A new bill in Congress would allow sales tax to be charged on Internet transactions – a move backers say would eliminate the edge online retailers have over brick-and-mortar small businesses.

Proposed by Bill Delahunt (D-Mass.) and known as The Main Street Fairness Act 2010, the bill would end one of the biggest perks of online shopping – no sales tax – by allowing states to require tax payments for online transactions, provided they have a uniform set of rules to streamline collection. Nearly half of all states (24) already have such rules, and experts predict others swiftly would follow if the bill passed. Delahunt's bill includes a get-out clause for small businesses, but it doesn't define "small" – at least not yet.

The proposed legislation is not without controversy. On Thursday, Rep. Paul W. Hodes (D-N.H.) introduced a resolution opposing it, asking House members not to approve a "burdensome" tax requirement on small online businesses.
"The internet has opened a fast lane to further job creation and innovation, and allows our small business to compete in the worldwide marketplace," Hodes said in a statement.

States desperate for revenue – and protective of local business – are behind Delahunt's bill. Collectively, states claim they lose as much as $23 billion because they can't force online retailers to pay state sales taxes unless those businesses have a physical presence in the state, such as an office, store or warehouse. This stems from 1992's Quill v. North Dakota, where the Supreme Court held that it was difficult and expensive for businesses to determine what should be collected because of byzantine tax rules with huge variation from one state to another. (At the time, there were 45 state and 7,600 local tax systems across the country). Instead, shoppers were supposed to figure out how much they owed and pay up, but of course few people did – and it was too expensive and time-consuming for states to chase the money. This ruling dates from the early days of the Internet, of course, and only catalogs and TV home shopping channels really were affected, but since then Internet shopping has mushroomed into a $130 billion business.

"A consumer walking in [to a store] looks at the product you have to offer and includes in their mind the cost of tax when they buy the product. But they go on the Internet and they purchase the same product, and that Main Street businessman starts out at a disadvantage because he's collecting tax on the product," South Dakota Governor Mike Rounds, a Republican, said in a Capitol Hill news conference Thursday. "That's what this is all about: making it fair for brick-and-mortar businesses."

Rounds said his home state could pull in an extra $35 million per year in revenue from the proposal – or about 3 percent of the state's $1.2 billion budget.

About a dozen states this year have considered bills containing various attempts to collect tax, including broadening the definition of the Supreme Court's "physical presence" rule to catch certain types of advertisers. Online retailers with brick-and-mortar stores must collect sales tax, but online-only retailers (among them Amazon and eBay) do not. Industry trade group NetChoice said the legislation would be expensive for small businesses.

"Don't believe it when tax collectors say their software makes it trivial for tiny sellers to collect everyone's sales tax," said Steve DelBianco, NetChoice's executive director. "Small sellers will spend thousands of dollars making changes to their website software, plus endless time and accounting fees to handle exceptions, customer questions, and state tax audits."

Movement on the proposed legislation is unlikely to happen quickly. It's been referred to the House judiciary committee, but Congress's summer recess begins at the end of next week.