Perfect Storm Threatens Internet Tax Freedom

Published May 15, 2009

A perfect storm is brewing that may end the days of the Internet being a relatively tax-free zone, threatening to wash away one of the last remaining redoubts of economic enterprise in the United States.

State legislators are desperate for new tax revenue to plug massive deficits without cutting spending (of course). And a confident Democratic Washington, DC now has the power to enact virtually any tax policy it wishes. Together these two forces of nature are poised to impose sales taxes on everything you buy online.

The Commerce Clause of the U.S. Constitution, as interpreted by the Supreme Court in the 1992 Quill v. North Dakota decision, prevents a state from compelling a company to collect sales taxes unless it has a physical presence in the state. For example, if you live in Indianapolis and buy a book on Seattle-based, Indiana cannot force the Internet book-selling giant to charge and collect its 7 percent state sales tax.

In that ruling, however, the Court noted Congress, which has the authority to regulate interstate commerce, is free to determine “the extent the states may burden interstate mail order [and online] concerns with a duty to collect use taxes.” That day is imminent.

Sen. Mike Enzi (R-WY) and Rep. William Delahunt (D-MA) are widely expected to sponsor a bill to allow states to force out-of-state Internet sellers to collect their sales taxes.

The National Conference of State Legislatures (NCSL) is writing the bill. The only current hold-up, according to spokesman Neal Osten, is “adding some new provisions at the request of various stakeholders.”

“Stakeholders,” let’s be clear, are not American taxpayers, but the state legislatures wanting a new source of revenue to fill the gaps in their bloated budgets.

This bill would buffet the U.S. economy at the worst possible time. U.S. GDP contracted by more than 6 percent in the past two quarters. The last thing we need right now is more policies that suppress commerce.

The largely tax-free Internet has been a net contributor to state tax coffers, by encouraging economic growth and the collection of income taxes from those who make their livings with online firms. Increase the burden on those firms, and you decrease the number of jobs. This happened in New York in 2008 when closed all its offices in the state in response to a new online sales tax.

Internet sales taxes also present a compliance nightmare for every online firm, from small “mom & pop” retailers to behemoths such as Amazon and Overstock. There are about 7,400 tax districts across the United States, which makes it absurdly difficult to ascertain which state gets what cut of tax revenue for a sale by an online retailer in California, made from a coffee shop in North Carolina, using a wi-fi connection from a company based in New York and routed through servers in Illinois, Nebraska, and Texas.

Supporters of this idea—a cabal known as the Streamlined Sales Tax Project—say part of the deal will be a simplification of sales taxes from state to state. The public can be forgiven for looking at the history of tax “simplification” in America and seeing it as a scheme to force all states’ tax rates up by reducing competition among the states.

One can empathize with state legislatures dealing with budgets bleeding pools of red ink. The solution, however, is not to buffet Americans with a hurricane of new taxes but to reduce government to handle only what is really needed. The public can easily afford that without new taxes.

James G. Lakely ([email protected]) is a research fellow at The Heartland Institute in Chicago, Illinois, and managing editor of InfoTech & Telecom News.