Internet Taxation Trends and Options

February 11, 2012

These remarks were presented at the 2012 Conservative Political Action Conference in Washington, D.C., on February 11, 2012.

Who knows what these states have in common? Alaska, Delaware, Montana, New Hampshire, and Oregon.

Correct! Those are the states that do not have a sales tax.

Citizens of these states have decided to do without one of the major tax sources. They have achieved it in different ways. New Hampshire, for example, does it with a reduced size and scope of government. Oregon does it with higher taxes on other things, like income.

But that’s the beauty of federalism and the 50 states. Different states can have different mixes of taxes, services, and opportunities, and compete for all of us. And we can choose what works best for us as individuals.

Now there’s one group that hates that there are states with no sales tax. And that’s states WITH a sales tax. What I consider competition, they call tax cheating. So every state with a sales tax has adopted a “use tax” – a tax on any item purchased tax-free.

So take me. I live in Virginia. If I travel up to Delaware and buy some shoes tax-free, and bring them back to Virginia, under Virginia law I owe Virginia a 5% tax on those shoes. So Virginia asserts that it can tax a transaction between me in Delaware and a Delaware retailer. That’s the use tax, and every state with a sales tax has one, and the Supreme Court upheld them as constitutional 7-2.

Now almost no one pays their use tax. States don’t bother to try to collect it because they know you would have a few words if they tried, and because it’s hard to do so.

Now there is one limitation on the states. They can’t force the collection of use tax from someone who is not physically present in the state. So a retailer with all its property and employees outside the state is beyond the state’s jurisdiction, and can’t be forced to collect tax for the state. This is what’s known as the physical presence rule, or the Quill rule, after the latest of a long line of constitutional cases that limited state tax powers.

Why does the Constitution allow the Congress and the Supreme Court to prevent states from extending their taxing powers beyond their borders?

Well, one reason is because it’d be a mess. State sales taxes are a mess. We have nearly 10,000 different sales taxes in the U.S., growing a couple hundred a year. I work for a tax research organization, and we have trouble keeping up, and we’re not trying to run our small business.

Also, each taxes different things differently. Here in DC, bottled fruit juice at CVS is tax free, a bottle of soda at CVS is 6%, a glass of fruit juice or soda in a restaurant is taxed at 10%. In Minnesota, fur clothing is taxed differently than regular clothing, while in New York, clothing is taxed only if it’s over $55. That changes to $110 in April. 16 states have sales tax holidays, temporary tax reductions for some items. These change every year. And so on.

In the period of the Articles of Confederation, the Founding Fathers saw states tax whatever they want, wherever they want, and saw it harm interstate commerce and damage the national economy. So they included in the Constitution protections to make sure it didn’t happen.

If the states got their way (and some are trying, with so called “Amazon” taxes that go far beyond just Amazon purchases) we face new questions. Who gets to tax an online sale? Where the customer is located? Where the seller is located? Where the Internet server is located? Where the truck passes through? Where the warehouse is? All of them? Some of them?

Now, I have a lot of sympathy for brick-and-mortar retailers. They say that they’re selling the exact same product to you and me as an online company, and you and I pay the sales tax when we buy it from them but not when we buy it from an online company. And they’re right that there’s no economic reason why one should be taxed and the other is tax-free.

So if we are going to change the system, we ought to make sure that it’s something simple, understandable, and fair across the board. Whatever burdens the tax system puts on online businesses should be borne by brick-and-mortar. And states shouldn’t be allowed to collect until they accept basic rules about what gets taxed and where. I’d love to hear your thoughts and ideas and reaction. The bill before Congress now achieves this better than previous bills.

We also have handouts: testimony I presented to Congress on this issue, a USA Today front-page story from last week on the topic, and a postcard of sales tax rates. You can also keep up with the issue at TaxFoundation.org.

Thank you.


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