Orbitz is an Internet travel company that adds significant convenience to making travel reservations. Several times I have booked a flight and hotel room for a vacation at a great rate through the website within minutes. I get a good deal, the airline and hotel get their cut, and Orbitz gets theirs. Everybody wins, right?

Not so fast.

A report recently released by The Center on Budget and Policy Priorities claims that state and local governments throughout the U.S. are losing roughly $275 million to $400 million in sales tax revenue from business conducted by online travel companies (OTCs). (Hat tip to Citizens for Tax Justice for alerting me to this report.)

The basis of this alleged deficiency is straightforward. OTCs, such as Orbitz, apply the applicable sales and lodging tax rate only on the “wholesale” room rate that the OTC pays the hotel for the right to rent the room, and not on the “retail” room rate that is charged by the OTC to travelers who book a room through the OTC. OTCs justify their position by claiming that the difference between the “wholesale” and “retail” room rate is a “facilitation fee” not subject to sales tax.

The report makes a fine counterpoint by comparing services provided by the OTC with those provided by hotels themselves:

The OTCs are providing the same kinds of marketing and room booking services that the hotels themselves engage in. If the hotels may not deduct a pro-rated amount of their advertising and website operation expenses from the retail room charge prior to calculating applicable hotel taxes when they incur such expenses directly, there is no possible justification for compelling such a deduction when hotels pay an OTC to provide the same services.

I have to agree. The uneven treatment by OTCs is further corroborated by the fact that non-Internet based travel agents use the “room” rate, not the “wholesale” rate, for sales tax purposes.

State and local governments have filed lawsuits against these OTCs in order to compel them to change their practice. As the report notes, many of the applicable tax laws were written before the advent of the OTC industry. As a result, I wouldn’t be surprised to see the courts in various jurisdictions take differing approaches in terms of statutory interpretation; this will likely result in contrasting court opinions. In order to get what they want ($$$), many state and local governments may be required to amend their current tax laws in order to rectify the situation.

But don’t think that will necessarily be an easy task. The OTCs claim that if forced to charge sales tax on the additional difference, this cost will be passed onto consumers; as a result, tourism travel will decrease. Read the report linked above to read the Center’s response to that point. This policy debate may stall progress in the state legislatures.

The current debates concerning sales tax on online purchases are actually taking place on both the federal and state levels. Senators Durbin (D-IL) and Enzi (R-WY) plan to introduce to Congress the Main Street Fairness Act. This bill requires online retailers to collect sales tax for states who join a formal compact. I’ll save my thoughts on the “Internet Sales Tax” for another day.