About that Online Sales Tax ‘Loophole’

by on July 23, 2012 · 3 comments

Proponents of higher taxes have taken to calling the exemption that out-of-state online shoppers enjoy a “loophole,” as if it were an unintended flaw in two established court rulings that addressed the power of one state to tax residents of another.

My latest commentary at Reason.org looks at the so-called Marketplace Fairness Act, a bill that the House Judiciary Committee has scheduled for hearings tomorrow. The bill aims to help states collect sales taxes on out-of-state purchases, typically made via catalogue or, to an ever-greater extent, the Internet. Two Supreme Court decisions, Quill vs. North Dakota and National Bellas Hess vs. [Illinois] Department of Revenue, both of which pre-date Internet shopping, protect out-of-state consumers from the taxman’s reach.

As I write:

Editorials and op-eds supporting the bill, such as in the Arizone Daily Star and the Chicago Sun-Times, say it will close a “loophole” that allows Internet purchases to escape taxation. This is akin to saying the Supreme Court’s Miranda decision is a loophole for defendants to escape prosecution. No doubt some overzealous prosecutors may think so, but in truth, Miranda sharpened and affirmed the right of due process already present in the Fourth and Fifth Amendments. Likewise, in Quill and Bellas Haas, the courts sharpened and affirmed the Constitution’s commerce clause that prevents one state from taxing residents of another.

Seeing it as counterproductive to an interdependent economy, the Founders did not want states plundering each other’s residents and enterprises with taxes. Yet that’s exactly the environment the Marketplace Fairness Act sets up. New York State can tax residents of Illinois and the Prairie State can tax Hoosiers.

In doing so, the Marketplace Fairness Act ignores the constitutional underpinnings of the Quill and Bellas Hess decisions and treats the Internet sales tax issue as a procedural issue when the in fact the constitutional bar is set much higher. The giveaway, however, is the portion of the bill that requires states to simplify their state tax collection procedures before launching cross-border taxation. It’s an unusual quid pro quo, perhaps because Congress has to offer states the prerequisite of a buy-in. That’s because any attempt to impose a tax collection structure wholesale on the states would likely face a constitutional challenge on 10th Amendment grounds of state’s rights.

In reality, the states, struggling as they are with debt crises of their own making, are angling for a greater piece of the $200 billion Americans are spending with Internet merchants each year. Of course, not all of this goes untaxed; on-line retailers who have brick-and-mortar stores within a state must collect tax from residents in that state. Besides creating a mess of competing state tax grabs, this law stands to increase paperwork and complexity for thousands of small online businesses and catalogue firms, who would now be obliged to calculate taxes on some 11,000 sales tax jurisdictions throughout the country. Whether or not it’s “simplified” in line with some Congressional definition, it still stands to be the burden as noted in Quill and Bellas Hess.

But all the talk of loopholes, level playing fields and what does or does not constitute a “burden” diverts attention from the real issue. The Marketplace Fairness Act is not about the Internet, e-commerce, the marketplace or fairness–it’s about what the Constitution says about the power of state governments to tax citizens beyond their borders.

  • Mgersh1

    I’ll add that most, if not all states require their citizens to pay sales tax on purchases of the goods purchased by mail or online. The enforcement mechanism is weak, but the law exists. If the federals mandate that we all pay sales tax at the point of shipment, we will all still owe sales tax in our state of residence.

  • http://www.facebook.com/profile.php?id=667365734 R David L Campbell

    One question: do you assume retailers have no access to computers or access to the internet in your argument?

    I ask because the arguments I have heard in opposition to this idea in the past from this forum clearly made the assumption that the world worked by carrier pigeon and fax.

    I will go read your “reason.org” article referenced in the article now, so i can understand your perspective.



  • http://www.facebook.com/profile.php?id=667365734 R David L Campbell

    Ok. I read it.

    My estimation of your technical prowess has not changed.

    Let me give yu an example you may relate to as an author/blogger.

    Do you know how twitter works? You have a cool little icon on your article to allow people to twitter link to you… Did you ever have to download the entire twitter universe database just to put that link on your website? No. I didnt think so. Well, e-commerce works the same way. If you want to provide real-time shipping quotes, you follow the instructions and (BOOM) you suddenly can calculate shipping costs based upon origin, destination, speed, insurance, weight, etc. (and as a merchant, you didnt have to learn any of those sciences).

    Believe or not, ecommerce works in the same way. The fact is, these issues will not be left to merchants to figure out, just like merchants are not left to figure out most aspects of their business on their own.

    Congress should act.

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