Tax Online Sales at Point of Purchase

Last month, I wrote about a brewing battle on Capitol Hill over on-line purchases and sales taxes. Governors, state officials and retailers are pushing Congress to force on-line retailers to collect state and local sales taxes on e-commerce purchases. An equally strong coalition is forming to oppose the effort. It will be a dominant issue over the next few years. I proposed what I thought was a modest solution to the debate. 

A couple weeks ago, Sen. Jim DeMint took to the pages of The Wall Street Journal to argue against on-line sales taxes, as currently proposed. He begins:

Our nation was born from the idea of "no taxation without representation"—that citizens should not be taxed by governments in which they have no political voice. Yet now lawmakers in Washington want to overturn that bedrock principle in order to extract more revenues from American consumers.

This is a noble sentiment, but it doesn't at all reflect how sales taxes are applied in this country. If I travel to, say, South Carolina on vacation, I pay their state sales tax on every purchase I make, even though I have "no political voice" in the state. I pay their state and local governments' gas taxes, hotel taxes and rental car taxes. This is true of every state and local government in the country. Surprisingly, only Europe subscribes to what DeMint calls the "bedrock principle" of "no taxation without representation." When leaving Europe, they actually provide a refund of all sales taxes paid by non-residents.   

The principle we have in sales tax policy today is that the consumer pays the applicable rate wherever that business is located. If I'm in Illinois, I pay Illinois sales tax, and so on. It is considered a reasonable charge to reimburse the government's costs for enforcing the law, contracts and providing certain public goods. Sen. DeMint agrees with this system:

Today's origin-based sales tax system, which allows states to tax purchases made at any business within their borders, is fair. I believe that states should focus on cutting spending, lowering taxes and creating the best business environment to attract new companies and new jobs. If states want to raise taxes they have the power to do so—yet only on citizens and businesses within their political jurisdiction.

And herein lies the solution to the on-line sales tax debate. On-line retailers could simply collect sales taxes on purchases, based on the rates and rules in the jurisdiction where they are located. If I buy a product on-line from a business based in Missouri, I will pay Missouri sales tax. Just as I would if I physically drove to that store. Commerce would be treated exactly the same.   

I hate taxes probably more than the next guy, but the on-line sales tax dilemma is something we need to solve. 

In 2010, retail e-commerce sales were around $170 billion, almost 5% of all retail sales. While that may seem relatively small, online sales have been growing at an annual average rate of 17% since 2002. The growing ubiquity of smart phones and tablets will likely push this annual growth rate even higher. You can now purchase goods and services online from literally anyway, rather than just when you are at your computer. As more commerce migrates online, the sales tax base, which funds a significant portion of state and local governments, will erode, opening up new holes in their budgets. Many governments will respond by increasing their sales tax rate, which will only exacerbate the situation.  

The conservative in me agrees with Sen. DeMint and thinks governments should adjust their spending for this new reality. If future sales tax revenue is going to be lower than it otherwise would be, then future spending should be lower than it otherwise would be. That works to a point. But, in the near future, when online sales are 10, 15 or 20% of retail sales it becomes unsustainable. 

In the coming years, with the spread of technology and the rise of mobile-commerce, will shift much more consumer spending on-line. It will be increasingly hard to justify tax-exemption for certain transactions solely on the basis of how that transaction is made. There are enough carve-outs in the tax code as it is. We shouldn't sustain or create new ones to further distort the market. 

That said, we also shouldn't create some byzantine new tax scheme that, in the name of fairness, imposes a new burden on some other part of the retail market. Treat all commerce equally. Taxing the on-line world in the same manner we apply the tax in the terrestrial world will satisfy our principles of tax policy, fairness and simplification. 

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