Internet tax far more than a fairness issue

Steve Knopik, CEO of $1 billion retailer Beall's Inc., looked across the lunch table straight at his target with steely eyed seriousness and said, “How is that fair?”

How is it fair that his company is required to charge and remit Florida's sales tax, and out-of-state Internet-only retailers that sell to Floridians are not?

How is it fair that Beall's is required to charge and collect the tax and Amazon.com isn't?

“It makes us less competitive,” he said, referring not only to Beall's but to all of Florida's brick-and-mortar retailers.

The conversation was approaching simmer, just as the issue itself — expanding state sales taxes to out-of-state Internet-only retailers — is on the verge of boiling in Congress and the Legislature ... and likely on the verge of passing in the U.S. Senate.

But mark these words: If Congress and the Legislature adopt their respective Internet bills as they are written today, consumers here and nationwide will rue the day.

They not only will be paying more taxes that will fuel the size, scope and spending of an already-gargantuan government, but they will unravel crucial principles our Founders adopted to promote and protect freedom and to avoid the tyranny of a too-powerful central government. These principles — established in Articles I, IV and VI in the Constitution (see box on page 18) — assured the sovereignty of the states and promoted economic competition among the states as a way to restrain them from their own runaway taxation.

Few people realize it, but this issue of expanding sales tax collection to Internet-only retailers is not the battle most people think — one of leveling the playing field and tax fairness for brick-and-mortar retailers versus Internet-only retailers. It goes far deeper than that.

What's more, there is a better way to settle this issue than the bills in Tallahassee and Washington, D.C.

State THINKS it's cheated
It's remarkable how Internet-tax proponents have framed the issue. They don't see it as imposing a new or expanded tax grab on consumers. They see it as an issue of the states being deprived or cheated out of money that is rightfully theirs. As one Florida legislative study reports, Florida's treasury is deprived of about $450 million a year in lost Internet sales-tax revenue that isn't collected by out-of-state retailers.

Technically, the Internet-tax proponents are right. By law, the state is indeed entitled to that lost sales-tax revenue. Here's why:
In Florida, it's a “sales-and-use” tax. When consumers buy retail goods in other states and bring them back for use in Florida, they are legally obligated to pay the state sales tax.

But few people ever pay — except, say, when they register new vehicles or boats purchased out of state. Those purchases require registration with the state, and it can track you down.

Likewise, it's virtually impossible for the state to enforce or collect the sales taxes on out-of-state purchases. Can you imagine all of the tax snoops that would be required to chase down everyone's Internet or out-of-state retail purchases?

Because of consumers' unwillingness to pay those out-of-state sales taxes directly, the Internet-only retailers have become the tax-collection evaders. The bad guys. They are logical targets for lawmakers who constantly seek more money to feed the insatiable government money pit. As the rationale goes, if you can't get consumers to own up and pay, then collect the money at the source of the out-of-state Internet sale and remit it to the appropriate state. After all, the argument goes, it's not fair that the Internet retailers don't carry the same burden as the brick-and-mortar stores. It's all about fairness.

To an extent, those favoring the Internet tax are right. Good tax policy should not favor some goods and channels over others. But claiming the Internet-tax as a fairness issue to level the playing field is also hypocritical. Just look at Florida's patchwork quilt of more than 200 sales-tax exemptions that favor one industry over another.

What's more, requiring out-of-state Internet retailers to collect and remit sales taxes is fraught with practical and, more importantly, constitutional problems.

Constitutional issues
To begin, think of the practical consequences. Imagine the burdens on small to mid-size Internet-only retailers required to manage and know all of the sales-tax rates, rules and nuances of 7,500 tax-collecting jurisdictions throughout the United States. They would have to hire sales-tax specialists just to meet all of the filing and accounting requirements. This would spawn a new industry of tax preparers.

Representatives of Amazon and Wal-Mart Inc. say no big deal. All of this activity can be done with software coding. Yes, but a higher cost of business nonetheless.

New accounting and filing schemes are only two of the issue's many tentacles. Here's another: who benefits from the taxes that are collected.

When retailers collect and remit sales taxes in Florida, those taxes help pay for state and local government services — streets, public schools, parks, social programs, etc. — that benefit Florida's citizens and businesses. Florida-based retailers use some of those services for which they collect the taxes.

But what benefits, say, do a Levenger or Frontgate, two prominent out-of-state Internet retailers, gain from being Florida's tax-collecting proxy? Neither of them consumes any government services in Florida.

When this point was made at the TaxWatch luncheon, Beall's Knopik noted that Amazon trucks (which are third-party contractors) use Florida roads to deliver the big retailer's packages. Presumably, though, those trucks are paying gas taxes to cover their use of our roads.

That's the practical side. Now consider the constitutional.

A larger and dangerous consequence of forcing out-of-state retailers to collect Florida's sales tax is one of power: specifically, the authority that would be conveyed to states over out-of-state retailers.

As the Heritage Foundation explains, the “Marketplace Fairness Act,” the misnamed legislation in the U.S. Senate, “would allow states to impose taxes in a way that favors their local businesses over out-of-state firms.” If you think that through, that's another way of saying giving states power over retailers outside their borders is unequivocal taxation without representation.

Equally bad, expanding sales-tax collections to out-of-state retailers would create the incredibly slippery slope of cross-border taxation, a concept the Founders prohibited for good reason. It's not beyond reason to imagine how lawmakers would extrapolate the fairness logic they use for the Internet tax: What applies to local retailers should apply to Internet retailers.

So imagine this horror: If Tallahassee were given authority to lay claim to taxing Floridians' Internet purchases from Amazon, what's to stop Tallahassee from going a step further and laying claim to any retail purchase you make in other states?

In other words, what's to stop Tallahassee from requiring all out-of-state retailers to ask for your domicile identification at the point of purchase to charge the proper sales tax?

To be sure, this is far more than a brick-and-mortar fairness issue. Think of the proverbial camel's nose in the tent.

The issue of 'nexus'
The writers of the Constitution clearly saw the danger of this, and thus in the first Article of the Constitution explicitly prohibited cross-state taxing. This is the Commerce Clause. In Article I, Sections 9 and 10 (see box above), the Founders said no tax shall be laid on articles exported from any state; no state shall enter into agreements or compacts with other states without Congress' consent.

The Founders understood it was crucial to liberty to keep the federal government from becoming what England was (and what we have today) — a centralized, tyrannical, taxing monstrosity — and that it was equally important to keep state governments from becoming tyrannical as well.

They saw that economic and tax competition among the states served as powerful incentives to keep states' tax rates low, operate efficient state and local governments and take steps to win the allegiance of their citizens and businesses. (Sound familiar? The Rick Scott doctrine: low taxes and the best business climate.)

In the 237 years hence, particularly in the past century, states have tried at various times to get a piece of more revenue from interstate commerce transactions. So far, though, the U.S. Supreme Court has thwarted these efforts, with one exception. If there is “nexus,” the states can require businesses to pay the tax.

Nexus essentially is this: Maryland-based men's clothier Jos. A. Bank is a big Internet retailer. It also operates about 30 stores in Florida. If you purchase a Jos. A. Bank dress shirt online, because of its stores in Florida, Jos. A. Bank has “nexus” and is required to charge the Florida sales tax for that online sale.

If you order an Internet item from a company that doesn't have stores in Florida, but has “dealers,” employees or representatives selling the product, the company also has nexus. If a company delivers Internet-sold items to Florida in company-owned trucks, the Legislature says the company has nexus.

No surprise, then, state lawmakers all over the country, including Florida, are trying to expand the definition of “nexus.”

The risk, of course, is whether the states' definitions will conflict with Supreme Court rulings that so far have upheld the Commerce Clause. This is why Florida's proposed Internet bill appears stalled in the Legislature. Lawmakers apparently are eager to see what Congress does with the “Marketplace Fairness Act” because Congress has the authority to change the nexus barrier.

The court has even said in rulings upholding the Commerce Clause that this complex issue of sales-tax collections is ripe for Congress to address. Universally, legislative and tax experts agree: The current sales-tax regimes are not attuned to a digital age. Change is coming.

A new bureaucracy
Unfortunately, as the “Marketplace Fairness Act” is written, Congress appears headed toward doing almost exactly the opposite of what the Founders wanted.

Senate Bill 1832 would create a compact among states — the Streamlined Sales and Use Tax Agreement — that would require all sellers, even those without “nexus,” to collect and remit sales taxes. Of course, the bill also creates special exceptions — sellers with annual sales of less than $500,000.

This compact would require states to adopt uniform practices, such as the same list of goods to be taxed and same methods of administration. Proponents of this compact talk of creating “harmonization” and “simplification.”

Yet, predictably, via the establishment of the Streamlined Sales and Use Tax Agreement, the states' compact would create a new government bureaucracy. It would have a “governing board” of representatives from each state. And this board would have the power to “employ staff, advisers, consultants or agents”; create and “promulgate” rules and regulations; and allocate the cost of the administration among the member states.

You get the picture: the birth of our version of the European Union. Count on it.

Even scarier, you can imagine Congress, in the name of the ultimate in harmony and simplicity, could take this compact a step further and legislate a national uniform sales-tax rate. And you can bet that tax rate would do only one thing once instituted: go up.

It doesn't take much of an intellectual leap to realize that what is lurking in the “Marketplace Fairness Act” is the eventual creation of a federally sanctioned, 50-state, sales-tax cartel. In other words, the end of what the Founders created, the end of economic and tax competition among the states.
Talk about unfair.

Origin-based sales tax
What should be done?

First, contact Sens. Marco Rubio and Bill Nelson and urge them, strongly, to vote “no” on Senate Bill 1832, the “Marketplace Fairness Act.”

It's a Trojan Horse.

There are a variety of alternatives, none of them perfect, many of them not politically feasible or palatable. A sampling:
• Do nothing.
Who's being harmed? In the 10 years Congress has avoided addressing this issue, Internet retail sales have reached about 10% of total national sales and are expected to grow to 15% in the next few years.
While brick-and-mortar retailers will continue to bemoan the Amazons, another way to look at the issue is Internet retailing is just another form of what Joseph Schumpeter called “creative destruction,” or to put it less onerously, disruptive innovation.
If Congress does nothing, the brick-and-mortar retailers will do what they've been doing: learning to cope and adjust.
From the consumers' perspective, doing nothing is a plus.
• Refine the definitions of “nexus.”
While Congress could provide more certainty over what constitutes nexus, state and local governments don't want Washington meddling in their abilities to levy taxes.
• Eliminate all sales-tax exemptions in Florida, including on services, and dramatically lower the tax rate.
This would help Florida's brick-and-mortar retailers address the competitiveness issue, but the politics of this in Tallahassee would be too much for lawmakers to bear.
• Eliminate the sales tax altogether and adopt a savings-exempt income tax.
This is totally unrealistic in Florida. Floridians would never accept a state personal income tax.
But ... if state sales-tax collections erode over time, alternative sources may be needed. And to a large degree, a savings-exempt income tax is a hybrid form of a sales tax. Think of it this way: The sales tax is a tax on consumption of goods. A savings-exempt income tax (subtract your savings from your total income) would be the same thing — paid once a year at income-tax time rather than at the point of sale. Just as the Legislature sets the sales-tax rate, it would set the income-tax rate.
It makes sense. It would never fly here.
• Have all states adopt an origin-based system of sales-tax collection.

This is the best option.

The way most sales-and-use taxes are structured, they target the destination and user of the good. The origin-based sales tax would be a system whereby every retailer collects the tax at the point of sale and remits it to the state where the retailer resides. For instance, all Amazon-collected sales taxes would be remitted to the state of Washington — clearly a boon for that state.

Lawmakers and politicians hate this idea because they fear it would trigger what they call a race to the bottom. To remain competitive and keep businesses and residents, states and local governments argue, they would be forced to lower their sales tax rates. And this is a bad thing?

An origin-based tax would also eliminate other problems: It would level the playing field between brick-and-mortar retailers and Internet-only retailers. It would minimize the burden on retailers of having to deal with out-of-state sales-tax rates. It would eliminate nexus issues. It would preserve buyers' privacy (no need to tell retailers your domicile). It would eliminate the “use tax.” It would maximize the amount of sales taxes collected. And it would preserve and promote jurisdictional tax competition — a great thing for taxpayers.

Don't expect to see the origin-based sales tax emerge. It's a concept that is beyond most politicians' ring of risk taking. Politicians, understandably, are far more comfortable legislating in the margins and proffering nice-sounding bill titles like the “Marketplace Fairness Act.”

But as economics Professor Thomas DiLorenzo of Loyola College of Maryland recently wrote: “Whenever Congress starts talking about 'marketplace fairness,' it's time to hold on to your wallet.”

Call your senator. Tell him “no” on the Internet tax.

Commerce Clause
• Article I, Section 8, Clause 3 (the “Commerce Clause”) “[The Congress shall have power] “To regulate commerce with foreign nations, and among the several states, and with the Indian tribes.”
• Article I, Section 9, Clauses 5 and 6: “No tax or duty shall be laid on articles exported from any state. No preference shall be given by any regulation of commerce or revenue to the ports of one state over those of another: nor shall vessels bound to, or from, one state, be obliged to enter, clear, or pay duties in another.”
• Article I, Section 10, Clauses 2 and 3 (additional shipping / trading protections): “No state shall, without the consent of Congress, lay any imposts or duties on imports or exports . . . [or] lay any duty of tonnage. . . . ”
• Article I, Section 10, Clause 3 (the “Compact Clause”): “No state shall, without the consent of Congress . . . enter into any agreement or compact with another state, or with a foreign power. . . . ”
• Article IV, Section 2, Clause 1 (the “Privileges and Immunities Clause”): “The citizens of each State are entitled to all the Privileges and Immunities of Citizens in the several States.” (Intended to prevent states from discriminating against constitutional rights of out-of-state citizens.)
• Article VI, Clause 2 (the “Supremacy Clause”): “This Constitution . . . shall be the supreme law of the land.” (Made it clear that when state laws came into conflict with each other or national laws, federal law was to prevail.)

'Nexus'
How Florida Senate Bill 316 defines nexus:
In addition to the nexus creation provisions of current law, that an out-of-state dealer has nexus with Florida and is therefore obligated to collect tax if a person other than the dealer (excluding common carriers) engages in any of the following activities within Florida:
• Sells a similar line of products as the dealer and does so under a similar business name;
• Maintains an office, distribution facility, warehouse, or similar place of business to facilitate delivery of products or services sold by that dealer to in-state customers;
• Uses trademarks, service marks, or trade names that are the same or substantially similar to those used by the dealer;
• Delivers, installs, assembles, or performs maintenance services for the dealer's Florida customers;
• Facilitates the dealer's delivery of property to customers in this state by allowing the dealer's customers to pick up property at a distribution, warehouse, or similar place of business maintained by the person;
• Conducts any other activities in this state which are significantly associated with the dealer's ability to establish and maintain a market in Florida for the dealer's sales.