The Internet Tax Threat Is Here Again

by Veronique de Rugy

I do like it when Congress is in recess. When lawmakers are out of town, I can get a table without a reservation on a Saturday night at Central and lawmakers can’t introduce bills that we will have to fight against. Unfortunately, good times never last and it looks like as soon as next week, Sens. Dick Durbin (D., Ill.) and Mike Enzi (R., Wyo.) could introduce the Main Street Fairness Act, a bill that would force retailers to collect sales tax for states that join a formal compact in order to get around constitutional hurdles to taxing out-of-state vendors.

I haven’t worked much on this issue since 2003, when I wrote this paper about the Internet tax with my colleague Adam Thierer. Back then, the Internet tax was proposed as a way to harmonize taxes in the name of leveling the playing field. Adam and I were against this idea and suggested boosting tax competition and moving to an origin-based tax system (as opposed to a destination-based one where, no matter where you buy stuff, you are taxed at the same rate — preferably high).

Well, it seems that some things never change. The issue is back and states are arguing, once again, for a way to put their hands on some of the cash made by out-of-state companies that sell you good and services on the Internet. In Adam’s column this week, he makes the following point:

States claim they desperately need the money. Of course, that’s nothing new. States are always looking to plug budget gaps in bad times—and increase their revenues in good times.

Net taxes won’t yield them much. A 2010 study conducted for NetChoice by Jeffrey Eisenach and Robert Litan of the economic consulting firm Empiris LLC revealed that “Total potential uncollected sales tax revenues in 2008 were approximately $3.9 billion, or less than three-tenths of one percent of state and local tax revenues.”

States should find other ways to cover budget shortfalls, including cutting their profligate spending habits. From 2000 to 2009, state and local spending grew at nearly twice the average annual rate as the private sector. Since these governments depend entirely on the private sector for their resources, this level of spending growth is clearly not sustainable.

Interestingly, for about five years, very few people have kept on working on this issue, and the data is pretty outdated. But the arguments made by the states for why they should be allowed to tax the Internet remain the same. They now claim they have managed to get 24 states to agree to a sales-tax-simplification deal. Yet the document is roughly 200 pages long and doesn’t seem to simplify rates or tax bases in any significant way. Adam explains why states are working so hard to pretend this will simplify their tax systems:

Forcing online vendors to collect local taxes would create significant burdens on interstate commerce. There are approximately 7,400 local jurisdictions in the U.S. and different definitions and exemptions further complicate the code. For example, is a cookie a “candy,” (which is taxed in most jurisdictions) or a “baked good,” (which is typically tax-exempt)?

The Supreme Court prevents states from imposing collection obligations on interstate commerce because of these burdens. The Court’s rulings stipulate that only retailers with a physical presence (or “nexus”) within a taxing jurisdiction are required to collect and remit sales taxes. If an online retailer has a store in the state, it qualifies as sufficient nexus for the state to demand tax collection. By contrast, if an official or salesperson from the online company visits the state just for a day, that’s not enough to establish nexus.

You can check out the states’ attempt at simplification of their sales tax base here. The more things change, the more they stay the same.

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