Why the Internet Sales Tax is a Bad Idea

The internet sales tax bill currently being considered by Congress is fundamentally flawed

(Photo credit: echobase_2000)

Last week, the US Senate passed the Marketplace Fairness Act, otherwise known as the Internet Sales Tax. While the odds are against its passage in the House, it does have some bipartisan support. Opinions are wildly divergent on the bill, but I for one think the internet sales tax is a bad idea and a bad law.

The Marketplace Fairness Act would require online retailers to collect sales taxes for the buyers state. Sellers with under one million dollars in sales would be exempt. In exchange for receiving extra sales tax revenue, states would have to streamline their sales taxes according to the Streamlined Sales and Use Tax Agreement (SSUTA).

Previous Supreme Court decisions weigh against the internet sales tax

Legal precedent weighs against this bill. 55 years of case-law, including a Supreme Court decision in 1967 and again in 1992, show that while a state can require sales tax to be paid from all purchases, catalog and online sellers who are not physically present in the state are not required to collect those sales taxes.

While passing laws to contradict Supreme Court rulings is part of the checks-and-balances of the US governmental system, this law is a sudden about-face from a 1998 attempt to ban states from taxing the internet. The Internet Tax Freedom Act has been continually extended since it’s passage and is currently in effect until 2014.

Streamlined Sales taxes hurt development in economically depressed areas

One reason that the Supreme Court had previously ruled against an internet sales tax was the added complexity of accounting for all of the varied sales tax laws across the 45 states that collect sales tax. Not only does each state have a different base rate, but many states have different rates for different parts of the state. Plus, different items can be exempt from tax (commonly unprepared food items), or have a different sales tax rate. Examples of different rates for different items include hotel taxes, tire taxes, telecommunications taxes, and the sale of marijuana in Colorado. Finally, some states will occasionally hold sales tax holidays to spur spending.

None of that qualifies as very streamlined. According SSUTA, states must use a single tax rate across all jurisdictions, items, and days of the year. This means that areas that have traditionally gotten preferential tax treatment from their states would lose it. No longer could a state try to promote growth in its inner cities by creating “Enterprise Zones” with a lower tax rate.

Local sales taxes are ignored by the internet sales tax bill

The Marketplace Fairness Act specifically bans local governments from collecting internet sales tax (Section 2 (b)(1)(A) Paragraph 2). The SSUTA also requires that all sales tax collection for a state be done by a single state entity. Since SSUTA also requires that sales tax rates be uniform, there is no way that a state could actually allow municipalities and counties to charge sales and use taxes.

If the reasoning is that is unfair that states should be loosing out on sales tax revenue from consumers purchasing online from out-of-state companies, why should it be any less unfair for local municipalities to barred from collecting sales taxes just so the states can collect more?

Of course, including local jurisdictions would be a nightmare of compliance. Online sellers would be required to have a database of every sales tax jurisdiction, and all of the addresses that fall into it. I have previously mentioned how I am saving on utilities by being 100 feet from the city line. My in-laws are roughly the same distance from the line on the other side. Yet the city, state, and zip code of our addresses are identical. Nothing short of a database with millions of entries would work. And then retailers would have to worry about city lines expanding!

Taxing buyer’s location is backwards

Think for a moment how sales tax works in the world of off-line commerce. You travel to a store and make a purchase. The location of the store determines the sales tax rate. In NJ, it is 6%, but in Colorado it is 2.9%. If you walk into a store in Delaware, New Hampshire, Montana, Oregon, or Alaska, you won’t pay any sales tax.

The Wal-Mart nearest to me is inside the city limits of Fort Collins and charges Colorado state, Larimer County and Fort Collins city sales taxes. The one closest to where I work is just outside the city limits. So it only collects state and county sales taxes. By shopping at that Wal-Mart instead, I save 3.85%

What all this shows is that by picking where you shop, you have some control over the amount your are taxed. Because the seller’s location is used to determine the sales tax rate, not the buyers.

The Marketplace Fairness Act would flip that model for internet sales tax. Instead, the buyer’s location is taxed instead of the seller’s. This could lead to foreign companies having to collect sales taxes on sales within the United States, creating additional barriers to international commerce.

Where do you stand on the internet sales tax bill? Do you think the issues I brought up are serious problems or unimportant?

 

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21 thoughts on “Why the Internet Sales Tax is a Bad Idea

    • I’ve seen a few articles in favor of the bill, but overall, the brunt of public opinion seems to be against it. It is kind of funny that public opinion doesn’t seem to be an important factor by those elected by the public. I’ve reached out to my Representative and even sent him this link. How he votes on the issue will have a direct impact on how I vote on him next year (I’m talking about you, Jared Polis!)

  1. I’m not a big supporter of it, but at the same time I haven’t read up on it. Your article (thanks for the indepth research) is about all I know. I definitely don’t agree when it limits international business.

    I do wonder though if some states are in support of it because they’re losing out on revenue by receiving nothing when the buyer chooses to buy online/out of state?
    John @ All Things Finance recently posted..How To Make Your Money Grow Part 1: Educate YourselfMy Profile

    • That’s an issue states have faced for a long time, especially ones that border a no-sales tax state. I read once that Massachusetts loses millions of dollars per year in sales tax revenues from people who live near the New Hampshire border and shop there instead.

  2. I don’t think the tax is a terrible idea. It’s just another situation of how the internet has completely changed the game. Living in a state that charges a sales tax, it’s not fair to the local B&M retailers that I can order a product online and save x% because I don’t have to pay the tax I would buying it from their store.

    I get the point about using the stores location vs the buyers. But I think if you’re going to tax online transactions, taxing the purchase wherever the buyer is the only way to do it. If I’m in my living room in NY state, the purchase is technically being made in NY. Therefore the applicable tax should be applied regardless of where the online retailer is located.

    • I don’t think that there is anything wrong with extending sales tax to online purchases, just not how it is done here.

      While the purchase is being done in your living room, it is also being done wherever the server is located and wherever the business is located. Basing it off of the business’ location would allow you to shop for a better sales tax rate, just like you can do off-line by shopping in another state, or outside the limits of a city with it’s own sales tax.

    • While no-one likes taxes, I understand their purpose and their need. Which is why I find this bill so upsetting. It allows SOME tax jurisdictions to get paid while simultaneously blocking others from doing so as well. What’s good for the goose is good for the gander, isn’t it?

  3. This sales tax issue can be done easily if one company creates a tax database that is integrated into ecommerce software. It can be created with ease and updated with ease. This would make things much easier for smaller sellers. The biggest complaint that many use is that it is a new tax, which is blatantly false. This is not a new tax as most states require you to pay a USE tax on purchases made outside of the state. Most people do not pay this or have no idea that it exists, so they think it is a new tax. It is not. If this passes, then some streamlining will need to be done, but it won’t put people out of business. This will create a new market for software developers to create a manageable system.
    Grayson @ Debt RoundUp recently posted..Why I Shut Down My Profitable Online BusinessMy Profile

    • I agree that a software solution would be the only way to reasonably go. I’m just concerned about the size of the database required. There has to be at close at least 100 million addresses in the US. Any coarser level of detail is going to get local taxes wrong. And any tax law that protects some tax districts over others is untenable to me.

  4. I think the tax was just a matter of time and makes me glad I don’t sell anything online. I do get the point about choosing where to shop for the lesser tax. I seem to remember living in Memphis but driving over the bridge to Arkansas because the sales tax was less if I needed to buy lots of stuff. It does take that option away if it only matters where you live.

    If the tax revenue was used for worthwhile projects like improving roads or hiring more police officers, I have no problem. The worthwhile use tends to get murky most of the time, though.
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  5. I guess the law is good if not I really wouldn’t expect to pay sales tax on anything. If course I don’t have a million in sales so I guess I am not really worried about it. Besides at that point you should be a big company if you are doing a million in sales and paying taxes is a part of doing business.
    Thomas @ Debt Repayments recently posted..Are You in Need of Debt ConsolidationMy Profile

    • While a million in sales is substantial online, it’s not really that large a number for most businesses. Many farmers sell over a million a year and wind up with a salary under $50k.

  6. Personally, as a consumer I obviously aren’t too fond of it. But then again, the government needs its tentacles around every money making machine out there!

  7. Oh man I hope this doesn’t pass. What a logistical mess and more pages to add to the already freakin’ ginormous tax code. We really need to simplify the tax code in our country. I think the less complex the rules, the fewer errors and more compliance there will be.

    • Actually, I think any attempt at simplifying the tax code would backfire. This law actually does try to streamline things, but it does so at the expense of cities.

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