On June 30th, two days before it was scheduled to go into effect, the Massachusetts Department of Revenue (DOR) pulled a directive that would tax online retailers without a physical presence in the state. Under the directive, any company that has over 100 transactions and at least $500,000 in sales in the state in the prior year would be subject to a 6.25% sales tax.
An internet sales tax is not, however, as easy to implement as it sounds. In 1992 the Supreme Court ruled in Quill Corporation v. North Dakota that that states could not levy taxes on businesses unless they had a physical presence in the state in which they were being taxed.
To get around the ruling, the DOR decided to expand the definition of “physical presence” to include browser cookies. Historically, a physical presence has been a storefront, warehouse, or office space. The DOR argued that cookies are property of the online retailer and are necessary to facilitate sales and thus should count as a physical presence.
According to PC Magazine, a cookie is a “small text file (up to 4KB) created by a website that is stored in the user’s computer.” Cookies keep track of shopping information such as the contents of a customer’s shopping cart and are used by the vendor’s website to facilitate sales.
Not everyone agreed with the DOR’s definition of physical presence. After the directive was issued, two business advocates NetChoice and the American Catalog Mailers Association (ACMA) mounted a legal challenge to it. After initial arguments were presented, the DOR pulled the proposal.
E-commerce is a fast-growing byproduct of advances in technology. According to the U.S. Census Bureau, e-commerce made up just 3.5% of all retail in 2007, but it now accounts for over 8.5% and is growing by around 15% annually. As consumers continue to shift to online sellers, for, political debate concerning internet taxation will become increasingly important, especially in states that rely heavily upon sales taxes to support government programs. So why do some people support an internet tax while others say it will be a disaster for American business?
Arguments in Favor
The National Retail Federation, an organization that represents retail and department stores, suggests that “online sellers should not continue to receive an unfair price advantage.” Companies without a physical presence in Massachusetts are able to undercut local businesses and retailers by avoiding the current 6.25% sales tax, making their products significantly more competitive.
Americans place a lot of emphasis on making sure that our laws are fair and give everyone an equal opportunity to work hard and rise to the top. Hardworking businesses that would otherwise be successful are handicapped by an unfair system of taxation that favors internet retailers.
Inequitable sales tax treatment undercuts the free market by allowing certain businesses to gain competitive advantages from factors other than the quality and price of their product. This reduces the quality of goods to which consumers have access.
Supporters also argue that shifting consumer purchasing to online sellers exacerbates the Commonwealth’s fiscal challenges. Governor Baker estimated that the new internet tax would bring in $30 million in FY 2018. This number would be even larger if Massachusetts were to lower the minimum threshold of $500,000 in annual Massachusetts sales to widen the tax base. In South Dakota, after passing a tax on retailers with over $100,000 in sales, only 206 companies were subject to the tax. If Massachusetts were to lower the minimum threshold to $50,000, for example, many more retailers would be subject to the tax and revenue would greatly increase.
Everyone hates tax season. Even with tax-filing software like TurboTax, it took the average American about 15 hours to file their personal income taxes just for the country, state, and district where they live, according to CNBC. Now imagine you are an online retailer that sells your product all around the country. With an internet tax, you would have to file tax returns in many jurisdiction and be prepared to answer questions if an auditor calls. You would need to know all the rules concerning various effective tax rates, which products are tax exempt, and if and when different districts have tax holidays.
There are about 10,000 tax districts that collect sales tax across the country. There is not much rhyme or reason for the number of districts in each state. Some are state-level districts while others are single counties or even sections of one. In 2014 Massachusetts had just one district, while Texas had 1,515. Keeping track of all the rules and regulations in each one would be a huge burden for the average business. Even knowing which goods are supposed to be taxed and which are not can be a difficult task. In a report by the trade association True Simplification of Taxation (TruST) “a granola bar might be classified as non-taxable food in one state and taxable candy in another, but a merchant might classify it as ‘Trail Food’ with no relation to whether it is candy or not.”
In the same study, TruST reported that it would cost the average mid-market firm $57,000-$260,000 per year to comply with a theoretical cross-state sales tax that included all 10,000 districts. This number includes the cost for software, classification of taxable items, compiling reports and complying with audits, and lost sales caused by software complications.
Money spent on tax compliance is money not being used to grow businesses. Increasing the cost of doing business will certainly slow down economic growth. Mid-market firms employ 100-1000 employees, so a burden of even $200,000 per year could be very significant.
Some advocates of the tax argue that the projections by groups like TruST are overblown and any realistic internet tax legislation won’t have such cumbersome logistics. In 2013 Congress failed to pass the Marketplace Fairness Act. Under this bill, states would be allowed to tax online commerce only if they simplified their tax code. States would be required to allow businesses to file taxes at the state level with a single rate and would also take responsibility for dividing up revenue at the local level. States would also need to provide businesses with free tax filing software.
Massachusetts is not the only state to add taxes for online retail sales. Last year, South Dakota passed a tax on online retailers with more than 200 transaction and $100,000 in sales. This law is currently being challenged in court and could reach the Supreme Court by this fall.
Despite the controversy, however, most online retailers are already taxed in Massachusetts. Every year the National Retail Federation rates the largest retailers and e-commerce companies. Most of the top online retailers are companies that already pay taxes in the Commonwealth such as Walmart, Amazon, and Home Depot. Only 12 companies in the top 50 are online-only, and one of them, Wayfair, is based in Massachusetts. Last year, Massachusetts collected $2.1 billion in general sales tax. In its current form, the DOR directive’s $30 million would account for only about a 1.4% increase in sales tax revenue.
Many people have a lot at stake in the internet sales tax debate. Cash-strapped states and local districts are looking for politically palatable ways to close revenue gaps. Brick and mortar retailers are hoping a tax evens the playing field, while online retailers dread the prospect of complying with thousands of separate tax codes. This debate is not going away any time soon.
Joshua Beck is Roger Perry Government Transparency intern studying economics and computer science at Brown University