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Sales Tax, Use Tax, & the Internets

I’m generally a Jim DeMint junkie, but his comments in opposition to the “Marketplace Fairness Act” are off the mark.

The MFA seeks to bring some order to that vast, wild frontier known as ‘online shopping’—specifically, it provides a standardised framework to collect state sales taxes on Internet purchases.  DeMint says the current collection model of whatever-the-corporate-legal-department-thinks-is-a-good-idea-today is working just fine—it’s not.  Both retailers and consumers would benefit from clarification of online sales tax law.

A Brief History of Online Taxes: Everything You Never Wanted to Know

Why are we even talking about this?

In my storied Internet shopping career, I’ve been charged variously my home state’s sales tax, the retailer’s state’s sales tax, some other state’s sales tax (still don’t know why that happened), and—everyone’s favorite—no sales tax.  Nobody’s really sure what’s correct.  Retailers who are out of compliance face audits, fines, legal battles, and surprise back tax bills.  Consumers who buy from out-of-compliance retailers consequently face rising prices and could themselves run afoul of tax law for failure to pay the appropriate “use” tax (more on use taxes later).

Ye Olde Origin Model

DeMint says the current origin-based structure is fair and should be kept.  The idea is that the tax collection authority belongs to the jurisdiction in which the sale originates.  So if Joe Customer walks into the Mom & Pop Shoppe to buy a pack of gum, Mom & Pop would kindly add to his purchase something like the astronomical 10¢ on the dollar I pay in my hometown for the privilege of giving someone else my money.  Later, when Joe takes a road tour of states that end in “Hampshire”, he’ll pay 0% sales tax on his purchase of a commemorative representation of what Ye Olde Man of the Mountain used to look like.

That was all fine and dandy in 1954 when the Supremes decided Miller Brothers Co. v. Maryland, in 1967 for National Bellas Hess v. Illinois, and even in 1992 for Quill Corp. v. North Dakota—when the vast majority of purchases were made directly at the counter, there was not much need to question where, exactly, an order originated.  Today, however, the Internet and mobile devices account for a significant and growing volume of transactions, and it can be difficult to determine what tax authority has jurisdiction.  Did it originate with the company the received the order?  Did it originate at the home of the buyer?  What if he placed the order from his smartphone while he was on vacation in another state?  What if he was in his car and actually crossed a state line while the web receipt was loading?  What if he wants it shipped to his niece for her birthday on the other side of the country?  What if the Internet traffic was routed through a server farm in yet another state, or worse—Canada?

And this is a problem because…?

It’s not so cut-and-dried anymore, and it’s no longer appropriate to treat an interstate sale as an incidental rarity.  The lack of clear regulation has created a hodgepodge of expectations between Internet retailers, consumers, and various state departments of revenue that has been the subject of continued legal wrangling.  Amazon, for example, has been duking it out for years state by state by state in court.  Additionally, it’s created the opportunity for sales tax evasion—in much the same way that income tax evaders send money across jurisdictional lines to avoid paying, savvy consumers order from retailers that collect no sales taxes.

If you were looking at a major purchase, would you buy from the aforementioned, local mom & pop for $2500 + 6.6% Arizona gross receipts tax + 0.7% Maricopa County sales tax + 2.0% City of Phoenix transaction privilege tax = $2732.50?  Or would you opt for the massive online retailer based out of, say, Wisconsin that can get you the same item for $2500 + $25 shipping + 3 days of continuously refreshing FedEx/ = $2525?  Given the choice, most of us would be staring at “Tracking number not found, please try again later” before you can say “impulse control issues”.

Theoretically, you’re supposed to pay a ‘use’ tax when sales tax is not collected (or not enough is collected) on a purchase you make.  In most states, it’s just an extra blank on your state income tax form: Please tell us how much you owe in use taxes? Uhhh, Zero. Done.  —But even if you were trying to comply, who records whether a sales tax was collected and whether it was greater than or equal to their home state’s sales tax percentage on every Internet and out-of-state roadside pit stop transaction they make?  Seriously?

DeMint is Wrong

The current system is not fair

Leaving retailers wrangling with legal action by fifty (okay, 45+) different Departments of Revenue and leaving consumers fumbling to pick up the pieces and calculate their own use tax is not fair.  Allowing local shopkeepers to be undercut—not by honest competition—but by sales tax evasion is not fair.

The proposed system is not ‘taxation without representation’

DeMint argues that sales taxes are taxes on businesses, and that by moving the tax structure from an origin-based (retailer headquarters-based) to a purchaser- or destination-based system, we will be subjecting retailers to taxes in jurisdictions where they have no representation.  I think I speak for the sales-tax-paying world when I say that sales taxes are primarily taxes on end-consumers, not on retailers—retailers simply pass the tax on to the buyer.

It’s the current system that allows taxation without representation.  The tax rates I pay on Internet purchases are currently decided in court rooms and internal corporate legal department memos—not by my elected representatives.  The MFA would tighten the relationship between end-consumers and the applicable taxing authority—a relationship that DeMint says must remain “as tight as possible.”

Not a power grab

DeMint says that this is an unjustified revenue grab by the states and implies that it would be the first step to a unified federal sales tax.  He (or his spokes-blogger) at his official site goes so far as to say the proposal is unconstitutional.  I almost find this argument amusing—given how abused the federal government’s Commerce clause authority has been, it’s actually refreshing to see Congress exercising it’s authority to regulate interstate commerce in a fashion so thoroughly consistent with the Constitution’s clear wording: “The Congress shall have power to…regulate commerce…among the several states….”  If cross-jurisdiction, ‘in-the-cloud’ commerce isn’t “commerce among the several states”, I don’t know what is.

The MFA is an overdue, legitimate exercise of federal authority to regulate what has until now been a morass of contrary and overlapping claims of authority, to provide a form of due process, and to help the states respect each others’ sovereignty and cooperate in the enforcement of each others’ existing use tax laws—a standardisation and enforcement of existing law—not a money or power grab.

The MFA is perhaps not perfect.  Senator DeMint’s efforts, though, to drown it in a sea of buzzwords like ‘taxation without representation’ are beneath him, and he would better serve his constituents by more clearly voicing his specific objections and directing his considerable talents toward improving the proposed legislation.

And another thing

Those use taxes are unconstitutional

I hate use taxes.  Any tax which is entirely self-reported and impossible to audit is begging for abuse, but, more importantly, if anything is unconstitutional here, it’s the use taxes whose existence DeMint uses to excuse the current mess.

Insofar as states ask citizens to pay the use tax in place of sales tax on a purchase, I don’t really have a problem with them other than their complete unenforceability; but use taxes don’t stop there—many, if not all, use tax laws are written such that if you are physically present in another state, make a lawful purchase there in full compliance with that state’s tax laws (including perhaps a state where your sales tax liability is zero)—you must also pay your home state an additional tax of however much their tax rate exceeds the rate paid at point of sale.  Don’t believe me?  See item 5 under “Who Pays Use Tax?” from this flyer from the Arizona Department of Revenue.

So if Home State’s use tax rate is 7% and Vacation State’s sales tax rate is 5%, when you get home you owe the additional 2% to Home State.

Why do they do this?  Well, if you live in High Tax State, but live a reasonably short drive from Low Tax State, will you take your shopping over the border when given the chance?  In the enlightened, immortal words of Sarah Palin, “Yoou betcha.”  High Tax State doesn’t want you to do that.

Now, if instead of High Tax State and Low Tax State, we were talking about High Tax Country and Low Tax Country, this purchase would be called an import and the additional tax would be called a duty.  Article I §10 specifically states:

No state shall, without the consent of the Congress, lay any imposts or duties on imports or exports, except what may be absolutely necessary for executing its inspection laws: and the net produce of all duties and imposts, laid by any state on imports or exports, shall be for the use of the treasury of the United States; and all such laws shall be subject to the revision and control of the Congress.

We tend not to think of such domestic transactions as imports today, because we have a much stronger national identity than we had in 1787 when this was written.  Prior to the Constitution, the States were states in the technical, political science sense of the term: countries—and under the loose Confederation which preceded the Constitution, interstate import-export taxes could be discriminatory and protectionist.

The weight of historical evidence indicates clearly that this clause was meant to apply to all imports and exports, including domestic ones, in the newly formed nation.  The whole reason for replacing the dilapidated Articles of Confederation was because the central government was powerless and the ‘nation’ was divided by petty bickering between the states.  In Brown v. Maryland, an early (1827) Import-Export Clause case, Chief Justice John Marshall said the prohibition against state import taxes extended “equally to importations from a sister State”.  The clause served to bring about that cohesive, national identity we enjoy today and to reaffirm Congress’s §8 exclusive power to regulate interstate commerce.  Today’s use taxes collected in excess of out-of-state sales taxes are just domestic, protectionist import duties under another name.

One thought on “Sales Tax, Use Tax, & the Internets”

  1. I’ve been asked what solution I think would be best. My post focused on the deficiencies in DeMint’s arguments against not only the MFA, but essentially against changing the status quo at all, so I’m open to conversation in terms of a fix. That said, here are my thoughts:

    As much as I might personally like the option that would allow me to pay no sales tax—from a public policy perspective it would be better to create a destination-based structure, which is what the MFA tries to do. It just makes sense that Arizona buyers pay Arizona taxes, whether the transaction occurs between two people physically standing on a corner in Winslow or is processed by a server somewhere over the rainbow.

    First, there needs to be some discussion around what an appropriate exemption would be. The most specific complaint I’ve heard against MFA is that it exempts only businesses that do less than a half million in annual sales—I’m told that number is far too low, falling short of many other commonly used measures of what makes a “small” business. (And the quick math does make that seem like an awfully low threshold: We’re talking less than $1400/day. Even if that’s net of expenses, that’s a small number.) That dollar limit has to be higher to avoid placing a cripplingly expensive compliance burden on small businesses, and, since some interstate business is truly incidental, we should also include a measure of what percentage of a company’s business crosses a state line. Companies where less than, say, 20% of sales are interstate should also be exempt.

    Secondly, the ‘nexus doctrine’, as expounded in Quill, etc, should be codified. Smaller companies would continue collecting sales taxes only in those jurisdictions where they have a physical presence.

    Secondly and a half, Congress should ban those pesky ‘use’ taxes. At best they are an intrusion upon Congress’s exclusive authority to regulate interstate commerce, and at worst a direct violation of the Import-Export Clause, as I argued earlier. And banning them won’t really reduce state tax revenues, because 1) we’re talking about just exempt companies with low interstate revenue and 2) nobody pays them anyway.

    Finally, states that want to get tax money collected should be required to simplify the tax laws that apply to remote sellers—again something the MFA works toward. (In fact, it builds on an existing, voluntary sales tax simplification agreement many states have already adopted). I haven’t looked at how far MFA goes in terms of streamlining, but it should include the stipulation that non-exempt sellers with no physical presence in the state collect a uniform sales tax rate for the entire state. That is to say, online/mail-order retailers don’t have to worry about what county and municipal taxes are, and they don’t have to worry that foodstuffs may be taxed at a different rate than Justin Bieber bobble-heads.

    States, in turn, should be allowed to set their remote seller tax rate independently of their regular sales tax rates (up to a maximum variance, to preclude a state’s wholesale discrimination against remote sellers). I would cap it at [average state rate for all classes of items] + [state’s average local rate]. Each state could then take its tax revenue and distribute it among its municipalities by whatever formula it chooses (or not—the wonders of unitary government).

    By saying only businesses that conduct a significant volume of interstate business are subject to the regulation, we eliminate that burden on businesses whose interstate activities are negligible, and focus on those companies that have built a national empire for themselves; and we do so in a way that fulfils the federal government’s responsibility to provide a fair national marketplace, while still accommodating state sovereignty, allowing that variation and competition that helps make America great.

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