With his state staring at a budget deficit that could hit $35 billion, California Gov. Gray Davis is rethinking his longstanding objection to imposing sales taxes on internet commerce—a move some analysts say could ignite similar steps around the nation.

States around the country face a collective $50 billion budget gap this year and $70 billion next year, so lawmakers are increasingly eyeing online revenues to plug their shortfalls.

The issue could cut two ways for schools, which increasingly rely on online purchasing for their technology equipment and other supplies. Collecting and processing sales taxes from businesses and consumers would result in increased expenses for online merchants. And even though most schools don’t pay sales tax, these operating increases ultimately would be passed on to schools and other customers in the form of higher prices. On the other hand, internet sales taxes also would provide some welcome relief for cash-strapped states, many of which are being forced to dip into their education budgets to offset soaring deficits.

Last year, internet sales ballooned to $79 billion, or about 3 percent of all retail sales, according to Forrester Research. California alone may be losing $1.7 billion this year by not taking a deeper cut of internet sales, which is why two bills to tax internet sales have been filed in the state Legislature. If either were to pass, the movement to tax internet sales would gain serious clout, said Utah Tax Commissioner R. Bruce Johnson, a leader of the push.

“It’s difficult to overstate the importance of California’s participation in this project,” he said.

A U.S. Supreme Court decision says states cannot force businesses to collect their sales taxes unless the company has a physical presence in that state.

Although California-based stores with online sites faithfully collect sales taxes for the state, most online sellers—such as Seattle-based Amazon.com—say it’s impossible to collect sales taxes for an estimated 7,500 taxing districts nationally.

But 34 states and the District of Columbia are trying to come up with a simple standard from a hodgepodge of sales-tax definitions in an effort to persuade Congress to lift a national moratorium against internet sales taxes. Also, a group of major online retailers—including Amazon.com, Target, Office Depot, and Wal-Mart—have agreed on a way to collect internet sales taxes in 37 states.

So far, however, California and other states with sizable high-tech and investment sectors—including New York, Colorado, Massachusetts, and Georgia—have largely watched from the sidelines.

New York Gov. George Pataki, a Republican, remains opposed to taxing internet shopping. But Massachusetts Gov. Mitt Romney, also a Republican, has expressed a willingness to examine the issue. The Massachusetts Legislature sent Romney a bill Feb. 25 that would move Massachusetts into the growing group of states working on the issue nationally.

It’s unclear whether other online commerce sites, such as auction house eBay, could be included in sales-tax initiatives. eBay spokesman Kevin Pursglove notes that some sellers on the site already collect sales tax, and he says the company is closely monitoring the developments.

In 2000, just months after the internet bubble burst and tech stocks tumbled, Davis vetoed a bill passed by the California Legislature to require online merchants to collect sales taxes. Davis said it would send the “wrong signal” to a California-based industry transforming the world.

But now, officials such as California Controller Steve Westly, a former eBay executive, say it’s time the state reaps sales taxes from the internet. Westly says Davis is rethinking the issue and has asked him for suggestions that could lead to bills Westly hopes will pass this year.

For weeks, Davis spokeswoman Hilary McLean has been saying Davis is open to internet sales taxes, considering how California’s economy and budget have turned for the worse. She also notes that Davis’s 2000 veto message said the state should revisit the issue in three to five years.

Despite growing support for internet sales taxes among the states, two federal lawmakers are working to ban such taxes permanently. Republican Rep. Chris Cox of California and Democratic Rep. Ron Wyden of Oregon have introduced a bill that would turn the current moratorium on internet-specific taxes into an outright ban. The two lawmakers were instrumental in creating the first such moratorium in 1998, which Congress extended in 2001. That moratorium is set to expire in November.

Links:

California’s internet sales tax bills, SB157 and SB103
http://www.senate.ca.gov

States’ efforts to simplify the sales tax system
http://www.geocities.com/streamlined2000

University of Tennessee study on the issue
http://www.statestudies.org