Internet sales taxes attack states’ rights

Proponents of Internet sales taxes are asking the lame-duck Congress to bless their state tax cartel as part of a larger tax reform package by passing the Marketplace Equity Act (H.R. 3179) and its companion in the Senate, the Marketplace Fairness Act (S. 1832). These aren’t your average tax increases, but grim blueprints for government’s future relationship with the online world. Long after we’ve either swerved at the last minute or gone off the “fiscal cliff” a la “Thelma and Louise,” we’ll have to live with the harmful consequences of expanding government to every corner of the Internet.

State and local governments already can tax in-state sellers regardless of their method of delivery to consumers — online, through the mail or in person. Now some states want Congress to let them expand their reach to tax businesses that have no physical presence and no political voice within their borders.

This interstate grab clearly is a violation of the principle of “no taxation without representation” that so animated the Founding Fathers. The Supreme Court said as much 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 store or warehouse in the buyer’s state. For example, if a New Yorker buys a book online from a California retailer, the purchase is taxed only if the retailer also has a nexus — that is, a physical presence — in the Empire State. This prevents New York from imposing its tax regime on a Golden State business that has no say in the shaping of New York tax law.

The proposed legislation removes that safeguard by codifying into law the multistate Streamlined Sales and Use Tax Agreement (SSUTA). The stated goal of the SSUTA, which 24 states have passed as legislation, is to “simplify and modernize sales and use tax administration.” However, the agreement also calls for Congress to overturn Quill and allow remote taxation, so the unarticulated goal of the SSUTA is to form a de facto state tax cartel.

In practice, this means member states agree to simplify their sales tax rates and bases in exchange for the lucrative privilege of taxing businesses in other states. For example, under the SSUTA scheme, a state could collect tax from a retailer with no physical presence within its borders if one of its residents purchased from that retailer. Never mind that the company being taxed has no voice in what items the state decides to tax or at what rates, and that the company receives no benefits from any services for the tax dollars it sends out of state.

By overturning Quill, the legislation does away with the crucial notion that one state’s sovereignty stops where another state’s begins. Under this cartel, state tax laws extend everywhere commerce happens on the Internet. Republican Sen. Jim DeMint of South Carolina recently wrote, “[T]hat concept is antithetical to our federalist system, which promotes competition among our states for the best economic policies.”

The SSUTA plan destroys that healthy tax competition, which allows consumers to vote with their feet by choosing to do business in jurisdictions with lower taxes, such as New Yorkers busing to Delaware shopping outlets or District of Columbia residents driving over the Potomac River to Virginia for gas. Thus, the tax “simplification” heralded in the SSUTA agreement ultimately will homogenize and ratchet up sales taxes everywhere.

It also will mean the extinction of exemptions on certain products because extending local exemptions and low rates to every jurisdiction ultimately would narrow the tax base to zero. That result would be the opposite of the SSUTA’s objective, which is to divert more money from consumers’ pockets into state tax coffers.

There are real inequities in sales tax policy, but there are better ways to address them than the SSUTA’s approach. One possibility is an origin-based approach in which all transactions — in-person, catalog and online — are assessed for sales taxes at the sellers’ primary point of business. That would address fairness concerns, preserve constitutionally mandated limits of state jurisdiction and promote efficiency for businesses and consumers.

Technological advance requires adjustments in policy, but those adjustments must preserve the beneficial incentives that have served consumers well in the past. 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.

This is a chance to get the first principles right. Opposing this legislation will help keep state governments at bay and let the Internet reach its full economic potential. Online sales taxes are a complex and impactful policy issue, but the real question for lawmakers is a simple one: Do you want a government as big as the Internet?