Taxing Internet Purchases

States have been trying to collect sales tax on internet purchases for decades—since the beginning of internet commerce. The holdup has been a 1992 Supreme Court ruling that states cannot require businesses in other states to collect taxes for them. Now, legislation is moving through the U.S. Senate to facilitate internet sellers to collect sales tax and remit it to the purchaser’s state.

The issue is based on a difference in the way the law depicts retail sales taxes and the way they are actually collected and paid. State laws say the tax is paid by the buyer, and the seller acts as an agent for the state, collecting and remitting the taxes paid by purchasers. The problem, as the Supreme Court sees it, is that sales taxes are extremely complex, partly because what is taxable varies from state to state, and partly because local sales taxes create different rates even within states. This, the Court says, places an unreasonable burden on sellers to calculate and remit sales taxes across state lines.

In fact (with few exceptions) the sales tax does not work this way. The sales tax is (almost) always paid in the seller’s jurisdiction, not the purchaser’s, and is paid at the rate charged in the seller’s jurisdiction.

If I travel from my home state of Florida to California and buy something in a California store, I pay California sales tax and the seller does not remit any tax to Florida. If you take a vacation to Disney World in Florida and buy some souvenirs, you pay Florida sales tax, and no tax is remitted to your home state.

If sales tax law reflected the way the tax works in practice, states would tax sales in the seller’s jurisdiction, every seller would pay one rate, and the revenue would go to the state in which the seller operates. Then, no Act of Congress would be necessary for states to collect sales taxes. States could just require that sellers pay sales tax on all sales, no matter where the buyer lives.

As the bill is currently constructed, states would be allowed to join a multi-state consortium, and those that joined would agree to collect sales taxes for each other. States (under the current Senate bill) would not be forced to join.

How would this work? Surely states with no sales taxes would choose not to join. They have already chosen not to burden their businesses with the collection of sales taxes in their own state, so one would not expect that they would burden their businesses to collect sales taxes for other states.

The result would be that states with no sales taxes could sell to anyone and not charge sales tax, so any business wanting to offer its customers sales tax-free purchases could relocate to New Hampshire, Alaska, Delaware, Oregon, or Montana, which do not have sales taxes. The Senate bill would provide a huge benefit to sellers in those states.

The playing field would be uneven enough that the likely next step would be requiring those states to join the consortium, placing a burden on businesses in those states that their governments currently explicitly avoid.

Having sales tax paid in the jurisdiction of the seller makes more sense anyway. The seller’s business uses the local roads, relies on the local fire department, and employees send their children to local schools and are protected by the local police. That is how sales taxes work in the “brick and mortar” world already. Why change?

The pressure for the Senate bill comes from “brick and mortar” stores who argue that out-of-state internet sellers have an unfair competitive advantage because they don’t charge sales tax on their sales. They are arguing to do it this way because they want more taxes placed on their out-of-state competitors. If they petitioned their states to tax sellers on all sales to both in-state and out-of-state competitors, brick and mortar businesses might be taxed more (if they have out-of-state customers) but their competitors in other states won’t be.

A California business can say “California purchasers owe this tax, and we need a federal law to collect it.” That helps both the California business and California’s state government. A California business would be less successful arguing to the government of New York that New York businesses should be paying New York tax on sales to California. Also, California’s state government would get no benefit from that.

The Senate bill, and the whole Streamlined Sales Tax initiative, is driven by political interests, not common sense. But then, so are all public policy decisions. Even for those who want to tax internet sales, the Senate bill is not the right way to do it.