Research & Commentary: Online Taxes, Legislative Update

Published April 18, 2013

Early this week Senate Majority Leader Harry Reid began the process of pushing to the Senate floor a major online tax bill originally titled the Marketplace Fairness Act, bypassing the committee process. The proposal would expand states’ ability to force out-of-state retailers to collect sales taxes for online and mail-order sales even if the seller has no physical presence in the state.

This would give states a vast new power over retailers outside their borders, including the imposition of auditing requirements. States would be allowed to create their own unique definitions of how and when items are taxed, increasing confusion for out-of-state sellers.

Proponents argue the proposal confirms the ability of states to charge sales taxes as they see fit, and they have begun to frame the issue as a matter of state’s rights. Allowing one state to tax a resident of another state, however, represents an expansion of state taxing powers, which logically end at the state’s borders. This expansion of powers would undermine tax competition by limiting the ability of taxpayers to move between states and their tax systems. Tax competition among states has been one of the key factors in keeping taxes low.

Removing the physical presence standard for sales taxes also reduces states’ accountability to taxpayers. Consumers, who ultimately bear the burden of added costs, are the real losers in this scenario. The “nexus” standard is an important taxpayer protection that has been upheld in the U.S. Supreme Court. This standard protects citizens from an abuse that Americans have fought against since our nation’s inception: taxation without representation.

It is not justifiable to allow a state to charge sales taxes to residents of another state, as the latter have no political voice in the taxing state and receive no government benefits or services. Instead of forcing out-of-state businesses to serve as government tax collectors, Congress and 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 Internet sales taxes and the proposed expansion of state taxing powers.

Conservative Groups Oppose So-called “Marketplace Fairness Act”
Andrew Moylan of the R Street Institute collects the work of multiple conservative groups outlining their opposition to the online sales tax changes under the Marketplace Fairness Act. 

The Mirage of False Federalism in the Marketplace Fairness Act
Bartlett Cleland of the Institute for Policy Innovation examines the importance of the physical presence standard and argues against states having the right to tax out-of-state residents, citing the right of states to protect their citizens from other state governments. Cleland argues that if the latter right is denied, the United States should be prepared to watch foreign governments begin to loot U.S citizens, because U.S. politicians will have no principled grounds to stop them. When foreign governments begin taxing U.S. citizens, he writes, they will see the folly of their ways. 

Enzi’s ‘Marketplace Fairness Act’ a Trojan Horse
Bruce Edward Walker of the Wyoming Liberty Group argues the Marketplace Fairness Act is a Trojan horse of bad policy changes that could have numerous negative effects on all businesses: The MFA is one such ploy wheeled in by politicos with the illusion of ‘fairness’ when it’s nothing more than a bill seeking enhanced revenues for the government trough. It may appeal to brick-and-mortar special interests seeking government enforcement to guarantee competitiveness against technological innovations, but it would succeed only in hurting Internet retailers and their customers.”

Lawmakers to Renew Push for Online Sales Tax
Brendan Sasso of The Hill discusses the efforts by a bipartisan group of senators to renew a push for online sales tax legislation, the Marketplace Fairness Act. 

Conservatives Should Run, Not Walk, Away from So-Called ‘Marketplace Fairness Act’
Andrew Moylan of the R Street Institute argues the Marketplace Fairness Act “ends up giving a federal blessing to a massive expansion in state tax collection authority, the dismantling of a vital taxpayer protection upon which virtually all tax systems are based (the notion that physical presence is the appropriate limit for state tax authority), all while harming a sector (online sales) that still only accounts for roughly $0.07 of every $1 in retail spending.” 

Policy Tip Sheet: Myth vs. Fact—Internet Taxes
In this Heartland Policy Tip Sheet, Heartland’s government relations director, John Nothdurft, examines several myths and facts about Internet taxes. 

Research & Commentary: Internet Sales Taxes
The Heartland Institute explains how taxing the Internet hurts businesses 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
Veronique de Rugy and Adam Thierer discuss the Main Street Fairness Act in this study from the Mercatus Center. The legislation would force retailers to collect sales tax for states that join 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
In this article from the American Legislative Exchange Council, Andrew Moylan discusses the origin-based sourcing rule for Internet sales taxes and argues 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,” he writes. 

Marketplace Fairness: Leveling the Playing Field for Small Business
In written testimony before the Senate Commerce, Science, and Transportation Committee, Kelly Cobb of Americans for Tax Reform discusses the issue of remote-state sales tax collection and physical presence in response to the proposed Marketplace Fairness Act. “The effects on taxpayers of the Marketplace Fairness Act and similar legislation would be dramatic,” Cobb states. “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.” 

Congress Should Not Authorize States to Expand Collection of Taxes on Internet and Mail Order Sales
David S. Addington of The Heritage Foundation considers efforts by Congress to override the Supreme Court’s Quill decision through the Marketplace Fairness Act. Addington argues the bill 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
Michael S. Greve of the American Enterprise Institute notes an overlooked element of the Internet sales tax debate, the often-unenforced use tax. Currently, if a product is purchased from a “remote” seller that has 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.

The Marketplace Fairness Act Would Create a State Sales Tax Cartel and Hurt Consumers
Jessica Melugin argues against the Marketplace Fairness Act and in favor of an origin-based tax approach. “If Congress is to consider Internet sales tax policy as part of broader tax reform efforts, an origin-based approach would address the legitimate need for sales tax reform and avoid the Marketplace Fairness Act’s harmful consequences,” she writes.

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 Heartlander’s Tech News Web site at, The Heartland Institute’s Web site at, and PolicyBot, Heartland’s free online research database, at

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or [email protected].