As online shopping explodes in popularity, creating a new retail marketplace with no geographical boundaries, an intense political fight has erupted over whether electronic purchases should be subject to the same sales taxes as goods bought on Main Street or in a shopping mall.

On one side are many state and local government officials, who fear that as more of the nation's economy shifts online they will lose tax revenue needed for schools, police officers and other basic municipal services. These officials have been joined by bricks-and-mortar merchants who argue that they can't compete if online rivals play by different rules.

"This is about a huge reshaping of the government being driven by the market," said Utah Gov. Michael O. Leavitt (R), the chairman of the National Governors' Association. "It boils down to a question of whether sales taxes are viable in the 21st century."

Across the table are Republican congressional leaders, anti-tax activists, some business executives and even a few local officials, including Virginia Gov. James S. Gilmore III (R), who say a lack of hassles over sales tax has accelerated the growth of e-commerce. Forcing an Internet business in Boston, for example, to compute how much tax to charge a customer in San Diego would be onerous and, they contend, would stifle the $30 billion Internet retail market and its contribution to the U.S. economic boom.

Depending how the issue is resolved, millions of consumers either could be slapped with new charges when making online purchases or they could continue to enjoy a virtually tax-free way to buy books, cameras, TV sets, furniture and other products available from electronic merchants.

Like so many other aspects of the Internet, the tax debate has mushroomed in recent months from relative obscurity to a front-burner issue in Congress, state capitals and the 2000 presidential race.

In what is expected to be the most-heated confrontation on this issue to date, the two camps will square off tomorrow in San Francisco at a two-day meeting of the Advisory Commission on Electronic Commerce, a 19-member panel created by Congress last year. Gilmore, the group's chairman, will push a proposal to give online commerce a permanent tax exemption. "E-commerce is a driving force of our economy and we shouldn't saddle it with new taxes," he said.

Leavitt and the governors' association will advance a rival proposal that would arrange for third-party clearinghouses to work with online merchants to compute the appropriate tax and remit it to the states. The clearinghouses would be compensated by a fraction of the tax revenue. The entire plan would be voluntary, but businesses that participated would be granted an immunity from certain tax audits, he said.

"The only justifiable position is to treat every business--online or not--equally," Leavitt said. "We need to create a level playing field."

That view is shared by a surprising number of Internet businesses who argue that they don't need a tax break to survive.

"Electronic commerce has bigger advantages than being tax free," said advisory commission member John Sidgmore, vice chairman of MCI WorldCom Inc. "You can shop at home at midnight if you want to."

A version of the debate began simmering decades ago, when mail-order catalogues grew popular. States, which receive about half their revenue from sales taxes, attempted to force mail order companies to collect the levies. But courts consistently have ruled that businesses cannot be required to do so in states where they have no substantial "physical presence," such as a retail outlet or warehouse.

In the 46 states that have a sales tax, however, consumers are supposed to pay a "use tax"--equivalent to their local sales tax--on goods bought out of state. Few people actually do so, making most out-of-state purchases effectively tax free.

Now states and local governments worry that they could lose as much as $10 billion a year in tax revenue to online commerce by 2003, according to the governors' association. That's only a little more than 2 percent of the total tax revenue collected by states, but the group believes the figure will grow substantially in subsequent years.

"This is money that's being used to pay for schools, for parks, for firefighters and police officers," said Howard County Council Chairman C. Vernon Gray (D), the president of the National Association of Counties.

Collecting taxes could be highly complex in the online world. There are more than 6,000 different sales tax jurisdictions nationwide, and each has different rules. Nine states, for instance, exempt clothing. In eight of them, a shoelace is considered clothing, but in Texas it is not, said Frank G. Julian, vice president for tax issues at Federated Department Stores Inc., which owns Macy's and Bloomingdales, each of which has a World Wide Web site.

Faced with complaining states and fearful businesses, Congress last year decided to punt the thorny tax issue to the advisory panel. When the group first met during the summer, most members indicated that they saw a solution in streamlining the patchwork of state tax rules so that businesses could collect the fees in a less burdensome way.

But in recent months, Gilmore and a few other members of the group have pushed for a permanent tax exemption. They argue that taxes would smother online merchants, pointing to a University of Chicago study that found that applying existing sales taxes to the Internet could reduce the number of online buyers by 25 percent and spending by 30 percent.

"We shouldn't do anything that might throw a wet blanket on e-commerce," said Greg Drew, the president of, which sells television sets, stereos and other electronic devices. Saying that current tax rules provide "a compelling reason for people to go online," his Web site displays a prominent message it hopes will persuade visitors to make a purchase: "No surprises at checkout . . . thanks to no sales tax."

Proponents of an Internet tax ban argue that it won't give any special advantages to online merchants, noting that shipping costs often account for as much--if not more--than what consumers save in sales taxes.

They also assert that state and local governments have not seen their tax revenue drop because of electronic commerce. "Anyone who visits a mall this holiday season will have a hard time saying that traditional retailers and local governments are hurting," said Sen. Ron Wyden (D-Ore.), who introduced the legislation creating the advisory panel and enacting a three-year moratorium on any new taxes on Internet commerce.

The effort to permanently ban Internet sales taxes has been gaining political momentum. Sen. John McCain (R-Ariz.), a presidential candidate, recently introduced a bill to that effect. Anti-tax groups, including Americans for Tax Reform, have made the issue a top priority. The topic also has popped up in Republican presidential debates, during which candidates Steve Forbes, Gary Bauer and Orrin Hatch, as well as McCain, have cited their opposition to Internet taxes.

Political analysts view Gilmore's plan, which follows on his politically popular efforts to eliminate Virginia's property tax on cars and trucks, as an effort to take his tax-cutting agenda to a national stage. His "No Car Tax" mantra now has been replaced with a similar three-word slogan: "No Internet Tax."

Gilmore and his allies cast their effort as protecting consumers from new taxes, which has confounded those on the other side of the issue. "This debate has turned into a political fight, not a policy debate," Leavitt said. "We're trying to teach people that we just want to collect taxes that are already on the books, but that doesn't fit nicely on a bumper sticker."

When the commission meets in San Francisco this week, traditional retailers intend to be out in force to make that point. They've formed a group called the "E-Fairness Coalition" that includes a disparate group of retailers who have often been adversaries in other disputes: shopping mall owners, independent booksellers and Wal-Mart Stores Inc. They plan to brandish a survey conducted for the National Association of Counties and the U.S. Conference of Mayors in which 60 percent of respondents said they support sales taxes on goods bought from online retailers.

The Clinton administration on Friday said the Gilmore plan "raises troubling questions" and the administration asked whether the approach provides "an incentive for merchants to establish a kiosk in every store so that customers can make all their purchases online and avoid paying sales tax."

In fact, uncertainty over online taxes had already prompted some businesses to make changes. Bookseller Barnes & Noble has established its Web site ( as separate operation so its brick-and-mortar stores won't create a physical presence that would force it to collect sales taxes. Personal computer maker Gateway Inc., which sells its products through a Web site, over the phone and at about 200 stores nationwide, recently started to operate the stores as a separate business because of tax concerns. "We can't live at a competitive disadvantage," said John Heubusch, Gateway's government relations director, who noted that online rivals such as Dell Computer Corp., which doesn't have any stores, doesn't have to collect sales tax on most consumer purchases.

Many large retailers, which are rushing to set up Web sites to complement bricks-and-mortar stores, share Gateway's concern, and as a result, oppose the Gilmore plan.

The commission is supposed to deliver its recommendations to Congress by April 1, but many members believe the group will be unable to reach a consensus. If that happens, Congress could take up the issue itself or ask the group to continue its work, Wyden said.

But at least one state isn't willing to wait. In Michigan, the state treasurer is asking residents to list on this year's income tax forms the value of goods they bought from out-of-state Internet and catalogue merchants--and pay the state a 6 percent sales tax on the items.

"We don't want there to be a 6 percent price difference between Main Street and the Internet," Michigan Treasurer Mark Murray said.

Although he is not expecting every resident to comply this year, Murray and others following the issue believe that when faced with the consequences of a declining tax base, people will become more willing to support collection efforts.

William Whyman, an Internet industry analyst with Legg Mason Wood Walker Inc., agreed. "People will start to ask," he predicted, " 'Why are we subsidizing all these Internet billionaires at the expense of our schools and the people who pick up the garbage?' "