Wednesday 8 May 2013

Internet sales taxes revisited

Mitchell Hall at PC Mag canvasses opinion on the proposed US internet sales tax.
The Marketplace Fairness Act isn't actually a new tax. It's not even compulsory. It simply allows—but does not require—states to collect sales tax on out-of-state purchases over the Internet. The bill is designed to address a loophole created by a 1992 (pre-ecommerce) court case called Quill Corp v. North Dakota. In it, the Supreme Court ruled that "Congress is now free to decide whether, when, and to what extent the states may burden interstate mail order concerns with a duty to collect use taxes." The upshot was that out-of-state retailers didn't have to collect state sales taxes unless they had a physical presence in the customer's state.

Current Heritage Foundation President, former South Carolina Republican Senator, and Tea Party leader Jim DeMint is predictably against the bill, but frames his argument in political terms. He declares in the Wall Street Journal opinion pages that America "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."
"The proposal before Congress would give a federal blessing for states to chase revenues far outside their borders," says DeMint. He cites the example of a customer buying a product in a store: does the cashier ask for the customer's home address? "Of course not," he answers. "The store simply charges the state and local sales taxes applicable for its physical location, no questions asked."
DeMint writes that the proposed law would hold online sellers to an entirely different standard than physical retailers. Websites would have to add taxes to a sale based on the shipping destination of the product, possibly a state in which neither the seller nor the buyer resides. "We would never ask mom-and-pop store owners to do such a thing," he argues.
I tend to figure that consumption taxes should be levied at the place the product is consumed. While DeMint is right that the proposal will fail to address distortions caused when people drive across state lines for shopping deals, the volumes there involved have to be smaller.

Libertarian-minded economist Eric Crampton from the University of Canterbury is also against the bill, albeit for different reasons. He conceded to PCMag that from a best-case standpoint, states with sales taxes that do not charge a tax on Internet purchases from out of state will distort consumers' decisions. Consequently, you'd want shoppers in a state to face the same sales tax regardless of where they're purchasing it from.
"But," Crampton argues, "we're not in a first-best world. Most importantly, it's not easy to collect these taxes. The transactions costs of collecting the tax arguably dwarf the revenue that would be collected or the inefficiency induced by having smaller purchases effectively tax-exempt."
I'll add in the caveats that I'd sent Mitchel for which there wasn't space in the final piece:
Were this implemented in the US, every internet vendor would effectively have to be remitting tax receipts to each of 50 states. That's fine for big guys like Amazon, but it would be murder for smaller online retailers.

Finally, inefficiencies caused by failure to administer an internet sales tax are clearly third or fourth order relative to the massive inefficiencies built into the American tax system. Comprehensive tax reform lowering rates but abolishing the home mortgage interest deduction and applying a fringe-benefits tax so that employer-provided health insurance would not be tax-preferred would be far more effective in fixing whatever ails the American tax system than chasing after internet sales taxes. Were the US to apply a federal VAT while reducing income taxes, that federal VAT should apply equally to online and offline transactions. But I'm really unconvinced that current internet sales tax proposals are worth the effort.
Josh Barro pointed to one way out of the mess: states willing to run a single less-crazy sales state tax code could implement internet sales taxes across that set of states. But allowing states to require retailers from other states to conform to their particular mess of tax codes...disaster. As Barro there wrote:
And one state’s picayune rules don’t necessarily conform to other states’ equally picayune rules. Both New York and New Jersey apply sales tax to candy but not to most other food, yet they have different definitions of what “candy” is. A Twix bar is taxable candy in New York, but in New Jersey it’s a non-taxable baked good. An online retailer has to keep up with this morass not in just one state, but in all of them.

More dauntingly, there are over 8,000 local sales taxing jurisdictions in the country, again with their own rates. New tax jurisdictions are created frequently and their boundaries do not necessarily conform to Zip or even Zip +4 boundaries. A few states, such as New York, even allow local jurisdictions to determine their own tax bases. One particularly relevant example for online retailers is that New York State does not charge sales tax on clothing and footwear under $110, but most counties in New York do – and sometimes a city has different sales tax rules than the county it is in.
I'd taken this as excellent reason for America's adopting New Zealand's tax code.

Back to Hall's piece:
Surprisingly, Kevin Hassett disagrees with Crampton and DeMint, telling PCMag that "the conservative tax people I know think the Senate bill is a pretty good idea." ...
Hassett explains that the current status of Internet sales taxes is crazy from an economic point of view because it disadvantages local businesses relative to non-resident vendors in a way that is highly distortionary.
Hassett also addresses the criticism that this tax will be a nightmare for small businesses to comply with, given the potentially thousands of different tax rates, laws, and jurisdictions to navigate. "All those jurisdictions are imponderable to a human brain but are pretty easy for even the simplest computer programmer," he points out. "If small retailers have to do that, there's probably an app for that that you can buy for a quarter…Put it this way, these are people who are savvy enough to set up an Internet business, but the argument is that we can't ask them to withhold sales tax because they can't figure out the computing end of that? That seems like a stretch to me."
I think Kevin Hassett somewhat understates the complexity induced by 8000+ potential ever-changing local sales tax jurisdictions that disagree on whether a Twix bar is candy, and of parsing 1,437-word memos on whether an ice-cream sandwich is or is not taxable in Wisconsin.

The problem isn't just knowing what tax rates are in place in which jurisdictions; it's figuring out which of your products wind up being subject to which taxes in which places. Easy enough for Twix bars: set up the spreadsheet that says where it's taxable. Suppose you stock some local producer's ice cream sandwich as one of your thousands of products and find out that whether it's taxable in some jurisdictions depends on how it conforms to memos like Wisconsin's. I just can't see a 25-cent app being able to tell whether that ice cream sandwich is taxable.

Hassett is right that it would be dead simple in a world where the different jurisdictions only varied in the rates they charged over categories that were identically defined. But that sure isn't America.

Update: Imagine that you're a state legislator and some big local producer comes in wanting protection from out-of-state products. Now it's illegal to prohibit the import of out-of-state products: Commerce Clause. But you could set up a special set of state tax codes around that product that are just such a darned mess to figure out (tax the 1,437-word memo as example) that nobody from out of state can figure out what tax to charge. And then sue the pants off anybody who fails to comply. Pretty soon, nobody ships that stuff to your state. Ta-dah.

Update 2: The Bill does go some way towards reducing complexity. Participating states must have their local tax authorities on a common base, even if rates can differ. But I can't see anything prohibiting things like Wisconsin's ice-cream sandwich tax complexity. They'll have to provide a database listing the rates and exemptions for things, but somebody from out of state still has to figure out just where his ice-cream sandwich sits. Caveat: I'm not a lawyer.


  1. One thing that doesn't seem to have been considered so far is how this is going to affect re-shippers, in particular NZ Post's "YouShip" service. As I understand it, from the vendor's perspective goods are simply shipped to a warehouse somewhere in the US, after which NZ Post reposts the goods to the NZ purchaser--the vendor has no idea that the purchaser is not in the US.
    The problem here is that the vendor will now be charging GST (or whatever the US calls GST) on the goods, at the rate applicable in the state where the warehouse is located. Contrast this with the situation where the vendor ships directly to NZ--no tax would apply.
    It's not a major issue in the big scheme of things, but it is bad policy (exported goods shouldn't be subject to GST), and it will make re-shipping services less attractive than they previously were.

  2. There are two easy solutions for federal countries like the U.S. and Canada. (Easy, that is, except in a public choice sense.)
    1. Make indirect taxation an exclusively federal jurisdiction, setting a highish broad-based value-added tax that is common across all states/provinces.
    2. Change the tax from zero-rating exports and taxing imports, to the reverse. If that sounds crazy, remember the Lerner equivalence theorem: an export tax and an import tax are equivalent in their effects (both tax trade). Shifting from a 10% import tax to a 10% export tax would cause an offsetting depreciation of 10% and leave after tax prices unchanged, but with an important exception. Now imports that take the form of leaving the jurisdiction and consuming overseas are effectively brought into the tax net, while exports sold within jurisdiction (haircuts to tourists, for example) are effectively exempt. And the optimal way of dealing with out-of-state internet purchases in this world? Tax at origin not destination.

  3. The warehouse then just needs to be sited in one of the five-or-so states without a sales tax.

  4. Interesting nugget: I HAVE been asked where I live when shopping at a Walmart on the Washington/Oregon border.

    Confused the hell out of me, but it turns out they were collecting sales tax for both. (and charging a different rate.)

  5. I thought I remembered that VA police would keep an eye out for VA residents going to DC liquor stores to evade higher VA taxes, but I couldn't find anything on it online and wasn't sure enough about my memory...

  6. I was told a story many years ago about how Massachusetts would not allow their residents to buy tax-free alcohol in New Hampshire and then carry the liquor across the state border. Massachusetts cops would hover at New Hampshire liquor stores close to the MA border, and radio back the licence plates of buyers to other cops sitting just on the other side of the border. So New Hampshire responded by having their cops arrest the MA cops for loitering!

  7. Rival police gangs fighting one another. I approve.

  8. Since I grew up in Northern VA the reason the residents went to DC to purchase liquor was because the prices were cheaper. Virginia sold liquor via state run alcohol beverage control stores(ABC). DC had private businesses selling liquor who drummed up business by aggressively promoting their products. Over a period of years Virginia decided it was wiser and simpler to allow VA grocery stores to competitively price beer and wine and to allow the ABC stores to competitively price their liquor than to ask police officers to monitor liquor sales at the border. The simple solution won but it took many years and a lot of complaining by local residents and grocery stores.

    If we try to look for a simple solution to internet sales tax we do not have one for either the small businesses or the smaller states. If I had a choice of creating a small business that was tax exempt or expand one that would pay internet sales taxes, I would choose to create a tax exempt business. Internet retailing is brutal so any advantage I get on Amazon is good! What can California do? Sue me in civil court!? Good luck with that!

    Does anyone think it will be cost effective for Alaska and the other smaller states to try collect internet sales tax? I am sure there are state employees who are dreading the thought of thousands of sales tax applications that will result in little to no tax revenue. All that work for so little money. Isn't this the same situation as posting police officers at the border to catch out of state liquor sales? Customers are amazingly adaptive. I would not be surprised if we create a new market for package forwarding from states that do not collect sales tax. If the internet sales tax is not as simple to implement as the payroll tax, it will fail. Simplicity wins in the end.

  9. I had thought that VA had cops sitting at the DC liquor stores, recording plate numbers for later catching at the bridges.

    Is any state's sales tax high enough to warrant transshipment? I suppose for some high value, low weight products. Ekh...what a mess.

  10. PA does the same thing to stores just across the border in MD. My cousins have a habit of turning south out of the parking lot and then turning around down the road.