Taxing Internet Sales

A consortium of states has been working since 2000 to design an agreement to levy sales tax on purchasers of goods bought via the Internet. The Supreme Court declared that it was unconstitutional for states to require sellers not in their states to remit sales taxes on their sales. The Streamlined Sales Tax (SST) project is an attempt to overcome this by having states join together and agree to require sellers in their states to remit sales taxes to the purchaser’s home state. Currently, if a buyer in California purchases something over the Internet from a seller in New York, the seller has no obligation to collect and remit sales tax to California. That would change if the SST were approved by those two states. New York law would then require the seller to collect and remit sales tax to California.

The sales tax has never worked this way. In practice, sales tax is almost always paid to the government in the seller’s jurisdiction, not the buyer’s. If someone from California actually goes to New York and buys something, the Californian pays New York sales tax, not California sales tax. So, why do states seem intent on making that transaction subject to California sales tax if it is made over the Internet, whereas it would be subject to New York sales tax if it was made in person?

The political interests behind the SST are heavily skewed toward businesses that engage in retail sales through “brick and mortar” stores. Their claim is that they are put at a competitive disadvantage because they have to charge sales tax on their sales while their Internet competitors do not. The SST would level the playing field by making all sales subject to the same tax.

An economic argument on the other side is that the government costs related to the sale occur mostly in the seller’s jurisdiction. They need the roads and infrastructure to get customers to their businesses and provide police protection, garbage pickup, and so forth. Their employees send their children to the local schools and enjoy the local parks. So, as with in-person sales, the tax revenue should be remitted to the seller’s jurisdiction, not the buyer’s.

In addition, opponents of the SST argue that it would impose unreasonable costs on small businesses, who would have to first figure out whether what they are selling is taxable in the buyer’s jurisdiction and then figure out the tax rate, which varies not only from state to state but from locality to locality. Such a tax would make Internet sales prohibitively costly for many businesses.

The economic argument is nearly irrelevant, though, because tax laws are determined through the political process. Retailers like the idea of taxing Internet sales because it would impose costs on their out-of-state rivals. The argument, if true, that it would be prohibitively costly to collect the tax, would be a benefit to the retailers who are promoting the idea. If you ask them, “Wouldn’t this impose huge costs on small businesses that engage in some Internet sales?” they will answer no. But if the answer was yes, the brick-and-mortar retailers would like the Internet sales tax even more!

Would the SST impose huge costs on Internet sellers? Proponents claim states would distribute free software to make calculating and remitting taxes easy, but this website says that there are existing firms who offer to do the sales tax calculations and add the tax to an on-line shopping cart for a fee. The fee they quoted was $1.56 a transaction, with some companies also asking for an up-front payment of more than $7,000 to set the system up. This appears to be an argument against the SST, but if the figures are correct, this makes it even more attractive to retailers who want to raise competitors’ costs.

Retailers argue against collecting sales taxes in the seller’s jurisdiction because that law could be passed by an individual state. If California passed such a law, Internet sellers in California would pay taxes on their sales, but sellers in states that didn’t pass such a law could sell to Californians tax-free. Laws that would place the sales tax in the seller’s jurisdiction would hurt retailers; laws that would place the tax in the buyer’s jurisdiction would help them.

There are strong economic arguments against the SST, and from an economic standpoint it makes more sense to charge sales taxes in the seller’s jurisdiction rather than in the buyer’s. But tax laws are determined by political interests, not economic analysis, and the retail lobby that is pushing for the SST is doing so because it will raise the costs of their out-of-state rivals, not because it makes economic sense.

Randall G. Holcombe is a Senior Fellow at the Independent Institute, the DeVoe Moore Professor of Economics at Florida State University, and author of the Independent Institute book Liberty in Peril: Democracy and Power in American History.
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