Internet sales tax bill a bad idea

If less complexity, fewer loopholes and lower rates are the signposts of meaningful tax reform, the dubiously named Marketplace Fairness Act embodies the exact opposite.

The act, introduced in both houses of Congress last month, would empower states to collect sales tax from companies with no physical presence within their borders. The bill, sponsored by Sens. Mike Enzi, R-Wyo., and Richard Durbin, D-Ill., and in the House by Rep. Steve Womack, R Ark., among others, would greatly expand state tax collectors’ reach, resulting in a huge tax hike on many online and catalog purchases.

Currently, under the Quill Corp. v. North Dakota Supreme Court decision, a business must have “nexus” in a state before it can be subject to its tax regime. For example, if a resident of Oklahoma buys something online from a retailer in Virginia, Oklahoma can collect tax only if that retailer has a store, warehouse or some other facility in the Sooner State. Because it’s the retailer, not the consumer, that remits the sales tax, this arrangement prevents taxation without representation. That safeguard will disappear, and a messy new tax regime will emerge if Congress blesses this unprecedented state tax cartel.

The plan violates each of the tenets of good tax reform.

First, it would create a system of burdensome complexity, as it would turn small online businesses into tax collectors for the 9,600 distinct taxing jurisdictions across the country. Businesses with a single location — perhaps even in one of the five states with no sales tax at all — will become responsible for calculating, collecting and remitting tax obligations to all of those jurisdictions with their unique rates, definitions and exemptions.

This also would impose taxation without representation. Presumably, these businesses could become subject to audits and penalties from states where they have no political voice and do not benefit from the services that their taxes fund. Many small online businesses will not survive these compliance costs.

Second, instead of doing away with loopholes, the legislation contains an exemption for businesses with gross annual sales of less than $1 million. That might sound like a welcome relief from the plan’s business-killing compliance costs, but many small businesses have annual sales above that threshold. (In fact, the Small Business Administration defines a small business as one making $30 million or less.) So this exemption won’t do nearly enough to protect smaller retailers online.

Moreover, the $1 million threshold is for the company’s total annual gross sales, not sales in any one state. In practice, this means that an entrepreneur will be subject to a remote state’s tax regime even if he sells $1 million in merchandise through walk-in business to his storefront and only makes one remote online sale. For the lawyers out there, that’s a due process problem. Having a website that someone is able to access in another state doesn’t qualify as purposefully availing your business to that state’s tax regime, as Supreme Court jurisprudence requires.

The third principle of sound tax reform is that rates should go down. The Marketplace Fairness Act will likely make them go up. If state lawmakers can raise tax rates on a group with no political recourse against them, it’s a safe bet that they will. Taxes on hotel rooms, rental cars and airports all illustrate politicians’ propensity to raise taxes on those who lack the clout to vote them out of office. Most politicians won’t be able to resist squeezing a little more tax revenue from out-of state businesses because there won’t be any incentive not to. Downward pressure on these taxes will be lessened, and, accordingly, rates will rise.

This legislation will mean more burdensome complexity, more loopholes and higher tax rates. If this is what Congress thinks state tax law needs, let’s hope it doesn’t get around to working on the federal tax code anytime soon.