Avoiding an Internet Sales Tax Cartel: Why Congress Must Protect Interstate Commerce & Reject the SSTP

by on April 21, 2009 · 26 comments

There’s a movement afoot in Congress to advance legislation that would eviscerate the Commerce Clause of the Constitution, empower a state-based tax cartel, and potentially decimate the Internet economy in the process.  Business Week has the details:

In the next week, legislators are expected to introduce bills in the House and Senate promising to do away with the “physical presence” requirement. If a bill passes — and that’s a big “if” — it would require all online retailers, except for the tiniest companies, to collect sales taxes in the 23 states that are part of the Streamlined Sales Tax Project. The states would compensate the retailers for the trouble, while promising not to sue them for tax collection mistakes that are made.

The Streamlined Sales Tax Project, or “SSTP”, sounds good in theory but would be disastrous in practice.   Michael Graham of the Boston Herald penned an editorial about the SSTP today and he does a nice job pointing out why, when it comes to “tax simplification,” the devil is always in the details and those details are typically anything but “simple” (or taxpayer-friendly for that matter).

The real danger of the SSTP, however, is what it means for the Constitution and tax competition among the states.  In this 2003 paper I penned with Veronique de Rugy for the Cato Institute, we showed why the SSTP would not only fail to simplify the sales tax code, but would actually cede dangerous taxing powers to state and local governments over the interstate marketplace.  In the process, Veronique and I argued, a multi-state sales tax cartel would be spawned:

Bringing greater uniformity to the current system may have some positive benefits, such as more straightforward tax administration, but it would come at the expense of tax competition between the states and localities. Moreover, when supporters of the [SSTP] argue for greater uniformity in the sales tax system, they may just be making a covert effort to sustain higher tax rates and expand the current system to incorporate remote vendors on interstate goods and services. But at what cost? The states are essentially proposing to abandon true federalism and jurisdictional tax competition in exchange for the power to potentially recoup a small amount of tax revenue from interstate sales through a uniform system of third-party tax collection. Sadly, it appears that state and local officials would prefer to create a cozy tax cartel instead of relying on a “laboratories of democracy” model of competition between the states.

Many analysts have labeled the SSTP proposal “collusive federalism” or “cartel federalism,” because it runs counter to America’s true federalist structure of government and has very little to do with protecting states’ rights. In fact, if a state wants to simplify its sales tax base, it can do so and does not need to reach an agreement with other states.  Federalism is about state independence, not state collusion.

That’s why Congress should never cede taxing authority over interstate commerce to state or local governments. Of course, the Founders taught us this years ago when the tossed out the Articles of Confederation in favor of our current Constitution. They realized federalism was a two-sided coin, and while the states should be left with broad discretion to craft their own tax policies, that authority must end at the state border.  It must so that a free-trade pact among the states can work and interstate commerce can flow freely.  The SSTP would sabotage that.

That doesn’t mean that there is no way for states to constitutionally tax online sales.  As Michael Graham notes, there is an easier solution that would be pro-constitutional and pro-tax competition: An “origin-based” taxing rule:

The fair and obvious solution is to treat every Internet purchase like an ice cream cone on Hampton Beach. The Ben and Jerry’s guy there doesn’t ask where you’re from. For every dollar of ice cream he sells, he collects the same sales tax, period. Why not have Internet retailers do the same? If a business in New Hampshire sells a product, online or at the drive-thru, it always collects the local sales tax. It’s fair — after all, that business and its workers use services the taxes support. And it’s easy — every business already knows how much to collect.

Here’s how Aaron Lukas and I described an origin-based taxing system in a 2001 Cato article:

Most people don’t realize it, but nothing is stopping states from “leveling the playing field” on sales taxes. Each state has the legal authority to tax all transactions that originate within its borders (i.e., an “origin-based” tax). But no state chooses to tax sales that in-state businesses make to out-of-state buyers. In other words, states purposefully exempt their exports from sales taxes.

So why don’t states treat all merchants the same by having them collect the local sales tax regardless of where the buyer lives? When you walk into Wal-Mart, checkout clerks don’t ask you where you live; they collect the taxes due where the store is located. We could treat Internet sellers that way. But states fear that a few low- and no-tax rogue states might lure businesses away. Politicians call that a “race to the bottom.”  But it’s really just healthy tax competition.

An origin-based taxing methodology would also have the important added benefit of protecting buyer / taxpayer privacy.  There’s no need for extensive data-collection and reporting requirements that would have to accompany a destination-based taxing rule, as required under the SSTP.

Federal lawmakers should reject the SSTP proposal as an anti-competitive, unconsitutitonal nightmare for our Republic.  If states want to “simplify” their sales tax codes, then by all means, go for it.  But there is no need for Congress to grant them power to extend those taxes outside their borders or, worse yet, do it in unison with other tax officials as part of an interstate tax cartel.   Tax competition must trump tax collusion.

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  • MikeRT

    Federalism is about state independence, not state collusion.

    Now you're just twisting definitions to support your argument, Adam. Federalism implies a separation of powers between the federal government and the states, not between the states. The states already cooperate on a number of issues ranging from respecting each other's traffic laws, to extradition of criminals. Perhaps the implementation of this is bad, but the idea itself is sound. Why shouldn't the residents of a state that has a sales tax, by law, have to pay the sales tax when they have the package delivered there? The only reason I can think of is the typical libertarian argument of “more taxes, no matter what they are, are always–always–bad.”

    The problem with your argument is that sales taxes don't hurt the seller, they hurt the buyer. If the buyer doesn't vote for candidates that will lower taxes, then that's their problem. If they can't, they can move to another state. Excise taxes are fundamentally fair because most of the time you can avoid paying them by altering your buying habits. They aren't based on pure greed like the income tax, especially since everyone pays the excise taxes when they buy the goods and services associated with them. We need more of that. About 50% of the adult population pays no taxes. It's time that America's so-called “poor” pay their fair share. They are, after all, the primary reason why we have most government in the first place.

  • thegooru

    New Hampshire doesn't have a sales tax.

  • bradencox

    Sales taxes do hurt sellers. It's a big (and for now, unconstitutional) burden on remote sellers, particularly small online sellers, to collect and remit sales taxes to the 40+ states with sales taxes, and each of these states have varying definitions, classifications and rates. The states were supposed to simplify to minimize the interstate commerce burden, but they haven't gone far enough.

  • bradencox

    Sales taxes do hurt sellers. It's a big (and for now, unconstitutional) burden on remote sellers, particularly small online sellers, to collect and remit sales taxes to the 40+ states with sales taxes, and each of these states have varying definitions, classifications and rates. The states were supposed to simplify to minimize the interstate commerce burden, but they haven't gone far enough.

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  • http://Fed-Tax.net/ R. David L. Campbell

    While I appreciate the impassioned argument for origin-based taxation, I feel it is flawed.

    To follow your premise:

    ” If a business in New Hampshire sells a product, online or at the drive-thru, it always collects the local sales tax. It’s fair — after all, that business and its workers use services the taxes support.”

    While this would be correct and fair in the drive-thru, it would not be fair for an online purchase, particularly if I were purchasing from that business and I was in another state.

    Before I continue, the New Hampshire business really would never collect sales tax, because New Hampshire has NO sales tax (“live free or die” is their state motto).

    But presuming I was purchasing from a business in a state that did have a sales tax, and I lived in a different state, well then I would certainly disagree with paying the businesses local sales tax, because I did not vote on our approve that tax. Charging an out-of-state consumer a sales tax they did not approve of results in taxation without representation – one of the most fundamental revolutionary causes of our nation!

    Instead, in the context of online purchases, the business should simply look up the local sales tax rate based upon the purchaser's zip code, and then collect and remit that amount to the purchaser's state.

    Our company is building a service which will manage this process for merchants at absolutely zero cost to the merchant! We are currently pending certification under SST rules, but soon we will be able to provide local sales tax calculation, collection, remittance, and simplified electronic returns to all jurisdictions in the country!

  • http://Fed-Tax.net/ R. David L. Campbell

    While I appreciate the impassioned argument for origin-based taxation, I feel it is flawed.

    To follow your premise:

    ” If a business in New Hampshire sells a product, online or at the drive-thru, it always collects the local sales tax. It’s fair — after all, that business and its workers use services the taxes support.”

    While this would be correct and fair in the drive-thru, it would not be fair for an online purchase, particularly if I were purchasing from that business and I was in another state.

    Before I continue, the New Hampshire business really would never collect sales tax, because New Hampshire has NO sales tax (“live free or die” is their state motto).

    But presuming I was purchasing from a business in a state that did have a sales tax, and I lived in a different state, well then I would certainly disagree with paying the businesses local sales tax, because I did not vote on our approve that tax. Charging an out-of-state consumer a sales tax they did not approve of results in taxation without representation – one of the most fundamental revolutionary causes of our nation!

    Instead, in the context of online purchases, the business should simply look up the local sales tax rate based upon the purchaser's zip code, and then collect and remit that amount to the purchaser's state.

    Our company is building a service which will manage this process for merchants at absolutely zero cost to the merchant! We are currently pending certification under SST rules, but soon we will be able to provide local sales tax calculation, collection, remittance, and simplified electronic returns to all jurisdictions in the country!

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