Latest Internet sales tax bill gives states unprecedented taxing power

This week’s introduction by Rep. Jason Chaffetz (R-Utah) of yet another Internet sales tax bill illustrates the importance of understanding this complex issue and the different reform proposals circulating on Capitol Hill.

Currently, a Supreme Court decision, Quill v. North Dakota, requires that a seller have a physical presence, or “nexus,” in the buyer’s state to become subject to the latter state’s sales tax. For example, if a resident of Virginia buys something through the website of a Texas retailer, a sales tax obligation is only triggered if that Texas seller also has a store, warehouse, or other facility in Virginia. 

Critics of the current system often call this a tax loophole. In truth, it keeps taxing authorities accountable to those they tax. The seller, not the buyer, is the taxpayer in this online transaction. The seller remits the sales tax to authorities and is subject to audits, even when the cost of the tax is passed along to the consumer. This prevents state and local governments from taxing a seller that has no physical presence and no political voice in that jurisdiction—a clear case of “‘taxation without representation.”

Yet, the rapid growth of online retailing has led state and local officials to call for greater authority to capture more sales tax revenue, and from brick-and-mortar retailers to allow states to “level the playing field” by collecting sales tax from anyone who sells to their residents, regardless of the seller’s location. 

Unfortunately, Chaffetz’s Remote Transactions Parity Act of 2015 (RTPA) is the latest example of this approach. Like its forerunner, the Marketplace Fairness Act (MFA), it would give states unprecedented power to reach outside their borders to tax businesses in other states.

This is a radical departure from the point-of-sale model used in the brick-and-mortar world. When you pull into a gas station, the attendant doesn’t calculate your sales tax rate based on your license plate or remit the tax to your home taxing domicile. Yet, this destination-based system is what the MFA and RTPA seek to impose on online sellers. 

Compliance would be costly. There are approximately 10,000 distinct tax jurisdictions in the U.S., each with its own rates, definitions, and tax holidays. Supporters of destination-based sales taxes claim that specialized software can help ease the burden for retailers, but commissioned studies show high compliance costs for these smaller online sellers regardless. 

Unfortunately, many big box retailers support a destination-based system because they see these compliance costs as a potential competitive advantage. Walmart, Target, and Best Buy have spent millions lobbying in favor of these bills. They are joined by Amazon, whose distribution warehouses in an increasing number of states trigger sales tax obligations. 

Many state and local governments also support a destination-based system. For state and local politicians, the more tax money they can capture in their coffers, the less unpopular budget cutting they’ll be forced to do. And they get to collect taxes from businesses that are not among their constituents.

So is there an alternative that is fair to all parties involved? Yes, it’s called an origin-based approach.

A pure origin-based plan keeps compliance costs low for businesses, keeps taxing authorities politically accountable to tax payers, and often makes for some healthy tax competition. A seller would calculate based on his primary place of business and remit to his own state tax agency, regardless of the buyer’s location.

This arrangement preserves political accountability by confining states and localities to collect taxes only from their own constituents. It also preserves tax competition between states by allowing consumers to “vote with their wallets” when shopping online. It levels the playing field by treating all retailers—bricks and mortar, online, whatever we think of next—the same for sales tax purposes.

This approach is partly embodied in draft legislation from House Judiciary Committee Chairman Bob Goodlatte (R-Va.) to create a hybrid origin-based system. Under Goodlatte’s plan, the seller applies his home domicile’s sales tax to remote purchases, then remits the tax (and the buyer’s zip code) to the seller’s home state. The states participate in a fund reimbursement program that channels the revenue created based on the seller’s tax rates and rules back to the buyer’s home taxing authority. This approach avoids the high compliance costs of the MFA and RTPA and preserves much of the healthy tax competition we currently enjoy. Unfortunately, it doesn’t allow the five states with no sales tax to decline to participate in the program, thereby compromising those states’ autonomy. Hopefully, future drafts will rectify this flaw.

While the debate around reforming online sales tax remains a complicated and contentious one, it’s critical for voters to understand the issues involved, and for politicians to get the principles and incentives right as more and more commerce happens over the Internet.