Internet Taxes, “Main Street Fairness” & the Origin-Based Alternative

by on August 2, 2011 · 4 comments

The debate over the imposition of sales tax collection obligations on interstate vendors is heating up again at the federal level with the introduction of S. 1452, “The Main Street Fairness Act.” [pdf]  The measure would give congressional blessing to a multistate compact that would let states impose sales taxes on interstate commerce, something usually blocked by the Commerce Clause of the U.S. Constitution.  Senator Dick Durbin (D-IL) introduced the bill in the Senate along with Tim Johnson (D-SD) and Jack Reed (D-RI).  The measure is being sponsored in the House of Representatives by John Conyers (D-MI) and Peter Welch (D-VT). At this time, there are no Republican co-sponsors even though Sen. Mike Enzi was rumored to be a considered co-sponsoring the measure before introduction.

Without any Republicans on board the effort, the measure may not advance very far in Congress. Nonetheless, to the extent the measure gets any traction, it is worth itemizing a few of the problems with this approach. My Mercatus Center colleague Veronique de Rugy and I have done some work on this issue together in the past and we are planning a short new paper on the topic. It will build on this lengthy Cato Institute paper we authored together in 2003, “The Internet Tax Solution: Tax Competition, Not Tax Collusion.” The key principle we set forth was this: “Congress must.. take an affirmative stand against efforts by state and local governments to create a collusive multistate tax compact to tax interstate sales.” “It would be wrong,” we argued, “for members of Congress to abdicate their responsibility to safeguard the national marketplace by giving the states carte blanche to tax interstate commercial activities through a tax compact. The guiding ethic of this debate must remain tax competition, not tax collusion.”

Proponents of simply extending current sales tax collection obligations to interstate sales will claim that the so-called “Streamlined Sales and Use Tax Agreement” (SSTUA) they want Congress to bless has solved the compliance cost and complexity problem associated with taxing “remote” interstate sales. Yet, as I pointed out in my recent Forbes essay, “The Internet Taxman Cometh,” this 200-page “simplification” effort remains a Swiss cheese tax system, however, riddled with loopholes and complexities that could burden vendors, especially mom-and-pop operators. America’s estimated 7,400 local jurisdictions still have many different definitions and exemptions that complicate the sales tax code. For example, is a cookie a “candy,” (which is taxed in most jurisdictions) or a “baked good,” (which is typically tax-exempt)? Thus, forcing online vendors to collect local taxes would create significant burdens on interstate commerce.

This is not to say there aren’t some legitimate tax “fairness” arguments in play here. It really is unfair that “Main Street” vendors are burdened with significant tax collection responsibilities while others are not. But “fairness” cuts many ways. It’s also unfair and unconstitutional to require out-of-state vendors to collect sales taxes on behalf of a jurisdiction where they have no physical presence. After all, at least in theory, those who are taxed should expect to receive some benefit for it. Interstate vendors receive no benefit but bear all the cost.

To the extent we want to “level the playing field,” therefore, one approach is to cut or eliminate sales taxes on in-state vendors. Of course, that’s a tough pill for many states and localities to swallow. If they got their profligate spending habits under control, however, that might be easier.

Another alternative would be the creation of a national Internet sales tax that would avoid the complexity problem by imposing a single rate and set of definitions on all vendors. But that just opens the door to a new federal tax base, which would grow to be burdensome in other ways at a time when American consumers and companies are already over-taxed. I doubt the idea would get much traction in Congress, anyway.

Perhaps the best alternative would be to switch the sourcing methodology for state sales tax collection obligations from destination-based to “origin-based.”  Stated differently, the rule would be “you can tax your own exports, not the imports from other states.” Here’s how Veronique and I summarized an origin-based solution in our old Cato paper:

under an origin-based sourcing rule—also referred to as a “seller state,” “vendor-state,” or “source-based” rule by some scholars—all interstate sales through all channels (traditional stores or cyber-retailers) would be taxed at the point of sale (meaning the company’s “principal place of business”) instead of at the point of destination, if the state or locality chooses to impose a tax. All goods within a given state or locality would be taxed at the locally applicable rate no matter how they were purchased and no matter where they were consumed.  This option would take care of most of the problems posed by the destination-based methodology that is favored by most state and local policymakers today.

Specifically, an origin-based sourcing rule would have the following advantages:

  • Minimize the burden on sellers by requiring sellers to know and abide by the tax rates and regulations within their principal place of business instead of the rates and definitions of thousands of different taxing jurisdiction.
  • Ensure tax parity between Main Street vendors and interstate sellers.
  • Do away with the need for a multistate collection arrangement such as the SSTUA by eliminating any need to trace interstate transactions to the final point of consumption.
  • Remove nexus uncertainties and constitutional concerns, because only companies within a state or local government’s borders would be taxed.
  • Largely remove any need for continued reliance on the use tax because all transactions would henceforth be sourced to the origin of sale and collected immediately by the vendor at that point.
  • Respect buyers’ privacy rights by eliminating the need to collect any special or unique information about a buyer, and  by not using third-party tax collectors to gather information about buyers.
  • Respect federalism principles and enhance jurisdictional tax competition  by permitting each state to determine its  own tax policies and encouraging healthy state-by-state tax rivalry.
  • Preserve local jurisdictional tax authority where a harmonization proposal like the SSTUA plans would create a de facto national sales tax system and run roughshod over local governments.
  • Because it is more politically / constitutionally feasible it may maximize the amount of tax collected for states by making compliance easier and incorporating activities that are currently untaxed.

Please see the old Cato paper for more details and answers to potential objections, but I hope it’s clear why an “origin-based” solution offers a sensible way to break the current logjam and achieve tax “fairness” in the process.

Some states officials will object to the vigorous tax competition spawned by an origin-based sourcing rule. But that’s a feature, not a bug! Tax competition is good for consumers and the continued vitality of American federalism. A multistate tax compact, by contrast, would encourage tax collusion and let states too easily raise rates on interstate sales.

Moreover, I think it bears repeating that state officials have been at this for 15 years and still not found a way to truly simplify their sales taxes and get around constitutional limitations on the taxation of interstate activity. An origin-based system, therefore, may offer them the only way for them to finally tax the Internet and interstate sales.  I’d prefer they scale back their taxing ways, of course, but to the extent they insist on pushing out the boundaries of their tax authority, an origin-based solution — not the “Main Street Tax Fairness Act” — is the only sensible, constitutional way for them to do so.

 

  • Sten Wilson

    There is a simple solution: TaxCloud (http://taxcloud.net).

    The statements by Ebay and others opposing the legislation confuse me. My company currently uses a PayPal checkout button that works with TaxCloud’s service so my business (with less than $50k in annual sales) already calculates, collects and remits sales tax for any jurisdiction in any state.  It is simpler in most cases for my business to calculate and remit sales tax than to deal with shipping.

    If my business can manage to collect the legally due sales tax for my customers, why is it so hard for Ebay?

    Technology available freely on the internet (such as Taxloud) is more than capable of handling sales tax calculation and remittance. Sorry everyone, the “too burdensome” argument carried merit in 1967 and in 1992 (when SCOTUS last ruled on this matter), but in the era of modern computing where large Internet merchants maintain a dominant position, multijurisdictional sales tax calculation and remittance is easily accomplished.

    So what is the real reason Ebay and other opponents chooses to evade supporting your schools, hospitals, infrastructure, libraries, parks and so much more? 

    Destination based taxes maintain Constitutional autonomy regarding taxing issues. Origin based sales tax is simply not possible. Remember the Boston Tea Party and no taxation without representation? How is it fair for a consumer in NH where there is 0% sales tax to be supporting and paying a tax to the state of California where the item purchased is located and the transaction takes place, where he does not vote or garner any political representation? Sales tax is assessed the consumer and remitted to the community and state in which the consumer resides. The consumer directly benefits from supporting (voting for) the tax he is levied and chooses to donate directly to his/her community. Asking someone to pay a sales tax to a state where he/she has no benefit or representation (State Representatives, Senators and Governors) is simply unconstitutional.

  • http://twitter.com/FedTaxBlog FedTax

    I usually respect Mr. Thierer’s writings, but on this point which he has written about before, I am afraid I simply cannot agree with the conclusion that origin-based taxation is a viable or constitutional solution.Mr. Thierer does point draw out the unfairness issue that “main street” retailers being required to collect while others are not. But his conclusion that “fairness cuts many ways” simply cannot be supported. He says:”those who are taxed should expect to receive some benefit for it. Interstate vendors receive no benefit but bear all the cost.”The problem with such logic is that although the interstate vendor is collecting sales tax, it’s still the consumer who pays it and the consumer’s community that receives it. Sales tax revenue helps fund vital local services that voters/consumers/taxpayers approve, either directly, through ballot initiatives, or indirectly, through their elected local governments.The National Conference of State Legislatures calculates that non-collection of sales tax on internet and mail-order purchases will cost over $23 billion during FY2012.Strangely, as the solution to this enormous national problem, the author proposes a national origin-based sales tax system.To understand the problem with this idea, one must first remember: Sales tax is local.Our country was founded on the most basic concept of taxation with representation. That is why each state has its own House of Representatives and Senate—to ensure that there is local representation and a local voice regarding why, how much, and for what purpose you and your community will be taxed.To adopt the origin-sourcing concept at a national scale would mean that if you bought something from an online store that charged you sales tax based upon where that online retailer is located, then you would be paying a sales tax you did not vote on.Consider if you lived in California and bought a $1,100 LED TV from an online consumer electronics store based in New York City. Under the author’s plan, the NYC retailer would add 8.875% to the price of your TV ($97.63) and remit those proceeds to the retailer’s jurisdiction—New York City—not your California jurisdiction.Under such a plan, you would be forced to pay a tax without any representation.Origin sourcing gets even more toxic at a national scale. Consider how many e-commerce retailers in California or New York (or any of the 45 states with sales tax) would immediately relocate all operations to a state with no sales tax just to stay competitive—if you think your property and income taxes are high now, imagine what would happen if 40% of these states’ annual budgets vanished overnight.The Main Street Fairness Act is the right way to solve this problem. It allows states to retain all their sovereign rights to govern according to their citizens will, while also ensuring that multi-state retailers can easily comply with each states sales tax laws.The Main Street Fairness Act does not grant collection authority to any state unless that state first simplifies and standardizes their sales tax laws to alleviate the three points of undue burden cited by the Supreme Court in its 1967 Bellas Hess ruling.Once again, sales tax is local—when online retailers refuse to collect, it only hurts your community.

  • Pingback: Press on the Main Street Fairness Act « blog.FedTax.net

  • Ryan Radia

    Your argument against an origin-based sourcing rule doesn’t make much sense given the myriad other ways in which consumers are already affected by other states’ laws. Each time you purchase a good or service from an out-of-state vendor, you are buying a product that is governed by numerous different taxes, regulations, and other governmental mandates. You have no direct electoral influence over any of these laws. If for instance you buy a product manufactured and sold by a California-based company, that company must comply with California’s pollution, labor, environmental, and competition laws (which, incidentally, are among the nation’s most onerous, yet many companies are headquartered in CA nonetheless). There are also state corporate incomes taxes and property taxes, which you as a consumer end up paying to a significant extent whenever you buy from a Californian vendor. If you don’t like it, you can buy from a vendor located in a different state — or a different nation, for that matter. Why should sales taxes be any different? Under your logic, shouldn’t companies be allowed to write off any income they generate from sales to consumers in states that lack a corporate income tax?

    Moreover, the idea that an origin-based rule would cause Internet companies to flee to low-sales tax states is inconsistent with reality. NewEgg, one of the nation’s biggest online retailers, is headquartered in Whittier, CA, and also maintains a physical presence in New Jersey. Both CA and NJ have corporate income taxes, and NewEgg must collect and remit taxes to each respective state on all sales shipped to NJ/CA residents. If state tax rates were truly the make-or-break issue you make them out to be, would a retailer maintain a physical presence in states with a combined population of over 50 million Americans, we wouldn’t see so many retailers based in high-tax states.

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