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. Now, states are beginning to challenge that principle including Rhode Island and South Dakota.
In Rhode Island, legislators are considering a new law that would require online sellers to collect the state’s sales taxes, even if the seller has no nexus in the state. The bill was first proposed in January and was most recently acted on in May, when the Rhode Island House Committee on Finance recommended the proposal be held for study. The proposal attacks one of the main arguments against internet sales taxes across borders: the cost of implementation.
Text within the bill itself argues, “[D]ue to the ready availability of sales and use tax collection software, it is no longer an undue burden for companies without a physical presence in Rhode Island to accurately compute, collect and remit their sales and use tax obligations.” Supporters argue the proposal is needed to recover more than $30 million a year in tax revenue lost to out-of-state retailers.
South Dakota has taken these efforts a step further. On May 1, a new law took effect in South Dakota that requires all online retailers to pay state sales taxes, regardless if the seller has a presence in state. The tax is only applied to retailers who make more than $100,000 a year from South Dakota customers or more than 200 transactions a year in the state. Shortly after the bill was signed, the state sued four major online retailers for failing to collect the state’s 4 percent sales tax on orders from South Dakota.
South Dakota’s suit directly challenges the U.S. Supreme Court’s 1992 decision in Quill Corp. v. North Dakota, which set the precedent that a state must prove a company has a “substantial nexus” within a state before taxes can be imposed. Since this ruling, the nexus, or “physical presence,” standard has been an important taxpayer protection.
Removing the physical presence standard for sales taxes reduces states’ accountability to taxpayers and enables a dramatic expansion of state taxing powers. “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,” wrote The Heartland Institute’s government relations director, John Nothdurft, in a Heartland Policy Tip Sheet. “States will see the Internet as a practically unlimited source of tax income by charging low rates on large numbers of transactions.”
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.
Instead of forcing out-of-state businesses to serve as government tax collectors state legislators should implement a sales tax system based on where the product was sold, known as an origin-based tax system. This would truly level the playing field, with both online and bricks-and-mortar retailers paying the same tax.
The following documents examine state internet sales taxes in greater detail.
Ten Principles of Telecom Policy
http://heartland.org/policy-documents/ten-principles-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
http://heartland.org/policy-documents/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.
Research & Commentary: Amazon Taxes
http://heartland.org/policy-documents/research-commentary-amazon-taxes
Writing for the Heartland Institute Research & Commentary series, Elizabeth Henderson reports on the efforts of many state legislatures to enact legislation forcing out-of-state online and catalog retailers to collect and remit sales taxes on purchases made by residents in the state. Henderson argues these so-called “Amazon taxes” do not “level the playing field,” as proponents argue, but instead punish online retailers and stunt economic growth.
Research & Commentary: Internet Sales Taxes
http://heartland.org/policy-documents/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.”
The Internet, Sales Taxes, and Tax Competition
http://heartland.org/policy-documents/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
http://heartland.org/policy-documents/original-solution-taxation-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
http://heartland.org/policy-documents/congress-should-not-authorize-states-expand-collection-taxes-internet-and-mail-orde
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
http://heartland.org/policy-documents/marketplace-fairness-leveling-playing-field-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 subject, visit Budget & Tax News at http://news.heartland.org/fiscal, The Heartland Institute’s website at http://heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.
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 Logan Elizabeth Pike, Heartland’s government relations manager, 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.
