E-Commerce Taxation & Regulation

The U.S. Senate holds hearings Wednesday on the so-called Market Fairness Act (S. 1832), which would be better dubbed the “Consumer and Enterprise Unfairness Act,” as it seeks to undo a critical requirement that prevents states from engaging in interstate tax plunder.

In a series of court decisions that stretch back to the 1950s, the courts have consistently affirmed that a business must have a physical presence within a state in order to be compelled to collect sales taxes set by that state and any local jurisdiction.

That meant catalogue and mail order businesses were not required to collect sales tax from customers in any other state but their own. The three major decision that serve as the legal foundation for this rule, including Quill v. North Dakota, the case cited most frequently.

Quill left room for Congress to act, which indeed it is doing with the Market Fairness Act. The impetus for the act has nothing to with the catalogue business, however. Rather, it’s the  estimated $200 billion in annual Internet retail sales, a significant portion of which escapes taxation, that’s got the states pushing Congress to take a sledgehammer to a fundamental U.S. tax principle that has served the purpose of interstate commerce since 1787.

That year, of course, is when the U.S. Constitution replaced the Articles of Confederation. One of the flaws of the Articles was that it permitted each of the states to tax residents of others. Rather than get the budding nation closer to the nominal goal of confederation, it was endangering the expansion of vital post-colonial commerce by creating 13 tax fiefdoms and protectorates. The authors of the Constitution wisely addressed this by vesting the regulation of interstate commerce in the federal government.

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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.

The Reason Foundation today has published the Telecommunications and Internet section of its 2011 Annual Privatization Review.

Although there’s been a bit of lead time since the articles were written, they are still timely. Notable is the discussion on the collection of state sales taxes from Internet retailers, back in the news now that Amazon.com has reached an agreement with the state of Texas to collect sales taxes from consumers in the Lone Star State. The settlement concludes a lengthy battle in Austin as to whether Amazon’s distribution facility in Ft. Worth constitutes a “nexus” as defined in previous court cases.

While a blow to Amazon’s Texas customers (full disclosure: I count myself as one), the action may shed further light on the debate as to how much advantage the Amazon has because it can waive sales tax collection. Competitors such as ailing Best Buy have said it’s enough to hurt brick-and-mortar retailers. Amazon points to findings that in New York, the most populous state where it collects sales tax, sales have not fallen off. Soon we’ll see if Texas tracks with that data as well. If it does, it will further validate opinions that Amazon and other on-line retailers are succeeding because they have fundamentally changed the way people shop, not because they can simply avoid sales taxes.

Also in the report look for updates on the FCC’s options for the next spectrum auction, state and federal policymaking on search engines and social networking sites, and how priorities may change as the FCC migrates from the current Federal Universal Service Fund to its new more broadband-oriented Connect America Fund.

The telecom section of APR 2011 can be found here.

A few weeks back, now-former Best Buy CEO Brian Dunn blamed the retailer’s $1.7 billion quarterly loss and its decision to close 50 stores nationwide on the fact that its online competitors, Amazon.com in particular, “aren’t encumbered by the costs of running physical locations and in many cases don’t have to collect sales tax.”

Dunn’s comments rehash the now-familiar meme that forcing e-retailers to collect sales tax is the silver bullet to saving brick-and-mortar retailers. It gives politicians on all sides cover–for some, it’s a way to keep revenues coming in for excessive spending. For others, it’s a handy way to wave the flag for local commerce.

But slapping consumers with more taxes isn’t going to save retailing. In a short piece this week, BusinessWeek explores the fundamental shifts online retailing has created in consumer behavior. Here’s a nugget from the article:

Best Buy’s decline reflects a cultural shift that’s reshaping the retail world. All big-box stores, and Best Buy in particular, thrived in an era when comparison shopping meant physically going from store to store. The effort required of consumers was a kind of transactional friction. With the advent of mobile technology, friction has all but disappeared. Rather than ruminate with a salesperson before making a selection, tech-savvy consumers are more likely to walk into stores, eyeball products, scan barcodes with their smartphones, note cheaper prices online, and head for the exit. Shoppers can purchase virtually any product under the sun on Amazon or eBay while sipping a latte at Starbucks. For traditional retailers, that spells trouble, if not death. “So far nothing Best Buy is doing is fast enough or significant enough to get in front of these waves,” says Scot Wingo, CEO of e-commerce consulting firm ChannelAdvisor.

Certainly e-commerce created competitive problems for Best Buy, but the sales tax advantage was likely the least of them. Brick-and-mortar retailing is facing an out-and-out crisis that’s going to require creativity and innovation to solve. Taxing consumers who buy online won’t do much toward that end.

And for more, see Adam’s post on Heritage Foundation’s new report on Internet tax policy.

Heritage Foundation released a new study this week arguing that “Congress Should Not Authorize States to Expand Collection of Taxes on Internet and Mail Order Sales.” It’s a good contribution to the ongoing debate over Internet tax policy. In the paper, David S. Addington, the Vice President for Domestic and Economic Policy at Heritage, takes a close look at the constitutional considerations in play in this debate. Specifically, he examines the wisdom of S. 1832, “The Marketplace Fairness Act.” Addington argues that, “enactment of S. 1832 would discourage free market competition” and raise a host of other issues:

The Constitution of the United States has set the legal baseline—the level playing field—around which the American free-market economy has built itself. The Constitution, as reflected in the Quill decision, is the source of the present arrangement regarding collection of state sales and use taxes by remote sellers. Ever since the Supreme Court decided Quill in 1992, American businesses have made millions of business decisions in the competitive marketplace based in part on settled expectations regarding state taxation affecting their sales transactions. The states and businesses advocating S. 1832 seek to change the current, constitutionally prescribed playing field. They seek to use governmental power to intervene in the economy to help in-state, store-based businesses by imposing a new tax-collection burden on out-of-state competitors who sell over the Internet, through mail order catalogs, or by telephone. Free-market principles generally discourage such government intervention in the economy to pick winners and losers based on legislative policy preferences.

Veronique de Rugy and I raised similar concerns in both a recent Mercatus white paper (“The Internet, Sales Taxes, and Tax Competition“) and an earlier 2003 Cato white paper, (“The Internet Tax Solution: Tax Competition, Not Tax Collusion”). We argued that there are better ways to achieve “tax fairness” without sacrificing tax competition or opening the doors to unjust, unconstitutional, and burdensome state-based taxation of interstate sales. Specifically, we point out that an “origin-based” sourcing rule would be the cleanest, most pro-constitutional, and pro-competitive alternative. I also discussed these issues at a recent Cato event. [Video follows.]

Reason.org has just posted my commentary on the five reasons why Federal Trade Commission’s proposals to regulate the collection and use of consumer information on the Web will do more harm than good.

As I note, the digital economy runs on information. Any regulations that impede the collection and processing of any information will affect its efficiency. Given the overall success of the Web and the popularity of search and social media, there’s every reason to believe that consumers have been able to balance their demand for content, entertainment and information services with the privacy policies these services have.

But there’s more to it than that. Technology simply doesn’t lend itself to the top-down mandates. Notions of privacy are highly subjective. Online, there is an adaptive dynamic constantly at work. Certainly web sites have pushed the boundaries of privacy sometimes. But only when the boundaries are tested do we find out where the consensus lies.

Legislative and regulatory directives pre-empt experimentation. Consumer needs are best addressed when best practices are allowed to bubble up through trial-and-error. When the economic and functional development of European Web media, which labors under the sweeping top-down European Union Privacy Directive, is contrasted with the dynamism of the U.S. Web media sector which has been relatively free of privacy regulation – the difference is profound.

An analysis of the web advertising market undertaken by researchers at the University of Toronto found that after the Privacy Directive was passed, online advertising effectiveness decreased on average by around 65 percent in Europe relative to the rest of the world. Even when the researchers controlled for possible differences in ad responsiveness and between Europeans and Americans, this disparity manifested itself. The authors go on to conclude that these findings will have a “striking impact” on the $8 billion spent each year on digital advertising: namely that European sites will see far less ad revenue than counterparts outside Europe.

Other points I explore in the commentary are:

  • How free services go away and paywalls go up
  • How consumers push back when they perceive that their privacy is being violated
  • How Web advertising lives or dies by the willingness of consumers to participate
  • How greater information availability is a social good

The full commentary can be found here.


On Monday it was my great pleasure to participate in a Cato Institute briefing on Capitol Hill about “Internet Taxation: Should States Be Allowed to Tax outside Their Borders?” Also speaking was my old friend Dan Mitchell, a senior fellow with Cato. From the event description: “State officials have spent the last 15 years attempting to devise a regime so they can force out-of-state vendors to collect sales taxes, but the Supreme Court has ruled that such a cartel is not permissible without congressional approval. Congress is currently considering the Main Street Fairness Act, a bill that would authorize a multistate tax compact and force many Internet retailers to collect sales taxes for the first time. Is this sensible? Are there alternative ways to address tax “fairness” concerns in this context?”

Watch the video for our answers. Also, here’s the big Cato paper that Veronique de Rugy and I penned for Cato on this back in 2003 and here’s a shorter recent piece we did for Mercatus.

Reps. Jackie Speier (D-Calif.) and Steve Womack (R-Ark.) have introducedThe Marketplace Equity Act,” which would open the floodgates to anything-goes State-based taxation of the Internet and interstate commerce. The bill essentially sacrifices constitutional fairness at the alter of “tax fairness.” Building on concerns raised by state and local officials as well as “bricks-and-mortar” retailers, Speier and Womack claim that, as “a matter of states’ rights” and “leveling the playing field,” Congress should bless state efforts to impose sales tax collection obligation on interstate (“remote”) companies.The measure would allow States to do so using one of three rate structures: (1) a single blended state/local rate; (2) a single maximum State rate; or (3) the actual local jurisdiction destination rate + the State rate (so long as the State “make(s) available adequate software to remote sellers that substantially eases the burden of collecting at multiple rates within the State.”)

This builds on a long-standing effort by some States to devise a multistate sales tax compact to collude and impose taxes on interstate transactions. In the Senate, Sen. Dick Durbin (D-IL) has floated legislation (“The Main Street Fairness Act”) that would bless such a state-based de facto national sales tax regime for the Internet.

There is a better way to achieve fairness without sacrificing tax competition or opening the doors to unjust, unconstitutional, and burdensome state-based taxation of interstate sales. In a new Mercatus Center essay,”The Internet, Sales Taxes, and Tax Competition,” Veronique de Rugy and I argue that: Continue reading →

Over the weekend, Janet Morrissey of The New York Times posted an excellent article on the U.S. government’s continuing crackdown on Internet gambling. (“Poker Inc. to Uncle Sam: Shut Up and Deal“) Ironically, her article arrives on the same week during which PBS aired the terrific new Ken Burns and Lynn Novick documentary on the history of alcohol prohibition in the United States. It’s a highly-recommended look at the utter hypocrisy and futility of prohibiting a product that millions of people find enjoyable. If there’s a simple moral to the story of Prohibition, it’s that you can’t repress human nature–not for long, at least, and not without serious unintended consequences. Which is why Morrissey of the Times notes:

And so the poker world now finds itself in a situation many liken to Prohibition. America didn’t stop drinking when the government outlawed alcoholic beverages in 1919. And, in this Internet age, it won’t be easy to prevent people from gambling online, whatever the government says. “It’s a game of whack-a-mole,” says Behnam Dayanim, an expert on online gambling and a partner at the Axinn Veltrop & Harkrider law firm. “They’ve whacked three very large moles, but over time, more moles will pop up.”

Exactly right (except that it should be “whac” not “whack”! There’s no K in whac-a-mole.)  It reminds me of the paper that my blogging colleague Tom Bell penned back in 1999 for the Cato Institute with its perfect title: “Internet Gambling: Popular, Inexorable, and (Eventually) Legal.” As Tom noted back then: Continue reading →

States are ratcheting up legislation in order to capture sales taxes from on-line retailers, even as companies like Amazon.com aggressively push back.

A closely-watched bill in the Texas legislature that defines Amazon’s distribution center in Ft. Worth as a physical nexus, thereby obligating the on-line retailing giant to collect taxes on sales to residents of the Lone Star State, passed on a second go-through of this year’s session, overcoming an initial veto by Gov. Rick Perry.

The next move is up to Amazon. Its distribution center is essentially a warehouse that fulfills online orders and employs 200. Amazon previously said it would close the center if the bill passed, but has yet to make good on the threat. However, it is dangerous to dismiss it as a bluff. When South Carolina passed a similar bill, the company closed a distribution center there; only to return once the legislation was reversed.

The collection of taxes from on-line sales has become touchy among even the free-market-minded. Brick-and-mortar store owners have become increasingly vocal as to what they see as a purposeful scheme of “tax avoidance” that puts them at an unfair disadvantage against on-line retailers. Research, such as an April paper from the University of Tennessee’s Center for Business and E-Commerce Research, stoke the flames by calling the current sales tax rules a tax subsidy for online merchants.

The heart of the Texas dispute is whether a distribution center counts as a nexus. The case law is Quill Corp. v. North Dakota and National Bellas Hess v. Illinois Department of Revenue, which, as broadly understood, stipulate that a business must have a nexus, that is, brick-and-mortar store, in the state in order to be liable for tax collection. If there is a viable court test to either or both of these decisions, the contention that a distribution center constitutes a nexus may have the most potential.

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