As the Kansas Legislature convenes in January, lawmakers in the Sunflower State are considering legislation that would levy taxes on out-of-state internet sales as a source of state revenue. Although revenue projections from these potential taxes make the legislation seem like a good idea, out-of-state internet sales taxes inherently reduce states’ accountability to taxpayers and will ultimately lead to higher costs for consumers.
For years, states avoided the legal complexities of implementing internet sales taxes on persons or businesses without a physical presence in the state. However, after the U.S. Supreme Court upheld South Dakota’s internet sales tax law in South Dakota v. Wayfair, all of this began to change.
The ruling overturned the 25-year-old “physical presence nexus” standard set in Quill Corp. v. North Dakota. Under this new standard, a business may be required to pay sales taxes to a state or local government even if it has no physical location, or nexus, in the taxing jurisdiction.
The Wayfair v. South Dakota ruling overturned decades of sales tax law and has encouraged many states to issue new sales taxes on online businesses and consumers. In response to the ruling, the Kansas Legislature is now primed to consider several bills that would impose new taxes on remote vendors.
Between burdensome licensing laws, onerous fees, and arduous regulations, small businesses already face substantial barriers. Adding a new internet sales tax would only tighten the screws on small businesses.
At present, small businesses face a labyrinth of taxing bodies. According to the Tax Foundation, there are more than 10,800 sales tax jurisdictions in the United States. Increasing the number of taxes and taxing bodies on small businesses, during an epidemic, would make it more difficult for struggling small businesses to stay afloat.
Applying sales taxes to internet transactions would produce negative consequences, as well. First, the power state governments wield over retailers outside their borders would dramatically expand. Second, because individual states have very different definitions and rules on sales taxes, confusion and uncertainty for out-of-state buyers and sellers is inevitable.
Supporters of online taxes argue these taxes are needed to restore a competitive balance between online and brick-and-mortar retailers. However, the imposition of sales taxes on internet transactions would slow the expansion of e-commerce, one of the key growth sectors of the U.S. economy. According to a study from the Kem C. Gardener Policy Institute at the University of Utah, e-commerce retail sales have grown 15-fold since 2000. From an estimated $23 billion to an estimated $371 billion annually. A trend that has been further exacerbated during the ongoing pandemic.
The majority of states that have enacted out-of-state internet sales taxes have adopted South Dakota’s monetary thresholds for their new tax laws, while others have chosen to expand the threshold in an attempt to exempt a larger number of small businesses. Alabama, Connecticut, Georgia, and Mississippi all set their thresholds for exemption at greater than $250,000. Meanwhile, in Massachusetts and Tennessee, the threshold is $500,000. If Kansas lawmakers ultimately choose to impose an internet sales tax, it should set the threshold as high as possible, allowing maximum exemptions for small businesses.
While many states are still reeling from lost revenue due to the pandemic and mandated lockdowns, out-of-state internet sales taxes are not a good solution for filling their revenue deficits. Internet sales taxes, and tax hikes in general, ultimately raise the costs of goods and services for all residents, while also posing significant challenges to small businesses throughout the nation. Allowing one state to tax a resident of another state represents an expansion of state taxing powers, which logically end at the state’s borders. Members of the Kansas Legislature should consider all of these factors as the new session is underway.
The following documents examine state internet sales taxes in greater detail.
What Does the Wayfair Decision Really Mean for States, Businesses, and Consumers?
In this “Q&A,” Joseph Bishop-Henchman of the Tax Foundation discusses the Wayfair decision and the potential effects it could have on states.
Understanding an Internet Sales Tax
Jessica Melugin of the Competitive Enterprise Institute examines the effort by states to expand their internet sales taxes to draw more revenue from taxpayers. Melugin argues in favor of the origin approach of taxation, a sales tax system where the sales tax is determined based on where the product was sold.
Taxes on Remote Sales
This election brief from the Kem C. Gardner Policy Institute at the University of Utah examines the complexity of online sales, including the legal context and the growth of online sales, and provides some policy options for consideration.
Research & Commentary: Internet Sales Taxes
This Heartland Institute Research & Commentary on internet sales taxes explains how taxing the internet hurts business and fails to bring in the revenues proponents hope for: “The new tax-remittance burden, however, would fall on online retailers. It would add to their costs and could demolish one of the last remaining redoubts of vibrant economic enterprise—the last thing any state needs during a deep recession.”
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.”
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
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 oft 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 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 Heartland’s government relations team at [email protected] or 312/377-4000.