Political Hay

Here Comes the Internet Tax

Politicians leave no revenue source behind.

By 5.27.09

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What is the single modern invention most responsible for enhancing peoples' freedom and standard of living across the world? Arguably, it is the Internet. Yet, Democrats from revenue-starved states and Congress are proposing to make it less free by taxing Internet commerce. (Content regulation should be coming soon to a screen near you.)

This should not come as a terrible surprise. After all, the Internet was just too good, too free, too easy, too innovative, and too favorable to small businesses for government to stay away. So now, several states, and Congress, are considering laws that would require online retailers to collect state and local taxes from online consumers.

New York was the first state to pass such a law last year in defiance of the 1992 U.S. Supreme Court decision, Quill v. North Dakota, which held that retailers must have a physical presence within a state for that state to require sales tax collection. The decision, which was based upon the dormant commerce clause doctrine -- which essentially says that Congress’s power to regulate interstate commerce implicitly denies such power to the states -- upheld a bright line physical presence test. It also held that only Congress, through legislation, could delegate broader powers to the states.

New York's legislation attempted to end run around Quill by requiring online retailers to collect state and local sales tax if they had affiliate advertisers within the state. (It depends on what the meaning of physical presence is?) Affiliate advertisers basically consist of websites, often run by small businesses or organizations like the Parent Teacher’s Association, that carry advertisements from other online retailers, like Overstock.com or Amazon.com. As a result of the massive administrative costs that the law would have imposed, Overstock.com immediately terminated its relationship with approximately 3,400 affiliates. Jonathan Johnson, Overstock.com's president, explained that "New York’s law made the cost of doing business with affiliates based in New York prohibitively high."

Overstock.com and Amazon are now litigating the constitutionality of the New York law before the New York Appellate Division, but other states are considering passing similar laws in order to generate more tax revenue. Thus far, opponents have succeeded in defeating these proposals in many states where they have been proposed, although the Hawaii and Minnesota legislatures recently passed Internet sales tax bills that still must be signed into law. However, the real fight appears headed for Congress, where proposed legislation would allow states that are part of the Streamlined Sales Tax Project (designed to simplify state tax collection) to force online retailers to collect state sales tax.

As part of the growing co-dependency of big government and big business, the National Federation of Retailers supports the tax, since it would significantly burden pesky online competitors who provide consumers with lower priced products. And proponents of the proposed federal law argue that it would not significantly increase the burden of online retailers to collect state and local taxes. However, despite the Streamlined Sales Tax Project, online retailers could still be forced to collect taxes under thousands of separate tax regimes -- something that would be technologically difficult and very expensive for many smaller online businesses.

Currently, consumers who purchase online products are required in many cases to report those purchases and pay sales tax on their own. Of course, most do not. And the high rate of non-compliance should raise questions about the entire sales tax regime as it exists, especially
vis-à-vis the Internet, which has been a boon for smaller businesses and consumers.

It is simply too administratively burdensome to require businesses to become agents for local and state tax collectors all across the country. Similarly, it is as ridiculous to expect consumers to monitor and report online purchases as it is to expect babysitters to report their income to the IRS.

If the government wants to impose a sales tax on consumers who purchase products online, there is a simple, fair, and efficient way of doing so: pass a federal FAIR Tax law that establishes a uniform consumption tax rate in place of the current income tax regime. Doing so would balance administrative feasibility with the need for government revenue, without destroying incentives to do business.

That, however, is not happening in the current political environment. They always say freedom isn't free. Lawmakers throughout the country are once again proving that adage accurate.

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About the Author
Brett Joshpe is an attorney and entrepreneur in New York City. He is Of Counsel to the American Center for Law & Justice and co-authored the book Why You're Wrong About the Right (Simon & Schuster, 2008).