America's independent, non-partisan advocate for overburdened taxpayers.

Commentary


NTU Comments to House Judiciary Committee Regarding the Internet Sales Tax

March 12, 2014
By Pete Sepp

The Honorable Bob Goodlatte, Chairman
The Honorable John Conyers, Jr., Ranking Member
Committee on the Judiciary
U.S. House of Representatives
2138 Rayburn House Office Building
Washington, DC 20515

Dear Chairman Goodlatte, Ranking Member Conyers, and Members of the Committee:

On behalf of National Taxpayers Union’s (NTU’s) 362,000 members, I write to offer comments for the record in regard to the Committee’s hearing today, entitled “Exploring Alternative Solutions on the Internet Sales Tax Issue.” We applaud the thoughtful approach the Committee has taken toward this matter, which has extremely serious implications for taxpayers.

As you know, National Taxpayers Union’s members have long been concerned about the extraterritorial tax collection powers that could have arisen from the Streamlined Sales and Use Tax Agreement (SSUTA) and its predecessor, the Streamlined Sales Tax Project. More recently, we have expressed grave doubts over the constitutionality, administrability, and equitability of the Marketplace Fairness Act (MFA).

After more than a decade of attempts to conclude a pact among a sufficient number of member-states, it is time to acknowledge that SSUTA is a failure. Not only has there been underwhelming progress in simplifying states’ often byzantine sales and use tax systems, the cartel envisioned under SSUTA would arrogate dangerous powers unto itself. In 2008 Steve DelBianco of the NetChoice Coalition perceptively noted that what started with an “original simplification vision of one-rate-per-state” is mutating into a “dual-sourcing scheme to accommodate both origin and destination based taxes at the same time.” Little has changed since then to reassure policymakers of SSUTA’s approach.

Nor would it appear that the Marketplace Fairness Act, which amounts to a federalized attempt at imposing a similarly disturbing regime, is any more advisable a route to addressing the question of remote sales. This legislation (S.743), which passed the Senate in May of 2013, is in NTU’s opinion the single greatest threat to taxpayers currently under serious contemplation in the 113th Congress. Our reasons for opposing MFA are legion and could occupy page after page of analysis. However, the summary of our position, expressed in Vote Alerts, fact sheets, and other materials, bears repeating here:

  • The bill would hinder tax competition among the states, and may even encourage governments to “round up” their levies. NTU believes that the competitive dynamic among states and localities has exerted a more positive influence on tax rates, bases, and administrative procedures than any other force, save Constitutional tax and expenditure limitations (TELs). Indeed, one could argue that even TELS would be weaker and less prevalent, were it not for the salutary pressure on states to distinguish their own pro-taxpayer fiscal policies from those of their neighbors.
  • The Supreme Court’s Quill ruling has prevented state tax collectors from aggressively reaching across their borders, but MFA would overturn this important protection against abuse of power. The bill’s attempt to carve out a sales-tax only exception to this ruling likely won’t survive long, and the way would be paved for state administrators to gain authority over other taxes. The physical presence safeguard helps to shield taxpayers from many types of aggressive policies that could affect income, property, and other taxes.
  • S. 743 gives wide latitude to define taxable “nexus,” including its controversial extension to online advertising affiliates. Even states not participating in MFA’s framework would have new powers.
  • MFA would heap heavy burdens upon small businesses, which would face the task of collecting and remitting to nearly 10,000 taxing jurisdictions. MFA’s supporters have tried to mitigate these burdens with a “small seller” exception, which is paltry by comparison to other government definitions of what constitutes a small business. A 2006 PricewaterhouseCoopers study demonstrated that small businesses with sales between $1 million and $10 million still face enormous costs that would threaten profitability, causing significant harm to interstate commerce and the economy during an especially fragile time.
  • MFA fails to acknowledge that so many of the “Main Street” businesses the proposal aims to protect are actually thriving because of, not in spite of, the Internet. E-commerce allows “mom and pop” firms to market their goods and services to the entire world, not just to their immediate neighborhoods. It also gives these entities a much wider range of options to purchase supplies and other inputs, maximizing their cost-efficiency and productivity. In 2012, research by The Boston Consulting Group found that “small and medium-sized companies that embrace the Internet in their business operations grew by 10 percent annually in the last three years, adding jobs as they did so.”

Owing to these misgivings, we were quite pleased that Chairman Goodlatte decided that the House should take greater responsibility for deliberating MFA than the Senate did. The serious manner in which the Committee has undertaken this task is reflected in the seven principles for Internet taxation which Chairman Goodlatte and Regulatory Reform, Commercial and Antitrust Law Subcommittee Chairman Bachus offered last September. Their guidelines aim to keep taxes low, level the playing field for all businesses, preserve interstate tax competition, prevent out-of-state tax collectors from unaccountably auditing and harassing businesses and individuals, simplify the collection and remittance processes to minimize or eliminate compliance costs, protect consumer privacy, and maintain an appropriate balance of power between states and the federal government.

Based on these precepts, the many demonstrable defects of MFA should disqualify it from further consideration. The American people would wholeheartedly agree. In September of 2013, NTU and the R Street Institute released a poll of 1,000 likely voters conducted by the respected Mercury firm. The results confirmed not merely a reflexive dislike of taxes, but instead revealed that Americans have a sophisticated understanding of (and trepidation toward) the administrative implications of an MFA-style structure:

  • By a 57 percent to 35 percent proportion, respondents opposed the imposition of a remote sales-tax collection requirement.
  • Self-identified Republicans and conservatives disliked MFA by 2 to 1 margins. Independents opposed MFA by a 56 percent to 37 percent margin, Democrats by a 48-43 percent margin, and split ticket voters by a 58-36 percent margin.
  • When respondents were informed “the proposed legislation would allow tax enforcement agents from one state to collect taxes from online retailers based in a different state,” and that it would entail new tax collection obligations for businesses, the margins against it swung to 70 percent and 69 percent, respectively.
  • When confronted with the best arguments in favor of the legislation and against it – e.g., an MFA regime would be “fairer” to brick-and-mortar retailers – more than 60 percent of respondents supported the anti-MFA arguments.

Based on all of these cautionary arguments, what type of policy toward taxation of remote sales could satisfy the seven principles that Chairman Goodlatte and Chairman Bachus articulated? Some would argue that despite its flaws, the existing structure, with sufficient modifications and commitments to helping citizens meet use tax obligations, could still answer to the purpose. Evidence from states that have proactively engaged consumers is somewhat encouraging. For example, several years ago California’s Board of Equalization estimated that a letter campaign reminding taxpayers they may owe use taxes for Internet purchases would help revenue from these activities to grow to $183 million in 2011, $367 million in 2012, and $600 million annually by 2013. Alabama has tested a similar letter campaign with success, including instances of taxpayers voluntarily sending the state checks for several thousand dollars.

Nonetheless, we understand that many Members of Congress do feel compelled to fashion a federally-directed response to state taxation of remote sales. For this reason, we recommend that lawmakers consider legislation defining the ability of states to proceed with such taxation only within the bounds of what is known as “origin sourcing.” Simply put, this method would confer an obligation upon a business, whether selling to consumers locally or remotely, to collect and remit sales only to the jurisdiction in which that firm is based.

Members of this panel will hear and read a lengthier treatment of this concept today from R Street Institute’s Andrew Moylan, who until 2012 served with NTU as its Vice President of Government Affairs. From our perspective, however, we continue to agree with the advantages of such a system, which would also comport with the seven principles outlined by Chairman Goodlatte and Chairman Bachus. Among them:

        1) True “Fairness.” While differently defined among the details of state laws, by and large origin sourcing is already the governing model for most brick-and-mortar retailers. Even though many areas technically practice “destination sourcing” for these stores, in effect the “destination” is the consumer at the cash register. Applying this philosophy to remote sales would avoid the need for a complex web of transaction-monitoring among almost 10,000 taxing entities and treat “e-tailers” the same as traditional stores. On the other hand, the scheme proposed under MFA would unfairly force online sellers to quiz their customers about their tax domicile and send back a properly-calculated amount to each buyer’s home state.

        2) Administrability. Some proponents of MFA claim that the existence of “free” (likely taxpayer-funded) software would sweep away any compliance problems that a destination-based scheme would impose upon remote sellers. This would seem laughable to most Americans who have experience with the federal income tax system. After all, according to NTU’s most recent “Taxing Trend” study, 9 out of every 10 taxpayers rely on preparers or software to get through the tax-filing process. Yet, the business and personal tax system still imposes a deadweight loss on the economy conservatively estimated to exceed $240 billion.

As a recent NTU podcast with online retail entrepreneur Josh Olivo recounted, software is only a small part of the Internet sales tax compliance picture: it must somehow be seamlessly integrated into each business’s existing systems. And despite MFA’s promise of simplification, states’ varying sales tax definitions and regulations could still mean many compliance headaches.

Moreover, the very real prospect of states’ tax authorities reaching across their borders to audit and otherwise intimidate remote sellers elsewhere is daunting to small businesses. Olivo described how dealing with just one state’s sales tax enforcement arm can slow his daily business development to a crawl. Giving 44 states’ other auditors a chance to investigate him as well could deal a crippling blow to the future of his firm. Bruce Phillips, a CPA and managing member of a company specializing in small business compliance issues, recently told Fox News that “Sales tax audits can be just as bad or worse than IRS audits – and imagine you could have 10 to 20 auditors going through all of your sales!” It is therefore no wonder a coalition of small and medium-sized e-tailers affirmed this and other fears about compliance overhead with hard numbers in an open letter to Congress, warning lawmakers that MFA could cost the signatories some 220,000 jobs. They characterized the MFA as “a weapon for Big Retail to crush Small Business.”

        3) Fiscal Federalism. Because origin sourcing would simply apply each state’s existing tax rate and collection system for traditional retailers to every seller (even remote ones) located within their borders, the current balance of fiscal policies that every non-federal government has undertaken would remain in effect. All states would still have the prerogative to experiment with whatever taxation options are deemed most efficient and effective for its particular circumstances, provided it does not do so in a way that impedes commerce with its neighbors or across the nation generally. It is also entirely within the constitutional prerogative that the federal government can and should exercise: ensuring that the “laboratory of the states” functions to the benefit of all citizens and businesses while restraining predatory practices that would amount to tax enforcement without representation. In any case, as Professor Walter Hellerstein noted in 2012 testimony before the Senate Finance Committee, Congress already can and does limit the taxing activities of states in a number of ways. Among these are forbidding higher state taxes on air and motor carriers than on other businesses, restricting the application of stock transfer taxes, and prohibiting the levy of state taxes on the retirement income of non-residents.

An important step Congress could take to clarify the balance of state and federal tax policy would be to pass the Business Activity Tax Simplification Act (H.R. 2992), which was the subject of hearings late last month before the Subcommittee on Regulatory Reform, Commercial and Antitrust Law. The legislation would better define the concept of physical presence and set firmer proscriptions on state taxation of interstate commerce (including intangible property and services).

One aspect of the debate over alternative solutions to the Internet sales tax issue which should not excessively occupy Members of this panel is the question of state revenues. As other witnesses will explain to you in-depth today, the prospect of tens of billions of dollars in “lost” collections to the states has depended upon a highly-flawed methodology developed by the University of Tennessee that overstates the likely amount of revenue at stake. Furthermore, the “doomsday scenario” of massive business flight to zero-sales-tax jurisdictions concocted by opponents of origin sourcing is, in our opinion, unconvincing. For one, some of the states without broad-based sales taxes today offer unattractive rates of income and other taxes that might deter some businesses from making such a move.

Still, it is quite possible that some remote-selling firms will relocate to more hospitable retail tax climates. Yet, this is the essence of tax competition. The response to it is not to “lock down” businesses in their current locations, but rather to develop reasonable tax policies that will persuade them to remain where they are. This is a central task that should occupy not only states, but Washington, DC as well. Indeed it already has done so, as evidenced by the recent blueprint for a more internationally competitive federal tax system that your colleagues on the Ways & Means Committee unveiled in February.

Nor should Members of this panel who would describe themselves as “fiscal conservatives” be lured into believing claims that MFA-style legislation could finance some massive wave of pro-growth tax reforms among states. In an analysis of this argument – made in a study by economists Art Laffer and Donna Arduin late last year – NTU determined that the likelihood of states plowing every penny of a supposed $47 billion tax collection windfall into corresponding reductions in other taxes (thereby adding over $563 billion to economic output) was problematic at best. Indeed, Laffer and Arduin themselves provided contradictory evidence to suggest that at least eight states, among them California, New York, and Massachusetts, would likely use their new-found gains to grow government. This immediately shrank the supposed economic benefit by nearly one-third. They could only name Governors in two states – Wisconsin and Ohio – who at that time had formally committed to using MFA for tax reform. As Chairman Goodlatte is well aware, another state’s Governor – Virginia’s – endorsed a tax-hike package in 2013 that countenanced passage of MFA to underwrite infrastructure programs instead.

It has been suggested that one potential model to deal with remote sales could be the current fuel-tax compact that governs interstate operations of motor carriers. In our opinion, this plan would at least offer one advantage over MFA: it would require governments themselves to directly shoulder the collection and remittance obligations that would otherwise be foisted upon remote sellers. We submit that this would give public officials a more direct appreciation of the opportunity costs that destination sourcing would have on each state’s economy … and, perhaps, an incentive to abandon the entire exercise as unworkable. We would caution, however, that this approach should not be made mandatory for states that currently do not have sales taxes.

Others have suggested creating a reporting system for remote sales that governments, in turn, could utilize to collect taxes due. To us this would not entirely ameliorate the heavy compliance tasks on small businesses or the liability issues that might arise from inaccurate reporting. Another proposal, conferring a federal blessing upon states’ ability to exclude remote sellers from reaching customers within their borders if firms refuse to abide by a destination-sourcing requirement, would in our opinion open the door to unacceptable depredations upon interstate commerce. It would also give license to the same kind of mischief that MFA would unleash.

To conclude, we believe that if the Committee wishes to recommend for the whole House legislation that addresses the role of remote sellers in the sales tax realm, Members should studiously avoid the Marketplace Fairness Act and the concept of strict destination-based sourcing. Rather, lawmakers should embrace origin-based sourcing for its consistency with the seven principles that Chairmen Goodlatte and Bachus have expressed. Origin-based sourcing inarguably puts all retailers on the same tax-collection footing, while not being any more burdensome for a small remote seller than for a “mom and pop” store. It would not create any new or discriminatory tax obligation, and would at least not be more complex to administer or intrusive on individuals’ privacy than current sales-tax laws (however much they may be in need of clarification). Furthermore, the vital underpinning of our federal system – state sovereignty within their borders, with Washington’s guidance over commerce outside them – would be preserved, as would the absolutely crucial evolution of tax policy through healthy competition.

Once again, I wish to express our members’ gratitude for this Committee’s willingness to explore the issue of Internet sales taxes outside the troubling confines of MFA. Please feel free to call upon us in your future deliberations over these and other matters that come before your Committee. Thank you for your consideration of these comments.

Sincerely,

seppsig
Pete Sepp
Executive Vice President