A Terrible Response to the Internet Tax Mess

By :: March 18th, 2014

Ten months ago the Senate overwhelmingly passed legislation aimed at sorting out the mess over online sales taxes, which consumers owe but states rarely collect. Now, House GOP leaders are floating what they call a compromise:  Set national rules for sales tax collection based on the location of the seller, not the buyer.  It is a terrible idea.

It may, in fact, be worse than that. It may really be a classic legislative poison pill: A cynical effort to exempt Internet sales from any tax under the guise of “fairness” and “state sovereignty”  that could not possibly pass Congress. If it somehow became law, it could well be a recipe for the ultimate demise of sales taxes as a source of state revenues. At a House Judiciary Committee hearing last week, Stephen Kranz, a tax partner in the law firm of McDermott, Will & Emery, called the idea “the nuclear bomb version of tax competition.”

stupidtax2That’s certainly dramatic. And apt. Imagine what would happen if online sellers (which account for a growing share of retail sales) could effectively sell tax-free merely by locating in a state such as Oregon that has no sales levy. States with a sales tax would come under enormous pressure to repeal the levy to “save jobs.”

To understand what’s happening here, let’s review the history. More than two decades ago, in a case called Quill v. North Dakota, the U.S. Supreme Court barred states from requiring remote sellers to collect sales taxes unless the retailers had some physical presence (nexus in legalese) in their state.

In that decision, the High Court strongly urged Congress to work with states to establish a uniform set of rules to reduce complexity and avoid potential double-taxation. Congress dodged the request.

But during the Great Recession, cash-strapped states started finding ways around the High Court prohibition. New York State discovered a loophole, began taxing most online sales, was sued by Amazon.com and Overstock.com…and won in state court. Last year, the U.S. Supreme Court refused to hear the case, effectively letting stand New York’s requirement that online sellers collect sales tax. And the High Court once again left it to Congress to sort out the mess.

In a rare bit of bipartisanship, the Senate passed a bill last spring that allows states, under some conditions, to require remote sellers to collect sales taxes. But the House has not acted.

In an effort to avoid looking recalcitrant (heaven forbid), divided House Republicans have been searching for a solution of their own. The idea of an origin-based sales tax was brought to lawmakers by Chris Cox, a former congressman who is now lobbies for trade association called NetChoice that represents Overstock.com and a handful of other Internet firms.

Under the plan, the federal government would let retailers collect tax based on the levy where the seller is located, no matter where the purchaser resides. This would apply to all retailers, as long as they had no physical presence in the consumer’s state.

A firm could base its “home jurisdiction” on the state where it has the most employees, the most physical assets, or the state it designates as its principal place of business for federal tax purposes.

Given the nature of online sellers, changing locations to a no-sales-tax state would be fairly easy. It would almost certainly set off the sort of tax competition that worries Kranz. And at least some states would end up increasing property and income taxes—not an outcome that most House Republicans would likely favor.

But that’s only part of the problem. Such an origin-based tax would create immense complexity for sellers and consumers. It would still leave unanswered the vexing question of when a firm had physical presence (and would collect taxes owed to the buyer’s state) or did not (and would collect taxes levied by the seller’s state).

And, as Krantz notes, it would raise a huge issue of taxation without representation since a buyer would have no say in the tax rate he pays. And, he argues, it would very likely violate the Due Process clause of the Constitution.

In short, this proposal would make our current incoherent system of taxing Internet sales massively worse. Other than that, heckuva job, Brownie….

 

 

 

7Comments

  1. Joel Michael  ::  4:27 pm on March 18th, 2014:

    This proposal is perplexing on several levels. Two obvious ones:

    (1) Congress does not need to take action for states to impose their sales taxes on an origin basis. Since the seller and the sale actually take place within its borders, the state could constitutionally impose its sales tax on all of those sales. There are more than sufficient contacts to give the state authority to do so. Bellas Hess and other sales tax cases require physical presence by the seller; there is ample physical presence and taxing all sales (regardless of where they are shipped to) does not violate some other constitutional no-no, such as discriminating against interstate commerce. There is no need for Congress to act to enable this “compromise” to occur; states can already implement it on their own, if they thought it made sense.

    (2) They do not think so. In fact, as far as I am aware, all states and most local governments have destination based sales taxes – they exempt sales shipped to buyers located out of state. (If the seller has nexus in the destination state, it may be required to collect the destination state’s “use tax” on the transaction, but then the same tax applies that local sellers in that state charge and all is equal.) An origin based tax is essentially an export tax, which potentially disfavors in-state sellers as they compete for customers outside the state. Why would a state shackle its local businesses with an export tax? (Most states have moved to make their corporate taxes “destination” style type taxes by going to single sales apportionment – even though that is contrary to the economic theory underlying the corporate tax – for precisely that reason.) The result could be movement toward the sorts of decisions Howard points out in his post.

    Perhaps, the idea is to require states to have origin based sales taxes? That seems unlikely; it would create large revenue losses for some states, as well as having the effects Howard outlines.

  2. Michael Bindner  ::  4:30 am on March 19th, 2014:

    There are two ways this might work. One is if it authorized detailed regulations used to determine which state the seller actually resides in. For small e-Bay sellers, it is pretty obvious. Amazon could claim some other state then Tennessee, but the Tax Court would likely not let them do so with a straight face. As to a seller based tax, that is essentially a Value Added Tax. Indeed, if they wanted to check out how a VAT works, this is the way to do it. Of course, if we were very loud and clear that this is a precursor to a National VAT, I suspect the conservative think take world would howl “NO WAY! and force the House to take the Senate deal or obstruct the whole thing – which is the likely outcome.

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  5. Joel  ::  4:52 pm on March 19th, 2014:

    Talk about hyperbole!

    There is already competition between tax jurisdictions. Following your rationale, all businesses should exist in the borders of Alaska, Delaware, Montana, New Hampshire and Oregon. They don’t. Why?

    Advocates for the demonstrably complex Marketplace Fairness Act want a level playing field for all businesses. An origin based system specifically answers that question. A brick and mortar store does not interrogate customers walking through the door about where they live. Tourists visiting a small retailer in NYC pay the local tax. Why should the same business in New York who also operates a remote storefront operate any differently?

    And so many empty assumptions…

    How does the “nature of online sellers” make changing their nexus easy? You suggest some proposed tests for determining nexus, including number of employees or most physical assets. These are hardly trivial things to move.

    Where is this consumer harm you casually drop as if it is a given? Is a tourist visiting San Francisco who purchases a model of the Golden Gate Bridge and pays local sales tax to a storefront entrepreneur harmed or disenfranchised?

    And from a remote seller’s point of view, what is a more complex system? The one offered by Rep. Cox or the Senate passed Marketplace Fairness Act?

    It’s hard to tell if you’re being purposefully misleading or are just new to the subject.

  6. Andrew Moylan  ::  10:11 am on March 20th, 2014:

    I was also a witness at the Judiciary hearing, where I advocated for the origin sourcing regime that Howard Gleckman derides here. If he had bothered to reach out to me, I’d have been happy to disabuse him of several mistaken notions he repeats here.

    First, I’m not sure it’s accurate to say that House GOP leaders are floating origin sourcing. To my knowledge, no one has introduced a bill to that effect and a hearing to discuss it as a potential solution, along with several other proposals, doesn’t constitute support (though I wish it did).

    Second, this idea that it’s a poison pill designed to eliminate sales taxes in the United States is just laughable to me. The tax competition that apparently terrifies both Gleckman and Stephen Kranz, whom he quotes, already exists under current law. Unless I’ve missed it, there hasn’t yet been a stampede to locate in Montana simply to avoid sales tax collection.

    Amazon could locate all of its operations in non-sales tax states today and thus relieve itself of the legal obligation to collect sales tax for any sale, but instead they’re building distribution centers all across the country. They’ve made a calculation that faster shipping is worth the headache of having to collect in more states. And besides, few businesses make location decisions on sales tax alone. They’d also take into account income and property levies, workforce quality, access to transportation, etc.

    The notion that an origin-based solution would “create immense complexity for sellers and consumers” is simply false. As Scott Peterson, former executive director of the Streamlined Sales Tax Governing Board, said at an event where the two of us spoke, an origin sourcing system would be “radically simpler” than anything like the Marketplace Fairness Act or other destination-based proposals.

    Scott has since left SST to work for one of the software companies looking to profit from the MFA (go figure), but he understood the simplicity of an origin system. Under such a plan, the ONLY vexing question facing retailers would be determining the origin of a good. If the rules are properly constructed, in most cases it will be easy and where it’s not, we have procedures to work through disputes.

    Alternatively, under a destination sourcing system retailers have to deal with the physical presence question AND the rates of nearly 10,000 taxing jurisdictions across the country while subjecting themselves to audit and enforcement actions from every other non-sales tax state. Apparently that complexity doesn’t concern Mr. Gleckman.

    Finally, it does not raise any “taxation without representation” issues as Kranz claims. Because the business bears all legal responsibility to comply with sales tax rules, it is the representation of the business that is the relevant metric and an origin sourcing system ensures that a business collects for and deals with revenue officials in its own state, where it has recourse to address disputes. This easily meets a due process test, and in fact it should be noted that former Solicitor General Paul Clement has said that it’s the Marketplace Fairness Act, not an origin system, that would violate the due process clause.

    I’d encourage a review of my testimony, where I address all of these issues in greater detail: http://www.rstreet.org/wp-content/uploads/2014/03/Andrew-Moylan-Internet-Sales-Tax-Testimony-3-12-14.pdf

    Other than that, heckuvan article, Mr. Gleckman.

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