Myth 1: A tax on Internet sales just enables states to collect taxes they are already legally entitled to collect.
Fact: A state is not legally entitled to collect taxes from Internet sellers with no physical presence in that state.
In Quill Corp. v. North Dakota, the U.S. Supreme Court ruled in 1992 that a mail-order or Internet business must have a physical presence in a state for that state to require it to collect sales or use taxes, affirming the ruling in a 1967 case. While individuals may be legally obligated to report purchases they make out-of-state or from online sellers and then pay a “use” tax to the taxing jurisdiction in which they live, the Supreme Court has said states legally cannot compel out-of-state businesses to collect and pay such taxes to states where the sellers have no physical presence.
More than 9,600 government units levy sales taxes, making compliance with an Internet sales tax incredibly difficult. For each state in which a business has a physical presence, a business already needs to collect accurate information on a buyer’s home or place of business, access online databases to calculate the tax due, collect the tax, and then arrange for it to be sent to the taxing body. North Dakota argued for a flexible test under which sellers with certain contacts with a state or buyers residing in that state (though lacking physical presence in it) would also be required to collect and pay the tax. The Supreme Court recognized this burden was unreasonable.
Myth 2: An Internet tax would level the playing field between online and bricks-and-mortar businesses.
Fact: A new tax is not necessary to “level the playing field,” and in fact introduces new distortions and unfairness.
Businesses that maintain bricks-and-mortar stores are free to sell their products online, and in fact many or most do. So if the playing field isn’t already level, a retailer can make it so by launching a Web site. A tax on Internet sales is really just a subsidy to businesses that refuse to make the transition to a blended retail model of bricks-and-mortar store with Internet sales.
Local businesses benefit from federal, state, and local expenditures related to a business district, including roads, water, sewers, lights, and police and fire protection. The taxes they pay go to pay for those services, and arguably are the price of those services.The only cost an out-of-state Internet seller imposes is the use of roads by a Fed Ex or UPS truck delivering the product from a warehouse to a customer’s home. UPS and Fed Ex pay hundreds of millions of dollars a year in motor fuel taxes to pay for roads.
The current arrangement, in short, accurately allocates the responsibility to collect taxes to the use of public services.
Myth 3: Compliance will be easy and inexpensive due to software.
Fact: The cost of compliance would be unduly burdensome for small businesses despite advances in software.
Currently there are more than 9,600 state and local sales tax jurisdictions in the United States. An Internet sales tax would require online retailers to comply with the detailed, conflicting, ever-changing, and often-ambiguous requirements of those 9,600 taxing jurisdictions. A 2006 PricewaterhouseCoopers study found small retailers (less than $1 million in sales) already have compliance costs of 17 cents for every dollar they collect in tax revenue for states.
Mail and Internet use allow even the smallest businesses to sell their products or services all over the country, giving them enormous opportunities to expand their reach and grow while at the same time giving customers the greater choice and cheaper prices increased market competition provides. With increased compliance costs and liability risks, small businesses and entrepreneurs are less likely to expand their reach into other states.
Myth 4: States are missing out on a massive amount of revenue.
Fact: This tax would kill jobs and not be the revenue windfall advocates are claiming.
The total potential uncollected sales tax revenues in 2008 would have been “less than three-tenths of one percent of state and local tax revenues,” according to a study by Jeffrey A. Eisenach, an adjunct professor at George Mason University Law School, and Dr. Robert Litan, a senior fellow at The Brookings Institution.
To date very little revenue has been actually collected in states that have passed so-called “Amazon taxes.” Revenues from Internet taxes are likely to be curbed from economic losses as a result of small businesses and affiliate programs being no longer able to compete.
According to the Tax Foundation, “Contrary to the claims of supporters, Amazon taxes do not provide easy revenue. In fact, the nation’s first few Amazon taxes have not produced any revenue at all, and there is some evidence of lost revenue. For instance, Rhode Island has seen no additional sales tax revenue from its Amazon tax, and because Amazon reacted by discontinuing its affiliate program, Rhode Islanders are earning less income and paying less income tax.”
Myth 5: The taxing powers offered by the Marketplace Fairness Act (MFA) are limited in scope.
Fact: The MFA would open the door to state taxes on digital products, such as iTunes, and on other transactions outside their borders.
Allowing states to collect taxes on transactions occurring outside their borders is fundamentally unfair and threatens basic economic liberties. The persons paying and collecting the taxes do not have an opportunity to vote or otherwise participate in the government process that creates the tax or sets its rate. This “taxation without representation” is compounded by the fact that those paying the taxes receive no public goods or services in return for their payment – “taxation without benefits.” The incentive structure created by allowing such taxation will lead to ever-rising taxes and government spending, since the victims have no way to vote against higher taxes.
Once the online sale of real goods is taxed, it will be only a matter of time before digital products, such as iTunes, apps, ring-tones, digital books, and movies will also be taxed. States will see the Internet as a practically unlimited source of tax income by charging low rates on large numbers of transactions.
According to a study by the Mercatus Center, “Requiring out-of-state vendors to collect sales taxes on behalf of jurisdictions where they have no physical presence remains unfair and unconstitutional, especially when there are other ways states could promote fairness. One way to level the playing field would be to cut or eliminate sales taxes on in-state vendors. Another alternative would be a national Internet sales tax that would avoid the complexity problem by imposing a single rate and set of definitions on all vendors. But that solution opens the door to a new federal tax base, which would grow to be burdensome in other ways at a time when American consumers and companies are already over-taxed.”
Conclusion
An origin-based tax system for online purchases is simpler and more taxpayer-friendly than a destination-based tax system.
In a destination-based tax system, a customer is charged at the rate where the customer is located or is expected to use the product. The increase in the number of intangible services and property sold over the Internet makes it extremely difficult to determine where the product will be used, since computer programs and digital property such as music files can be downloaded all over the country.
There are three problems with a destination-based tax on the Internet. Tax competition among the states would be hindered, it would undercut federalism, and it would push tax rates up.
In comparison, states currently tax sales using an origin-based tax system. A consumer buys a product in a store or from a remote business, and he or she is taxed at the rate where the business is physically located.
So while destination-based taxation requires reporting to multiple governmental jurisdictions and creating substantial business costs for small start-up companies and Internet entrepreneurs, origin-based taxation would foster competition among the states and would be simpler for businesses to comply with.
Nothing in this report is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. If you have any questions about this issue or The Heartland Institute, contact Heartland Government Relations Director John Nothdurft at 312/377-4000 or [email protected].
John Nothdurft joined the staff of The Heartland Institute in May 2008 and left in January of 2019.
