September 26, 2001
By Daniel J. Mitchell, Ph.D.
Fearful of competition, some politicians in
high-tax states want to stop their residents from saving money by
purchasing products where taxes are lower. Using the excuse that
they want to "streamline" and "simplify" retail sales taxes so that
there will be a "level playing field" between Main Street merchants
and e-commerce, these state and local politicians are asking
Congress for unprecedented power to impose taxes on transactions
that take place outside their borders.
issue is not whether to tax Internet sales. States already have
that power. Instead, the debate is about whether Congress should
pass a law that allows taxation without representation. Should
there be a national law, for example, allowing Utah to compel a
Colorado business to collect and remit Utah taxes if that business
sells something to a Utah resident?
U.S. Supreme Court already has ruled that states may not tax
companies that have no presence (or "nexus") inside their borders.
State and local politicians want to overturn this decision by
getting Congress to approve a state sales tax cartel and attach
legislation authorizing the cartel to a bill extending the Internet
Requests to establish this destination-based tax authority should be
denied. Such a regime would create an anti-consumer sales tax
cartel for the benefit of profligate governments. It also would
undermine privacy by requiring the collection of data on individual
purchases. And it would violate important constitutional principles
by giving state and local governments the power to impose their own
taxes on businesses in other states.
Proponents of a destination-based sales
tax regime who claim that it would level the playing field ignore a
crucial fact: The current inequity exists only because state and
local governments have chosen not to tax the sales of in-state
companies on purchases sent to out-of-state buyers. The issue is
not the Internet. The issue is reducing competition from low-tax
The Threat to
Both the National Governors' Association (NGA) and the
National Conference of State Legislatures (NCSL) support the sales
tax cartel. In their view, people should not have the freedom to
shop where taxes are lower. This activity, they argue, creates a
"race to the bottom" because states would be forced to lower their
tax rates to remain competitive. But governments should not be
allowed to act like monopolists. The possibility that taxpayers
might shift economic activity to a lower-tax jurisdiction is a
useful form of fiscal discipline. Tax competition forces
politicians to be more responsible, much as competition among
banks, pet stores, and car companies results in lower prices and
Threat to Privacy
In addition to being bad tax policy, the
destination-based regime is a threat to privacy. The system
envisioned by the NGA and NCSL would require merchants to verify
the residence of every customer and then impose the state and local
taxes that apply in that locale. For this system to work, however,
state and local bureaucrats would have the right to inspect records
of transactions. At best, this approach means that personal
financial information and buying patterns would cease to be
private. On a more ominous note, this type of system would
dramatically increase opportunities for such crimes as identity
theft and credit card fraud. Proponents assert that "trusted third
parties" could act as intermediaries to guard against these
problems, but cosmetic gestures will not deter hackers and others
who misuse private information.
Advocates of the state sales tax cartel may not realize
their regime also could undermine America's interests in the
international arena. High-tax European governments are upset that
many of their consumers avoid their punitive value-added taxes (a
form of national sales tax) by purchasing goods and services from
U.S. companies. In an effort to weaken America's competitive
advantage, these states want to compel U.S. companies to collect
taxes on their behalf.
its credit, the Bush Administration is resisting this effort to
make U.S. firms subservient to foreign law, but the President's
moral authority to defend American interests will evaporate if
state and local politicians are able to impose domestically what
European politicians seek to impose internationally. Simply stated,
it is important to defend the principle that sales taxes should be
imposed where a transaction occurs, not where a consumer lives.
Because of the shipping and handling fees that accompany
on-line and mail-order purchases, consumers rarely make
out-of-state purchases to avoid paying sales tax. But if state and
local lawmakers are truly concerned that local merchants are being
disadvantaged, there is a solution that would allow tax
competition, preserve consumer privacy, and respect constitutional
principles: States could level the playing field by taxing all
in-state sales at the same rate, regardless of whether the purchase
is made in person, over the phone, or by using the Internet.
origin-based or "territorial" approach is based on the
common-sense notion that there should be a link between taxes and
government services. A Texas-based business, for instance, should
pay taxes to the Texas government. That business, after all, uses
Texas roads and relies on Texas fire and police protection. Having
that business pay taxes to another state, by contrast, would be a
form of taxation without representation.
Another benefit of "territorial" taxation
is that it can level the playing field without special
congressional approval. States merely have to apply their sales
taxes on a non-discriminatory basis. Indeed, because a more broadly
based sales tax would generate additional tax revenue, legislators
should take advantage of this opportunity by using the extra
revenues to lower state income tax rates or reduce the overall
sales tax rate. This type of tax reform would improve state
economic performance by boosting wages, creating new jobs, and
A destination-based sales tax cartel would be bad for
taxpayers. It would damage competition and privacy, erode fiscal
discipline, and lead to higher tax burdens. It would threaten
personal privacy by allowing third parties to examine financial
transactions and buying patterns. And it would harm the President's
ability to defend America's economic interests when dealing with
Europe's welfare states. Rather than authorize a state sales tax
cartel, Congress should encourage state and local governments to
work together to implement origin-based or territorial sales tax
reforms that would ensure that all purchases are treated
Daniel J. Mitchell, Ph.D., is McKenna
Senior Fellow in Political Economy in the Thomas A. Roe Institute
for Economic Policy Studies at The Heritage Foundation.
A destination-based sales tax cartel would be bad for taxpayers. Itwould damage competition and privacy, erode fiscal discipline, andlead to higher tax burdens. It would threaten personal privacy byallowing third parties to examine financial transactions and buyingpatterns. And it would harm the President's ability to defendAmerica's economic interests when dealing with Europe's welfarestates.
Daniel J. Mitchell, Ph.D.
McKenna Senior Fellow in Political Economy
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