FreedomWorks Foundation Content

Internet Taxes Don’t Make Markets Fairer

The issue of how to handle sales conducted remotely over the internet has been a thorny one for lawmakers, as they struggle to adapt policies to rapidly advancing technologies. Nine states currently collect sales tax on out-of-state, online transactions, but a new bill dubbed the Marketplace Fairness Act of 2013 would expand this to a national mandate. The argument behind such legislation is that local retailers are placed at an unfair disadvantage, because their prices must include sales tax whereas out-of-state vendors are under no such compulsion.

The whole situation has the whiff of the famous Luddites, infuriated by the march of technology and unwilling to adapt themselves or their businesses to new methods of production. The claim that online retailers have an “unfair” advantage rests on a very peculiar definition of the word. How is it unfair to innovate, to discover a better business model? Fairness in this instance seems to mean penalizing innovators to protect industry dinosaurs.

A principal problem with the Marketplace Fairness Act is that it effectively eliminates the ability of states to compete for business. A fundamental principle of the federalist system is the states’ autonomy to manage their own economies, and competition ensures that state governments acting badly will see a corresponding loss in tax revenue as businesses and citizens relocate. This is the idea of “voting with your feet,” and it is a vital part of a free economy.

For online retailers, this act would offer no reason to physically locate in one state over another, and reduce the incentives for states to keep sales tax rates low. If business are not free to relocate to avoid rising tax rates, there will be very little reason for states to restrain their urge to tax, and the consumers will pay the price.

While it’s true that the act requires states to simplify their tax rates to reduce the administrative burden on companies, there is still no getting around the fact that an online retailer who wants to service the entire country will have to keep track of dozens of different tax policies, whereas local retailers only have to deal with one. So much for leveling the competitive playing field.

The fair competition argument also overlooks the fact that online retailers face other expenses from which brick and mortar stores are exempt, the most obvious example being shipping costs. Whereas the customer of a physical store can simply carry his purchase home with him, an online seller must either bear the cost of delivery or pass it on to the consumer. This is usually far more expensive than any sales tax rate currently on the books. Additionally, physical stores offer an immediacy that is impossible for mail order companies, where even the fastest shipping takes a considerable amount of time. These cost differentials are rarely mentioned in discussions of “fair” competition, and the notion that local stores need protection from their web-based competitors is questionable at best.

Finally, the benefit to consumers must be considered. It is undeniable that the economy has benefitted from the rise of the online retail trade, with a vastly expanded range of consumer options and a general lowering of prices that encourages commerce. A broader application of the sales tax would slow consumer spending and hurt businesses which form an important part of the American economy, at a time when we should be doing our best to encourage them.

If states absolutely must tax internet businesses, it would be far better to do so based on the origin of the company, rather than on the location of the consumer. Let a California based business collect California taxes. This simplifies the administrative problem while also preserving competition among the states. The destination based approach currently being proposed makes no sense, in that state governments collect revenue from businesses  who have chosen to locate elsewhere.

The issue of how to handle sales conducted remotely over the internet has been a thorny one for lawmakers, as they struggle to adapt policies to rapidly advancing technologies. Nine states currently collect sales tax on out-of-state, online transactions, but a new bill dubbed the Marketplace Fairness Act of 2013 would expand this to a national mandate. The argument behind such legislation is that local retailers are placed at an unfair disadvantage, because their prices must include sales tax whereas out-of-state vendors are under no such compulsion.

The whole situation has the whiff of the famous Luddites, infuriated by the march of technology and unwilling to adapt themselves or their businesses to new methods of production. The claim that online retailers have an “unfair” advantage rests on a very peculiar definition of the word. How is it unfair to innovate, to discover a better business model? Fairness in this instance seems to mean penalizing innovators to protect industry dinosaurs.

A principal problem with the Marketplace Fairness Act is that it effectively eliminates the ability of states to compete for business. A fundamental principle of the federalist system is the states’ autonomy to manage their own economies, and competition ensures that state governments acting badly will see a corresponding loss in tax revenue as businesses and citizens relocate. This is the idea of “voting with your feet,” and it is a vital part of a free economy.

For online retailers, this act would offer no reason to physically locate in one state over another, and reduce the incentives for states to keep sales tax rates low. If business are not free to relocate to avoid rising tax rates, there will be very little reason for states to restrain their urge to tax, and the consumers will pay the price.

While it’s true that the act requires states to simplify their tax rates to reduce the administrative burden on companies, there is still no getting around the fact that an online retailer who wants to service the entire country will have to keep track of dozens of different tax policies, whereas local retailers only have to deal with one. So much for leveling the competitive playing field.

The fair competition argument also overlooks the fact that online retailers face other expenses from which brick and mortar stores are exempt, the most obvious example being shipping costs. Whereas the customer of a physical store can simply carry his purchase home with him, an online seller must either bear the cost of delivery or pass it on to the consumer. This is usually far more expensive than any sales tax rate currently on the books. Additionally, physical stores offer an immediacy that is impossible for mail order companies, where even the fastest shipping takes a considerable amount of time. These cost differentials are rarely mentioned in discussions of “fair” competition, and the notion that local stores need protection from their web-based competitors is questionable at best.

Finally, the benefit to consumers must be considered. It is undeniable that the economy has benefitted from the rise of the online retail trade, with a vastly expanded range of consumer options and a general lowering of prices that encourages commerce. A broader application of the sales tax would slow consumer spending and hurt businesses which form an important part of the American economy, at a time when we should be doing our best to encourage them.

If states absolutely must tax internet businesses, it would be far better to do so based on the origin of the company, rather than on the location of the consumer. Let a California based business collect California taxes. This simplifies the administrative problem while also preserving competition among the states. The destination based approach currently being proposed makes no sense, in that state governments collect revenue from businesses  who have chosen to locate elsewhere.

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