Internet taxation without representation

Senator Jim DeMint is strongly opposed to the Marketplace Fairness Act, which is the bill that would allow states to begin taxing Internet sales.  On Monday, DeMint???s blog published a comprehensive indictment of the MFA, assembling documentation from numerous sources to score some critical points against the new legislation.

Before considering these criticisms of the MFA, it???s worth recalling the two strongest arguments made in favor of the legislation: ???brick and mortar??? retailers consider the tax-free status of most Internet sales to be an unfair advantage, and state governments are ravenously hungry for new tax revenue.

Not surprisingly, the latter motive is not discussed as eagerly as the former.  It should be fairly obvious that taxing Internet sales would represent a substantial tax increase upon American consumers ??? about $125 in new taxes for the average consumer, according to a Forrester Research report cited by Senator DeMint???s staff.  This is most certainly not an economy that can absorb the burden of another new tax.

An intriguing point raised against the MFA is that it is, quite literally, taxation without representation.  The collection of state taxes currently requires a physical ???nexus??? within the taxing state.  In other words, a retail store located in Illinois is collecting sales tax under Illinois rules, and remitting the tax to the state of Illinois.  The store directly enjoys whatever benefits the government of Illinois provides (let us save the discussion of just how enjoyable those benefits are for another day.)  The employees of the store are Illinois voters.

But when Internet sales are taxed, companies will suddenly find themselves collecting taxes for states where they have no physical or political presence ??? states where they cast no votes, and whose governments provide the company with no benefits.

This is not a minor objection ??? it???s a foundational principle of American government, and was the subject of a rather spirited dispute between our nation???s founders and the British crown.  It???s also not a trivial objection, because once the link between state taxation and representation has been formally severed for the purpose of taxing Internet sales, it will become a less significant barrier for other forms of taxation as well.  It would be hopelessly naïve to believe this would be the first new power asserted by government that was never subsequently expanded, or abused.

We???ve grown so accustomed to the federal government abusing its power to regulate interstate commerce, as an excuse for virtually anything Washington wants to do, that we have forgotten the original rationale for reserving that power to the federal government.  Just because the Internet has made interstate commerce exceptionally swift and convenient, its place within the structure of our Constitutional order has not been changed.

Another curious facet of the MFA is that it carves out a sizable exception for smaller companies, specifically those which have less than $500,000 per year in gross receipts in online sales.  That rather defeats the ???fairness??? argument ??? why should a traditional retailer with $500,000 in annual sales pay tax, while the online retailer with comparable sales does not?  It???s also a tacit admission that the Internet sales tax reporting requirements would be ridiculously complicated.  One reason online giant has been playing ball with state tax authorities recently is that they???re big enough to handle tax remission to fifty different states, with fifty different sets of tax law, but they know full well that some of their smaller competitors don???t have the resources to deal with such a regulatory burden.  (This is why the largest corporations will sometimes embrace taxes and rules that would, on the surface, appear to hurt them.  The pain is quite bearable if the big company knows its competitors will be hurt more.)

Also, the situation really should be even more complex than asking online retailers to grapple with 50 different sets of state tax law, because the MFA steamrolls all the county and city tax rules that brick-and-mortar retailers must comply with.  That???s not really ???fair,??? and there???s every reason to suppose it wouldn???t last forever.  How long would it take, after passage of the MFA, before there was a push to make online retailers begin dealing with thousands of different municipalities, instead of just fifty states?  Depending on how certain parts of the Marketplace Fairness Act are interpreted, the answer might be ???immediately??? ??? and that would simply obliterate many of the smaller businesses subjected to the new regulations.

Some of those state and local tax laws are incredibly complex.  The nature of the goods being sold, and even the time of year in which the sale takes place, can be factors in computing tax rates.  My own state of Florida just had a weekend-long tax holiday for the sale of school supplies.  How in the world would an online retailer be able to keep track of such things for all of the states at the same time?  And how much information would they be obliged to collect from their customers, to ensure that every little nook and cranny of every municipal law was satisfied?  Can you imagine what the sales tax audit for a million-dollar online company that paid tax to all 50 states would be like?  That???s the kind of menace that scares companies out of business, as they conclude the regulatory burden and risk of penalties is simply too great.

One other danger of Internet sales taxes is that they could result in the same transaction being taxed more than once.  This actually happens all the time under our hyper-complicated, prosperity-suppressing tax code ??? some of the dollars grabbed by estate taxes have already been taxed four or five times.  But it???s usually not so blatant, and it usually doesn???t happen in real time.  Under the MFA, it could be possible for an interstate online transaction to be taxed by both the state where the seller is located, and the state where the buyer resides.

We would likely see a number of ???unintended consequences??? from Internet taxation.  An obvious one is that the MFA provides a strong ??? in fact, nearly irresistible ??? incentive for companies to keep online sales below the $500,000 annual threshold.  There are various ways this could be done, and consumers wouldn???t like any of them.

Smaller companies might also respond by simply refusing to do business in states with complex tax codes, particularly after a few grim audits have been digested as warnings.  Certain local governments might trigger such a situation deliberately, at the urging of local businesses eager to do away with online competition.

And, of course, a guaranteed stream of revenue from online retailers who have no direct involvement in state or local politics would only make the spendthrift habits of some governments worse.  There would be no way for online companies to ???vote with their feet??? and move away from business-hostile environments.

The most commonly discussed alternative to the MFA vision of Internet taxation is an ???origin-based system,??? in which companies would pay sales tax based on the headquarters location of the Internet corporation, regardless of where the customer lives.  It is sometimes feared that such a system would trigger a massive exodus of online companies to states with low, friendly tax rates.  Good.  That???s the kind of ???unintended consequence??? we could use more of.