Taxing the Internet

Virginia's economy depended initially upon farming. In the colonial era, government operations were funded primarily by taxing land.

The Federal income tax was authorized by the 16th Amendment to the US Constitution in 1913. In the 20th Century, Virginia generated an increasing percentage of government revenues from state income taxes.

The General Assembly, at the request of Governor Godwin, passed the first Virginia statewide sales tax in 1966. The initial 3% statewide sales tax applied to food and non-prescription drugs, but not services. Revenues were intended originally to finance an expansion of education-related services.1

Sales taxes are collected at the point of sale by clerks in stores, by wait staff at restaurants, and by automated pumps at gas stations. In the 1990's, online sales raised the challenge of collecting sales made in cyberspace, where transactions were processed via clicks of a mouse. The 45 states with sale taxes in 2000 could not require sellers to collect any sales tax when the online sellers were located outside the state's boundaries, but those states did require customers to pay a "use tax."

A use tax was:2

due when an item is purchased from a business in another state and the business does not have sufficient presence (nexus) in the consumer’s state for the sale to be subjected to sales tax.

In theory, customers would self-report on their annual state tax forms and pay the use tax due for all their online purchases for the last year, or the money they would have paid if the seller had collected sales tax. In practice, few people paid the use tax and states had few enforcement tools for collection.

The US Supreme Court first addressed the issue long before development of the Internet. In 1967, the case National Bellas Hess, Incorporated v. Department of Revenue of the State of Illinois involved a mail-order business which had no facilities or sales representatives in Illinois, but shipped goods to customers in that state.

The Supreme Court had ruled previously that a state could tax sales where goods were delivered to a customer within that state, but only where the seller had a "substantial nexus" of physical facilities, equipment, or staff located within the same state. The court determined in 1967 that mail order sales conducted exclusively through the Post Office or common carrier were not taxable by individual states. The US Constitution gave that power only to the US Congress:3

For if Illinois can impose such burdens, so can every other State, and so, indeed, can every municipality, every school district, and every other political subdivision throughout the Nation with power to impose sales and use taxes. The many variations in rates of tax, in allowable exemptions, and in administrative and record-keeping requirements could entangle National's interstate business in a virtual welter of complicated obligations to local jurisdictions with no legitimate claim to impose "a fair share of the cost of the local government."

In 1992, the Supreme Court reconsidered the issue in Quill v. North Dakota. By that time, e-commerce sales were expanding as more people and businesses connected to the internet. North Dakota argued that it was entitled to tax purchases of software shipped via floppy disk to customers within the state.

The Supreme Court noted in its decision blocking North Dakota from taxing such sales that the Constitution's Due Process Clause:4

requires some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax... income attributed to the State for tax purposes must be rationally related to "values connected with the taxing State"... Congress is now free to decide whether, when, and to what extent the States may burden interstate mail order concerns with a duty to collect use taxes

The 1998 Internet Tax Freedom Act blocked state and local governments from taxing the fees customers paid to telecommunication firms for Internet access, a ban that was extended permanently by passage of the Trade Facilitation and Trade Enforcement Act of 2015. It was silent on a Federal sales (or use) tax on interstate sales conducted online. That silence revealed that Congress was not responding to the Supreme Court's suggestion that national policy on taxing online sales should be defined by the national legislature though a new law, rather than through a court decision.5

The Internet Tax Freedom Act also created the Advisory Commission on Electronic Commerce. Governor Gilmore of Virginia chaired it, and he boldly recommended that the commission recommend Congress:6

Permanently prohibits multiple and discriminatory taxation of electronic commerce, prohibits sales and use taxes on remote sales of goods and services to individual consumers, and prohibits taxation of sales of digitized goods and products purchased by individual consumers electronically over the Internet

At the time, the National Governors Association was concerned that a potential Federal tax on Internet sales might be intended to streamline the tax collection process by eliminating the complexity of thousands of different tax rates imposed by different jurisdictions, but would also pre-empt the ability of the states to set their own tax and budget policies.

Granting tax-free status to online retailers would discriminate against existing "brick and mortar" businesses. Over time, the economic advantage of online retailers would reduce the sales taxes collected in most states.

The National Governors Association objected to a Congressional proposal in 2000 to preempt existing state and local sales and use tax systems, and establish uniform national rates. The governors particularly feared that Congress would ban the collection of sales tax for e-commerce transactions while states would still tax transactions made at physical stores, noting:7

In effect, the federal government will be providing this significant price differential to those who don't support communities, create jobs, pay property taxes, and keep our cities and towns livable. It is both unfair and counterproductive public policy. It is, in essence, a two-tiered system: good for clicks, bad for bricks.

if Internet sales were exempted from sales taxes, a digital divide could result. Rural residents with slow or no Iternet access, and low-income consumers in inner cities, could end up shopping at store that imposed sales taxes and absorb a higher percentage of the tax burden.

As Amazon developed distribution centers in different states, creating "substantial nexus," the company dropped its opposition to collecting sales tax from customers in those states. In 2012, Amazon agreed to collect sales tax for sales shipped to Virginia. In 2018, the company opened its fourth distribution center in Virginia in Frederick County, joining others in Chester, Petersburg and Sterling.8

The General Assembly speculated on an Internet tax when it passed a major tax increase for transportation projects in 2013.

As part of the tax increase package, the legislature repealed the $0.175/gallon gasoline tax on retail sales collected from purchasers at the pump. That tax was replaced with a 3.5% wholesale gasoline tax, adjusted twice per year but with a minimum price set around $3.50 per gallon (the cost when the law was passed). That change reduced the 17.5 cent/gallon tax to as low as 12.25 cent/gallon.

The tax break was made effective only upon the condition that Congress authorize Virginia to collect sales tax from out-of-state companies with no "nexus" within the state. Amazon had already agreed in 2012 to pay such a tax, so the proposed new sales tax burden would fall on its e-commerce competitors.

If the Congress did not act by the start of 2015, then the gas tax would be set at 5.1% rather than 3.5%. Because the minimum was based on a price of $3.50 per gallon, a 5.1% tax would generate the equivalent of 17.85 cents per gallon. Congress failed to approve the Marketplace Fairness Act it was considering in 2013, so Virginia applied the higher 5.1% gas tax.9

In 2018, The US Supreme Court stopped waiting for Congress to act. It ruled in South Dakota v. Wayfair that states could require out-of-state retailers to begin collecting sales tax for online sales shipped to customers witin the state.10

In 2013, the Virginia Department of Taxation estimated that online sale tax revenues in Virginia could generate $180 million more for the state and $30 million more for local jurisdictions.

The Virginia’s Tax Fairness Act passed in 2013 ensured Amazon and other large companies with distribution warehouses in Virginia would collect sales tax from its in-state customers. By the time the Supreme Court issued the South Dakota v. Wayfair decision five years later, Virginia was already collecting sales tax from 19 of the 20 largest Internet sellers, including Amazon, Apple, and Walmart.

Nonetheless, state oficials initially estimated Virginia might collect $250-$300 million annually if the General Assembly passed legislation to authorize collection of online sales taxes, consistent with the interstate Streamlined Sales and Use Tax Agreement.11

Sales Taxes in Virginia

Virginia and the Internet

Will the Internet Change Virginia's Regions?



1. Michael S. Deeb, Stuart W. Connock, "Virginia's Sales Tax: Its Origins and Administration," The Virginia News Letter, Weldon Cooper, University of Virginia, Volume 46, Number 8 (March 31, 1970), (last checked June 26, 2018)
2. "Report to Congress," Advisory Commission on Electronic Commerce, 2000, p.13, (last checked June 26, 2018)
3. National Bellas Hess, Incorporated v. Department of Revenue of the State of Illinois, 386 U.S. 753 (87 S.Ct. 1389, 18 L.Ed.2d 505), Legal Information Institute, Cornell Law School, (last checked June 26, 2018)
4. Quill v. North Dakota, 504 U.S. 298 (1992), Legal Information Institute, Cornell Law School, (last checked June 26, 2018)
5. Jeffrey M. Stupak, "The Internet Tax Freedom Act: In Brief," Congressional Research Service, April 13, 2016, (last checked June 26, 2018)
6. "Findings, Recommendations, Resolutions, Amendments, and Modifications Submitted for Consieration at the Dallas Commision Meeting," Advisory Commission on Electronic Commerce, March 7, 2000, (last checked June 26, 2018)
7. "Testimony - Internet taxation," National Governor's Assciation, February 2, 2000 , (last checked June 26, 2018)
8. "Virginia sales tax looms for," The Virginian-Pilot, February 23, 2012,; "‘Amazon loophole’ to close in Virginia," The Washington Post, February 22, 2012,; "Amazon to open 4th Va. distribution center, add 1K jobs," WTOP, March 28, 2017, (last checked June 26, 2018)
9. "Virginia Legislators Approve Increases in Sales Tax, Car Tax, Regional Taxes," Tax Foundation, February 25, 2013,; "Death of a Sales Tax Rule: Wayfair's Implications for Virginia," Virginia Legislative Issue Brief Number 60, July 2018 , (last checked September 22, 2018)
10. South Dakota v. Wayfair, US Supreme Court, June 21, 2018,; "South Dakota v. Wayfair, Inc.," SCOTUS blog,; "Online Retailers Can Be Forced to Collect Tax, High Court Rules," Bloomberg, June 21, 2018, (last checked June 26, 2018)
11. "Death of a Sales Tax Rule: Wayfair's Implications for Virginia," Virginia Legislative Issue Brief Number 60, July 2018 ,; "Supreme Court decision could boost Virginia sales tax collections by $300 million a year," Richmond Times-Dispatch, June 21, 2018,; Steve Haner, "Steps Virginia Must Take to Tax Internet Sales," Bacon's Rebellion, September 3, 2018,; "2016 Fiscal Impact Statement - Bill Number HB 969," Virginia Department of Taxation, February 2, 2016, (last checked September 22, 2018)

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