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Future Cyber Mondays Could Take a Hit from Proposed Internet Tax

Adobe Digital Insights predicts that Cyber Monday’s sales will surpass last year’s sales by 11.5%, for a total of $3 billion this year. But if state officials and some big box retailers, who’ve been busy lobbying Congress to pass the dubiously named Marketplace Fairness Act (MFA) get their way, there could be a lump of coal in consumer’s stockings in the form of more and higher sales taxes online.

State and local governments can already tax in-state sellers regardless of their method of delivery to consumers—online, through the mail, or in person. But this comes with a political cost. If politicians raise rates too high, they may be voted out of office or lose taxpaying residents and businesses to lower tax jurisdictions. So states want new powers to tax businesses in other states that sell to their own residents.

That interstate tax grab is central to the MFA and is a violation of the principle of “no taxation without representation” that so animated the Founding Fathers. The Supreme Court agreed in its 1992 Quill Corp. v. North Dakota decision. Thus, under the current regime, sales taxes are assessed only on purchases in which the seller has a physical presence in the buyer’s state.

For example, if someone in Texas buys a book online from a retailer in Nebraska, the purchase is taxed only if the retailer has “nexus”—such as a store or warehouse— in the Lone Star State. This prevents Texas from imposing its tax regime on a Nebraska business that has no say in the shaping of Texas tax law. Furthermore, the Nebraska company would receive no services from the taxes it was required to calculate, collect, and remit. Austin isn’t going to send fire trucks to Omaha no matter how many books they’ve bought online.

The MFA damages healthy tax competition among states, which allows consumers to vote with their feet by choosing to do business in jurisdictions with lower taxes. Under the MFA, consumers are forced to wear their home tax regime like an albatross when shopping online. Businesses could only escape from the tax regimes of the 45 states that access sales taxes by refusing to sell into those states. We already know how that story ends, thanks to the failed Articles of Confederation. Then and now, America needs more interstate commerce, not more barriers to it.

As a practical matter, the MFA would impose high compliance costs on businesses, by requiring them to calculate taxes for approximately 10,000 distinct jurisdictions around the nation, each with its own rates, definitions, exemptions, and tax holidays. Proponents make promises of free calculating software from state governments, but a study by tax simplification group TruST estimates implementation costs of $80,000 to $290,000 and yearly maintenance costs of $57,500 to $260,000 for midsized retailers. It would seem that “free” means something different in political circles than it does to the rest of us.

The MFA also would subject businesses to audits by out-of-state tax authorities. And since it does not require states to consolidate audits or respect audits conducted by other states, a business could be audited in multiple states, perhaps simultaneously. These compliance costs will be fatal for some businesses.

There is room for improvement in sales tax policy, but the MFA is a cure worse than the disease.

Real progress would come from an origin-based approach in which all transactions—in-person, via catalog, and online—are assessed for sales taxes at the sellers’ primary point of business. That would keep politicians accountable to those they tax, preserve constitutionally mandated limits of state jurisdiction, and promote efficiency for businesses and consumers.

Technological advance requires adjustments in policy, but far from making the principles of tax competition and political accountability obsolete, the growth of Internet commerce only makes it more important to protect those valuable tenets.

The real question this Cyber Monday is: Do you want a government as big as the Internet?