The much-watched Senate vote last month on ethanol has been heralded by some as the beginning of the end of tax loopholes. On behalf of the states for which I work, I hope that prediction is true.
Congress has a predilection for creating special-interest exemptions in the federal tax code and a long and sordid history of doing the same to state tax bases. Even now, as states struggle with lagging revenue, increased needs and balanced-budget requirements, there are numerous bills in Congress to exempt special interests from state taxes — for rental cars, cellphones, online travel services and “digital goods.” Such efforts include a splashy communications strategy and sound bite justifying the exemptions as preventing “discriminatory” taxation. But in reality, they all preempt state taxing authority to give special tax treatment to the politically well-connected.
For Congress, state tax preemptions are attractive because none of the normal fiscal rules apply. There is no Congressional Budget Office score, no pay-as-you-go rules, no appropriations — it’s all a “free” tax cut using state tax dollars.
The most pernicious erosion of state sales tax bases is the proliferation of the sales of goods and services on the Internet — goods and services that if purchased from a local business would have sales tax collected. In other words, Internet sellers receive a tax subsidy for much of what they sell. This is unfair to local retailers that not only collect sales taxes but also contribute to the local economy, pay state and local taxes, operate as showrooms for Internet sales and technical services, create most of our jobs and contribute to our communities by sponsoring Little League teams and more.
Legislation under consideration, known as the Main Street Fairness Act, would reverse the decades-old federal court case that created this problem, but it faces some familiar foes. Namely, opponents claim that closing this loophole is a tax increase, a tax on the Internet and an administrative nightmare for business.
Of course, it is not a tax increase — it is a means of collecting taxes owed. In most states, the consumer is legally responsible for reporting and paying sales tax on out-of-state purchases. As such, the Internet encourages tax avoidance; the lack of an effective system to collect sales taxes at the time of purchase causes many Americans to incur — but not pay — the taxes they legally owe. This legislation is no more a tax increase than when a company that has not paid into the Social Security system on behalf of its employees is made to do so.
Collecting sales tax on items sold online is not a tax on the Internet; it’s a tax on the goods and services that happen to be sold over the Internet. If watches are sold out of the trunk of a car, should they be tax-exempt because it’s a “mobile platform” without a permanent physical presence?
Administrative complexity is the closest that opponents come to a legitimate argument. Indeed, the Supreme Court ruled against states in Quill v. North Dakota precisely on the grounds that it would be too hard to collect all of the different state sales taxes. Since that ruling, at least two facts have changed: (1) the proliferation of computers to calculate taxes due on sales — just as shipping costs are determined based on Zip code — and (2) a state agreement on streamlining and simplifying sales taxes so that there is only one point of collection per state and only a few tax rates per state. Does anyone really believe that a business that operates on the Internet cannot also compute the amount of tax owed?
Allowing Internet sellers to escape sales taxes also means that state and local governments will be forced to rely more heavily on personal and corporate income taxes, undermining consumption taxes that economists mostly favor.
Internet retailers justify their position with claims of new and innovative business models that reduce costs by eliminating the middleman. But if they are so efficient, why do they need continuing tax subsidies?
States are under enormous fiscal pressure. All states must balance their budgets, and the erosion of the sale tax base means less money for education, transportation, infrastructure and the myriad services that states uniquely provide.
There are thousands of organizations focused on Washington, trying to preserve federal funding for their specific programs while Congress tries to cut spending. Constituents might be well served if lawmakers closed this glaring loophole so states can collect what they are owed, and helped prevent the creation of other special-interest exemptions.
The writer, a former director of the Congressional Budget Office, is executive director of the National Governors Association. The views expressed here are his own.