Ed Lotterman: Internet sales-tax bills will level the field

May 3, 2013 

It is encouraging that the "Marketplace Fairness Act" is progressing well through the U.S. Senate. The House may prove to be a different story, although the odds are that some version of it will pass eventually.

Because it facilitates states collecting sales taxes on purchases made by their residents from Internet-based retailers in other states, it will level a playing field that has been stacked against brick-and-mortar retailers for more than a decade.

Anti-tax zealots, including the Wall Street Journal editorial board, squawk against it, and no federal bill dealing with the intensely varied system of state and local taxes in our nation will ever be perfect. But overall, the bill makes sense, and our economy will have fewer economic distortions if it becomes law.

The issue of sales taxes and how they affect trade across state borders pre-dates the Internet by decades. It first arose as a personal issue when my mother bought a badly needed hay mower in 1966. We farmed in southwest Minnesota, but our preferred implement dealer was across the border in Iowa. We paid some $500 for the mower on an invoice the dealer had marked "Tax Exempt - Out of State," and went home happy to have a replacement for the old piece of junk that had caused so many headaches.

More than a year later, we got a letter from St. Paul informing us we owed "use tax" on the mower and instructing us to remit some $15 or so. That was when I learned the law specified that we owed taxes to Minnesota on purchases in Iowa, even if the vendor there had no legal obligation to collect them. We sent a check to the state, but continued to do business with that dealer for another decade and never bothered to pay any more "use tax."

The incident - and the current legislation - illustrates long-term basic issues, however. Did the fact that we could effectively avoid paying tax if we made the purchase in Iowa influence our decision-making?

It likely does today for people making tax-free purchases at Amazon.com versus at a local Best Buy. Overall, how much do such purchases reduce the sales of my own state's physical business or the state's tax revenue?

Retailers, large and small, say it's a real problem. Are the "use taxes" coupled with sales taxes fated to be almost universally ignored? And should one state like Minnesota or North Dakota or Idaho have the right to dictate actions by businesses in another sovereign state?

Fifty years later, the issues have not changed much. But technology has, and that is forcing a major restructuring.

I don't think the question of taxes entered our mind in buying the mower. This was the closest dealership for a particular make of machinery we liked, and the owners had good prices and service. In the same way, the fact that we had to pay taxes on clothing bought in South Dakota, but not in our home town did not deter my mother and aunt from mounting back-to-school and Christmas shopping pilgrimages across the state line.

The degree to which cross-border shopping is motivated by tax differentials has been contentious from the start. Separating out factors such as convenience, lower prices from stores in larger cities and so forth is difficult. In general, research shows that differences in tax levels play a role, but not nearly as large as retailers in higher-tax states claim. Before the Internet age, the effect varied by location. The closer a store was to a state line, the bigger the effect of a tax differential relative to the costs of traveling farther to shop. The farther away, the less the effect - although distances often don't preclude people from seeking a bargain: Witness the popularity of outlying outlet malls.

The Internet, however, has changed things dramatically. Purchases on the Internet still make up only 5 percent of all consumer spending. But it is a much higher proportion for clothing, books, electronics, small appliances and myriad other items. And the difference between a state's rate and the 0 percent often due on Internet purchases usually is much higher than the difference between that same rate and those of adjoining ones. So brick-and-mortar retailers who handle such nonperishable, easily shippable merchandise are alarmed, indeed.

Republicans generally are anti-tax, but the bill to facilitate states taxing Internet sales has been tirelessly pushed by Wyoming Republican Sen. Mike Enzi.

But Enzi is a traditional small-city main-street retailer, having taken over his parents' shoe store and expanded it to two other towns. He understands how dramatically the Internet and contemporary package services have changed competition for merchants in Wyoming cities like Gillette and Sheridan. Tax differentials are only one part of that.

On grounds of fairness, it is hard to argue that one set of retailers should be exempt from taxes that another set has to pay. Basic economic theory also shows that doing so artificially skews incentives and reduces economic efficiency. The Internet is great, but that does not mean that government should give it an artificial advantage via tax policy.

Yes, brick-and-mortar retailers benefit from local services in a way Internet ones do not. Yes, Internet retailers located in the few states without sales tax will have to charge customers from neighboring states with taxes even though physical stores in the same town won't have to charge customers who drive across the state line.

Enzi's act is a step in the direction of both fairness and efficiency. Let's hope the House concurs with the Senate and passes it, even if that means I'll be taxed on the fence hardware I get from Pennsylvania and the drip irrigation supplies from California.

Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.

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