The Cloud

E-commerce: Click and Pay

A Senate bill would allow states that simplify their sales-tax laws to compel online retailers to collect taxes.
Economist StaffApril 3, 2013

The past few years have brought little relief for pinched state finances. But on March 22nd 75 senators, including majorities of both parties, approved an amendment to a proposed federal budget which, if enacted, would allow states to collect taxes on sales by internet retailers based in other states.

It makes no economic sense to tax sales in shops and over the internet differently. The prohibition is constitutional. In 1992 the Supreme Court ruled that states could not force out-of-state retailers to collect tax on sales to residents unless Congress, which oversees interstate commerce, said so. Only retailers with a physical presence—a “nexus”, in the legal jargon—in the state could be taxed.

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The economic consequences were relatively minor before Amazon and eBay appeared. Not any more. Since 1994, mail-order and internet sellers have grown from 2% of total retail sales to 7%. In the past five years, while retail sales have risen by 10% and total state and local taxes by 9%, sales-tax revenue is up just 2%. The National Conference of State Legislatures reckons that the court’s prohibition cost states $23 billion in lost taxes last year.

In theory, online customers are required to pay sales tax themselves. Unsurprisingly—since there are no means of enforcement, and no customs stations on state lines—few do. This galls traditional retailers like Best Buy and Target, who must charge tax not only in shops but also online in states where they have stores.

States have tried to find ways round the court’s ruling. Illinois redefined “nexus” to include local third-party affiliates who sell through larger web outfits, such as Amazon. Colorado ordered retailers to send customers a tax bill and report them to the tax collector. New York has defined “nexus’ to include any shop that can be reached by clicking through on a New York-based website. All have faced legal challenges: Illinois and Colorado have lost in court, although New York’s tactic has recently been upheld.

Retailers and state and local governments have long recognised that the ideal solution would be for Congress to allow states to tax the internet. But previous legislative efforts have stirred furious opposition from anti-tax activists and discomfort among many Republicans, who think this sounds like a new tax. Although the activists remain opposed, Republicans are increasingly sympathising with retailers and with local governments that are trying to build public works, such as sewers, while their tax base migrates into cyberspace. “You can’t flush your toilet over the internet,” says Mike Enzi, a Republican senator from Wyoming who spearheaded the amendment with Dick Durbin, a Democrat from Illinois.

The Marketplace Fairness Act, as the proposal is called, allows states that simplify their sales-tax laws to compel online retailers to collect taxes. In preparation for passage, 24 states have joined a coalition that harmonises and simplifies sales-tax collection, for example by using common definitions of goods that are subject to tax. That would soothe e-tailers’ worries about collecting different taxes in thousands of state and local jurisdictions. Amazon, one of the fiercest opponents of state-level efforts to collect internet taxes, backs the federal law, while warning against too high a threshold for exempting small sellers, now set at $1m. EBay, on the other hand, opposes any bill without a “robust” exemption. The law would not overturn the federal prohibition on taxing purely digital goods, such as internet access and e-mail.

Although a similar bill has bipartisan support in the House of Representatives, House leaders have yet to get behind it. Even the Senate must find another way to pass the legislation, since the March budget resolution is non-binding. Advocates believe that the best hope may lie in comprehensive tax reform. Buried in a slew of more sweeping changes, a heavier touch on e-commerce might go unnoticed.

© The Economist Newspaper Limited, London (April 23, 2013)