A terrible response to the Internet sales tax mess

Ten months ago the Senate overwhelmingly passed legislation aimed at sorting out the mess over online sales taxes, which consumers owe but states rarely collect. Now, House GOP leaders are floating what they call a compromise:  Set national rules for sales tax collection based on the location of the seller, not the buyer.  It is a terrible idea.

It may, in fact, be worse than that. It may really be a classic legislative poison pill: A cynical effort to exempt Internet sales from any tax under the guise of “fairness” and “state sovereignty”  that could not possibly pass Congress. If it somehow became law, it could well be a recipe for the ultimate demise of sales taxes as a source of state revenues. At a House Judiciary Committee hearing last week, Stephen Kranz, a tax partner in the law firm of McDermott, Will & Emery, called the idea “the nuclear bomb version of tax competition.”

That’s certainly dramatic. And apt. Imagine what would happen if online sellers (which account for a growing share of retail sales) could effectively sell tax-free merely by locating in a state such as Oregon that has no sales levy. States with a sales tax would come under enormous pressure to repeal the levy to “save jobs.”

To understand what’s happening here, let’s review the history. More than two decades ago, in a case called Quill v. North Dakota, the U.S. Supreme Court barred states from requiring remote sellers to collect sales taxes unless the retailers had some physical presence (nexus in legalese) in their state.

In that decision, the High Court strongly urged Congress to work with states to establish a uniform set of rules to reduce complexity and avoid potential double-taxation. Congress dodged the request.

But during the Great Recession, cash-strapped states started finding ways around the High Court prohibition. New York State discovered a loophole, began taxing most online sales, was sued by Amazon.com and Overstock.com…and won in state court. Last year, the U.S. Supreme Court refused to hear the case, effectively letting stand New York’s requirement that online sellers collect sales tax. And the High Court once again left it to Congress to sort out the mess.

In a rare bit of bipartisanship, the Senate passed a bill last spring that allows states, under some conditions, to require remote sellers to collect sales taxes. But the House has not acted.

In an effort to avoid looking recalcitrant (heaven forbid), divided House Republicans have been searching for a solution of their own. The idea of an origin-based sales tax was brought to lawmakers by Chris Cox, a former congressman who is now lobbies for trade association called NetChoice that represents Overstock.com and a handful of other Internet firms.

Under the plan, the federal government would let retailers collect tax based on the levy where the seller is located, no matter where the purchaser resides. This would apply to all retailers, as long as they had no physical presence in the consumer’s state.

A firm could base its “home jurisdiction” on the state where it has the most employees, the most physical assets, or the state it designates as its principal place of business for federal tax purposes.

Given the nature of online sellers, changing locations to a no-sales-tax state would be fairly easy. It would almost certainly set off the sort of tax competition that worries Kranz. And at least some states would end up increasing property and income taxes—not an outcome that most House Republicans would likely favor.

But that’s only part of the problem. Such an origin-based tax would create immense complexity for sellers and consumers. It would still leave unanswered the vexing question of when a firm had physical presence (and would collect taxes owed to the buyer’s state) or did not (and would collect taxes levied by the seller’s state).

And, as Krantz notes, it would raise a huge issue of taxation without representation since a buyer would have no say in the tax rate he pays. And, he argues, it would very likely violate the Due Process clause of the Constitution.

In short, this proposal would make our current incoherent system of taxing Internet sales massively worse. Other than that, heckuva job, Brownie….