Federal legislation has been proposed that could allow governments to tap into a long-prohibited marketplace — the Internet. If the legislation is successful, cities could gain billions of dollars in additional revenue.

An estimated $18.6 billion in sales tax from online transactions will go uncollected this year, according to Main Street Fairness Act (HR 5660) sponsor, Rep. Bill Delahunt, D-Mass. By 2012, that amount could rise to $23 billion.

HR 5660 would create uniform definitions to be used by all states in setting taxes on Internet sales, says Max Behlke, policy associate for the Washington-based National Conference of State Legislatures. The case of Quill v. North Dakota from 1992, which addressed mail-order catalog sales, essentially blocked taxation of Internet commerce by saying that it was too complex for states to tax products that are imported from other states because of varying tax code definitions, Behlke says.

Keeping track of local and state taxes owed on Internet sales could place an undue burden on small businesses that do transactions online, says Fred Neff, president of the Wellington, Fla.-based International Merchants Association. “To me, it seems like it's going to be such a daunting task that it's going to force a lot of the small Internet businesses to want to either leave the marketplace or not obey the law,” Neff says.

Opponents to Internet sales tax should remember that local governments need more revenue to continue to provide services, says Lars Etzkorn, program director for the Washington-based National League of Cities. “American cities are going to be faced with continuing service cuts over the next two to three years, and those service cuts are going to affect quality of life,” he says.

It's all about freedom

Currently, the only way for states and local governments to tax online sales is if the company selling the product has a physical presence in that state.

Colorado, Rhode Island and North Carolina have passed laws claiming that online retailers' affiliates in those states that make money by referring customers to their online partners constitute a physical presence and make them liable to state sales tax.

In response, Internet bookseller Amazon.com ended affiliate programs in those states and, in North Carolina, claimed that reporting sales would violate the First Amendment rights of their clients.

Source: ABC News, "Amazon.com: Fighting for Free Speech? Or Against Sales Tax?," May 11, 2010.