Free Money Online!

States scrounge in the couch cushions for more revenue, and find the Internet

Unless you live in Alaska, Delaware, Montana, New Hampshire, or Oregon, if you regularly buy things online then you are probably a tax cheat. Technically speaking, if you buy something online and don't pay sales tax as part of the purchase, you are obliged to pay the tax yourself (unless you live in one of the five states with no sales tax). It's safe to say, however, that vanishingly few people tacked that extra form onto their state and local tax returns two weeks ago.

As state budgets start to feel a little too snug for comfort (lots more on bloated state budgets in our May print edition) states are scrounging around for the tax equivalent of free money. The lowest hanging fruit is money citizens are spending or earning outside the state, much of it currently untaxed.

And where better to turn than the largely untaxed wilds of the Internet? Music downloads have a special allure for the taxman, with Wisconsin, California, and several other states trying for an "iPod tax" to capture revenue from online music purchases. Wisconsin legislators even had the chutzpah to try to include the online sales tax in their so-called stimulus bill. But Wisconsin is also trying to extract taxes from businesses headquartered within their borders on money earned outside the state—they call it the Las Vegas loophole.

Superficially, capturing online sales tax money looks like win-win for a state. Taxing online purchases or out-of-state earnings seems like getting something for nothing—the state doesn't have to provide any additional services, since the relevant business is already happening outside the state. Plus, adding tax to online purchases eliminates some of the allure of buying online. If you're not going to avoid taxes when you buy that new TV, you might as well schlep out and buy it at a bricks-and-mortar store in your home state to save on shipping and enjoy the instant gratification of an in-person purchase. This keeps local businesses humming and the tax base strong.

But this is a classic case of stealing from Peter to pay Paul. Increasing taxes online will further slow consumption of online goods, which has already proven to be one of the more robust modes of business as the recession slows our economy. And if online tax collection becomes onerous, this will only encourage mobile online businesses, already only tenuously tied to U.S. soil, to finally make the decision to flee the country for lower tax, business-friendlier climes (which, according to today's Wall Street Journal, means pretty much everywhere.)

Right now, the biggest hurdle for new online taxes is a 1992 Supreme Court ruling which prohibited states from requiring mail-order (and thus online) retailers to collect sales tax. The reasoning goes like this: Since every state has its own convoluted tax code, the burden on businesses catering to many states is simply too high. The Court essentially told Congress that unless states standardize their tax laws, online and catalog retailers were off the sales tax hook.

Never ones to give up on the prospect of a new vein of tax revenue, though, the states formed a Streamlined Sales Tax Project. There are now 22 states involved, and after nearly a decade, they have just about managed to come to an agreement on which goods should be taxable. This is a tougher question than it originally appears. The quandary is known in tax streamlining circles (yes, there are such circles) as the "Twix dilemma." Is a Twix a cookie, and therefore food, and therefore not taxable? Or is it candy, and therefore a snack, and therefore potentially taxable? The states in the Streamlined Sales Tax Project may have managed to settle that particular age-old question. But a tougher problem lies ahead: What should the universal sales tax rate be?

Still, legislators can't resist the allure of what could be $13 billion in new revenue, so they're asking Congress to go ahead and loosen up the laws. They promise to work out that Court-mandated standardization stuff real soon, honest. “This could qualify as a son of stimulus,” West Virginia state Del. John Doyle, (D-Jefferson County) told Congressional Quarterly. “This is something the federal government can do for the states that wouldn’t cost the federal Treasury a penny.” Doyle, unsurprisingly, heads up the streamlining project. On May 13, another big push will happen on the Hill, to beg Congress for a law that would authorize state sales tax collection online.

For every debate about relations between the states, there can be a macro version regarding the U.S. and its relationship with other nations. So, while states figure out how to extract tax money from businesses done on other states' territory, the United States is puzzling out how to grab cash from Americans earning abroad.

President Barack Obama is looking to force companies to "repatriate" more of the cash earned overseas, and to do it more quickly. Right now, companies have wide discretion about when to bring their earnings back to the U.S. and declare them for tax reasons, which means they can choose to do so whenever they will pay the least taxes. And if the money is "permanently reinvested" overseas, it is never gets taxed in the U.S. While this might sound reasonable, Obama sees it as a "loophole" that needs closing, just like those Wisconsin officials and their Los Vegas loophole. Like his state-level brethren, Obama is drawing the wrong lesson. Budgets are getting tight everywhere, but grabbing a little seemingly free money now could have bad long term consequences. Plus, everyone should know by now not to fall for those blinking "Win Free Money!" banner ads online. Those always end in heartbreak.

Katherine Mangu-Ward is an associate editor at Reason magazine.

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • Some Guy||

    As much as I love shopping tax-free online, I have to admit that it is giving preference to one form of business over another. If the shop across the street has to tax my widget, then allowing the store across the border not to isn't fair to the local store.

    That said, I agree with SCOTUS in that 50 sets of ever-changing laws is a quite a burden.

  • </||

    Fairness is for little girls on the playground.

  • classwarrior||

    The thing that annoys me in this debate is that most market-oriented economists (the ones Reason regularly quote) keep telling us that taxes should be low and broadly based. So it makes sense to tax online sales (when what to tax is sorted out). With all the advantages that online merchants enjoy over their bricks-and-mortar counterparts, the exemption of their business transactions causes big time economic distortions.

  • mr simple||

    It's actually perfectly fair since the state has no jurisdiction over the store across the border.

    That being said, fair is only clearly defined in baseball.

  • Government Tax Prospector||

    Thar's GOLD in them thar tubes!

  • zoltan||

    Wouldn't they be able to put some sort of import tax on stores "across the border"? I'm not sure what's been stopping them since now.

  • ||

    Wouldn't they be able to put some sort of import tax on stores "across the border"? I'm not sure what's been stopping them since now.

    The interstate commerce clause, properly applied.

    A state is justified in taxing sales made in-state, the argument goes, because the in-state vendor has a physical presence, benefits from the state government, and is under the jurisdiction of the state government. An out-of-state vendor has no such presence, reaps no such benefits, and is not under its jurisdiction.

    Take the logical next step: if doing business with a resident of State A means that a resident of State B has to remit sales tax to State A, why shouldn't the resident of State A have to pay income tax on its revenue from business in State A? If making sales in State A places you under the jurisdiction of State A for taxing purposes, why not for regulatory purposes?

    The current "physical nexus" requirement actually provides a reasonable bright line that prevents a host of ills. It ain't broke. No reason to "fix" it.

  • ||

    If the introduction of on-line sales taxes would be offset by a reduction in income taxes, classwarior might have a point.

    Additional taxes are additional taxes, no matter what form they take.

  • ||

    classwarior might have a point

    A point and an extra "r."

  • ||

    NutraSweet is correct. The scumbag fucks in government are looking for ways to tax more and not cut spending at all. If they get their hands on internet money, they will learn nothing, and our tax burden will just continue to increase (as it always does).

    They're looking to ream us in every little way possible, from upping DMV fees to taxing the internet to increasing property taxes to issuing more tickets. Government is a huge bloated parasite that will attempt to ride the fine line of being as big as possible before it weakens the host to the point of weakening itself.

  • ||

    Keep in mind, sales taxes are taxes on sales, imposed on and paid by the vendor (who typically tacks it on, transparently, to your price).

    They are not taxes on purchases, even though they feel that way because of the transparency of adding it to your bill.

    Applying a sales tax to an out-of-state vendor is taxing someone who the state has no connection with. If that isn't a really bad idea, I don't know what is.

  • Kolohe||

    To be a bit contrarian (but I haven't RTFA)
    I am broadly supportive of devolving more federal stuff back down to the states. And to do that, I am willing to revisit the interstate commerce clause.

    RC Dean is mostly correct, but states can and do put a 'use tax' for stuff brought in out of state that didn't have the normal sales tax applied. The Feds have put a moritorium of applying this to internet transactions that is scheduled to expire soon (next year?)

    Now the only state I know that really enforces the use tax is Hawaii, because it's the only one where 'interstate commerce' can be effectively monitored. (you can't just drive across the border, buy something and bring it back). However there is talk of doing stuff like increase in monitoring for specific items - like bringing cigarettes from down south into New York. Somewhere in this spetrum you do smack into both the plain and accepted meanings of the commerce clause, but I'm not sure where.

    Anyway, I fully acknowledge that this is a money grab from the state governments. But I am more interested in breaking down the federal leviathan, and am willing to accept a larger state govt where I theoretically have more control or at least have an easier exit if it becomes intolerable.

    What I also don't like (although this is mostly an east coast phenomenom) is large scale regulatory and tax arbitrage - which federal largesse simultaneously makes stable and feeds upon for it's own growth.

  • hmm||

    With all the advantages that online merchants enjoy over their bricks-and-mortar counterparts, the exemption of their business transactions causes big time economic distortions.

    I'd be interested in what advantages or disadvantages you think exist for each. From a business stand point most of the data I have looked at tends to lean towards the two businesses, B&M and online, about equal with advantages and disadvantages when compared to each other. There are, of course outliers in each group that have managed to break the mold for each group.

    More than one online start-up made the same assumptions I think you are making and soon realized such assumptions were not true.

  • Mad Max||

    If we were debating a broad initiative to reduce taxes and spending to reasonable levels, and in that context asking online retailers to pay their fair share of the resulting taxes, then that would be fine.

    In the current context, when the only "reforms" on the table (at the state level) involve tax increases, then this is *not* the time to talk about enforcing sales taxes on online transactions.

  • Justen||

    The argument against complex tax codes and obnoxious preotectionist tarriffs and such are easy enough to understand. What I don't understand is the counterargument that the guys who always seem to end up inhabiting government offices (presumably) go by.

  • Stevia||

    Get it?! STEVIA!!! It's sweet like Nutra...oh shit, nevermind.

    Anyhow, isn't there a type-o in the last paragraph: Los Vegas --> Las Vegas.

  • ||

    California requires paying sales tax on internet purchases. I live in California. Yet I don't report the tax. Why? Because I never bothered to keep records. Come April 15th I have no idea what I bought during the past year. I'm not about to keep a years worth of receipts (both physical and electronic) so I figure out what to pay to a fiscally irresponsible state. So screw 'em.

    Yeah, I'll get in trouble over it one of these years. I'll cross that bridge when I get to it. Hell, maybe I'll get disgustipated enough to leave the state before that happens.

  • Some Guy||

    Additional taxes are additional taxes, no matter what form they take.

    I see only spending as taxes. Spending has to be paid for, whether today or tomorrow. This just means slightly less borrowing against the future. Of course it'd be nice if they just didn't spend money they didn't have, meaning that taxes could actually be lowered (rather than deferred) but that's outside the scope of this post.

    I'd be interested in what advantages or disadvantages you think exist for each.

    In this case, the B&M store must either charge 6% (on average) less to have the same price, or must charge 6% more for the same profit margin. How is that not a disadvantage?

  • deja moo||

    Re: Vendor pays sales tax. I just bought a car. When I went to DMV to register, I paid the sales tax. What happens in a store is that the vendor collects the sales tax (as an unpaid agent of the state).

  • ||

    RC Dean is mostly correct, but states can and do put a 'use tax' for stuff brought in out of state that didn't have the normal sales tax applied.

    The use tax is mostly notional, because it relies on the customer to report and pay it. Its certainly theoretically possible, but it is practically a non-starter, and any attempt to seriously implement it would be politically radioactive.

    I just bought a car. When I went to DMV to register, I paid the sales tax. What happens in a store is that the vendor collects the sales tax (as an unpaid agent of the state).

    My understanding is that the vendor is liable for sales tax on all their retail sales, whether they collect it from you or not. The tax is imposed on them, and they pass it on to you. They are not allowed to not collect it and tell the state to go after you, the customer, for it if they want it.

    Cars are special case, I think, because you have to register them anyway (making it easy to hit up the buyer for the tax), they are a big ticket item generating serious sales tax (making it worthwhile to hit up the buyer for the tax), and so many used cars are sold by people who aren't commercial vendors (making it necessary to hit up the buyer for the tax).

  • ||

    In this case, the B&M store must either charge 6% (on average) less to have the same price, or must charge 6% more for the same profit margin. How is that not a disadvantage?

    I generally find that the sales tax I save on internet purchases is eaten up and more by shipping. Still, I'd rather pay UPS for a service they actually provide than throw the same money down the rathole of state finances.

  • Some Guy||

    To compare apples to apples, NewEgg has a warehouse in my state (NJ) so I have to pay tax to them, where Fry's does not and I don't pay tax. Either way I'm paying for shipping. But Fry's gets a "free" 6% out of the deal.

  • ||

    New York state requires you to pay NY taxes on any item purchased outside of the state, when a sales tax was not previously paid. It's a line on the state tax form. The form says you can not leave it blank, therefore you must declare how much tax you suppose to pay even if it's zero, under the penalty of prejury.

  • ||

    Yeah, we buy things out of state because the local state taxes are unreasonable. Its simple logic. The more you tax the less the public has to spend. Which means the stores don't need to stock it. Less jobs. The drivers don't need to deliver it. Less jobs. The distributors don't need to distribute it. Less jobs. The manufactures don't need to make it. Less jobs. Its fine though, legislate our country away... when we crash and burn we can rebuild it the right way again.

  • Mike Soh||

    I hate shopping at the Brick & Mortar stores because of sales tax. It's bad enough that Virginia taxes my income. Then they tax my car. Then they tax my property. It's like I getting rapped multiple times and I'm supposed to smile and ask for more.

    I will always refuse to pay sales tax as long as I pay taxes elsewhere. It's the one tax that's optional.

  • nike shox||

    is good

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