Senate approves online sales tax. Is it fair, or a tax increase?

The day is inching closer when consumers will have to pay state and local sales taxes on goods they purchase on the Internet.

The US Senate late Monday approved legislation to require any e-commerce business with more than $1 million in annual sales to collect a sales tax if the goods are delivered to a state that would normally charge such a tax. The Marketplace Fairness Act (MFA), which cleared the Senate by a vote of 69 to 27, now goes to the House.

Getting the legislation through the House, however, will be more difficult because a key Republican lawmaker, Rep. Bob Goodlatte (R) of Virginia, chairman of the House Judiciary Committee, has his doubts about the Senate version. Despite bipartisan support, the legislation will still have to pass through his committee – if or when he decides to allow a vote on it.

Conservative groups argue that it is unconstitutional to force e-retailers to tack on a sales tax when they have no physical presence in a state. They also say it will diminish tax competition among the states and will be difficult for online retailers to enforce, given that there are some 9,600 jurisdictions that collect a sales tax.

“It will present a great deal of compliance burdens that the existence of software cannot just magically erase,” argues Pete Sepp, executive vice president of the Washington-based National Taxpayers Union, which advocates lower taxes and limited government.

But conventional retailers, such as department stores and discounters such as Wal-Mart, as well as state governments looking for additional tax revenues, are urging the House to pass the legislation. They say it will “level the playing field” between themselves and Internet-only companies that have not charged sales tax in the past.

“This legislation is all about fairness,” says Michael Kercheval, president and chief executive officer of the International Council of Shopping Centers. “When lawmakers debate this bill, they usually start by saying, ‘I understand this is not fair and something needs to be done about it.’ ”

He says software now makes it possible for retailers to calculate sales taxes – which vary from state to state and city to city – just as easily as they calculate shipping charges. The law mandates that each state make sales tax software available free of charge to e-commerce businesses.

Most states would be happy to see the law enacted because they see a large pot of money that has not been collected in the past. A 2009 University of Tennessee study, based upon economic forecasting, projected unpaid sales taxes from Internet sales would amount to $23 billion in 2012.

“Closing the loophole will actually bring back jobs to bricks-and-mortar businesses, and the sales tax collected will bring new revenues into communities,” says Mr. Kercheval in an interview.

The dispute over collecting sales tax dates back to a 1992 US Supreme Court decision, Quill Corp. v. North Dakota, that barred states from requiring a retailer to collect sales taxes on its behalf unless the retailer had an actual physical presence such as a warehouse or sales office in the taxing state. However, the court left open the possibility that Congress could change the law.

Immediately after the MFA cleared the Senate, Representative Goodlatte said he was disappointed that the latest version did not follow “regular order” in the Senate, but instead bypassed the Senate committee with the subject-matter expertise.

“Consideration in the House will be more thoughtful,” he said in a statement.

Goodlatte has already indicated that he has deep reservations about the MFA. For one, the legislation does not make tax collection simpler, he said. “There is still not uniformity on definitions and tax rates, so businesses would still be forced to wade through potentially hundreds of tax rates and a host of different tax codes and definitions,” he said.

Goodlatte is also worried that aggressive state tax bureaus could try to pry money out of e-retailers in other states that the bureaus did not think complied with the legislation.

“The Committee will also look at alternatives that could enable states to collect sales tax revenues without opening the door to aggressive state action against out-of-state companies,” he said.

Goodlatte’s reservations prompt some independent analysts to wonder if the legislation has a future.  

“I think Goodlatte will proceed cautiously,” says Pete Davis of Davis Capital Investment Ideas, which advises Wall Street clients. “It looks like a tax increase to a lot of Republicans.”

Immediately after the Senate passed the legislation, the conservative R Street Institute issued a statement lamenting the Senate's vote. The organization suggested that the House consider “origin sourcing,” in which businesses collect sales taxes using the rate for their own physical location, not that of their customers. For example, a New York consumer purchasing an item from an e-commerce business in Maryland would pay the Maryland sales tax rate, not the New York rate.

“An origin sourcing approach could address the concerns of Marketplace Fairness Act proponents while preserving proper limits on taxation, due process rights, and privacy protections for consumers," said R Street senior fellow Andrew Moylan.

A major change, such as going to origin sourcing, would require a House and Senate conference to work out differences in the legislation.

However, not all conservatives oppose the legislation. On May 6, Colin Hanna of Let Freedom Ring and Al Cardenas of American Conservative Union endorsed the bill. 

“No one is in favor of piling new tax burdens on hard-working Americans, least of all the two of us, and this bill does not impose any new taxes,” they wrote in a letter to House and Senate Republicans.

MFA proponents hope that this argument ultimately sways the House to approve the legislation. “This is a tax already on the books,” says Kercheval. “It is a collection issue.”