Sell Globally, Tax Locally
By Michael S. Greve

The reauthorization of the Internet Tax Freedom Act (ITFA) this fall will again reignite the acrimonious debate over Internet sales taxes. A majority of states are asking Congress to extend their tax collection authority to Internet and catalog sellers, even when the seller has no store or warehouse or other business operation in the state. In my new AEI monograph Sell Globally, Tax Locally: Sales Tax Reform for the New Economy, I argue that Congress should categorically reject that proposal. I describe exactly why this is a bad idea. Then I offer a provocative alternative to this proposed expansion of the existing, deeply flawed sales tax regime: an approach that would impose sales taxes where products originate, not where they are consumed.

 

At present, cross-border sales, through the Internet, mail, or other channels, are commonly taxed on the basis of their destination, not the place of origin. That regime—which compels sellers to calculate, collect, and remit taxes in thousands of local jurisdictions for their sales in those areas—is uniformly decried as terribly complex, burdensome, and inefficient. It allows many Internet sales to escape taxation, depriving governments of revenues and giving Internet retailers an unwarranted advantage over traditional industries.

 

Many e-commerce tax reform proposals attempt to solve that difficulty through tax harmonization and interstate cooperation. I suggest those options are unworkable. To begin, state and local governments will never be able to agree on a lasting harmonization of their tax bases. And even if they did, many deep problems would remain. Any state agreement on imposing sales taxes based on the destination of the goods will amount to the creation of a tax-enforcement “cartel” among states. Such a tax cartel would undercut the potential for tax competition among states, and thus seriously erode incentives to keep taxes down.

 

An origin-based tax system, on the other hand, would break the tax cartel and replace it with tax competition—giving states an incentive to lower their sales taxes as a means of enticing companies to choose their state as a base of operations. Businesses located in low-tax states would gain a competitive advantage, and be able to offer their many consumers lower-priced goods and services. Tax competition is vastly healthier for an economy and society than tax cartelization.

 

Another drawback of today’s destination-based sales tax system is that it invariably conflicts with elementary principles of sensible taxation. Taxing according to shipping destination is not simple, not fair, not neutral, and not easy to administer. An origin-based system can do a better job on each and every one of those fronts. Each cross-border sale, through whatever channel, would be taxed equally, once, and by a single authority.

 

Instead of extending today’s already unworkable system, we should reverse course. We should tax interstate sales (all of them, not just Internet sales) on the basis of their origin. Fees should be collected by the seller’s home state rather than the customer’s.

 

Congress needs to give serious consideration to this origin-based proposal. But it may not be able to do so in the short time before the current Internet Tax Freedom Act comes up for reauthorization. Therefore, Congress should extend the ITFA moratorium on Internet taxes for another two years. That window would provide lawmakers and economists the time they need to consider the origin-based option.

 

This might also give selected states the opportunity to put an experimental origin-based tax regime to a test. The sterile debate over Internet taxation would benefit greatly from some practical experience with alternatives. A few sensible states—say, Colorado, Idaho, and Georgia—could refrain by mutual agreement from imposing sales tax collections on each other’s companies, and the trial could test whether an origin-based taxation is an economically practical option. I expect that would produce clear evidence that such a system amounts to a vast improvement over both the proposed, ill-considered tax cartel and the unworkable sales tax system we rely on at present.

 

Michael Greve is director of the American Enterprise Institute’s Federalism Project.

Sell Globally, Tax Locally is available at www.aei.org.