Internet Taxes

The following updates a column published in the Utah Statesman on September 14, 2011:

Proposals to allow the collection of taxes from consumers making purchases online are like vampires or zombies. They apparently cannot be killed unless stakes are driven through their hearts or their heads are blown off. I don’t know how to get rid of “Jason” either, except by refusing to buy tickets to the movies in which he appears.

As many state governments struggle to balance their budgets, it should come as no surprise that politicians are looking for new sources of revenue. Proposals to require state governments to collect sales taxes from consumers making purchases online again are back in play because, it is said, public treasuries are being starved of needed cash, and local “brick-and-mortar” retailers are being injured as more and more commerce shifts to a now-tax-free Internet.

A 24-state coalition, 16 of which already have enacted such legislation unilaterally, recently renewed demands that all online retailers be forced to collect sales taxes on behalf of the 45 states where buyers would owe them if purchases were made locally. That policy goal, which has brought a gleam to many a governor’s and treasurer’s eye since at least 1999, will be achieved if legislation introduced by Sens. Dick Durbin (D-IL) and John Conyers (D-MI)—the so-called Main Street Fairness Act—is passed and signed into law.

Sounds reasonable, doesn’t it? After all, the buyer of a book, a CD, a DVD or almost any other good will owe sales tax to his or her state of residence on every dollar spent at a local merchant. Why should anyone avoid paying the same tax by ordering from, or downloading music or movies from iTunes or Netflix?

The answer is found in Section 8 of Article II of the U.S. Constitution, delegating to Congress powers for regulating “Commerce among the several States.” Some scholars see acceptance of the Commerce Clause in Philadelphia as decisive in establishing our republican form of government. Promoting the economic prosperity of the nation as a whole by stopping individual states from taxing or otherwise interfering with the free flow of internal trade emerged as a point of agreement in Philadelphia, around which compromises on other constitutional provisions became possible.

Following the Constitution’s plain language, the Supreme Court ruled in 1992 (Quill Corp. v. North Dakota, 504 U.S 298) that sales taxes cannot be collected on mail-order purchases from an out-of-state retailer unless the seller had a “physical presence” in the customer’s home state. The door was left open for requiring buyers voluntarily to report and pay equivalent “use” taxes on items purchased elsewhere, but for obvious reasons that duty has not been enforced.

But with billions of dollars in tax revenue up for grabs—it is estimated that consumers will spend $11.8 billion online next year—the debate is reheating. Supporters of legislation aimed at overturning Quill contend that closing the online tax “loophole” is not the same thing as levying a new tax but simply “levels the retail playing field.”

Opponents of such taxation emphasize that electronic commerce does in fact generate substantial revenue for state governments from a variety of sources, including gasoline, business and personal income taxes owed by UPS, FedEx and other private companies that deliver customers’ orders.

Overlooked by virtually everyone voicing opinions on “e-taxes,” are the substantial benefits to taxpayers of America’s federal system of government. As in ordinary markets, competition between the 45 states that now levy a sales tax helps keep those rates in check. If one state imposes a sales tax higher than justified by the quantity and quality of public services those taxes help finance, its tax base will shrink as businesses and households relocate to states where taxes are lower, public goods and services are of higher quality, and government generally is more responsive to citizens’ preferences. (Governor Brown, call your office!)

Moving is costly, though. Consistent with the conclusions of a much-cited 1956 article published by Charles Tiebout, avoiding high state sales taxes by making purchases online or through mail-order catalogs supplies another margin on which inter-jurisdictional competition forces governments to be more fiscally responsible.

A tax-free Internet does place local retailers at a competitive disadvantage. “E-tailers” are handicapped, too, if they charge for shipping and handling; online customers also must wait for delivery and are less prone to buy on impulse. Local retailers can respond to the online competitive threat by providing point-of-sale services valued by customers (and for which they are willing to pay), such as friendly service or the chance to “touch and feel” products prior to purchase.

Because sales taxes are highly regressive, placing their heaviest burden on low-income consumers, lobbying state legislatures for lower tax rates is another way for “physical” retailers to do well by doing good. Sellers located beyond a state’s borders have less effective political influence.
The Commerce Clause has been a dead letter since Wickard v. Filburn, when the U.S. Supreme Court ruled that a farmer’s production and own-consumption of wheat reduced the amount of agricultural output to all and, hence, “affected” interstate commerce.

The Main Street Fairness Act is not just about Mom-and-Pop. Wal-Mart and other national chains operating brick-and-mortar retail outlets in many different states, also stand to gain because their virtual competitors would lose a pricing edge by having to collect sales taxes, too. Wal-Mart and state governments may consider that outcome to be “fair,” but everyone whose sales tax bills go up surely will not.

The United States has 30,000 separate sales tax jurisdictions; the proposed law, at least for now, applies only to state sales taxes and not to those levied by local government entities or special tax districts. But be careful about what politicians wish for!

Internet commerce may be the Commerce Clause’s last gasp. If so, we might as well cede all powers to Washington and obey the edicts of a totalitarian central authority.

William F. Shughart II is Research Fellow and Senior Fellow at the Independent Institute, the J. Fish Smith Professor in Public Choice at Utah State University, past President of the Southern Economic Association, and editor of the Independent book, Taxing Choice: The Predatory Politics of Fiscal Discrimination.
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