Are Online Sales Taxes Only Fair?

The Marketplace Fairness Act imposes an unnecessary burden.

At a 2008 shareholders meeting, Amazon founder and CEO Jeff Bezos explained why he opposed requiring businesses like his to collect state and local taxes on their interstate sales. "We're not actually benefiting from any services that those states provide locally," Bezos said, "so it's not fair that we should be obligated to be their tax collection agent."

Last year Paul Misener, Amazon's vice president for global public policy, testified in favor of a bill allowing states to demand sales tax from online merchants, saying Congress should "level the playing field for all sellers." As that switcheroo suggests, there are plausible fairness arguments on both sides of this issue. And although there is a way to bridge the gap, it is not the route Congress seems intent on taking.

The Marketplace Fairness Act, which Congress is expected to approve soon, sounds like something out of an Ayn Rand novel. But it reflects understandable complaints from brick-and-mortar retailers who believe their online competitors have been enjoying an unfair advantage for way too long, thanks to Supreme Court rulings that bar a state from requiring a business to collect sales tax unless the company has a physical presence in that state.

Shoppers are still legally obligated to pay their state's sales tax on items they buy online, but few are aware of this notional requirement and even fewer comply with it. The upshot is that online sales are effectively tax-free, unless you happen to live in the same state where the merchant is located.

At the average combined state and local tax rate, the savings amount to about $9 on a $100 purchase. That's not a huge difference, but it helps online merchants (and hurts their offline competitors) to the extent that it makes people care less about shipping charges.

At the same time, companies with customers throughout the country are understandably worried about complying with the multifarious demands of the 9,000 or so jurisdictions that have the authority to impose sales taxes. That burden is less daunting to big companies like Amazon (which might even be said to enjoy an unfair advantage in that respect) than to their smaller competitors. In partial recognition of that reality, the Marketplace Fairness Act exempts merchants with less than $1 million in annual out-of-state revenue.

The bill seeks to reduce the compliance burden by requiring each state to offer free software allowing merchants to calculate sales tax and file a single return for all taxing authorities within the state. States could not audit a business more than once a year.

Still, that's 46 returns (45 states with sales taxes plus the District of Columbia), which have to be filed monthly or quarterly, and 46 potential audits every year, not to mention all the misunderstandings, disputes, and hassles that fall short of an audit. You can start to see why the Supreme Court deemed collection of sales taxes from remote vendors an unconstitutional burden on interstate commerce.

But the Court also said Congress, under its power to regulate interstate commerce, could authorize such tax collection, which is what it is poised to do. Unfortunately, it has overlooked a simpler, fairer, and smarter way of letting states get the revenue they crave.

In a 2011 paper published by the Mercatus Center at George Mason University, Veronique de Rugy and Adam Thierer recommended "an 'origin-based' sourcing rule for any states seeking to impose sales tax collection obligations on interstate vendors." Under that rule, which mirrors what happens when you buy something while visiting another state, each business collects sales tax on behalf of the state where it is based, no matter where the customer happens to be.

The beauty of this approach is that it treats all retailers equally, eliminates the daunting challenge of dealing with many different taxing authorities, and respects state policy choices while encouraging tax competition between jurisdictions. Evidently the idea makes too much sense for Congress to consider.