Rising e-commerce could force watershed sales tax debate

Connecticut and most other states have watched for much of the past decade as Internet retail transactions increasingly have cut into their sales tax collections.

Though consumers here always have been required to pay tax on their online purchases, political pressures, a lack of direction from the federal government and even legal challenges from Internet retail giants have stalled efforts to collect that money.

But with a record-setting, $3.67 billion budget deficit looming just six months away, and new data showing online sales are bouncing back quickly from the recession, Connecticut officials may have no choice in the coming legislative session but to pursue a pot of online taxes possibly worth nearly $50 million per year.

“We can’t afford it,” Gov.-elect Dan Malloy said Wednesday, referring to projected $48.3 million annual loss Connecticut faces according to a 2009 study by the University of Tennessee. “My administration is looking at that (challenge) very seriously.”

The Democratic governor-elect is not alone in pledging to review a long-ignored problem that has sparked bipartisan concern.

“It really is a tremendous disadvantage to the business people in our state who pay all of the overhead to run a business” catering to a more traditional, in-person customer base, said Rep. Patricia Widlitz, D-Guilford, the new House chairwoman of the tax-writing Finance, Revenue and Bonding Committee.

Both Widlitz and Deputy House Minority Leader Vincent J. Candelora, R-North Branford, said addressing online sales has become a sticky-yet-pressing economic development issue.

Candelora, who has been ranking House Republican on the finance panel for the past two years, said he closed down a sporting goods business in 2004 because it was increasingly difficult to compete with online retailers who didn’t collect Connecticut sales tax.

“We were carrying an inventory we made a 5 percent profit on,” he said. “We couldn’t compete with the online companies,” that don’t collect the 6 percent sales tax.

The second-largest revenue component in the state budget, behind only the income tax, the sales levy is expected to yield $3.31 billion this fiscal year. That’s 4 percent higher than the $3.18 billion collected one decade ago, though the rate remains unchanged.

And Connecticut hasn’t experienced more than 5 percent annual growth in its sales tax since 2000.

Connecticut and most other states have struggled to determine just how severely online sales have weakened their sales tax collections since they can’t easily access business records showing the addresses of their online customer bases.

Nationally states lose a total of $7 billion a year in sales tax revenue, according to an analysis by the Center on Budget and Policy Priorities, a nonprofit fiscal and public policy group based in Washington, D.C.

The University of Tennessee study developed a methodology for estimating each state’s share of total national electronic commerce sales – and the corresponding sales tax loss – by assessing personal income and adjusted sales tax revenues tied to non-Internet transactions.

Many Connecticut legislators on the finance committee have estimated this state’s annual loss stands in the tens of millions of dollars, though they haven’t necessarily endorsed the 2009 study and its estimate of $48.3 million.

Regardless of the precise impact, though, there is agreement among state officials that the losses, unless addressed, will grow.

New data from the U.S. Census Bureau shows retail e-commerce sales rose nationally to $41.5 billion in the third quarter of 2010, up 13.6 percent from the same quarter in 2009. That marks the fourth successive quarter that sales rose by more than 13 percent over the prior year.

“It’s very clear people are getting more and more and more comfortable shopping online,” University of Connecticut economist Fred V. Carstensen, director of the Connecticut Center for Economic Analysis, said.

An increasingly common image in Connecticut stores this holiday season, he said, is a consumer, armed with a smart phone, comparing online prices with those on products on the shelves. “In many cases you see them making the online purchase while they’re still in the store,” Carstensen said, adding that this segment of retail commerce “is only going to continue to grow aggressively.”

One problem, legislators said, is the common misconception among consumers is that sales tax is waived on all products sold online. That makes any effort to collect this tax seen as a tax hike, while it really is an effort to enforce existing law, they said.

Connecticut residents are supposed to report all goods purchased tax-free, either out-of-state or online, on annual state income tax returns and add the corresponding charge to their total obligation.

But officials concede many residents do not pay the use tax. The $13.4 million in use tax paid last year by Connecticut income tax filers represented less than one-half of 1 percent of all sales tax revenue.

Widlitz said that while she doesn’t believe outreach programs educating the public about their obligations would solve the problem entirely, “I don’t think we can rule out anything. I think most people aren’t aware of the law.”

The finance committee has analyzed two approaches toward tackling the larger problem in recent years, but neither has met with much approval.

A measure approved with bipartisan support in committee last year, would have required Connecticut companies to pay sales taxes on transactions, if enough consumers linked through those company websites and onto a retail site, where they ultimately made a purchase.

Amazon.com responded to the bill last spring by threatening to sever its ties with thousands of Connecticut businesses that receive commissions by using their web pages to redirect shoppers to the Amazon site.

Uncertain over whether the so-called “Amazon law” would do more harm or good to Connecticut businesses, state lawmakers allowed the measure to die on the House calendar.

Another option, studied in finance committee in 2007 but not voted upon, would be to join a growing compact of states that pool “streamlined sales tax” data and are able more easily to track down all online consumers.

But to do so would require Connecticut to eliminate most of the $3 billion in sales tax exemptions it currently offers on such items as groceries, many clothing purchases, medicine and dozens of other goods and services.

Carstensen said the political objections to ending these exemptions could easily be overcome. The added revenue from taxing these new items could be used to lower the overall sales tax rate below 6 percent. It also could be used to provide new credits through the income tax to assist low-income households or others harmed by closing the sales tax exemptions, he said.