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 introduced “The 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:

Apart from getting chronic state overspending under control, a better solution to the states’ fiscal problems than a tax cartel that imposes burdensome tax collection obligations on outof-state vendors would be tax competition.  Congress should adopt an “origin-based” sourcing rule for any states seeking to impose sales tax collection obligations on interstate vendors. This rule would be in line with Constitutional protections for interstate commerce, allow for the continued growth of the digital economy, and ensure excessive, inefficient taxes do not burden companies and consumers.

Vero and I have detailed this alternative plan in much greater detail in this 2003 Cato white paper, “The Internet Tax Solution: Tax Competition, Not Tax Collusion.” As we explain in our new paper:

In this system, states would tax all sales inside their borders equally, regardless of the buyer’s residence or the ultimate location of consumption. Under that model, all sales would be “sourced” to the seller’s principal place of business and taxed accordingly. This is, after all, how sales taxes have traditionally worked. A Washington, DC, resident who buys a television in Virginia, for instance, is taxed at the origin of sale in Virginia regardless of whether he brings the television back into the District. Each day in America, there are millions of cross-border transactions that are taxed only at the origin of the sale; no questions are asked about where the buyer will consume the good. Policy makers should extend the same principle to crossborder sales involving mail order and the Internet. Under this approach, Internet shoppers would pay the sales tax of the state where the online retailer is based.

An origin-based sourcing rule has several advantages over the destination-based system States favor.

1. It would eliminate constitutional concerns because only companies within a state or local government’s borders would be taxed.
2. An origin-based system would do away with the need for prohibitively complex multistate collection arrangements because states would tax transactions at the source, not at the final point of consumption.
3. An origin-based system also would protect buyers’ privacy rights, eliminating the need to collect any special or unique information about a buyer and to use third-party tax collectors to gather such information.
4. It would also preserve local jurisdictional tax authority whereas a harmonization proposal would create a de facto national sales tax system that would exclude local governments.
5. Finally, because it is more politically and constitutionally feasible, an origin tax may actually maximize the amount of tax collected for states by making compliance easier and incorporating currently untaxed activities.

In closing, it is important to address the misguided claim at the heart of the Speier-Womack bill that this is a “states’ rights” issue. Let’s be clear what real federalism is all about. Federalism is not about “states’ rights.” States have powers and responsibilities, and under the Constitution — at least the proper interpretation of it — they have wide-ranging flexibility to purse different governance approaches. But that power is not unlimited. America abandoned its first constitution, The Articles of Confedertion, after just 14 years in part because untrammeled state authority was discouraging interstate trade and commerce. In their wisdom, the authors or our present Constitution made sure to include Article 1, Sec. 8, Clause 3 — the so-called “Commerce Clause” — which created and protected what might best be thought of as the world’s first free trade zone – The United States of America. It remains one of the greatest achievements in constitutional and commercial history.

Thus, properly understood, federalism is about a healthy tension among competing units of government. Each has a different role and set of responsibilities, and this tension bolsters the checks and balances at the heart of our constitutional republic. [I outline all this in far more detail my 1999 book, The Delicate Balance: Federalism, Interstate Commerce and Economic Freedom in the Technological Age.]

In the context of Internet tax policy, this means that the tax power of the States can be legitimately constrained by the federal government to ensure that the interstate market is not unduly burdened with unjust levies. States certainly retain the power to impose whatever levies they wish on those actors who have a substantial physical presence in their geographic confines. That is, they can tax their own exports. Taxing imports from another State, however, is an entirely different matter, and one the necessarily requires some degree of federal oversight to ensure America’s free trade zone is preserved and protected.

An origin-based sourcing rule accomplishes that goal while also leaving States the discretion to impose taxes on their own exports if they so choose. The fact that this system would lead to heated tax competition among the States is a feature, not a bug.

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.

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.

A new report from TeleGeography finds that bandwidth prices for backbone transit continue to decline rapidly across the globe. In San Francisco, for instance, the price per mbps of Gigabit Ethernet transit has dropped 38 % in the past 12 months. Developing countries are also enjoying substantial price cuts in 15 to 20% range.

But if the Internet’s core is controlled by an oligopolistic cartel—as Tim Wu argued in a recent New York Times essay—then why does bandwidth keep getting cheaper?

Perhaps it’s because the fourteen or so firms which offer backbone IP transit are competing fiercely to win over business from smaller carriers and enterprises. And as businesses of all sizes demand faster connectivity, more dark fiber is being lit, creating an expansion in network capacity. In DC, for instance, a price war has made high-speed commercial data services much more affordable, with one communications provider offering converged 10mbps full-duplex dedicated Ethernet over copper for less than the market price of four bonded T1 lines.

Why are some providers moving towards data transfer caps if bandwidth prices are dropping ? In part, it’s because backbone transit is not the only usage-variable expense that residential ISPs face. Last-mile bandwidth remains a highly contested resource in many neighborhoods, and the cost per megabit of bringing faster speeds to the doorstep far exceeds the cost of adding more wavelengths to a long-distance fiber optic line. As consumers demand greater speeds, providers are investing heavily in network upgrades—these costs are adding up, and there’s a strong case to be made that heavy users ought to shoulder a larger portion of the burden than light users.

So, if Tim Wu’s thesis is correct that the broadband marketplace is “a cartel,” should we be reading headlines in today’s Wall Street Journal and CNET News.com like this: “Price War Erupts For High-Speed Internet Service” and “Broadband Price War Brews“? From the WSJ story:

The battle between cable and phone companies to sign up new customers for high-speed Internet service is heating up, creating fresh opportunities for consumers to cut their bills. […] While the most generous offers are coming from the phone companies, some analysts expect cable companies will also become more aggressive in their own promotions as they compete to retain customers.

Geez, if that’s a cartel, give me more of them!

Tim Wu has an absurd piece in today’s New York Times comparing America’s broadband marketplace to OPEC. This really is quite outrageous, beginning with the fact that OPEC is a GOVERNMENT-RUN cartel. Wu also had a comment in the Washington Post today saying that he didn’t think broadband metering was an outrage. Well, that’s nice. I’m happy that we have Tim’s permission to experiment with new business models for financing broadband networks going forward!

This is indicative of what we can expect in the future once Net neutrality laws get on the books: A world of incessant “Mother may I?” permission-based forms of preemptive Internet regulation. Tim and his radical band of regulatory advocates over at Free Press will incessantly petition the FCC to review each and every business model decision and encourage the unelected bureaucrats at the agency to manage the Internet to their heart’s content.

And what does Tim offer for an alternative vision of the way the world should work since he doesn’t believe private markets can handle the job? Well, it’s back to the Big Government drawing board for more tax-spend-and-subsidize solutions! “Amsterdam and some cities in Utah have deployed their own fiber to carry bandwidth as a public utility,” he says. Yeah, that’s the promised land. After all, it’s working out soooooo well at the municipal level. Please.