Return of the Internet Sales Tax

Editor's Note: On Sept. 20, 2011, a Michigan lawmaker announced a proposal that would apply the state sales tax to online purchases from out of state retailers. This is a response to a long-standing controversy regarding when states should have the authority to apply their tax laws to out-of-state purchases. Mackinac Center President Emeritus Larry Reed wrote about this issue in 2001. His commentary is below.

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The U.S. Supreme Court has ruled that state and local governments cannot force out-of-state companies to collect taxes for them, since this would interfere with interstate commerce.  States and localities may only require companies with a "substantial physical presence" or "nexus" in their state to collect sales taxes. That's as it should be.

But some public officials aren't content with that ruling. Gov. Engler, for example, strongly supports a National Governors' Association (NGA) proposal that would apply sales taxes to virtually all Internet, catalog, and 1-800 number purchases. Labeled the "Streamlined Sales Tax Project," the proposal would deputize a private "third-party entity" to collect and distribute those taxes and could — if enough states approve it and Congress endorses it — open the door to a national sales tax.

Supporters of the NGA plan talk a lot about fairness and the need to "harmonize" states' sales taxes. But what's to fear from diversity in either the manner or the amount that states tax? It's not "unfair" that New Hampshire has neither a sales nor an income tax. Nor is it unfair that items on which some states impose a sales tax are exempted by other states. Michigan "loses" revenue all the time to states that tax less and tax better, and it gains revenue over states that tax more and in more harmful ways. That's healthy tax competition, and it's why the states are often called "laboratories of democracy." 

What concerns me are such things as compromising any one state's sovereignty over its tax structure in the name of "streamlining" or harmonizing it with the tax structures of other states.  I'm concerned about scrapping the privacy and anonymity inherent in the sales tax. And I'm concerned about making it much easier for the federal government to superimpose a national sales tax. 

But back to the fairness issue. Is it fair that Michigan bricks-and-mortar businesses must remit to the state a sales tax while their out-of-state competitors do not? Taxes are supposed to pay for services that governments provide, such as police protection. Out-of-state vendors with no physical presence in a state would not use any government services in that state. So it would be unfair to tax out-of-state Internet, catalog or 1-800 companies. 

Advocates of the NGA scheme argue that their plan is designed simply to collect existing sales or use taxes from Michigan consumers, not impose a new tax on out-of-state companies. But that argument is undermined by the fact that a consumer who orders a book from Amazon.com isn't using the roads or any other state service to make his purchase.

And privacy concerns about the NGA plan are certainly justified. When you pay a sales tax at a local shop, no one asks you your name, where you live, or anything about your buying habits. The third-party entity the NGA plan would deputize to facilitate Internet tax collection and revenue distribution may very well need to know such things to do the job.

Additionally, claims by state governments that they're "losing" revenue on Internet transactions are almost always inflated for these and other reasons:

• Business-to-business sales are sometimes included, but they would be exempt from sales taxes anyway. Most estimates put those transactions at 75 percent or more of all Internet transactions. 
• Internet transactions that result in physical sales in local stores — such as when a consumer purchases a product online but picks it up and pays sales tax at a local outlet — are frequently not factored out.  
• Increases in tax revenue that come from Internet-induced economic growth are excluded or underestimated. In 1998 alone, the Internet was responsible for 1.2 million new jobs, representing lots of new income and sales-taxable purchases. 
• At least some online purchases can be characterized as transactions that would never occur in a local store, where sales tax would be assessed. Thinking about the obscure items I purchase by the dozen on eBay auctions, I realized that almost none of them I would have bought in any local, Michigan store.

Some say the effort to impose sales taxes on all Internet transactions is a train rolling down the track. Maybe so, but it's still a train that should be derailed.