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Nightmare Part II: Internet Sales Tax Bill Sails Through Senate

The Marketplace Fairness Act (S 1832 IS) was passed by the Senate on May 6th, a bill which would require Internet companies to charge and collect local and state sales taxes on out-of-state sales, based on where their customers live. This bill attempts to override a Supreme Court ruling in 1992 that had affirmed that interstate commerce could not be interfered with by the states. But with online sales growing every year, state and local municipalities are now looking to collect sales taxes on transactions both local and national - a legally dubious attempt, with a host of unintended consequences that would decimate all but the biggest corporations involved in Internet commerce.

This bill, S 1832 IS, has the stated purpose “to restore States' sovereign rights to enforce State and local sales and use tax laws, and for other purposes."

 

This article first published   May 7, 2013

WE HAVE ADDED to our story about this proposed legislation on May 7th:

The concept of allowing states to tax interstate commerce is a big and bad idea, in law and principle. And as is the case with many bad ideas, which are often born of good intentions, the Devil is in the details, plotting all sorts of mischief.

First off, this is not just a tax for Internet businesses. This proposed law’s stated goal of ‘marketplace fairness’ is being touted as an effort to level the playing field for local storefront retailers. Those local businesses may be shocked to find out what ‘fairness’ will mean for them, as they will have to be in compliance also. When a customer calls a brick-and-mortar store from out of state, and wants an item shipped to him or her, that local non-Internet business will also be required to collect some other state’s sales tax. This requires that store to acquire and integrate into their business procedures the same proposed sales tax software that this bill promises to provide.

Will the common consumer practice of searching for the most favorable sales tax venue on big-ticket purchases be outlawed? Consider the case of a consumer who resides in Massachusetts, and orders from a firm in Arizona, requesting that the merchandise be shipped to Vermont. Try and define his or her tax venue. It is a common practice today for people to cross state lines to make purchases in a neighboring state that either has no sales tax, or does not tax the big-ticket item that the customer is shopping for. Under this proposed law, will merchants be required to ask for a state ID from their customers, to determine which state’s sales tax to charge? And what if the customer’s ID is not from the state where he resides? Or resides only part of the year? The correct answer is important, as the merchant will certainly find out via 'trial by audit.' Under this proposed bill, a merchant may be audited by virtually any taxing authority anywhere in the country, who will have regulatory and audit power over businesses in every state in the US.

And what is to happen to the ‘use taxes’ currently on the books in most states? Unless they are individually repealed in every state in the Union, you potentially have double taxation on some sales. This is just one aspect of this proposed law which would require an unprecedented amount of coordination among the states, each of which has its own local quirks, varied agendas, and unpredictable political actors.

And to avoid the million dollar sales threshold, will we see the Acme Clothing Company split itself into the Acme Belt Company, the Acme Shirt Company, the Acme Ballet Shoe Company, and so forth, each entity staying below the $1,000,000 limit?

This proposed legislation raises many issues of exactly how enforcement and compliance are supposed to work. They say the Devil is in the details, and we predict that if this law is passed, the Devil and all his hellish minions will be busy for a long, long time.

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THE FOLLOWING is our first article on this subject, which was posted on April 27th:

Bill S 1832 IS

SECTION 1. SHORT TITLE.

This Act may be cited as the `Marketplace Fairness Act'.

SEC. 2. SENSE OF CONGRESS.

It is the sense of Congress that States should have the ability to enforce their existing sales and use tax laws and to treat similar sales transactions equally, without regard to the manner in which the sale is transacted, and the right to collect--or decide not to collect--taxes that are already owed under State law.

SEC. 3. AUTHORIZATION TO REQUIRE COLLECTION OF SALES AND USE TAXES.

(a) Streamlined Sales and Use Tax Agreement- Each Member State under the Streamlined Sales and Use Tax Agreement is authorized to require all sellers not qualifying for a small seller exception to collect and remit sales and use taxes with respect to remote sales sourced to that Member State pursuant to the provisions of the Streamlined Sales and Use Tax Agreement. Such authority shall commence beginning no earlier than the first day of the calendar quarter that is at least 90 days after the date of the enactment of this Act.

In theory, most states have ‘use tax’ provisions which require retail buyers who buy from out-of-state merchants to voluntarily pay a ‘use tax’ to their home state on those purchases. Of course, few people are aware of, much less pay these taxes. Thus, sponsors of this bill argue that this is not a new tax, simply the collection of taxes which are already owed.

The bill would be an attempt to override a 21-year old Supreme Court ruling that determined that catalog retailers do not have to collect sales taxes in states in which they do not have a physical presence, such as a store or warehouse.

The unintended consequences that would follow should this bill become law are uncountable. Enforcement and compliance would be a nightmare. And the most entrepreneurial segment of our economy would be obligated under law to thousands of local taxation jurisdictions.

For instance, in an attempt to minimize the retail seller's confusion, the bill requires that the states provide software to pinpoint for the retailer the exact sales taxes to be collected for the various sales tax jurisdictions, of which there are over 9,000 in the US. Sure, the software will help the retailer determine exactly what items are taxable in each community, and what each tax rate is, but what if a seller has sales in, say, 500 of those jurisdictions? Would the internet retailer write 500 checks for sales tax remittals? Or send 500 separate electronic funds transfers? Every year? Every quarter? Every month?

And let's give a thought to the large segment of Internet commerce which is done by retailers who sell a lot of small ticket items. If a retailer makes a single sale to someone in a certain town with a tax rate of 6%, and the sale is for $9.95, the retailer then owes that municipality and state a total of sixty cents. Is that retailer going to have to write a check for 60c, and then put a 44c cent stamp on the envelope to mail it? Or pay a bank fee to execute a 60c electronic transfer? And be required to repeat that action 499 other times for all the different customer locations that he or she sold to that year? At best, this is a lot of time and trouble for the seller, and a tremendous complication for merchants on the Web. Everything sold on the Internet under this proposal would become more expensive, by significantly more than just the added tax amount.

And once these millions of little checks (or that many electronic micro-transfers) arrive at their destinations, how are most governments supposed to handle this flood of tiny payments? How will they absorb the costs of the extra clerks that would have to be hired just to process and monitor them? And assuming a normal level of municipal and state efficiency, does anyone believe that these government entities can receive, process, and credit these payments accurately, without the additional administrative costs actually exceeding the amount of taxes collected?

The bill as written contains an exemption for Internet sellers with gross sales of less than a million dollars a year. Of course, savvy Internet shoppers will want to buy 'tax free' by dealing with businesses below that threshold.

Because of the exemption for retailers with annual sales of less than a million dollars, in effect the "Marketplace Fairness Act" would create a two-tiered price structure for Internet retailing – non-taxable sales by the ‘little’ sellers, with administrative burdens and tax disparities for the larger companies. It may seem fair, in a populist sort of way, to skew the rules in favor of the little guy (small sellers), but it discriminates against the successful - those firms that may have, for instance, 5 to 100 employees, and have sales over a million dollars annually. For the most part, these businesses have grown that large (although not Amazon.com large) by offering favorable prices and good customer service.

Having an Internet retailer collect taxes for these myriad different tax authorities would legally make that retailer subject to audit by any of them. Practically speaking, what are the rights of a retailer who has to answer to tax authorities in 45 states, Guam, Puerto Rico, the Marianas Islands, and over 600 tribal American Indian districts? Let's say there's a disagreement or clerical error involving taxes due, and a taxing authority a thousand miles away sends an Internet merchant a notice of deficiency for $381.79, or $38.17, or $3.81. What can that seller do? You can’t hire a lawyer, or even travel by airplane in person, to appeal those sorts of sums. Sure, the big outfits like Amazon.com have the sales, profits, accountants, and in-house attorneys to take care of such disputes, but most Internet entrepreneurs do not. It cannot be said that any Internet business would have any practical 'rights' in such disputes, originating as they might from any of 9,600 different tax jurisdictions.

In short, it is the small to medium size businesses which would be crushed by the overwhelming burden involved in complying with this ill-considered piece of legislation. Should it become law, the large middle tier of Internet businesses would be crippled or eliminated entirely. The only businesses not affected would be the smaller 'exempt' mom-and-pop outifits, left to compete with corporate behemoths like Amazon and Walmart.

There are numerous good reasons why the taxing of interstate commerce has been forbidden since the beginning of the Republic. This bill seeks to overturn that sensible prohibition, yet is being described as an effort to simply "restores states sovereign rights." Of course, the 'right' hinted at in that disengenuous description is the 'right ' of states to collect use taxes. The obvious question is - Why don't they collect them already? Because, it's hard. For decades, states have been unable to find a way to collect the phantom use tax, but they did find friends in Washington who are willing to support an effort to make businesses in other states do all the work.

This bill would complicate, hinder, and upset Internet commerce, the fastest-growing segment of our whole economy, and one that now provides American consumers with a variety of choices and pricing power that 20 years ago could not even be dreamed of.

The patently unfair 'Marketplace Fairness Act' was passed in the Senate on Monday May 6th by a vote of 69-27. On the other side of the aisle, the House of Representatives is likely to be more skeptical. This would be a good time to write or email your Representative in Congress with your opinion on bill S 1832 IS.

-Richard Smith, April 27th 2013, revised May 4th and May 7th.


 


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