Congress has proposed several bills over the past few years that would expand states’ ability to tax purchases made online and from mail-order catalogs. The Main Street Fairness Act, Marketplace Equity Act, and the Marketplace Fairness Act were designed to expand the ability of states to charge sales taxes on out of state retailers regardless of if the retailer has a physical presence in the state. These proposals would allow states to impose scores of new taxes on consumers and may open the door to other new taxes.
The debate over internet sales taxes has reached a crucial crossroads. For years, the principle of nexus—the idea state governments cannot tax a person or business without them having a physical presence in the state—has been at the center of all proposals to add a sales tax to transactions made on the internet.
In July, Rep. Jim Sensenbrenner (R-WI) introduced The No Regulation without Representation Act of 2016, a bill that would limit the ability of states to impose a use tax or sales tax on remote online sellers. The bill would codify the long-standing standard set in the U.S. Supreme Court’s 1992 decision in Quill Corp. v. North Dakota; it held a state must prove a company has a “substantial nexus” within a state before taxes can be imposed.
Since the Quill ruling, the nexus, or physical presence standard, has been an important taxpayer protection. In recent years, however, states have begun to craft new laws attempting to widen the scope of the nexus standard in order to increase sales tax revenue. The Sensenbrenner proposal narrowly defines physical presence, limits the ability of states to shoehorn in as many sellers as possible, and protects sellers from taxes, tax reporting, and assessments and audits.
Unless a seller owns or leases real or tangible personal property in the state, has employees in the state, or maintains an office in-state with three or more employees, the company has not established a physical presence according to the bill. The bill also provides several exclusions from the physical standard rule including click-through referral agreements with in-state persons, presence in a state for less than 15 days in a taxable year, and online advertising services.
Removing the physical presence standard for sales taxes reduces states’ accountability to taxpayers and enables a dramatic expansion of state taxing powers. The Heartland Institute’s government relations director, John Nothdurft, argued in a Heartland Policy Tip Sheet that online sales taxes are likely to expand once they are implemented. “States will see the internet as a practically unlimited source of tax income by charging low rates on large numbers of transactions,” wrote Nothdurft.
Supporters of online taxes argue these taxes are needed to restore a balance between online and bricks-and-mortar retailers. But the imposition of sales taxes on Internet sales would slow the growth of the e-commerce industry, one of the few sectors of the economy that has seen growth in recent years. In addition, requiring online retailers to charge a sales tax in states where they do not have a physical presence would force consumers to pay a tax to a government with whom they have no political voice and from whom they receive no government benefits or services.
The proposal is a step toward ensuring online sales taxes are only imposed when a seller receives the benefits of such a tax. Maintaining the Quill nexus standard is essential to preserving the internet economy. Instead of forcing out-of-state businesses to serve as government tax collectors, legislators should implement a sales tax system based on where the product is sold, known as an origin-based tax system. This would truly level the playing field; online and brick-and-mortar retailers would pay the same tax.
The following documents examine state internet sales taxes in greater detail.
Ten Principles of Telecom Policy
https://heartland.org/publications-resources/publications/ten-principles-of-telecom-policy
In this Heartland Institute Legislative Principles booklet, Hance Haney and George Gilder examine the results of telecom reforms in Indiana, the advances made by other innovation leaders in the telecom market, and how other states can follow their lead to reap the rewards of new investment in telecommunications services.
Policy Tip Sheet: Myth vs. Fact—Internet Taxes
https://heartland.org/publications-resources/publications/policy-tip-sheet-myth-vs-fact—internet-taxes
In this Heartland Institute Policy Tip Sheet, John Nothdurft examines several myths and facts about Internet taxes.
The Internet, Sales Taxes, and Tax Competition
https://heartland.org/publications-resources/publications/the-internet-sales-taxes-and-tax-competition
Veronique de Rugy and Adam Thierer discuss the Main Street Fairness Act in this study from the Mercatus Center. The new legislation would force retailers to collect sales taxes for states joining a formal tax compact. The authors examine alternatives to the tax, including an origin-based sales tax.
An “Original” Solution to Taxation of Online Sales
https://heartland.org/publications-resources/publications/an-original-solution-to-taxation-of-online-sales
Writing for the American Legislative Exchange Council, Andrew Moylan discusses the origin-based sourcing rule for Internet sales taxes and explains how it solves many of the problems created by destination sourcing: “Perhaps the most important advantage of origin sourcing, however, would be the infusion of tax competition it could engender. Under such a system, businesses would have an incentive to invest in lower-tax jurisdictions so as to attract price-conscious customers.”
Congress Should Not Authorize States to Expand Collection of Taxes on Internet and Mail Order Sales
https://heartland.org/publications-resources/publications/congress-should-not-authorize-states-to-expand-collection-of-taxes-on-internet-and-mail-order-sales
In this Heritage Foundation Backgrounder, David S. Addington considers congressional efforts to override the U.S. Supreme Court’s Quill decision through the Marketplace Fairness Act. Addington argues enactment of MFA would encourage state governments to “take more money from taxpayers and spend it instead of getting the size, scope, and cost of state governments under control.”
States Already Can Tax Out-of-State Purchases, but Rarely Enforce those Laws
http://www.aei.org/article/economics/fiscal-policy/taxes/states-already-can-tax-out-of-state-purchases-but-rarely-enforce-those-laws/
Michael S. Greve of the American Enterprise Institute considers an overlooked issue in the Internet sales tax debate: the often-unenforced use tax. Currently, if a product is purchased from a “remote” seller with no contact with a consumer’s state, the sale is not “tax-free”—the consumer owes a “use tax” equivalent to the local sales tax. Many states do not enforce this tax.
Marketplace Fairness: Leveling the Playing Field for Small Business
https://heartland.org/publications-resources/publications/marketplace-fairness-leveling-the-playing-field-for-small-business
In written testimony before the U.S. Senate Commerce, Science, and Transportation Committee, Kelly Cobb of Americans for Tax Reform discusses remote-state sales tax collection and physical presence in light of the proposed Marketplace Fairness Act. “The effects on taxpayers of the Marketplace Fairness Act and similar legislation would be dramatic,” Cobb said. “From a taxpayer perspective, any bill that touches remote sales taxes must preserve the physical presence standard and protect consumers on net from a higher tax burden. Unfortunately, the federal online sales tax bills miss the mark widely on both fronts.”
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website, The Heartland Institute’s website, and PolicyBot, Heartland’s free online research database.
The Heartland Institute can send an expert to your state to testify or brief your caucus; host an event in your state, or send you further information on a topic. Please don’t hesitate to contact us if we can be of assistance! If you have any questions or comments, contact John Nothdurft, Heartland’s director of government relations, at [email protected] or 312/377-4000.
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance.
