This is at the heart of the Internet tax debate. States and local governments have the right to tax goods sold within their jurisdiction. In the world of brick-and-mortar retailers, the system is fairly straightforward. The retailer only has to deal with the taxes in the jurisdiction surrounding the store, and local governments have a relatively easy time of enforcing tax remittance.

Catalog sales, as they grew during the 1980s, put a crimp in this approach. Catalog companies could sell virtually tax-free to any customers in states where the business did not have any physical operations, providing them with a competitive advantage over traditional retailers and depriving states of that tax revenue.

It's important to note that tax laws do not maintain that states can't charge sales tax on such remote sales. They only say that the states can't force these businesses to charge sales tax to their customers. Technically, the consumer is ultimately responsible for paying any sales tax.

Reports differ on just how much revenue states stand to lose from the growth of E-commerce. Frank Shafroth, director of state and federal relations for the National Governors Association in Washington, says states lost $4 billion in revenue last year from untaxed remote sales. However, a study by Ernst & Young says states lost only $170 million, less than 1% of collected taxes. Either way, they will lose more and more as E-commerce continues its blistering growth.

To eliminate the loss of taxes from remote sales, states and other local governmental groups are pushing for tax assessment based on where the purchaser lives rather than the seller's location. This way, consumers lose all tax incentive to favor one type of retailer or another.

But retailers fear such an approach--and for good reason. There are roughly 6,500 taxing jurisdictions in the United States created by separate state, county, and city laws. Complying with all of these statutes could bury a company in a mountain of tax forms.

Shafroth's group, as well as county and city organizations, recognize these concerns and say they can be solved through technology. Basically, this would involve a database maintained by the states and local authorities that would automatically track and charge appropriate tax. They would couple the use of such a database with other legislative support such as limiting how often states can update tax rates.

While the states support a technology solution, others have reservations about such an approach. The problem is that technology can eliminate only so much of the work, says Mike Dever, CEO of online retailer Spree.com Corp. in West Chester, Pa. "Technology still requires someone to run it," Dever says.

The state approach to taxing according to the residence of the purchaser can avoid the growing issue of defining "nexus" for new, logistically complex E-commerce outfits.

But the buyer-based tax assessment approach also raises issues of consumer privacy, since all E-retailers will need to know the approximate geographical location of every customer.

Robin Lebo, director of customer acquisitions for Crutchfield Corp., a Charlottesville, Va., cataloger and online retailer of auto accessories, says such an approach is unfair to companies such as hers.

"I can't imagine us collecting taxes in every single state," Lebo says. "I could see such a system putting smaller Internet retailers out of business because of administrative expenses."

These issues are just the starting point for the Internet taxation debate. Another proposal calls for creating a common tax rate and centralized collection authority and then redistributing the funds in some proportional formula to the states--but that carries with it its own set of pros and cons. Many other ideas, such as eliminating any sales-tax burden on Internet sales or having the government contract third parties to collect all sales taxes from remote sellers, are also being discussed.

Regardless of what opinions people and groups involved in the debate may have about addressing Internet taxation, there's one thing on which everyone seems to agree: The subject is an incredibly complex issue that has no clear solution at this time. Says Shafroth, "This is a work in progress, no doubt about it."

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Photo of Lebo by Scott Robinson