Will Online Sales Tax Bill Spur or Stifle Competition?

Strong bipartisan support sends controversial Marketplace Fairness Act to the House, as opponents continue to raise concerns about impact on small businesses.

The U.S. Senate last night approved a bill that would give states novel taxing authority that could effectively end tax-free online shopping for many consumers.

Online Sales Tax

In a 69-27 vote, the Senate approved the Marketplace Fairness Act, a controversial measure that would authorize states to require out-of-state online retailers to collect and remit sales taxes on purchases that their residents make.

Currently, ecommerce companies only collect sales taxes on purchases made in states where they have a physical presence, the threshold for taxing authority that the U.S. Supreme Court set in a 1992 case concerning a catalog company.

But in that ruling, which predated the commercial Internet, the high court said that while states could not act independently to compel outside sellers to collect the tax, the U.S. Congress could grant them that authority by virtue of its jurisdiction in matters of interstate commerce.

"Under the legislation, states would have to provide software with the appropriate tax rates, but that still leaves the burden on retailers of incorporating the information and actually collecting the tax, a burden that will hit smaller retailers disproportionately hard." -- Nita Ghei, Policy research editor

George Mason University's Mercatus Center.

Backers of the Marketplace Fairness Act contend that the measure is necessary to level the playing field between Internet retailers and brick-and-mortar stores, and note that the bill would only give states the power to collect a tax that is already owed.

No New Taxes (Well, Maybe)

"Some have said it's a new tax. It's not. It's an existing tax," Sen. Lamar Alexander (R-Tenn.), one of the bill's co-sponsors, said on the Senate floor.

Indeed, in states with a sales tax consumers are required to keep track of the purchases they make online, and then report the expenditures that weren't taxed at the time of sale on their income returns. But that's news to many Americans, and even most of those who are aware of the sales-tax obligation ignore it, with the result that states lose out on billions of dollars of revenue that is owed to them.

Dick Durbin, an Illinois Democrat and co-sponsor of the bill, cited estimates that only 5 percent of residents in his state report and pay the tax on Internet purchases, arguing that the bill is a necessary legislative step to adapt to the steadily increasing volume of online shopping.

"What's it all about? It's about the way commerce has changed in America," Durbin said.

Supporters of the measure also contend that it puts Main Street retailers at a competitive disadvantage, arguing that savvy consumers are channeling more of their spending online because sales taxes aren't collected.

They describe the phenomenon of "show-rooming," where consumers peruse the aisles of a brick-and-mortar retailer, maybe trying on clothes or playing with electronic devices, and make a decision about what they want to buy, only to make their purchase on the Internet to avoid the tax.

But the bill has plenty of critics, including Sen. Ron Wyden (D-Ore.), who called it a "coercive affront to state sovereignty" for giving states the authority to impose their sales tax rules on out-of-state businesses. Wyden and several other members representing states with no sales tax voted against the measure.

In addition to the states-rights issue, opponents of the bill, including eBay and several trade groups and advocacy organizations, warned that it would have a detrimental impact on small businesses who would be saddled with a major accounting burden for having to navigate a patchwork of state and local tax codes.

"With this proposal," Wyden said, "I fear that what we're going to do is crush a lot of those startups."

The bill's authors acknowledged those concerns, and included a provision that would exempt small businesses with less than $1 million in annual remote sales. It would also require states that want to invoke the tax-collection requirement to simplify their tax codes, either by signing onto interstate Streamlined Sales and Use Tax Agreement or by taking other measures to reduce complexity, including the establishment of a single entity in the state to oversee sales-tax administration and developing a uniform sales and use tax return.

Participating states would also be required to distribute free software to affected retailers to help with the calculation of the taxes.

But those simplification measures are insufficient protections for small businesses, according to Nita Ghei, a policy research editor with George Mason University's Mercatus Center.

Big Hit on Small Retailers

"Under the legislation, states would have to provide software with the appropriate tax rates, but that still leaves the burden on retailers of incorporating the information and actually collecting the tax, a burden that will hit smaller retailers disproportionately hard. Resources that go toward compliance are no longer available for expansion and innovation," Ghei writes in a column for U.S. News and World Report.

"As the Internet sales tax kicks in, it functions as a barrier to growth. The tax, in effect, limits competition for the existing big retailers, who can spread the cost of compliance over a larger sales base," Ghei adds, arguing that the purported benefit to big retailers explains why Amazon threw its lot in with WalMart and other large enterprises in support of the bill.

eBay, a staunch opponent of the Marketplace Fairness Act, had proposed setting the threshold for the small-seller exemption at $10 million, while also excluding those with fewer than 50 employees.

The bill now heads to the House, where Judiciary Committee Chairman Bob Goodlatte (R-Va.) has said that he remains concerned by several provisions in the legislation and plans to take a hard look at the measure before voting it out of his committee.

Kenneth Corbin is a Washington, D.C.-based writer who covers government and regulatory issues for CIO.com. Follow everything from CIO.com on Twitter @CIOonline, Facebook, Google + and LinkedIn.

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