Internet Sales Taxation: Beyond the Moratorium

Internet Sales Taxation: Beyond the Moratorium

March 27, 2000

The Internet sales tax debate has been between the National Governors Association’s proposal to grant states the power of remote taxation and the extension of the current moratorium on additional—and discriminatory—Internet sales taxes. The moratorium, which codifies the "nexus" standard of the Supreme Court’s decision in Quill v. North Dakota (1992), is head and shoulders above the NGA’s tax grab. Unfortunately, however, it will likely prove unsustainable. The preferable long-term solution is to tax all sales at their point of origin.

Quill holds that a business must have "substantial presence" in the buyers’ state before that state can collect a sales tax from the out-of-state seller, thereby limiting tax collection without representation. States impose a "use tax" that is owed by citizens for remote purchases on the Internet. However, since states are reluctant to impose the tax directly on their citizens, most Internet purchases are practically tax-free.

But the Quill moratorium has its weaknesses. The "nexus" test is a source of much confusion and litigation, and greedy state attorneys general (who will face no real resource constraints) will chip away any rule that constrains the states’ ability to tax. The Quill regime has few ardent friends, since it imposes enormous compliance costs on sellers who sell in multiple tax jurisdictions. As Internet sales expand, concerns over "fairness" to traditional retailers and an Internet-induced "drain" on state revenue will gain political credibility and momentum.

THE NGA’S TAX GRAB. The NGA’s proposal to tax Internet sales:

· Extends and vastly expands taxation without representation (or, what amounts to the same thing, the imposition of tax collection obligations beyond a state’s borders).

· Increases the states’ ability to escape the political consequences of taxing their own constituents directly.

· Compromises consumer privacy. Mandatory information collection on e-commerce by a "Trusted Third Party" means a mini-IRS that’s accountable to no one.

· Turns domestic privacy concerns into a global human rights danger. The NGA’s plan would destroy the option of Internet anonymity, with alarming implications for the politically, ethnically, or religiously persecuted overseas. The United States would be setting a dangerous precedent.

A BETTER WAY: STATE COMPETITION. The current system is a sales tax cartel: the states agree to impose tax collection obligations on each other’s businesses. Congress should not even consider the NGA’s proposal to extend this irresponsible regime. Instead, Congress should tighten the "nexus" test of Quill and provide that sales taxes may be raised and collected only once—in the jurisdiction that serves as the vendors’ principal place of business. This proposal would:

· Replace the existing tax cartel with state competition. Each state and locality will be forced to balance generating sufficient revenue with the benefits of keeping and attracting businesses to its jurisdiction. Buyers and sellers alike will be empowered to discipline government both by voting at the ballot box and by voting with their feet—that is, by sorting themselves into low-tax jurisdictions.

· Decentralize disputes over tax "fairness" among "brick and mortar" businesses, e-commerce firms, catalogue retailers, telemarketers, and hybrid businesses. In contrast to the NGA’s uniform system of taxation, variegated tax regimes would encourage private experimentation with yet-to-be-invented sales and distribution strategies.

· Eliminate multiple reporting and sharply reduce compliance costs. Businesses would report their gross receipts to a single jurisdiction and pay accordingly.

· Eliminate the threat to privacy. No detailed information about buyers need be collected since the destination of the product has no bearing on how it will be taxed.

CONCLUSION. The Quill moratorium protects consumers from most Internet sales taxes. The most urgent order of business is to preserve that state of affairs in the face of the NGA’s proposed tax grab.

In the long run, however, the moratorium will prove politically unsustainable. Between now and the scheduled expiration of the moratorium in October 2001, e-commerce friends and advocates of limited, constitutional government should up the ante and insist on a sales tax regime that is consistent with the basic principle of republican government: no taxation without representation.

* Jessica Melugin (jmelugin@cei.org) is an Internet policy analyst at the CEI.

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