A New Idea for Tax Fairness Online

The misleadingly named Marketplace Fairness Act died a quiet death during the House of Representatives’ lame-duck session, but is it really the end? What does the new year and the new Congress have in store for the Internet sales tax debate? If recent experience is any guide, MFA supporters will be back to try again.

Many MFA supporters correctly point out that the current system creates inequities in the way brick-and-mortar and remote sellers are treated. But their proposed cure would be worse than the disease. To understand why, let’s consider what the nation just avoided.

The MFA passed the Senate with the support of lobbyists for big-box retailers and revenue-hungry states. It would have empowered states to reach across geographic boundaries and collect sales taxes from businesses outside their borders — meaning that Virginia companies would have become subject to New York state taxes and audits.

This would have weakened healthy tax competition among states and led to higher taxes. It also would have proved burdensome to implement, as it would have required single-location Internet sellers (think Etsy and eBay) to calculate sales tax in accordance with almost 10,000 jurisdictions across the nation, each with its own rates, taxing categories, exemptions and tax holidays. The compliance costs would have proved lethal for many small Internet sellers.

Cooler heads prevailed in the House, where the bill stalled in committee. Roanoke’s own Judiciary Committee Chairman Bob Goodlatte expressed concern about the MFA’s approach to address the inequities in how sales are taxed both online and at brick-and-mortar retailers.

Currently, a tax is only applied to online purchases when the seller has a physical presence like a store, warehouse or office in the buyer’s state. For example, if an online bookseller in Virginia sells to a customer in Texas, sales tax is only applied to the transaction if the seller has some physical presence in the Lone Star state. Far from a tax loophole, this is the principle of “no taxation without representation” in practice, because it is the seller who remits and is subject to compliance audits. In effect, the business is the taxpayer.

This system confines states’ taxing power to their borders, preserving tax competition among the states, which puts downward pressure on taxes. It keeps taxing authorities politically accountable to those they tax and limits the jurisdictions for which businesses must calculate and remit sales taxes to the states in which they choose to locate.

But what about the different treatment of online and brick-and-mortar retailers?

Instead of empowering states to tax outside their borders, Congress should consider some solutions proposed by Goodlatte in his 2013 report, “Basic Principles on Remote Sales,” which he is likely to reintroduce, recently saying he “greatly look[s] forward to hearing fresh approaches to this issue and continuing the discussion.”

One such idea is an origin-based system, under which the tax is assessed at the point of sale, not the destination of the good, as under the MFA. This would address the “fairness” issue by treating all retailers the same.

For walk-in stores, sales tax is calculated at the point of sale, not by the residency of the customer — who may be crossing state lines or city limits. Expanding this origin-based principle to all retailers will ensure that online, catalog, phone and yet-to-be-invented sales platforms will be treated the same as purchases on Main Street.

An origin-based system puts downward pressure on taxes. It allows customers to vote with their wallets by choosing lower tax-rate jurisdictions when shopping online or by mail.

The accounting burden would be minimal. Retailers would only have to calculate and remit taxes applicable to their primary place of business. Their rate would stay constant whether they sell an item in the store or mail it across the country. This efficiency would benefit the larger economy (with the possible exception of sales tax software makers).

An origin-based regime preserves consumer privacy. The tax calculations are based on the seller’s location only, so there is no need to collect, store or share the buyer’s location. An origin-based approach requires no databases to maintain, no third parties to calculate rates and no audits to verify accuracy.

Perhaps most important, an origin-based sales tax keeps political authorities accountable to those they tax. This is an especially important consideration for the maintenance of democratic governance; it’s simply too easy to tax those who lack a political voice.

So in the New Year and the new Congress, here’s to new ideas for e-fairness online.