Internet Sales Tax

25 May

e-commerceOn May 6th, the U.S. Senate passed a bill (the Marketplace Fairness Act) that would empower states to collect sales taxes from Internet sales – a largely tax-free frontier. There is currently no plan to take up the bill in the House of Representatives.

Under current law (upheld by the Supreme Court in 1992), states can only require retailers to collect sales taxes if the store has a physical presence in the state. Let me emphasize this point: a 1992 Supreme Court ruling held that states DO NOT have the power to require out-of-state retailers to collect sales tax, unless the retailer has a physical presence, such as a store, warehouse or distribution facility, in that state. The ruling gave many online retailers a competitive advantage and helped spur rapid growth in internet commerce.

This means big retailers with stores all over the country like Wal-Mart, Best Buy and Target collect sales taxes when they sell goods over the Internet. But online retailers like eBay and Amazon do not have to collect sales taxes, except in states where they have offices or distribution centers.

The bill would empower states to require businesses to collect taxes for products they sell on the Internet, in catalogs and through radio and TV ads. Under the legislation, the sales taxes would be sent to the state where the shopper lives. Some states have sales taxes as high as 7 percent, plus city and county taxes that can push the combined rate even higher. For example, the combined state and local sales tax is 9 percent in Los Angeles, 9.25 percent in Chicago, 8.5 percent in New York City and 5 percent in Richmond, Va., 5 percent. In many states, shoppers are already required to pay unpaid sales tax when they file their state income tax returns. However, states complain that few taxpayers comply.

Businesses with less than $1 million in online sales would be exempt from the proposed legislation. EBay wants to exempt businesses with up to $10 million in sales or fewer than 50 employees.

As with most legislation, the issues quickly become complex – with both sides having valid arguments. But I want to focus on two points that seem to have gotten lost in the debate.

1. Fairness: Supporters of the bill (particularly large brick-and-mortar retailers) want to “level the playing field” among businesses. Who can argue with fairness? When I teach introductory classes on small business, we often discuss the sources of business opportunities. Among these sources are:
• Changes in lifestyle;
• Changes in the economy;
• Changes or improvements in technology;
• Changes in policy, laws or regulations;
• Changes in trends or challenges to existing assumptions; and
• Advances in research.

Should it be the function of government to monitor and regulate all activity that could give business a competitive advantage? With estimated revenue of $469 billion (and estimated profit of $17 billion) in 2013, it is hard for Wal-Mart to argue that they have been disadvantaged by the current regulation.

2. Economic Impact vs. Taxes: The other set of supporters (cash strapped state governments) argue that they “lost” a total of $23 billion last year because they could not collect taxes on out-of-state sales. About half of that was “lost” from Internet sales; half from purchases made through catalogs, mail orders and telephone orders.

In business we say you can never lose sales, since you were never entitled to them in the first place. But more importantly, this narrow mindset (focused on the single issue of sales tax) completely disregards the other components of economic growth that generate revenue and in turn increase the tax base at the federal, state and local level. Internet sales in the U.S. totaled $226 billion in 2012, up nearly 16 percent from the previous year. In addition, Internet business supports manufacturing, sales and distribution services that employ people and contribute to the economy.

These considerations – coupled with allowing states to reach across boundaries to enforce their tax laws, to audit out-of-state business, to impose liens on property and sue in state court; along with imposing burdensome, multi-state tax compliance obligations on small business – make this a questionable piece of legislation.

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