As a result, a lot of the affiliates in the state lost most, if not all, of their revenue. Nick Loper, who was among the affiliate victims, spoke to WebProNews back in August and told us that he lost 70 percent of his revenue almost immediately after the law went into effect. He ended up moving to Nevada and starting completely over.

The motive for California’s law was driven primarily by its struggling financial situation. Because many other states are facing similar scenarios with large budget deficits, they too are contemplating related actions. It’s understandable why states want to impose these taxes, but does that make it right?

Can these interstate tax propositions actually solve the tax problem? What do you think?

Adam Thierer, a senior research fellow with the Technology Policy Project at the Mercatus Center at George Mason University, doesn’t think that they would. He co-wrote a report with Veronique de Rugy on this topic, and as he explained to WebProNews, the tax issue is very complex and far-reaching.

“The debate about Internet taxation is really an interesting debate, because the sales tax only being a state and local tax is not something that can be easily applied to something that’s interstate in nature, which the Internet and Internet sales clearly are,” he said.

Even before Internet taxes became an issue, states have wanted to impose taxes on interstate companies that provide catalog and mail order services. However, they have not been able to do so because of their constitutional restraints. According to Theirer, the Supreme Court has provided limitations in this area because the states can’t put “discriminatory or unfair burdens” on companies that they don’t have any authority over.

Congress is now trying to get these limitations reversed with new legislation. In August, the “Main Street Fairness Act” was introduced to the Senate. It, in essence, calls for a set of federal guidelines that would dictate how states could collect sales taxes from online retailers.

A second bill, called the “Marketplace Equity Act of 2011,” and was introduced to the House last week. It is similar to the one introduced in the Senate but is a little different since it would give states the authority to require retailers, both on and offline, to collect sales taxes even when customers are located in states where the companies have no physical presence.

“What both these measures try to do is find a way to, essentially, authorize a state-based system of taxation for the Internet,” said Thierer.

“The reason, again, that the courts have not thus far allowed it is because, really, the complexity question. It’s not just that the states don’t have authority over interstate vendors; it’s that if they went to actually impose these taxes, it would create a huge burden on interstate sales and trade.”

States are aware that tax systems are complex, and many of them have joined the Streamlined Sales Tax Governing Board to simplify the processes. They are working to not only explain rates, but they are also working to clarify definitions such as the difference between a cookie and candy bar. This might seem of minimal value on the surface, but as Thierer explained to us, each of these items is taxed very differently.

He went on to say that, even if the systems were clarified, there would still be issues with this approach. He told us that states want to tax one another’s imports instead of taxing their own exports, which is a process that he calls a “tax cartel.”

“The wrong answer, in my opinion, is to essentially tax everybody up to a higher level,” said Thierer. “The better approach would probably be to tax downward and find a way to have a more competitive tax arrangement, so that we don’t set this collusionary approach that some states want to use.”

“I think that that would create a troubling disincentive to actually seeing more tax competition,” he added.

Thierer also pointed out his frustration with Amazon being at the center of this debate, saying that he was “very troubled” by it. He not only thinks that Amazon is pulling the spotlight away from other online retailers, but he is also disturbed that it is making deals with politicians in order to eliminate its tax own burden. The online retailer has been negotiating with states to avoid or delay paying taxes in exchange for investment and jobs in those states.

“In theory, that sounds great,” said Theirer. “I really do wonder about Amazon’s ability to deliver on it, but at the end of the day, this is really just politics, and it’s not the kind of solution that is ultimately going to serve the broader marketplace or consumers.”

Theirer believes that there is a better approach to the tax issue than the approach that both the states and Amazon are taking. In the report, Theirer and de Rugy propose 3 potential solutions to the tax problem. One option would be to abolish sales taxes entirely. For this to work, states would have to rely on income, property, and various other taxes.

On the other extreme, a second option would be to have a nationwide sales tax that would give states a certain portion of the income. Thierer, however, doesn’t think either of these methods is ideal. Instead, he is advocating an “origin-based sourcing rule” that would apply the structure of offline sales taxes to the Internet.

As he explained, it’s the idea of taxing consumers at the origin of sale, not at the destination, which is what the states want to do.

“The states and localities want to have a destination-based system where they try to figure out where everybody’s going to consume their online goods… that’s what creates the complexity and the costs associated with the plan that they desire,” said Thierer.

On the other hand, he believes his idea would, “create tax competition eliminate the constitutional tax headaches associated with the states’ current plan, and it would make sure that we don’t have a confusing, complicated array of rates and systems for interstate vendors to contend.”

It’s clear that the Internet tax issue is complex, but the big question at the end of the day is – do any of these approaches actually provide a solution to the problem? If so, would you be more apt to follow states’ proposal or Thierer’s proposal?

Do you have ideas for what should be done about Internet-related taxes? Let us know in the comments.

I say it’s a great interview, and it is — but Trent also says something that I think is pretty dumb: he says that he’s in favour of an Internet tax, in which everyone would pay their service provider $5 extra and that money would then be distributed to artists to compensate them for downloading. He’s not the only one who thinks this would be a good way to solve the problem, either; the Songwriters Association of Canada recently came out in favour of the exact same thing: i.e, a tax on ISPs.

This idea is appealing primarily because it seems so simple. In reality, however, it would be horrendously complicated to administer, on top of being wrong. Why is it wrong? Because imposing a tax on a broad range of people for the behaviour of a small percentage isn’t just unfair, it’s bad policy and in most cases doesn’t work (and please don’t compare this to the taxes I pay to provide medical care to smokers or whatever; that’s life and death, and this isn’t).

Why should everyone who uses the Internet — even those who just use it to get their email once a week, or to send a web link to their bridge club, or better yet to legally download songs from iTunes — have to pay a fee to compensate artists for the fact that less than 10 per cent of Internet users commit copyright infringement on a semi-regular basis? It makes no sense at all, despite how appealing it seems at first glance.

I sympathize with Trent, and with other artists who are struggling to find a way to adapt as traditional business models fall apart around them, but coming up with new taxes is the wrong solution.

Comments

A Reuters report said Senate members who wanted a shorter ban, and those who wanted to make it permanent, reached the agreement ahead of the November 1st expiration of the 1998 ban.

The House of Representatives had already agreed on a compromise, but only for a four-year ban. Congress will have to reconcile its differences and send something along to the White House for President Bush to sign.

Without a ban in place, state would likely look to the millions of Internet-using people and businesses as a ready stream of new revenue to exploit. Senator John Cornyn (R-TX) praised the extension, saying it “has helped the Internet expand and has protected entrepreneurs from burdensome taxes.”