Monday, February 25, 2008 - The Progress & Freedom Foundation Blog

Online Sales Tax Cartel?

I hate to disagree with my friend Larry Magid, a technology analyst for CBS News, who writes this week in favor of a uniform online sales tax regime. Magid says he "can't think of any good reason why customers of online retailers should shop tax-free while people who spend their money locally have to pay sales tax." Well, I've got a couple of good reasons, Larry.

Back in 2003, Veronique de Rugy [now of the Mercatus Center] and I penned a lengthy Cato Institute white paper on this issue entitled, "The Internet Tax Solution: Tax Competition, Not Tax Collusion." In that study, we addressed the arguments in favor of the so-called Streamlined Sales Tax Project (SSTP) and noted that a move toward more simplified tax regimes was certain laudable. In reality, however, the effort by states to build a "uniform" sales tax regime for online sales was less about achieving simplicity and more about raising taxes and imposing tax collection burdens on interstate commerce. Veronique and I pointed out that this created both economic and constitutional concerns since the SSTP was tantamount to a state-run sales tax cartel:

Bringing greater uniformity to the current system may have some positive benefits, such as more straightforward tax administration, but it would come at the expense of tax competition between the states and localities. Moreover, when supporters of the [SSTP] argue for greater uniformity in the sales tax system, they may just be making a covert effort to sustain higher tax rates and expand the current system to incorporate remote vendors on interstate goods and services. But at what cost? The states are essentially proposing to abandon true federalism and jurisdictional tax competition in exchange for the power to potentially recoup a small amount of tax revenue from interstate sales through a uniform system of third-party tax collection. Sadly, it appears that state and local officials would prefer to create a cozy tax cartel instead of relying on a “laboratories of democracy” model of competition between the states.

Many analysts have labeled the SSTP proposal “collusive federalism” or “cartel federalism,” because it runs counter to America’s true federalist structure of government and has very little to do with protecting states’ rights. In fact, if a state wants to simplify its sales tax base, it can do so and does not need to reach an agreement with other states. Federalism is about state independence, not state collusion.

For those reasons, we came out squarely against the idea of uniform sales tax regime for the Internet and outlined alternative reform proposals for states needing the compensate for supposed revenue short-falls, including an "origin-based" sourcing rule for taxing online sales, which would be pro-competitive and completely constitutional. "Of course," as Veronique and I concluded in our old paper, "getting runaway state spending under control would go a long way toward solving many of their supposed [tax] problems"!

posted by Adam Thierer @ 2:54 PM | Taxes