State Cartel Looking to Hike Internet Taxes

A handful of U.S. senators are teeing up legislation to capture more tax revenue on Internet purchases. Certainly there are valid (and some not so valid) concerns with the way online sales are taxed, but in the case of the Main Street Fairness Act, the cure is worse than the disease.

Currently, a Supreme Court decision prevents states from collecting sales-tax revenues from companies with no physical presence in the state. For example, if a Virginia resident buys a product online from a company in Oklahoma, unless that Sooner vendor has a store, warehouse or anything else that qualifies as “nexus” in the commonwealth, Virginia can’t collect sales tax on the transaction.

This arrangement benefits consumers by promoting tax competition.It also protects interstate commerce by sparing sellers the burdensome task of remitting sales taxes to about 7,400 different state and local taxing jurisdictions across the country.Finally, it preserves the principle of “no taxation without representation” by preventing states from reaching outside their borders to tax businesses to which they are not accountable.

The multistate sales-tax cartel proposed in the Main Street Fairness Act does away with these benefits.The act empowers the member states of the cartel to collect sales-tax revenue from all retailers, no matter their location.The cartel is outlined in the Streamlined Sales and Use Tax Agreement, the product of a cooperative effort by 44 states and others to homogenize tax jurisdictions in exchange for permission to tax other jurisdictions’ companies.

So who wins and who loses under this proposed new regime?

Let’s start with the losers: Internet retailers.These online businesses will have no say in the sales-tax policies to which they’re subjected and often won’t benefit from the services they’re funding, nor will their employees.Online businesses will be forced to compute tax obligations for the thousands of(still not very simplified) jurisdictions around the country.

According to a 2006 PricewaterhouseCoopers study, the cost of sales-tax compliance amounts to 16 cents of every dollar earned by retailers with less than $1 million in annual sales. These smaller firms don’t have the accounting resources larger firms can afford, and therefore they will bear a disproportionate share of the new burden. While some states have made progress toward simplifying sales-tax collection in recent years, the burden remains substantial.If legislators think they get an earful from bricks-and-mortar constituents, wait until voters running online businesses out of their garages and dens get hit with these compliance costs.

Consumers also will suffer.Customers benefit from the downward pressure healthy tax competition puts on tax rates and rules.The tax simplification assumed in this legislation surely will mean overall increases in taxes paid.”Assumed” is the right word for the simplification because the so-called “streamlined” agreement document is still 200 pages of loopholes and exceptions.

Most important, the principle of federalism will lose, too.The “states’ rights” battle cry from proponents of this legislation is only half of what the Founding Fathers intended with their brand of federalism.They also meant to preserve the healthy tension among states competing for citizens and commerce.For this reason, they granted Congress authority to protect the free flow of interstate commerce – the antithesis of the bill’s blessing for interstate tax collusion.We’ve seen what happens when states’ rights include protectionism and discrimination against out-of-state entities; it was called the Articles of Confederation, and we all know how that ended.

Who wins if Congress signs off on this state tax cartel?

State and local tax coffers are meant to benefit from these increased revenues. The reality, however, looks a lot less lucrative than what is portrayed by cartel advocates. A 2010 study by the economic consultancy Empiris LLC found that total potential uncollected sales-tax revenues in 2008 were roughly $3.9 billion, or less than 0.3 percent of state and local tax revenues. That’s hardly the silver bullet states need to solve their fiscal problems – which are largely caused by overspending.

It’s true that bricks-and-mortar retailers may benefit from a more level sales-tax playing field.If Washington is really serious about righting this wrong, there’s a better way: an origin-based system.Taxing all transactions (online, mail-order, you name it) at the seller’s principal point of business, as we already do for traditional sales, would equalize treatment among retailers.

And, unlike the Main Street Fairness Act, an origin-based regime would preserve tax competition, protect the free flow of interstate commerce, spare retailers from reporting to more than one tax jurisdiction and keep state officials accountable to those they tax.

There are good reasons for Congress to reform online sales taxes, but the Main Street Fairness Act will do more unintended harm than good.