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The Internet Grinch Tax Threat

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Proposals to expand sales tax collection on Internet purchases just won’t go away. And this holiday shopping season—which kicked off with a $3 billion Cyber Monday—is sure to see them return yet again.

For 15 years, states have been asking Congress for permission to reach across their borders to tax businesses in other states. Today’s leading legislative proposals for helping states capture more sales tax revenue online are the Marketplace Fairness Act (MFA) and the Remote Transactions Parity Act (RTPA).

Currently, online retailers only collect sales tax when they have a physical presence in the buyer’s state, such as a storefront, warehouse, or distribution center. So, if you live in California and go online to buy a bauble from a seller in Texas, sales tax is only applied on that transaction if the Lone Star retailer has a physical presence in the Golden State as well.

Proponents of sales tax expansion often call this a tax loophole that favors online retailers over brick and mortar stores. Yet, that doesn’t exist. In fact, the arrangement is the principle of “No taxation without representation” in practice. The seller, not the buyer, remits the sales tax funds and is the legal taxpayer in the transaction.

The physical presence requirement helps keep politicians accountable to those they tax and prevents states from exporting their tax regimes across their borders. It also promotes healthy tax competition among jurisdictions, which puts downward pressure on sales tax rates and bases, to the benefit of all consumers. That’s no loophole; that’s federalism working exactly the way our founders intended.

In contrast, plans like the MFA and RTPA embody taxation without representation in that they empower states to tax businesses outside their borders. Those taxed sellers would have no political recourse against another state’s tax collectors, nor would they have any use for the services their remittances fund. California won’t send fire trucks to an eBay seller’s house in Texas, no matter how eager California politicians are to raise sales tax rates on residents of other states who can’t vote them out of office.

Some states are lobbying for expanded taxing powers to fill their coffers and avoid politically painful budget cuts, but big box stores have also spent millions lobbying for the MFA and the RTPA. That’s because plans like the MFA and the RTPA would impose disproportionately high compliance costs on small online retailers. They would require our fictitious online Texan selling baubles out of his garage comply with the almost the nation’s 10,000 distinct taxing jurisdictions, each with its own rates, definitions, exemptions, and tax holidays.

Large traditional retailers, including Target, Best Buy, and Walmart, have a physical presence throughout the country with brick-and-mortar stores that trigger sales tax obligations in almost every state—and rightly so, since they benefit from the state and local services those taxes fund. With each state these chains expand into, they make sure they have the internal legal and accounting resources needed to support the additional compliance demands of doing business in a new jurisdiction.

Their calls for “fairness” notwithstanding, large retailers stand to gain a competitive advantage from the MFA’s disproportionate compliance cost burdens on smaller retailers.

Amazon, with numerous distribution centers in many states that also trigger sales tax collection obligations, now aligns with those big box retailers. But Amazon will also enjoy the extra benefit of taking a cut of these smaller firms’ revenues when they are forced onto the Amazon platform in exchange for the retail giant’s tax calculation software. Why beat the competition in the marketplace when you can just outspend them inside the Beltway?

Thankfully, the idea is increasingly unpopular with voters. A 2013 Gallup poll found 57 percent of all adults opposed an Internet sales tax, while 73 percent of 18 to 29-year-olds opposed one. It seems people outside of the Washington political bubble don’t respond so well to misleadingly named bills, disingenuous calls for “fairness,” and millions of lobbying dollars.

There are sensible alternatives to make sales taxes more equitable in the Internet age. Expanding states’ taxing authority to reach across their borders is not one of them.