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Online Sales Tax Backers Oversell New Study
July 30, 2013
By Pete Sepp
When an esteemed economist like Arthur B. Laffer writes about tax policy and prosperity, conservatives rightfully tend to listen.
Apparently this was the intent behind a recent report from Dr. Laffer and his colleague Donna Arduin entitled “Pro-Growth Tax Reform and E-Fairness.” According to the analysis – which backers of the horrendous Marketplace Fairness Act (MFA) are hyping as a tract of biblical proportions – allowing states and localities to collect taxes on “remote” sales (through both the Internet and catalogs) from businesses beyond their borders could, over a ten-year period, lead to big dividends. These would include an additional $563.2 billion in Gross State Product (GSP) and more than 1.5 million new jobs, provided states and localities invest every penny of those higher tax collections (as much as $47 billion by 2022) into fixing other growth-inhibiting tax policies.
At least this is what MFA supporters would like us to take away from the study. But out of respect for Dr. Laffer, this writer – who is definitely NOT an economist – decided to read the full document and its appendix. Interestingly, the report itself provides some of the most important warnings against jumping to the conclusions that MFA’s cheerleaders would have us draw from it.
Dubious Tax Projections
For one, the authors’ estimates of potential retail Internet sales growth between 2012 and 2022 come with several important questions. Here they are, verbatim:
While these sales are potentially subject to the state sales tax, the questions are (a) how many of these sales are intended to be part of the sales tax base, i.e. do they or do they not fit into categories that are exempted even for in-state sales?; (b) how many of these sales that are intended to be part of the sales tax base are not currently paying sales tax to the government; and, (c) what proportion of these non- tax submitting taxable sales can be captured. There is also the question of how these sales would change if their tax status changes.
If only the answers were clearer. In discussing estimates of the “non-taxed Internet sales tax base” the report derives a calculation out of a 2010 figure from the National Conference of State Legislatures and finds that the 2010 nationwide “untaxed” base of $150 billion “represents close to 100% of the total estimated 2010 Internet retail sales base of $166 billion, based on the U.S. Census 2010 estimated Internet retail sales tax base.” Other estimates for 2012 through 2022 are made using additional sources.
But if the untaxed Internet sales base is assumed to be nearly 100 percent of the total Internet sales base, doesn’t that contradict the very questions the authors raised two paragraphs ago? It would seem so.
Further, it is important to remember that the portion of retail Internet sales subject to tax will likely grow in the future, without enacting the Marketplace Fairness Act. That’s because many big-box “click and mortar” chains like Sears and Target already charge taxes on Internet purchases because they have physical stores in purchasers’ states. And Amazon, the online-only seller that once had little to no “nexus” requiring it to collect state sales taxes from customers, is expanding its infrastructure to the point where such collections will become the norm for its business model.
Improbable Assumptions of Pro-Growth Tax Shifting
Well, it might be argued, there are still plenty of states where leaders would jump at the chance to cut income taxes, if only the pesky U.S. Constitution would get out of the way and give them a chunk of sales tax revenues from transactions involving businesses outside their borders. The foreword to the report cites numerous encouraging examples – provided your definition of “numerous” is two: Wisconsin and Ohio, whose “savvy conservative” Governors have signed into law budgets pledging to dedicate revenue from an MFA scheme to pro-growth tax reform. Omitted is an inconvenient counter-example: Virginia, whose once-conservative Governor signed a transportation funding package into law that counts on as-yet unsecured revenues from a federal MFA. No “savvy” tax reform for the Commonwealth, I guess.
Are there other potential counter-examples waiting in the wings? Yes, and the authors themselves provide the clues by noting:
But given the politics of state economics, we worry that a number of the states will squander the opportunity afforded by including e-commerce retail sales in the tax bases of their respective states. Therefore, even though we’ll assume each state uses their windfall wisely, we should warn that states like California, Minnesota, Illinois, New ork, Maryland, Massachusetts, Vermont and Connecticut are fraught with risk.
Suppose the risk becomes reality with these eight states? Instantly, the $563.2 billion GSP gain shrinks to $400 billion (a drop of nearly 29 percent). The 1.506 million additional jobs the authors claim will be created, falls to 1.109 million.
The more skeptical among us might add a few other states to this at-risk list: Rhode Island and Hawaii, which have large liberal majorities in their state governments, and of, course Virginia. Do that, and the economic and employment gains could plunge even further.
So the trust factor – that elected officials will do the right thing – is important, and here again the report provides (perhaps unwittingly) an interesting piece of cautionary evidence. The authors write:
In fact, based on our estimates of the states’ sales tax bases (retail sales as a percent of GDP), the total state sales tax base is down 19.4% from 1970 to the present, while the average state sales tax rate (state sales tax revenue as a percent of retail sales) has increased 40.7% over the same time period. In other words, states have been increasing the marginal sales tax rate to offset the declining sales tax base and to increase total sales tax revenues to around 1.5% of gross state product [my emphasis added].
Doesn't this at least somewhat contradict the premise that we can believe elected officials, Republican or Democrat, will do the right thing with their new-found tax collections? If the rate has been expanding by a greater percentage than the base has been contracting, then how can we expect that the rate will contact at a greater percentage than the base will expand under an Internet sales tax?
Failure to Include Compliance Costs
Besides the prospect of state “dropouts” from the pro-growth tax-cut curriculum that Laffer and Arduin outline, there’s also the matter of how heavily the compliance costs with the new sales tax collection regime will offset any potential economic gains. MFA advocates argue that “free” compliance software provided for in the legislation will allow businesses to cheerfully bear their new collection burdens. Naturally, this would mean some kind of expenditure on the part of governments, and as Laffer and Arduin point out, “The government doesn’t create resources, it redistributes resources. To spend, the government first has to take.” So, the software is hardly “free,” any more than a federal program giving away cell phones has no cost to taxpayers.
More important, 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.
Then there’s the big unknown: auditing. 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 whack as well could deal a crippling blow to the future of his firm.
Ironically, Dr. Laffer himself has acknowledged this type of threat. In an April 2011 study published by the Laffer Center for Supply-Side Economics, he and his co-authors examined complexity in the federal personal and business income tax system, and determined that “Comprehensive audits also impose an additional taxpayer burden of at least $9.3 billion annually,” based on the deadweight losses associated with extra tax return filing time and effort. The authors observed that:
Complex tax systems increase the costs of doing business and diminish the incentive to work, produce and invest. The costs incurred by tax complexity are similar to the costs of actual taxes, burdening workers, savers, and investors, only without the tax revenues. Tax complexity, per se, is detrimental to a country’s economy and every individual adhering to the tax code. The consequence of this ‘complexity tax’ is a diminished ability to compete in the global economy. The complexity tax is particularly problematic because it creates all of the negative incentives of a high tax burden, but nets the government no additional tax revenues.
Yes, sales tax compliance procedures are different from those surrounding income taxes. And yes, new revenues could potentially be used to simplify tax systems (e.g., base-broadening) rather than just cutting rates. Still, the compliance “wedge” cannot be ignored. Bruce Phillips, a CPA and managing member of a firm 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!” 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.”
Government Tilting the Playing Field
These worries would be compounded by the potential for net national economic losses due to international retail flight. In an April news release, Rep. Jim Bridenstine (R-OK) raised this point by contending, “The Marketplace Fairness Act cannot compel a business in Canada to collect and remit taxes to a U.S. state. Apart from the lost U.S. economic activity, offshoring will negatively affect U.S. federal revenues.”
Drs. Laffer and Arduin also repeat several arguments that remain controversial, and, in some cases, seem at odds with other parts of the paper. In one place, they write that “The Internet exemption creates a tax-based price advantage that encourages consumers to make purchases from out-of-state retailers.” Yet, their own projections indicate that by 2022 e-commerce will have zoomed to … 8.6 percent of all retail trade. Taxes certainly do influence economic decisions, but this statistic does not seem to indicate some massive dominance of supposedly “tax-free” (which aren’t) Internet sales over the traditional marketplace.
The authors then write that “Worse, the tax distortion incentivizes consumers to use in-state retailers as a showroom to evaluate purchases prior to ultimately buying the product from out-of-state Internet retailers.” This is actually a highly contestable notion. Recent evaluations, recounted here, seem to indicate that “showrooming” is not as pervasive as MFA’s adherents like to say it is. In fact, the reverse – where customers research a product online before buying it at a physical store – may be more prevalent.
Speaking of the “main street retailers” that MFA claims to be all about, here’s a passage about shrinking sales tax bases that might raise the eyebrows of all those brick-and-mortar dry cleaners, hair salons, and puppy groomers:
There are several drivers behind this trend including inequities in the application of state sales taxes (e-fairness); certain states offering special exemptions to certain goods; and the bias toward taxing goods and not services, despite the service sector’s growing share of the national economy.
Make no mistake -- under a low-rate system, an expanded base of tax could make plenty of sense. From a political standpoint, however, this author somehow can’t see MFA’s P-R experts flacking this suggestion for expanding taxes on neighborhood service providers and their customers.
A Question of Fairness?
But what’s left unsaid in the report is important too. Laffer and Arduin echo some of the standard rhetoric from MFA’s supporters about the perceived “unfairness” of the U.S. Constitution’s safeguards against extraterritorial taxation:
Addressing the e-fairness problem from a pro-growth perspective creates several benefits for the economy. An inequity is addressed—all retailers would be treated equally under state law. It also provides states with the opportunity to make their tax systems more efficient and to increase competition amongst all retailers. May the best business plan win, without government picking winners and losers.
On the other hand, they also give due credit to the concept of federalism and the beneficial “products” for taxpayers developed in the laboratory of the states:
Implementing different tax policies in different states is the essence of fiscal federalism – states should have the power to experiment with alternative approaches to fiscal policy. In other words, states should have the right to be wrong.
So the proper response to these imperatives is to enact MFA, which would create the “inequity” of holding e-tailers to a multi-state tax collection regime that brick-and-mortar stores don’t have to follow? A bill that would effectively quash tax competition by allowing “wrong” states to impose their misguided sales taxes and auditing tactics on businesses in other jurisdictions?
The answer is not necessarily evident in the report. A search of the entire PDF document shows that only the foreword mentions the Marketplace Fairness Act by name. The part of the report written by Laffer and Arudin only refers to “e-fairness legislation.” Perhaps the authors might consider another approach that would indeed be “equitable” and would preserve the “essence of fiscal federalism:” origin-based sourcing. This concept of taxation would simply require all retailers, whether traditional or online, to collect sales tax on behalf of a single jurisdiction: the one in which they are located. It would eliminate the need for tracking software to remit payments to governments halfway across the country, would respect the Constitution’s principle of taxation with representation, and would uphold states’ ability to compete economically.
Because of all these advantages, origin-based sourcing would be less of an impediment to pro-growth tax reform. Unfortunately, we’re left to wonder if the authors would support such an option. My hope is that they would have an open mind on the question.
In the end, Drs. Laffer and Arduin have produced a study whose parts arguing in favor of lower, simpler taxes overall are compelling. The appendix, especially, is a marvelous compilation of research on the link between smart tax policy and economic vitality.
Yet, something has been lost in the translation between the words of this study and those of self-proclaimed “Main Street” advocates, who are placing it in service to the bogus notion that the conservative community is warming to the Marketplace Fairness Act. By the sheer number of free-market organizations strongly opposing MFA, this is demonstrably untrue.
But if anyone needs more assurance that the issue is not cut and dry, they could read Laffer’s and Arduin’s warning on page 11 of their study: “To state the obvious, the actual implementation of taxing Internet sales is far more complicated and less certain than our estimates imply.” To mix a pair of well-known phrases, amen, and caveat emptor.