Defeating Internet Sales tax may seem like a Herculean feat, since businesses and state government have aligned against the average taxpayer.  But Internet sales tax keeps getting squashed at the state level and it will get crushed at the federal level as well because it is simply a bad plan. 

There is a new tactic being taken at the state level by Virginia Governor Bob McDonnell.  His plan to rebuild the Virginia Transportation Fund gets rid of the gas tax and raises the sales tax from 5% to 5.8% and reallocates funding as such:

First, 1.125 cents of the 5.8 percent sales tax will be dedicated to public education ($310 million over 5 years). Second, 0.5 cents of the 5.8 percent sales tax will be given back to the localities to use at their discretion ($138 million over 5 years). Third, 0.5 cents of the 5.8 percent sales tax will be given back to the localities for local transportation priorities ($138 million over 5 years). Finally, 3.675 cents of the 5.8 percent sales tax will be provided to the Transportation Trust Fund ($1.02 billion over 5 years).

However to get to these numbers McDonnell requires the passage of the internet sales tax.  He looks to the potential ability of having out of state businesses collect Virginia Sales tax to increase Virginia state revenues, but ignores that he will be putting Virginia businesses under the jurisdiction of every other state’s department of revenue.  Requiring businesses to comply with other state revenue departments will be costly to business in terms of compliance and in dispute resolution. 

Just incase you missed it, McDonnell is setting up his Transportation Fund plan based on a federal law that does not exist, and likely will not pass.

Here is the long and short of why any implementation of internet sales tax is bad:

Flaws in the Internet Sales Tax Mandate

How it works

At the end of each year businesses are responsible for sales tax.  They can choose to tax their customers at the point of sale or pay out what they owe in sales tax at the end of the year.  Businesses therefore act as a tax collection arm for the state in which they do business.  The Internet sales tax mandate would force businesses to become sales tax collectors for all states.  For example, if a customer in New York State makes a purchase from a company based in Virginia, the Virginia business would have to collect New York sales tax from the customer and then send the collected tax back to New York.  At the end of the year if there are any disputes over sales tax collection the Virginia business would be subject to the New York Department of Revenue and New York Courts.

Slippery Slope

To some people, passing a federal law authorizing states to collect internet sales tax across their borders may seem like a small change. However, eliminating the need for businesses to have a physical presence in a state in order to be taxed encourages states to tax non-residents who have no recourse to fight against said taxes. Additionally, this change would provide a precedent for lawmakers to authorize a host of new taxes on internet usage, ecommerce, and other services associated with the internet. With a digital goods tax (a tax on digital music, e-cards, video game accessories, etc.) being considered in Congress and the Internet Tax Freedom Act of 1998, which protects taxpayers from taxes on internet access and other ways, expiring in 2014, the passage of an internet sales tax would be a dangerous boost to greedy coalitions pushing for more internet based taxes. Essentially, an internet sales tax is a step towards states increasing taxes on consumers they do not serve and would aid government efforts to profit from areas in which taxpayers are currently protected from taxation.

Too Confusing

If Congress were to pass an internet sales tax mandate, a small business, for example an individual who sells large amounts of jewelry on Etsy, would have to comply with a host of different tax codes for every state and municipality they sold to. With over 9,000 of these state and local tax codes, this would be confusing and an onerous burden to place on businesses that have thrived online precisely due to the lack of internet regulations and taxes.

Supporters of an internet sales tax mandate claim that software will be made available to ease the burden of compliance with so many tax codes, yet this software will have to be approved by all states and purchased.  For small businesses already struggling in the recession, this barrier to the market is a burden that cannot be afforded. In response proponents may point to a small seller exemption to alleviate the financial burden.  However, the mere inclusion of a small seller exemption is an admission that this tax scheme would cause harm to small business.

Some may argue that the Streamlined Sales Tax Agreement would eliminate the burdensome number of tax jurisdictions.  However, the legislation as introduced in the 112th Congress, gave states the option to either meet the SSTA standards or other minimum standards as laid out in the bill.  If states have not been able to agree on a SSTA in the last ten years, what makes us think that they will now, especially when given the option for meeting far lower standards?

Discourages Tax Competition

An internet sales tax mandate will create competition among states for higher taxes, rather than lower taxes. Currently, states can only tax those consumers who reside within their borders. This “physical presence standard” ensures that the businesses taxed by states have the ability to express their approval or displeasure with state tax code through elections, referendums, etc. Eliminating the physical presence standard means that states will increasingly seek to collect taxes across their borders from businesses with no recourse. Thus states will compete for revenue by increasing cross-border taxes, rather than lowering taxes. In difficult economic times when many cash-strapped states are desperate for revenue, an incentive for them to raise taxes can never be beneficial.

Expands State Tax Authority

States have always taxed those people and businesses within their physical borders because legal and judicial precedents clearly instruct them to do so. The Supreme Court ruled in a case titled Quill v. North Dakota that the Constitution’s Commerce Clause establishes the need for a business to have a physical presence in a state in order for that state to collect sales tax from it. An internet sales tax mandate would overturn this decision, and would also go against the spirit of laws such as the Internet Tax Freedom Act of 1998. The 1998 law banned taxes on internet access and other means of internet taxes in order to promote economic growth through the free and open internet. The benefits of such policies can be clearly seen in the success of both large internet companies like Amazon and small-selling platforms such as EBay. Expanding state tax authority by passing an internet sales tax mandate would be an unprecedented step that flies in the face of decades of legal and judicial policy.

Threatens Privacy

In order to collect the proposed internet sales tax, businesses would be forced to send personal information about their customers to a host of state revenue departments. This opens consumers up to the very real potential of losing personal information. In South Carolina, for example, hackers gained access to tax return data, including social security numbers, of 5.7 million people and 700,000 businesses. Hackers have consistently proven they possess the capabilities to overcome many security measures. Government agencies lack the expertise and resources to properly protect the personal information they already gather. A law that mandates they collect more information only opens more individuals and businesses to the dangers associated with the loss of personal data.