Online Sales Taxes: A Good Idea Done Badly

Isn't this the perfect moment for a value-added tax?


On Monday, by a comfortable 69-27 majority, the U.S. Senate passed a controversial bill that will require online retailers with annual sales of more than $1 million to collect state sales taxes. Said Republican Mike Enzi of Wyoming: "This bill is about fairness. It's about leveling the playing field between the brick-and-mortar and online companies, and it's about collecting a tax that's already due. It's not about raising taxes."

Wait, isn't it? Leaving aside the anomaly in today's world of a Republican sponsoring a bill that raises revenue, the proposed law is entirely about raising taxes. The question, then, is whether these are taxes that ought to be raised, and if this is the way to raise them.

The short answers: Yes to the first, no to the second. This bill is precisely the wrong way to raise revenue from a growing stream of business. It applies a tax designed for physical entities to new commerce and does so in ways that will do little to help states or to reinvigorate small businesses that are hurting.

As is, much of the tax system is not fair. We are acutely aware of the labyrinthine quality of the U.S. tax code. The vagaries of state-by-state sales taxes only add to the complication. Five states don't even have a sales tax (Alaska, Delaware, Montana, New Hampshire and Oregon), and seven states have no income tax, including no tax on dividends and interest (Alaska, Florida, Nevada, South Dakota, Texas, Wyoming and Washington). If fairness is your litmus, as it is Enzi's, then it is rather unfair to live in New Jersey as opposed to, say, Florida, given the radically higher tax burden.

A Lotta Headache for a Little Revenue
That much of the code is currently unfair is hardly an argument against making one aspect of it fairer. But the online sales tax bill will place added burdens on those already paying more, whereas those living in sales-tax-free states will continue to feel none. For years, those of us who live in states that levy a sales tax have enjoyed the free pass that comes with shopping tax-free on Amazon, eBay, and any number of online sites. We get to sit at our computers at 1 in the morning and order those much needed gyroscope-equipped power drills without the nuisance of that extra 6 percent tacked on by state legislators whom we've never heard of, didn't vote for and aren't entirely convinced actually exist.

The bill was created because of angst from retailers and state legislators. Retailers have long cried foul, claiming that the ability of online sites to sell the same goods without sales tax provides unfair advantages that drive brick-and-mortar stores out of business. Many small businesses with storefronts that rely on local customers have actively lobbied for an online sales tax, asserting that unless that playing field is leveled, more small retailers will go out of business, eliminating jobs and harming local communities. Cash-strapped state governments have been even more adamant, arguing that they are losing more than $23 billion a year in foregone revenue because of the loophole, with negative consequences for teachers, police officers and all residents.

Even here, however, the problem isn't so simple. Some small business owners have warned that the burden of record keeping for their online sales by state will be immense. The bill has a proviso that each state develop software that will ease that burden, but there's hardly a guarantee that these systems will be harmonious, leaving a small business with $1 million in online sales to confront 44 different software widgets and a whole new IT budget. Given the competitive landscape of retail, the bill is likely to harm those who supposedly need it the most: small businesses.

While the bulk of commerce still takes place at brick-and-mortar stores, only e-commerce is seeing rapid growth. And while some of that is cannibalizing physical stores, e-commerce is creating new markets, which has been as much the savior of small, innovative businesses as a disruptor. Smart boutique owners know how to add an online component, which works in tandem with their physical store and often becomes an even larger entity.

Then there are state governments, many of which need all the cash they can get to cover pension plans that are seriously underfunded. The allure of "lost" online revenue is understandable, but states would be better served by encouraging online commerce, especially if they are determined to tax it. That is where the growth is. If you want vibrant communities, you have to support the virtual ones.

This or VAT?
Nonetheless, governments require revenue. Over the past years, there have been various calls for a value-added tax in the United States; the explosive growth of online commerce should renew that debate. The VAT is well suited to online commerce because it creates a chain of revenue that goes from vendors to wholesalers to final customers. Of course, a VAT would be inherently disruptive of state-sales taxes and would require radical changes at the state and national levels. We appear nowhere near that.

After sailing through the Senate, it appears that the bill's final passage in the House of Representatives is uncertain and perhaps unlikely. House Speaker John Boehner is in no hurry to bring the bill to a vote, and while we know that his views hardly determine the behavior of the Republican caucus, in this case it is certainly more in sync. There is predictable, if knee-jerk, opposition from those Republicans committed to no new taxes, and there is intense lobbying from powerful online players such as eBay to slow passage or further amend the bill.

This proposed bill is a bad implementation of a needed change. It's a reminder that what we can currently do politically is far short of optimal. In this case, it fails to even be acceptable. It raises a small amount of revenue and generates a large amount of friction. It does, however, highlight that not all areas of our economy are bleak and moribund. It's the very vibrancy of the e-commerce world, both independent of and connected to physical stores, that led to this legislation. Remember the thief who was asked why he robbed the bank and answered, "Because that's where the money is"? Well, that's why we have this new bill, because e-commerce is thriving. The bill may be a poor idea, but at least there's a sector of our economy that is doing so well.

"The Edgy Optimist" column is initially published at, an Atlantic partner site.