Abby Johnson | October 23, 2011

The Internet sales tax issue has been debated for a number of years, but the issue grew to a new level of intensity after the state of California signed into law a bill that required all online retailing sites to pay taxes on their affiliate advertising. This, of course, sparked a big dispute since many online retailers such as Amazon cut off their affiliate programs in the state.

As a result, a lot of the affiliates in the state lost most, if not all, of their revenue. Nick Loper, who was among the affiliate victims, spoke to WebProNews back in August and told us that he lost 70 percent of his revenue almost immediately after the law went into effect. He ended up moving to Nevada and starting completely over.

The motive for California’s law was driven primarily by its struggling financial situation. Because many other states are facing similar scenarios with large budget deficits, they too are contemplating related actions. It’s understandable why states want to impose these taxes, but does that make it right?

Can these interstate tax propositions actually solve the tax problem? What do you think?

Adam Thierer, a senior research fellow with the Technology Policy Project at the Mercatus Center at George Mason University, doesn’t think that they would. He co-wrote a report with Veronique de Rugy on this topic, and as he explained to WebProNews, the tax issue is very complex and far-reaching.

“The debate about Internet taxation is really an interesting debate, because the sales tax only being a state and local tax is not something that can be easily applied to something that’s interstate in nature, which the Internet and Internet sales clearly are,” he said.

Even before Internet taxes became an issue, states have wanted to impose taxes on interstate companies that provide catalog and mail order services. However, they have not been able to do so because of their constitutional restraints. According to Theirer, the Supreme Court has provided limitations in this area because the states can’t put “discriminatory or unfair burdens” on companies that they don’t have any authority over.

Congress is now trying to get these limitations reversed with new legislation. In August, the “Main Street Fairness Act” was introduced to the Senate. It, in essence, calls for a set of federal guidelines that would dictate how states could collect sales taxes from online retailers.

A second bill, called the “Marketplace Equity Act of 2011,” and was introduced to the House last week. It is similar to the one introduced in the Senate but is a little different since it would give states the authority to require retailers, both on and offline, to collect sales taxes even when customers are located in states where the companies have no physical presence.

“What both these measures try to do is find a way to, essentially, authorize a state-based system of taxation for the Internet,” said Thierer.

“The reason, again, that the courts have not thus far allowed it is because, really, the complexity question. It’s not just that the states don’t have authority over interstate vendors; it’s that if they went to actually impose these taxes, it would create a huge burden on interstate sales and trade.”

States are aware that tax systems are complex, and many of them have joined the Streamlined Sales Tax Governing Board to simplify the processes. They are working to not only explain rates, but they are also working to clarify definitions such as the difference between a cookie and candy bar. This might seem of minimal value on the surface, but as Thierer explained to us, each of these items is taxed very differently.

He went on to say that, even if the systems were clarified, there would still be issues with this approach. He told us that states want to tax one another’s imports instead of taxing their own exports, which is a process that he calls a “tax cartel.”

“The wrong answer, in my opinion, is to essentially tax everybody up to a higher level,” said Thierer. “The better approach would probably be to tax downward and find a way to have a more competitive tax arrangement, so that we don’t set this collusionary approach that some states want to use.”

“I think that that would create a troubling disincentive to actually seeing more tax competition,” he added.

Thierer also pointed out his frustration with Amazon being at the center of this debate, saying that he was “very troubled” by it. He not only thinks that Amazon is pulling the spotlight away from other online retailers, but he is also disturbed that it is making deals with politicians in order to eliminate its tax own burden. The online retailer has been negotiating with states to avoid or delay paying taxes in exchange for investment and jobs in those states.

“In theory, that sounds great,” said Theirer. “I really do wonder about Amazon’s ability to deliver on it, but at the end of the day, this is really just politics, and it’s not the kind of solution that is ultimately going to serve the broader marketplace or consumers.”

Theirer believes that there is a better approach to the tax issue than the approach that both the states and Amazon are taking. In the report, Theirer and de Rugy propose 3 potential solutions to the tax problem. One option would be to abolish sales taxes entirely. For this to work, states would have to rely on income, property, and various other taxes.

On the other extreme, a second option would be to have a nationwide sales tax that would give states a certain portion of the income. Thierer, however, doesn’t think either of these methods is ideal. Instead, he is advocating an “origin-based sourcing rule” that would apply the structure of offline sales taxes to the Internet.

As he explained, it’s the idea of taxing consumers at the origin of sale, not at the destination, which is what the states want to do.

“The states and localities want to have a destination-based system where they try to figure out where everybody’s going to consume their online goods… that’s what creates the complexity and the costs associated with the plan that they desire,” said Thierer.

On the other hand, he believes his idea would, “create tax competition eliminate the constitutional tax headaches associated with the states’ current plan, and it would make sure that we don’t have a confusing, complicated array of rates and systems for interstate vendors to contend.”

It’s clear that the Internet tax issue is complex, but the big question at the end of the day is – do any of these approaches actually provide a solution to the problem? If so, would you be more apt to follow states’ proposal or Thierer’s proposal?

Do you have ideas for what should be done about Internet-related taxes? Let us know in the comments.

COMMENTS:

Adeel Janjua says: October 23, 2011 @ 11:09am
What is the Government doing to support the local businesses which they want to tax? Nothing, nada, zilch. Taxes are supposed to be used to give back to the economy. Taxing internet businesses just because banks have failed is not the right way to go.

Stuart Holland says: October 23, 2011 @ 10:41am
Internet taxes are a major headache. We’re based in the UK so will eventually come under the European VAT system when our turnover dictates – but I have no idea if we’d stay in business if we had to have separate tax rates for every US state – and work out who to pay and when – probably we’d give up and call it a day at that point.
I personally think it would be a lot simpler if there was a global taxation system (which could be down to where you live, country or even State) whereby whatever you buy (online or in the High St.) is attributable to where your credit/debit card is issued. So, for example, a UK issued card may automatically add 20% (our VAT rate) to the value of any purchase, whilst a card issued in say Texas could only incur a 10% charge (or whatever rate Texas want to apply). This would move the onus of collection onto the source (ie the card issuers) and require them to deal directly with their governments. It would free up millions of small businesses to focus on their business rather than worry about getting taxes right, especially on the Internet where the customer base is truly global – and the same rules could be applied to High St. shops so if an American citizen came to the UK they would only pay their own country’s tax rate and not the UK one – which could be great for tourism!
By governments dealing with card issuers directly it would also make it much less likely for taxes not to be properly calculated and collected – and if a business goes “out of business” then the government has not lost the tax already collected.
I’m not a tax expert by any means, but it seems logical that taxes should be charged based on the individual customer and where they live as opposed to where they choose to shop – especially when it comes to the Internet.

John E says: October 23, 2011 @ 11:28am
I’m UK based too. Just wanted to say being VAT registered can work out in your favour. If your turnover dicates you’ll need to be VAT registered soon, it’s well worth having a look at “the flat rate scheme”. Can work out great for on-line businesses!

John Wheeler says: October 23, 2011 @ 9:51am
Small business is already facing a magnitude of regulations that inhibit the primary function of business, to serve the population and make money while doing it. Simplify PLEASE

Joe Canti says: October 23, 2011 @ 9:45am
This simply represents politicians gazing at the online market with dollar signs in their eyes…while the rest of the economy faltered, online sales grew by a sizeable amount and the politicians want a piece of the pie.
A more apt solution would be to impose cuts on the defense industry, which so far has not absorbed any cuts or efficiency savings. It’s inconceivable that an industry which takes a third of the entire US budget should carry on as if nothing has happened – totally unrealistic.

Glen Woodfin says: October 23, 2011 @ 8:50am
Government stupidity at it’s finest.

matt says: October 23, 2011 @ 9:35am
I aggree the Goverment can do anything it wants as long as it benifits them sad

brad averitt says: October 23, 2011 @ 8:37am
sales tax of ant type will give the local and BIG government the start to taxing anything and everything without limits. It is all unconstitutional. Noticed it starts in California. Where all the librals dream upthe wierdsest of all things. A cess pool of corrupt local governments wanting to impose taxes on the whole country in order to pay for their local governments corrupt leaders who have been stealing money from their tax payers for years. You know I find it amazing Texas has no state income tax and has less financial problems than all the states that do combined. If Texas does not create a sales tasx as such, I bet all those companies will soon re-locate to Texas and other states that won’t tryn this. Taht will do wonders for the bowl of fruits and flakes in California.

factchecker says: October 22, 2011 @ 6:36pm
One of the more sensible arguments, you pay taxes and receive services to your local and state government, the b and m stores want out of state companies to pay sales taxes while not receiving services.

Keith Yockey says: October 21, 2011 @ 12:15pm
I have been following this issue for several years now. Finding a compromise that works for all is no easy task.
Of course local tax districts want destination based tax. Just look at the latest battle Chicago just lost w StubHub. While fine for a local store w one location and one tax rate, why should I be required to know that a local community 3000 miles away want an extra 1% for a voter approaved Statue in Town Square to celebrate Earth Day? Worse is that town has 3 zip codes, and the city divides all 3.
Is Cotton Candy a Food, Entertainment, or Sugar? Depending on where you live, you may be taxed for one, noe, or all 3 classes. Again, it’s fine for a local store that knows local law, but it is fair to require a seller 15 States away to know local law?
The Marketplace Equity Act only requires a State’s Base Tax Rate. That’s a lot better than SSUTA’s plan to allow all tax districts into play. The downside is requiring online to make 45 Tax returns, which may cost small sellers more in administratives costs than the tax collected. A bad idea, if you ask me.
My solution is to have the Merchant Accounts (Visa, MC, PayPal, etc.) collect Sales Tax @ POS and remit tax directly to the States (States pay related fees) ~ States get instant funds, no privacy issues, no exemptions required, and it works for B&Ms as well as online. MA fees are taken from Sales Tax collected now, and that’s unfair (and costly) to businesses now. Shifting that cost back to the States is not only fair, it reduces out of pocket expenses online and B&Ms emdure now.
More in my blog http://www.thedumbdog.com/blog