Tax Simplification To What End? Today’s Simplification Could Be Tomorrow’s Higher Sales Taxes

From the August 2001 Edition of CEI Update

‘Tis a gift to be simple, so the song goes. But nothing could be further from the truth when it comes to sales taxes and the Internet.

A number of states are considering similar legislation aimed at simplifying sales taxes. Based on a model put forth by the National Conference of State Legislatures (NCSL), this legislation is an agreement between states to modify their tax laws to make it easier for so-called “remote sellers”—those without any physical presence in a given state—to collect and remit sales taxes.

If the idea of state governments banding together to make things easier on taxpayers makes you suspicious, you have good reason to be. Ultimately, states want to gain permission from Congress to tax all purchases made over the Internet. Currently there are more than 6,500 differing taxing jurisdictions—far too many to ask retailers to keep straight. So states are offering to homogenize their tax jurisdictions in return for Congress’s blessing to collect taxes from sales made over the Internet from companies located in other states.

Contrary to what many state tax collectors would like you to believe, the Internet is not a tax-free zone. On the federal level, the Internet Tax Freedom Act of 1998 banned “special and discriminatory taxes” that states might create especially for the Internet, but it’s a 1992 Supreme Court decision, Quill Corp. vs. Heitkamp, that governs sales taxes for Internet purchases (and catalogue sales). Quill prevents states from collecting sales taxes from vendors who lack a physical presence, like a warehouse or a salesperson, in that state. (It should be noted that all fifty states have “use tax” laws on the books that legally obligate the customer to remit a tax to their home state, but these are seldom enforced).

As things stand now, if a resident of New York buys a gift over the Internet from a company in California and that company has no physical presence in the Empire State, New York cannot force the Golden State retailer to remit a sales tax on the purchase.

This arrangement is less a quirky turn of tax law and more a modern-day manifestation of “no taxation without representation,” because it is vendors who remit the tax to the government, not customers. And, much to the advantage of consumers, it is vendors who put pressure on politicians to keep tax rates at bay. But if states are allowed to tax vendors in other states, to whom they are not accountable, there will be substantially less downward pressure on tax rates. Consumers will take the tax heat.

The same shopping scenario under the rules that the NCSL wants adopted would look like this: New York would be able to collect tax from the California-based retailer. Never mind that the company being taxed has absolutely no voice in what items New York decides to tax or at what rates it does so. And never mind that it doesn’t benefit from any services New York provides with those tax dollars.

Make no mistake about it; companies aren’t the only ones to get the short end of the stick in this instance. When state taxing officials have no accountability to these extra-territorial taxpayers, and have no incentive to keep rates reasonable, it is consumers who will be left paying higher taxes, and more of them. While the long-term effects of sales tax simplification will spell bad news for taxpayers, the more immediate implications are troubling as well.

A simplified sales tax base will inevitably involve an across the board expansion of what gets taxed. Currently, only about forty percent of sales that could be taxed are. Certain items enjoy exemptions for a variety of reasons. Foods are often viewed as staples.  Or, a town might exempt the product of its local industry. In the simplification process, each area’s exemptions can’t be made universal without narrowing the base to the vanishing point. Since that would defeat the whole goal of states increasing their revenue, states will have to take the opposite tack. Necessarily, items subject to tax somewhere will be subject to tax everywhere. Good news for the already overflowing state tax coffers, but bad news for consumers.

There are viable alternatives to simplification and “taxation without representation” in the Internet sales tax debate. For the sake of consumers, state lawmakers across the nation should take a look at them.

Jessica Melugin ([email protected]) is director of federal affairs in the Washington offices of the Manhattan Institute and an adjunct scholar in CEI’s Project on Technology and Innovation.