providers in the SSTP draft) could not be trusted with the massive amounts of information they would have on the buying habits of consumers.

2. Certification under the SSTP
The SSTP envisages 2 types of certification, plus (for Model 3 sellers, discussed below) performance agreements.

a. Certified Service Provider (CSP)
A Certified Service Provider (CSP) is an agent certified to perform all the seller's sales and use tax functions, other than the seller's obligation to remit use tax on its own purchases.
Comment:CSPs would play a central role in simplification, as they would (or could) perform all the tasks vendors now perform for themselves and be responsible for the accuracy of taxation. They, rather than vendors, would be responsible for liabilities resulting from errors they make.

b. Certified Automated System (CAS)
A Certified Automated System (CAS) is software certified to calculate the tax imposed by each jurisdiction, determine the tax to remit to the appropriate state, and maintain a record of the transaction.
Comment:CAS software is at the heart of the technology-based solution to the sales/use tax problem. It would incorporate "lookup" tables mapping addresses to taxing jurisdictions and indicating the tax treatment of each defined product (taxable or exempt) in each state and the tax rate to be applied to taxable transactions in each jurisdiction. It would calculate the amount of tax due, attribute it to the proper jurisdiction, and prepare the documents necessary for compliance.

3. Three compliance models
The SSTP describes three compliance models, based on the system of certification and performance agreements and presumably envisages a fourth model for sellers who conform to none of the other three.
Comment:It seems likely that small firms (and perhaps medium-sized firms making substantial amounts of interstate sales) would employ Model 1, that medium-sized firms would employ Model 2, and that large firms with legacy systems in place would employ Model 3. Firms operating in only one state or making only small amounts of sales into a state might fit the fourth model, which involves compliance along traditional lines, without the benefit of CSPs, CASs, and performance agreements.

a. Model 1 seller
A Model 1 seller would employ a CSP to perform all sales and use tax functions, other than remit tax on its own purchases.

b. Model 2 seller
A Model 2 seller would retain responsibility for remitting the tax, using a CAS to perform part of its sales and use tax functions.

c. Model 3 seller
A Model 3 seller would use a proprietary system to calculate the tax due each jurisdiction after entering into a performance agreement with the member states that establishes a tax performance standard for the seller. Eligibility for this regime would require sales in at least five member states and total annual sales revenue of at least $500 million, a figure the states acting jointly could lower. Affiliated group of sellers using the same proprietary system would be lumped together.

4. Vendor compensation
Member states anticipate providing monetary allowances to encourage implementation of new technological models and/or voluntarily registration where it is not required (because the seller lacks use tax nexus in the state). The following payments are anticipated.⁷³

a. Incentives for voluntary registration
For a period not to exceed 24 months following a voluntary seller's registration through the Agreement's central registration process, CSPs (in the case of Model 1 sellers) and voluntary sellers (other than Model 1 sellers) would receive a percentage of tax revenue generated for a member state by the voluntary seller. "Voluntary seller" means a seller that is not legally required to register to collect the tax for a member state. Payments to CSPs would be determined in the contracting process.

b. Incentives for the use of new technology
Model 1 and 2 sellers — that is, those using a CAS, either directly or through a CSP — would receive a "base rate" applicable to all taxable transactions.⁷⁴ Payments to CSPs would be determined in the contracting process.
Comment:Under these rules Model 3 sellers and non-certified sellers having nexus in the state would receive no incentive payments.

5. Amnesty for voluntary registrants
Those who voluntarily register for use tax collection will be absolved of any liability for tax, penalty or interest, provided they had not been previously registered or were not subject to audit when they registered.

IV. Concluding Remarks: Tentative Appraisal of the SSTP
The efforts of the states to simplify their sales and use taxes, as reflected in the SSTP (before the modifications made by the Executive Committee of the NCSL), are laudable and, if enacted, will go a long way to reduce complexity, without sacrificing local autonomy over tax rates. The uniform definitions, the requirement for a common state and local tax base, the elimination of caps and thresholds, the single state rate, the uniform bad debt provision, the uniform sourcing rules, and the repeal of the "good faith" requirement on exempt sales are particularly noteworthy. (Of course, unless — or until — the NCSL's modifications and deletions, particularly its deletion of the uniform definitions, is reversed, substantial complexity will remain.) But I think it unfortunate that there is no desire to seize the moment to create a truly modern sales tax system that would be economically neutral, as well as simpler than what is contemplated, by exempting all B2B transactions and taxing all B2C transactions.

The retention of needless complexity involves primarily definitions of products to be either taxed or exempted. Because of the unwillingness to propose adoption of comprehensive taxation of all consumption, the need to distinguish between taxable and exempt products remains. More important, the SSTP has not dealt with the need for uniform standards for exempt sales to business and non-profit organizations. Instead, it has attempted to sidestep the problem, by placing the onus on the purchaser, over which the states have greater control.

Finally, aside from the areas enumerated above, the SSTP does not, for the most part, address the need for greater uniformity in the wording and interpretation of laws and regulations. Instead, it has adopted a "technological fix" based on Certified Service Providers, Certified Automated Systems, and performance agreements with Model 3 sellers. In theory CASs and proprietary software employed by Model 3 sellers would incorporate the vagaries of tax laws of the various states. It would be preferable to have a Uniform Sales and Use Tax Law, within which the states could exercise the autonomy envisaged in the SSTP.

See FOOTNOTES

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