Tax Complexity Leads to Sales Tax Switcheroo

March 27, 2009

Consumerist has a story today about Jane, who bought shoes online from Nine West, and then discovered that she was charged $5.48 more than she expected on a $220 order. Nine West explains that the change was an adjustment to sales tax:

When placing your online order, on your checkout page you will see that we indicate the sales tax amount as being an approximate rate. Once your order is submitted, we pass it through two separate tax verification systems to ensure that you are charged the correct tax amount for your county. I’m very sorry if we have caused you any concern and please let me know if I can be of further assistance.

Customer Jane isn’t satisfied, and neither is Consumerist blogger Carey, who somewhat rashly urges Jane to file a chargeback with her credit card company (even though Nine West claims it disclosed that the tax listed on the order confirmation was an estimate). Many of the commenters are astounded that the retailer couldn’t accurately calculate the sales tax on the first try—after all, how hard is it to multiply a price by a percentage?

The answer is, harder than you might expect. Thirty-six* states impose sales taxes at the county, city, school district and/or transportation district level. Some places, like Chicago, even have add-on taxes only for specified areas within cities. All told, there are more than 8,000 sales taxing jurisdictions in the country. And because those taxing jurisdictions do not necessarily align with zip boundaries, or even zip+4 boundaries, knowing the buyer’s zip code isn’t enough to calculate the relevant tax.

Nine West is only required to collect sales tax for states in which it is physically present—generally, the states where it has brick and mortar stores. However, once a retailer has a physical presence somewhere in the state, it can be required to collect local sales taxes throughout the state, even for taxing jurisdictions in which it is not physically present.

The proliferation of taxing districts has become more problematic as more commerce has moved online. Sales tax for internet and catalog sales is “destination sourced,” which means it’s levied based on the buyer’s location rather than the seller’s. While a brick and mortar retailer must only comply with taxes in the places where it has stores, an online retailer must comply with sales tax for any location within any state where it has a physical presence.

Compliance costs could be greatly reduced with a switch to origin sourcing, where tax would be levied based on the seller’s location, as is done in brick and mortar stores. However, origin sourcing is inconsistent with the consumption tax nature of the sales tax, as goods are consumed at their destinations. Additionally, it would foster more tax competition, which could be good or bad, depending on your perspective.

Another option would be to reduce the number of sales taxing districts, or to align them with zip codes. Such streamlining would be an ideal initiative for the Streamlined Sales Tax Project, which was formed by state governments to reduce the cost of sales tax compliance. Unfortunately, this summer, when my colleague Joe Henchman asked a representative of SSTP whether they were pursuing a reduction or realignment of taxing districts, the short answer he got was “no and no.”

*Thanks to Indiana University Prof. John Mikesell for pointing out one city in Mississippi (Tupelo) levies a local sales tax, bringing the total to 36 states. The last two paragraphs of this post were modified from an earlier version for clarity and to better address drawbacks of origin sourcing.


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