Marketplace Fairness Act: Back Door To New Tax

House Speaker John Boehner blocked passage of the Marketplace Fairness Act (MFA) in the lame-duck congressional session. So consumers were able to shop online this holiday season without fear of new taxes on out-of-state purchases.

But after Jan. 1, consumers and investors need to watch their wallets.

The MFA would allow states and localities to require "remote sellers" to collect taxes on sales to their residents. It passed the Senate last year but not the House. Supporters pushed for passage during the lame-duck session, and with that failure promised to be back in full force in the next Congress.
Advocates for the bill, a powerful coalition of large retailers and state and local politicians of both parties, claim that online businesses enjoy an unfair advantage over their brick-and-mortar competitors because they don't have to collect taxes from out-of-state residents.

But as opponents point out, the MFA would impose taxation on businesses that have no physical presence in the taxing state.

That's bad enough. But the damage likely doesn't end there. In its current form, the bill is silent on the particular products and services of "sellers" and "sales" that it covers.

Thus, it could open the door for state and local governments to tax all sorts of service industries, including legal services, tax preparation and financial transactions.

But don't take it from me. Those likely affected by the legislation strongly oppose it. The Financial Services Roundtable and the Securities Industry and Financial Markets Association (SIFMA) have expressed concern.

"The bill could lead to unexpected costs being passed on to consumers of financial services, including sales taxes on services or state-level stock-transaction taxes," SIFMA says in a statement.

American Society of Pension Professionals and Actuaries Executive Director Brian Graff notes, "The legislation would allow states to impose a financial-transaction tax that would apply to American workers' 401(k) contributions and other transactions within workers' accounts."

MFA proponents have done little to address these concerns. One of the bill's co-sponsors, Sen. Mike Enzi, R-Wyo., says that the financial industry has nothing to worry about because "no state imposes a sales tax on financial transactions." However, states have done so in the past, and the legislation would give them incentive to do so again because doing so would stifle tax competition with other jurisdictions.

For an idea of what a state-level financial transaction tax would do, the state of New York is instructive. From 1905 to 1981, the state imposed a transfer tax on securities transactions. After a 50% increase was proposed in the 1960s, the president of the New York Stock Exchange threatened to build a second trading floor in Trenton, N.J., to bypass the New York tax.

New York settled on a 25% increase instead, but even that caused many investors and financial firms to flee.

"New York securities markets have experienced increasing competitive problems in recent years from regional stock exchanges located in San Francisco, Los Angeles, Chicago, Detroit, Philadelphia and Boston," noted a 1968 NYSE analysis. "From 1965 through 1967, the volume of trading on the regional exchanges increased by 73.2%."

The competition prompted New York to phase out the tax, starting in the 1970s. The state still collects a nominal tax, but since 1981 the proceeds have simply been returned to traders. Since the November elections, however, some progressives have called for the tax's reinstatement. "New York could serve as a pilot program for an eventual national tax," write Lenore Palladino and Sean McElwee in Vox.

A national tax, of course, would allow for no escape. Yet the MFA would also bolt the exit doors pretty tight.

If New York were to re-impose a stock-transfer tax and the MFA were in effect, the state could blunt the impact of the New York Stock Exchange leaving by classifying it as a "remote seller" and taxing any transaction involving a New York business or resident.

The possibilities for revenue-hungry state governments and populist politicians would be mind-boggling. For example, New York and other states could also tax "remote sales" made from the Better Alternative Trading System exchange (better known as BATS) in Lenexa, Kan., which now accounts for more than 10% of equity trading in the U.S.

Middle-class savers would lose out as hidden taxes chip away at their 401(k)s, mutual funds and brokerage accounts. So would U.S. competitiveness, as international investors would be forced to contend with an unpredictable tax regime of varying tax rates on financial transactions from several different states.
The MFA is bad policy and bad politics. As the recently passed election season shows, imposing a financial transaction tax is certainly not among voters' priorities. Congress should honor their wishes and not seek to impose one during the next congressional session.