The Internet sales tax issue has been debated for a number of years, but the issue grew to a new level of intensity after the state of California signed into law a bill that required all online retailing sites to pay taxes on their affiliate advertising. This, of course, sparked a big dispute since many online retailers such as Amazon cut off their affiliate programs in the state.

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.