Here’s how a small-business exemption could undermine online sales tax legislation

November 20, 2013

As Congress continues to wrangle over legislation requiring online sellers to collect sales tax, one of the key sticking points has been whether to include an exemption for small merchants, shielding them from what some say would be overly burdensome administrative requirements.

New research from the very agency charged with supporting small businesses, however, suggests that a small-business safeguard could actually undermine some of the original intent of the legislation.

The analysis, conducted by economists at the University of Tennessee and published by the Small Business Administration’s Office of Advocacy, shows that a small-seller exemption included in a bill approved by the Senate, for instance, would reduce by about half the additional revenue states could collect as a result of the law. In addition, it would limit the degree to which the law levels the playing field for online and brick-and-mortar retailers.

“This is a tough issue for small business owners,” Winslow Sargeant, chief counsel for the SBA’s Office of Advocacy, said in a statement. “On one end of the spectrum, a small-seller exemption would reduce burdens for small online retailers. On the other end, brick-and-mortar stores without an online presence would continue to collect sales taxes.”

At issue are proposals like the Marketplace Fairness Act, approved by the Senate in April, which would give states more authority to collect sales tax on transactions made over the Internet. Supporters say the legislation is overdue, arguing that online retailers have an unfair advantage over their brick-and-mortar counterparts, whom are required to collect sales tax.

Conversely, responsibility for online sales tax currently falls on shoppers, but states rarely enforce compliance. So, lawmakers are trying to shift the onus to the sellers, requiring them to collect the proper tax rates for the state in which each buyer lives.

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In the weeks leading up to the bill’s passage, critics warned it would pose an administrative nightmare for small online sellers, who would be forced to navigate the country’s 9,600 state and local taxing jurisdictions. Senators responded by including an exemption for firms with less than $1 million in annual sales.

Months later, House Judiciary Committee Chairman Bob Goodlatte (R-Va.) released an outline for a similar bill in the lower chamber, but without the small-business exemption. In the outline, he argued that tax laws “should be so simple and compliance so inexpensive and reliable as to render a small business exemption unnecessary.”

The SBA’s new study finds that an exemption would “reduce the potential revenue gains to state and local governments by exempting a portion of online sales from taxation”—and it’s no small portion.

A safeguard for merchants with less than $1 million in annual sales would prevent states from collecting taxes on more than $100 billion worth of online commerce, representing 42.7 percent of all sales over the Internet. Based on an average national sales tax of about 9.6 percent, the Marketplace Fairness Act’s exemption would short state and local governments out of as much as $10 billion every year compared to a bill without a small-seller safeguard.

Still, even a smaller amount of tax revenue would still be considerably more than states are now collecting, noted Janemarie Mulvey, chief economist for the agency’s Office of Advocacy.

That may be little solace to brick-and-mortar retailers , who would continue to face virtually the same handicap compared to many of their online competitors.

“Main Street vendors — small and large alike — would continue to be disadvantaged relative to many online and mail-order vendors that would be protected” by a small-business exemption, Bruce and Fox wrote.

“The final decisions on whether and how to implement a [small-seller exemption] therefore require careful consideration of whether the reduced administration and compliance costs are worth the loss in economic efficiency and state and local revenue,” they added.

Follow J.D. Harrison and On Small Business on Twitter.

J.D. Harrison covers startups, small business and entrepreneurship, with a focus on public policy, and he runs the On Small Business blog.
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