You've Got Sales Tax

flickr/ Mr. Boger

In 1984, CompuServe launched the first “Electronic Mall,” a Pleistocene-era Amazon with which owners of a TRS-80 personal computer could browse and buy goods over the Internet. Such modern retailers as “The Record Emporium” and “The Book Bazaar” were given prominent virtual storefronts. A full page ad in the May 1984 issue of Online Today boasted, “By the year 2000, the world may catch up with the way CompuServe’s new Electronic Mall lets you shop today.” The world took less time to catch up than that: By 1995, eBay and Amazon had been incorporated; in Amazon’s first two months as an online bookstore, it averaged $20,000 per week in sales. Americans would go on to spend around $700 million online in 1996, and by 1999 sales had grown to $20 billion. Figures released earlier this year by the Commerce Department revealed that Americans spent $225 billion online in 2012—a 400 percent increase in only a decade.

That number represents about 5 percent of the $4 trillion in total U.S. retail sales, but the amount is expected to double by 2017. CompuServe’s Electronic Mall ended up being prophetic. The allure of online shopping isn’t hard to understand: “I can do it naked,” one shopper told an ABC News poll.

Naked or not, there’s another reason Americans love to buy online: Most of us don’t pay sales tax when we do.

It’s a precedent that dates back to a 1992 Supreme Court decision exempting mail-order catalogues from the onerous task of tracking the thousands of tax systems currently in place across the country. Online retailers have piggy-backed on the ruling, able to skirt tax collection as long as they don’t maintain a physical presence in the states where they do business. Congress widened the loophole in 1998 with the Internet Tax Freedom Act, granting tax relief to online shoppers to stimulate the emerging market of e-commerce—a temporary exemption that has been extended in perpetuity.

All of that may be about to change. This week, the Senate is expected to vote on the Marketplace Fairness Act, a bill that will finally empower states to collect the sales tax revenues they’ve been missing out on for a decade. It’s a controversial bill by Washington standards, in that it’s supported by a bipartisan coalition of members from cash-strapped states, including some of Congress’s staunchest tea-party conservatives. It also happens to be opposed by Democratic stalwarts Max Baucus and Ron Wyden, whose home states—Montana and Oregon—don’t currently levy a sales tax. “Talk about taxation without representation,” Wyden said of the bill. "I think some people think this is easy revenue. It's low-hanging fruit."

Online sales aren’t technically free from tax as the law currently stands, but retailers get a pass from having to collect them at the time of purchase. Instead, you—the consumers—are supposed to declare your online purchases when you file your taxes. It’s called a “use tax,” and almost no one pays it—just 1.6 percent of Americans, according to a 2012 national study by the Minnesota state legislature. “One out of 20 people in Illinois fill out that line,” said Illinois Democrat Dick Durbin, a primary sponsor of the Senate bill.

This low-level tax evasion becomes an issue when you consider the many state budgets teetering on the edge amid a tepid recovery. States are collectively facing a $55 billion budget shortfall this year. An Internet sales tax could help ease the budget gap, generating an estimated $23 billion in additional revenue.

Most politicians frame the debate on a smaller scale though, saying it’s local businesses that are hurt the most by the tax holiday. “There shouldn’t be special incentives in the tax code to buy from Amazon instead of your local retailer,” says Carl Davis, a senior fellow at The Institute on Taxation and Economic Policy, the research arm of Citizens for Tax Justice.

“Show rooming”—when customers look at the products they want in stores, and then buy them online and pocket the tax—is the primary offender. Virginia Representative Scott Rigell told The New York Times he’s supporting the bill in defiance of Grover Norquist to protect “the hardworking men and women who have mortgaged their homes to buy or to rent a little brick-and-mortar shop.”

There’s no question that local businesses are hurt by e-commerce; a 5-10 percent off-the-top price break is considerable, especially for big-ticket items such as electronics and appliances. And the effect on local economies can be stinging: “When local stores lose sales to Internet retailers, the least that happens is that they don’t hire as many people as they would if their sales were higher,” said Michael Mazerov, a senior fellow at the Center on Budget Policies and Priorities. “At worst, they go out of business.”

Even in today’s information-driven economy, between 20 and 30 percent of Americans still lack basic home Internet. Even fewer—65 percent of all adults—have broadband Internet access, meaning those without the resources to shop online—and with the most to gain from the tax savings—are the ones most penalized for their inability to work the system. “Poorer families pay a larger share of their income in sales taxes than better-off families do because they have to spend almost everything they earn,” Mazerov said. “Tax-free Internet shopping compounds the problem: Many low-income families would love to shop online to avoid sales tax but can’t because they don’t own a computer or can’t afford high-speed Internet access.”

But unsentimental capitalism will continue to undermine traditional retail whether the bill passes or not. Online retailers have a distinct advantage over their brick and mortar competitors; as Amazon, Overstock, Zappos, and many others have long demonstrated, it’s possible to run an extremely successful e-retailer with little overhead and razor-thin margins, as long as you’ve got the volume to support it. Online stores can stock fewer products and drop ship the rest, they don’t need cashiers, and they can seek out cheap real estate for fulfillment centers, leaving the pricey storefronts for the little guys. One need look no further than Amazon’s own support of the bill—the company believes it has more to gain by leveling the playing field than by holding out on tax breaks in the few states it has yet to set up shipping centers.

It’s far from ideal to add to low and middle-class Americans’ tax burdens—especially now—and in the form of a regressive sales tax; that extra 5-10 percent charge disproportionately harms those with less money to spend. But the alternatives are far worse. State budgets need to be balanced, and that balancing will come on the backs of jobs and services. 46 states have already reduced public services in response to deficits—in many cases to their most vulnerable populations. In an ominous nod to the power of online retail, a Kansas school district facing a $14 million budget gap attempted to auction off the naming rights to one of its high schools on eBay—the district raised $600,000 before pulling the listing. The revenue from the Internet sales tax would pay for things “like schools and road repairs and traffic lights,” says Davis. “Online shopping is growing every year, so every year the stakes get higher, in terms of the amount of revenue being lost, and the sales-tax base being eroded enormously by not applying to all sales.”

The bill’s opponents—a handful of Republicans and Democrats from states that don’t collect sales tax, and major Internet retailers such as eBay and Overstock—say it will be too burdensome for small online businesses to work out the arcana of countless local tax systems, widening the disadvantage they’ll face against companies like Wal-Mart and its legion of tax lawyers and accountants. But the legislation exempts truly small businesses—those with revenue under a million dollars a year (including eBay sellers)—and mandates that the states provide free software to calculate taxes for the rest. “You’ll hear that there are 9,600 tax jurisdictions in this country, and how it’s just unreasonable to ask any retailer to have to navigate all those,” says Davis. “But we see companies today—Netflix for example—that have been navigating those jurisdictions without problems for years, because there are already private companies that sell inexpensive software that compiles this information.”

If the Internet sales tax doesn’t pass, many Americans' taxes will go up anyway. Virginia has already approved a transportation bill that anticipates the new revenue. If the act fails to make it through Congress, the state will raise gas taxes instead. 

Maryland is in the same boat—they’ve built the extra money into their budget for the coming year. If there’s a shortfall, they’ll raise gas taxes too, and supplement that with a 2 percent increase to the general sales tax. 

The Marketplace Fairness Act is expected to pass the Senate; then it’s on to the House, where it too maintains bipartisan support and stands a good chance of succeeding. President Obama supports it. It makes sense. The bill simplifies tax collection. It evens the playing field for local businesses—and for those Americans without Internet access most disadvantaged by the status quo. And it may ultimately preempt states from taking ever more draconian steps in their pursuit of balanced budgets. It’s not going to single-handedly save your local florist from But it is something very rare for a deeply polarized Congress in an era of unprecedented corporate influence: it’s fair.    

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