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February 18, 2015
Groundhog Day: Waking Up to the Online Sales Tax Issue -- Again
by Billy Hamilton

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This article first appeared in the February 2, 2015 edition of State Tax Notes.

Billy HamiltonBilly Hamilton was the deputy comptroller for the Texas Office of the Comptroller of Public Accounts from 1990 until he retired in 2006. He is now a private consultant.

In this article, Hamilton celebrates Groundhog Day by resetting the debate over the taxation of online sales. With the Marketplace Fairness Act of 2013 all but dead, Hamilton writes, another bill is attracting attention -- this time from Rep. Bob Goodlatte, R-Va., who is proposing that sales taxes on purchases be based on the location of the seller, not the buyer.

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Another year has passed, and it's time to reset the debate over online sales taxes. This repeating cycle reminds me of the movie Groundhog Day, in which Bill Murray plays Phil Connors, a weatherman who keeps reliving the same day over and over again. If you've seen the movie, you'll know what I mean when I say the only thing missing is a clock radio flipping over to 6 a.m. and Sonny and Cher singing "I Got You Babe." In the movie, Phil says, "What would you do if you were stuck in one place, and every day was exactly the same, and nothing that you did mattered?" That's where those involved in the online sales tax debate find themselves, but rather than starting the same day over, they restart the issue in Congress year after year, getting nowhere.

And so it begins again. In mid-January, House Judiciary Committee Chair Bob Goodlatte, R-Va., circulated a draft plan for legislation to allow states to collect sales taxes on sales by out-of-state, mostly Internet-based, sellers. The 2014 version of this effort, the Marketplace Fairness Act (MFA), was last seen going down for the count in November when House Speaker John A. Boehner, R-Ohio, delivered a final knockout punch to whatever slim hope the legislation had by vowing to prevent it from advancing for the remainder of the year -- effectively pigeonholing it until the new Congress convened in January with Republicans controlling both the House and Senate.

Goodlatte's plan differs markedly from the MFA, which the Senate passed in 2013 with the support of the states and large retailers, including and Wal-Mart, only to die in the House late last year. The new version, known as Home Rule and Revenue Return, would base the taxation of Internet and mail-order purchases on the location of the seller, not the buyer. So if you lived in Texas and bought something from an online seller in California, that seller would collect tax at California's rate and remit it to California rather than Texas, as the MFA would have required.

Both of these efforts are designed to solve a decades-old problem of how to collect tax on sales made by out-of-state retailers. Under the U.S. Supreme Court ruling in Quill Corp. v. North Dakota in 1992, sellers, both mail-order and online, are required to collect sales tax only for states where they have a physical presence -- a store, a warehouse, or employees. In cases in which these remote sellers aren't required to collect tax, the consumer is obligated to pay use tax directly to their home state. Although business compliance with the use tax is high, most individual consumers either don't know about the requirement or conveniently overlook it. State tax agencies, facing the impossibility of identifying thousands of online shoppers and collecting tax from them, have mostly stopped trying to do so and have moved on to other ideas, including the Streamlined Sales and Use Tax Agreement and the passage of affiliate nexus legislation that attempts to require tax collection by online retailers that have in-state affiliated sites that link to them.

Although Quill guides current law, state government fears over remote sales go back much further than 1992 and decades before the Internet was born. Verenda Smith, deputy director of the Federation of Tax Administrators, said the FTA has records documenting discussions of the issue dating back to 1982. She believes tax administrators probably began discussions sometime around 1967 after the Supreme Court ruling in National Bellas Hess v. Illinois, a precursor to Quill, in which the Court found that the commerce clause prohibits states from requiring a "seller whose only connection with customers in the State is by common carrier or by mail" to collect and remit tax. "I keep saying there's a PhD thesis in here for somebody," Smith said of this tangled history.

Besides establishing limits on state taxation of remote sales, Quill did two other things. It strongly urged Congress to work with the states to establish a uniform set of rules to reduce complexity and avoid potential double taxation, and it said Congress could authorize states to require remote sellers to collect tax if it wished to do so. While the states have spent the intervening two decades hacking away at the problem, Congress has consistently dodged doing much of anything and continues to do so.

The net effect of state tinkering and congressional dithering is a mess. The streamlined process has dragged on for years, and although it has accomplished much, its momentum has slowed. In the meantime, state efforts to get around Quill's prohibitions, such as affiliate nexus legislation, have spread across the nation, creating a patchwork of states with and without the laws. Meanwhile, the business community has split into factions for and against congressional action. Bricks-and-mortar retailers lobby Congress to allow state collection because they feel disadvantaged by the current situation. Online retailers and many Internet advocates fight the requirement, arguing that the Internet should remain tax-free, that collecting tax for thousands of governments is too hard, and just about every other excuse imaginable.

The only winners are consumers, who benefit from de facto tax-free online shopping, and some retailers, who continue to benefit from their tax-free advantage. And even that second set of winners has become increasingly muddled over time. Amazon, which arguably created the greatest retail juggernaut in history at least partly because of the online tax advantage, has now switched sides -- sort of. It has increased the number of states in which it has agreed to collect tax, particularly where it is building new warehouses, and it has become a major proponent of a national fix, particularly one to its own liking. On the other hand, the company continues to fight state legislation in states where it doesn't have a physical presence and isn't planning to build facilities. Its program operating agreement for its affiliates now reads that "if at any time following your enrollment in the Program, you become a resident of Arkansas, Colorado, Maine, Missouri, Rhode Island or Vermont, you will become ineligible to participate in the Program, and this Operating Agreement will automatically terminate, on the date you establish residency in that state."1

The day that kept repeating in Groundhog Day was February 2, but the details of what happened during the day changed depending on what Phil did. So it is with the online tax issues. Goodlatte's plan is a marked departure from the MFA. Rather than allow the state of origin to keep the tax from its online sellers, the MFA would have required sellers to send tax to the sales' destination state. Goodlatte's approach reverses the flow. That shift is meant to address a key objection to the MFA that argues that it would put online retailers at a competitive disadvantage. "Under [MFA], Internet and catalog retailers would have to collect sales tax and comply with confusing sales tax rules for every jurisdiction where they sell (presumably, many or most of the 9,646 U.S. jurisdictions with a sales tax). By contrast, bricks-and-mortar stores pay attention to sales tax only where the store is physically located, since customers come to them," said Joe Henchman of the Tax Foundation in 2013.2 One way the MFA attempted to mitigate this burden was by exempting businesses with annual U.S. receipts of less than $1 million.

Goodlatte's proposal offers an apparently simple solution: treat an online sale like a local sale by the seller. Instead of requiring retailers to identify and collect sales taxes for thousands of jurisdictions, they would simply collect taxes at the local tax rate. The solution is meant to be consistent with seven basic principles for remote sales tax legislation that Goodlatte proposed in September 2013 after the Senate passed the MFA. Those principles include avoiding unequal tax treatment between online and bricks-and-mortar retailers, giving those who pay state taxes greater ability to challenge them in that state's forum, making compliance simple and inexpensive enough that a small business exemption would be unnecessary, encouraging competition among states to keep tax rates low, and supporting state sovereignty issues, including the idea that the federal government shouldn't mandate that states impose any sales tax compliance burdens.

Under Goodlatte's proposal, all retailers would charge local rates and comply with the law in effect in their home state. A state could gain a comparative advantage as far as online sales are concerned by keeping its sales tax rate low or nonexistent, and the scheme is simple enough that a small business exemption wouldn't be needed. It seems to touch all of the bases, but does it really? In part, that issue will become clearer once actual draft legislation is released; however, it's possible to draw a few conclusions from the proposal as it now stands.

James Gattuso and Curtis Dubay of the Heritage Foundation called the plan a "good-faith effort," but also said that it's "flawed" and highlighted what they view as problems in a recent article in The Daily Signal, a Heritage Foundation online news outlet. "Most problematic is a provision requiring retailers in states which impose no sales taxes to do one of two things: (1) collect a minimum sales tax on out-of-state purchases, or (2) report information about the sale to the buyer's home state. In either case, retailers would face a regulatory burden that their own state specifically declined to impose on them. And the explanation given for the new burden -- discouraging tax competition -- is a weak one."3 Still, they say Goodlatte's proposal is better than the MFA.

I imagine that the response from the states, when it comes, will be more critical than that mild objection and will take an entirely different tack. A preview of the likely objections can be found in a Forbes article from March 2014 by Howard Gleckman, editor of the TaxVox blog and a resident fellow at the Urban Institute. He called the idea of setting national rules for sales tax collection based on the location of the seller a "terrible idea."4 In fact, he said, it would be worse than that; "It may really be a classic legislative poison pill: A cynical effort to exempt Internet sales from any tax under the guise of 'fairness' and 'state sovereignty' that could not possibly pass Congress. If it somehow became law, it could well be a recipe for the ultimate demise of sales taxes as a source of state revenues." He said that at a House Judiciary Committee hearing, Stephen Kranz, a tax partner in the law firm of McDermott, Will & Emery, called the idea "the nuclear bomb version of tax competition."

As Gleckman described it, the problem is that the plan does little to actually corral online companies and is likely to touch off an explosion, to borrow Kranz's analogy, of interstate tax competition. According to Gleckman:

    A firm could base its "home jurisdiction" on the state where it has the most employees, the most physical assets, or the state it designates as its principal place of business for federal tax purposes. Given the nature of online sellers, changing locations to a no-sales-tax state would be fairly easy. It would almost certainly set off the sort of tax competition that worries Kranz. And at least some states would end up increasing property and income taxes -- not an outcome that most House Republicans would likely favor.

Another question that might occur to suspicious minds is whether Goodlatte's legislation eventually will be "decorated" with other provisions to preempt state tax authority, something that's been tried before. There are several possibilities floating around Congress from which to choose, including the Mobile Workforce Act, the Business Activity Tax Simplification Act, the Digital Goods and Services Tax Fairness Act, and even the Internet Tax Freedom Act (ITFA). This sort of choice -- gain the ability to tax online sales but give up other authority in other areas -- has never been something the states are comfortable with because their goal is to regain lost revenue, not achieve something like a revenue-neutral result.

Probably not coincidentally, at about the same time Goodlatte was shopping his remote seller plan, he also reintroduced his bill to make ITFA permanent. That legislation -- the Permanent Internet Tax Freedom Act (PITFA) -- would bar state and local taxes on Internet access and was, for a time, tied to the MFA. ITFA was originally passed in 1998 and has been extended five times since then, most recently in December, when President Obama signed H.R. 83, extending it till October 1. Goodlatte's bill, H.R. 235, which he introduced with Rep. Anna G. Eshoo, D-Calif., and several other House members of both parties, would eliminate the sunset date on the current tax moratorium and also eliminate taxes on Internet access already collected in seven states, namely Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin, which were grandfathered in under ITFA. According to an estimate last year in Stateline, those seven states and their local governments stand to lose about $500 million annually in revenue, an amount PITFA supporters dismiss as minor. That's easy to say when it isn't your budget that's affected. In any case, the legislation, which easily passed the House last year, is expected to go directly to the House floor for a quick passage by the new Congress, without new hearings or Judiciary Committee action.

While the PITFA sails along in Congress, the online sales tax issue faces longer odds. Politically, it splits congressional Republicans. Some will oppose the measure no matter how it's justified or explained because it might be perceived as a tax increase. Other Republicans have shown an inclination to support a clarification of the issue but may not agree with Goodlatte's approach. One member of that latter group is Rep. Jason Chaffetz, R-Utah, a member of the Judiciary Committee, who has said of the draft, "Don't like it, don't like it." Chaffetz is working on his own legislation, which is likely to more closely resemble the MFA and has the support of many retailers and states. In some readings of the situation, Goodlatte's bill is less about fixing the online sales tax issue than it is targeted at undercutting Chaffetz's more far-reaching legislation.

Another factor that shouldn't be overlooked is the level of Internet outrage that rains down on this subject whenever it's in the news. Many consumers and Internet advocates just don't believe the Internet should be taxed in any fashion and aren't shy about making the point. Several of those individuals are in Congress but none is a more implacable a foe of online taxes than Senate Finance Committee ranking minority member Ron Wyden, D-Ore. Wyden has a longtime interest in e-commerce issues and comes from a state that doesn't have a sales tax. In the past, he has introduced versions of the original ITFA, PITFA's precursor to the Internet Tax Freedom Forever Act, and the Digital Goods and Services Tax Fairness Act. All of these bills were drafted to prevent the states from laying their grubby hands on the Internet in one way or another.

In 2013 while the MFA was moving toward passage in the Senate, Wyden signed a bipartisan letter opposing the legislation, along with three Tea Party Republicans, two Democrats, and one Republican from no-sales-tax states like Oregon. He has also warned that expanded sales tax collection might encourage states to raise their sales tax rates, which makes no sense at all. The problem isn't that states are straining at the bit to raise taxes. It's that remote sales are slowly killing the retail portion of the sales tax base. States lost an estimated $23.3 billion in 2012 from being prohibited from collecting sales tax from online and catalog purchases, according to the National Conference of State Legislatures. More recent estimates aren't available, but the total rises annually as the pace of online shopping picks up. Despite what Wyden seems to believe, allowing state and local governments to tax these sales arguably would prevent or limit future tax increases or even allow tax reductions, a fact that even tax cut apostle Arthur Laffer has figured out.

Beyond the usual foes, congressional demographics may also work against the legislation, weirdly enough. In reviewing the 2013 Senate vote on the MFA, Henchman pointed out that opponents of the bill were senators from states without a sales tax and every Republican senator younger than 50. The new Congress is younger and has less legislative experience than the 2013 version. The Senate's 13 new members will join 33 others who have served less than one six-year term, the highest total since 1981. In the House, roughly half of all lawmakers will have been in office only since the 2008 election, meaning, as The Wall Street Journal has pointed out, "their main political experience is the politics of polarization."5 So the structure of Congress is increasingly made up of Gen Xers and millennials who reached adulthood during the Internet era and started their political careers in the era of poisonously divisive partisan politics. That entertains little room for compromise. Gone are the days when members of Congress got along by going along, as former House Speaker Sam Rayburn put it. I don't see the modern Republican majority in either chamber going along with helping the states with their tax problems at a cost to their core principles, the lobbying efforts of Amazon and Wal-Mart notwithstanding.

So my bet is that 2015 will end with the states and local retailers still on the outside looking in and waiting for the 2016 reset of the issue. While I enjoy online shopping as much as the next person, this is bad news both for the states and for bricks-and-mortar retailers. According to NCSL's survey of state legislative fiscal officers, between fiscal 2008 and 2013, states closed a cumulative $527.7 billion budget gap, primarily through program reductions. As the NCSL noted, "Raising taxes in the sluggish economy remains an unviable option for most states, so closing the loophole on sales tax collection could provide states with the option of using some of the additional revenue to offset federal spending reductions."

In the absence of federal action, states have sought solutions to the remote sales tax loophole in order to protect their budgets as well as their local businesses, but the results aren't exactly satisfactory. They have created a patchwork of state legislation that flies in the face of a concept the Supreme Court underscored in Quill -- the need for greater uniformity. In January, Michigan Gov. Rick Snyder (R) signed legislation making it, in addition to the District of Columbia, at least the 24th state to have affiliate nexus provisions of one sort or another either by legislation or rule. Michigan's law takes effect in October. But these separate efforts, satisfying as they may be, aren't really setting things aright. "Unfortunately, state attempts alone will not solve the problem; it must be solved by Congress," the NCSL said.

That said, I doubt many members of Congress have more than a passing interest in the states' travails. Still, they should be worried about the local retailers in their home states. Retailers were hurt by the recession. Unemployment rose and shoppers held onto their money. Five years into the recovery, though, traffic in stores remains sluggish as consumers fret over the future and work to rebuild their balance sheets. On January 15 the Commerce Department reported a steep 0.9 percent drop in overall retail sales for December, with declines in almost every category. Online sales, however, continue to climb. According to a separate report released by IBM in early January, total online sales rose 13.9 percent in 2014 compared with 2013. That includes a 27.2 percent increase in purchases made on mobile devices. Online sales are still only a fraction of total retail spending in the United States, but they are rapidly growing as a percent of the total, and the trends aren't promising for local retailers.

Particularly hard hit by these trends are American malls, once a mecca of suburban culture, or, as Joan Didion described them, "pyramids to the boom years. . . . Toy garden cities in which no one lives but everyone consumes."6 That's less true today. Malls have been hard hit by online sales and the trend away from the sort of suburban living and shopping they have represented since the 1950s. Sales have declined and foot traffic has dropped. In the past decade, more than 150 major malls have closed. "With online sales expected to generate half of businesses growth this year, the American mall appears to be on a terminal decline, with more malls shuttering their doors than being built," according to a November 2014 article in Smithsonian magazine.7 Retail consultant Howard Davidowitz has predicted that as many as half of the country's 1,200 shopping malls could fail within 15 to 20 years.

If any members of Congress are curious about these trends, they should drive about 35 minutes north of the Capitol to see one of the latest casualties. On January 5 the formerly upscale White Flint Mall in North Bethesda, Maryland, closed its doors after 36 years and is being demolished to make way for other development. Online shopping played a role, but the causes of White Flint's decline are more complex than the Internet alone. "Twenty- and 30-somethings, myself included, no longer yearn to start families in suburbs designed around strip malls and unwalkable roads," Huffington Post business reporter Jill Berman wrote of White Flint's closing. "Instead, we want to live in picturesque towns and cities with main streets lined with shops, restaurants and other amenities -- not unlike the places where most Americans lived in the early 20th century, before malls came along."8 Places, I'm guessing, like the idealized Punxsutawney, Pennsylvania, in Groundhog Day.

Speaking of which, I have occasionally wondered just how long Phil was caught in that time loop. Since I was citing the movie in this column, I decided to find out. To do so, I didn't go to the bookstore and buy a book about the movie. I looked online and found that Harold Ramis, the movie's director, said on the movie's DVD that the original idea was for Phil to repeat February 2 for about 10,000 years. Later, he said Phil probably lived the same day for about 10 years, of which 38 days are depicted in the film either in whole or part. So lacking a better standard, we'll use that as the range for how long the Internet sales tax issue will be replayed in Washington. The states have been working on persuading Congress to authorize sales tax collection by online retailers for more than 10 years. I'm beginning to think maybe a 10,000-year wait isn't impossible.


1 Leroy Baker, "Amazon Acts Over Vermont's 'Click-Through' Sales Tax," Tax-News, Jan. 12, 2015.

2 Henchman, "House Chairman Goodlatte Releases Principles for Taxing Internet Sales," Tax Foundation Tax Policy Blog (Sept. 2013).

3 Gattuso and Dubay, "New GOP Plan Would Force Online Sales to Be Taxed at Rate of Seller's State," The Daily Signal, Jan. 16, 2015.

4 Gleckman, "A Terrible Response to the Internet Sales Tax Mess," Forbes, Mar. 18, 2014.

5 Siobhan Hughes, "Crop of Young Outsiders Remakes the Face of Congress," The Wall Street Journal, Jan. 5, 2015.

6 Didion, We Tell Ourselves Stories in Order to Live: Collected Nonfiction 311 (2006).

7 Natasha Geiling, "The Death and Rebirth of the American Mall," Smithsonian (Nov. 25, 2014).

8 Berman, "Why I'm Mourning the Death of a Mall," Huffington Post, Dec. 30, 2014.

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