There's Nothing Fair About an Internet Sales Tax

The tax revenues that states may be able to extract would be dwarfed by the damage the legislation inflicts on growth, innovation and competition.

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Amazon.com worker David Brendoff, left, moves boxes with merchandise for shipment Tuesday, Dec. 13, 2005, at the Amazon.com fulfillment center in Fernley, Nevada. With the holidays just around the corner, many shoppers are relying on online sites like Amazon.com to complete their shopping. This facility, over 800,000 sq. ft., or roughly 13 football fields, is capable of handling hundreds of thousands of orders per day.

Nita Ghei is a policy research editor for the Mercatus Center at George Mason University.

Just a few years ago, retail giant Amazon primarily stood on the sidelines of the debate over federal legislation – dubbed the Main Street Fairness Act – to require online retailers to collect sales taxes. But now Amazon is front and center supporting the current iteration of the bill wending its way through Congress. Amazon's support aside, the tax revenues that states may be able to extract would be far dwarfed by the damage the legislation inflicts on growth, innovation and competition, and by further entrenching cronyism in our already troubled economy.

Amazon's volte-face on an Internet sales taxes is a reflection, ironically, of its success. It is placing warehouses in more states as part of its plan to improve shipping speeds. That means that it is required to collect sales taxes in an increasing number of states – existing Supreme Court precedent limits the obligation to collect sales taxes to retailers with a physical nexus to the state, such as a retail store or a warehouse.

There is, consequently, far less reason for Amazon to oppose the tax regime proposed by the Marketplace Fairness Act than in 2011. On the contrary, Amazon now has good reason to throw in with other big bricks-and-mortar retailers like Walmart and lobby for the change because of the burden it would impose on potential competitors.

The act would require all online retailers with gross out-of-state sales exceeding $1 million to collect sales taxes imposed by the destination taxing jurisdiction. Compliance would be extraordinarily onerous and expensive, with upwards of 9,600 taxing jurisdictions in the country among the 45 states with sales taxes. The tax rates, as well as the scope of goods taxed, also varies widely.

Under the legislation, states would have to provide software with the appropriate tax rates, but that still leaves the burden on retailers of incorporating the information and actually collecting the tax, a burden that will hit smaller retailers disproportionately hard. Resources that go toward compliance are no longer available for expansion and innovation. True, a cottage industry for tax collection would likely flourish, but compliance jobs do not increase productivity or enhance welfare as higher compliance costs are inevitably passed on, at least partially, to consumers in the form of higher prices. 

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As the Internet sales tax kicks in, it functions as a barrier to growth. The tax, in effect, limits competition for the existing big retailers, who can spread the cost of compliance over a larger sales base. A tax regime which limits competition is one that emerges from cronyism.

The insult to this injury is that the statute will impose these costs on small online retailers and consumers for very little tax revenue. Claims that that the Internet sales tax will raise $23 billion in annual revenue are grossly overstated. Even if those optimistic projections materialized, this translates into less than three percent of total state and local tax revenues collected in 2012.

A careful 2010 study by George Mason adjunct scholar Jeffrey A. Eisenach and Robert E. Litan of the Brookings Institution estimated total potential tax revenue in 2008 at less than $4 billion, and forecast the 2012 level just under $ 5 billion – which is just over three-fifths of 1 percent of total state and local revenues. The potential tax revenue shrinks even beyond this miniscule amount when retailers with less than $1 million in gross sales are excluded.

The distortions and costs of this tax far outweigh the value of revenues going to state and local governments. If a tax has to be imposed, a point of sale tax determined by the seller's location would be less costly and less harmful to the economy.

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