Why the Marketplace Fairness Act Beats the Alternatives

Today in the U.S., ecommerce businesses are “more equal” than their brick-and-mortar peers. The Internet remains a tax-free zone, and the Marketplace Fairness Act remains shelved in the House of Representatives.

The Marketplace Fairness Act, which was passed by the Senate in May 2013, would grant states the power to collect sales taxes from online sellers. Of course, the bill is viciously contested. Meanwhile, brick-and-mortar business continue to shoulder the burden of state taxes, and opponents of the Marketplace Fairness Act continue to spin new reasons why this inequity should continue.

Marketplace Fairness Act detractors argue that it would create ‘new’ taxes; that it would subject businesses to tax policies of other states, where they have no ability to influence policy; and that it would force businesses to pay for infrastructure they don’t use. In reality, the Marketplace Fairness Act has been operating successfully in 24 states for over seven years under its predecessor, Streamline Sales Tax, without any of these ramifications.

Rather than debate these flimsy arguments, I suggest we ask a better question: What’s the alternative? Do opponents of the Marketplace Fairness Act have another solution, or is “no” the extent of their vision?

Very few people argue that the Internet should remain a tax-free zone. Even Speaker Boehner and Chairman Goodlatte, staunch opponents of the Marketplace Fairness Act, agree that some kind of Internet sales tax bill must pass. The question is what the bill will contain.

Legislators disagree about the location of an online transaction (a.k.a. “sourcing”) because that determines where a business will report and file the taxes. The Marketplace Fairness Act says that the transaction should be sourced to the buyer’s location. Opponents of the Marketplace Fairness Act argue that the seller is not located where the buyer is located and should therefore not have to file taxes in that state. Never mind that seller uses state infrastructure to deliver goods to the buyer.

Many Marketplace Fairness Act opponents, aware that a pure seller sourcing rule is untenable, are promoting what is known as the “mixed” sourcing rule.  This concept is the centerpiece of the draft bill released by Chairman Goodlatte for discussion, titled “Online Sales Simplification Act of 2015.”  The draft bill provides that transactions will be sourced to the state where the seller is located, and then the seller state would remit the taxes to the buyer’s state (through a clearing house, to be created).  This way sellers would only be subject to the tax policies of their home states. Marketplace Fairness Act opponents claim that this is the least burdensome approach because sellers already collect sales taxes under their home rules.

This hybrid solution would be a disaster for state governments and sellers.

First of all, implementing the hybrid solution would be virtually impossible. With each state tax return, the seller would have to submit a comprehensive report detailing each transaction. The state would then have to reconcile which transaction gets reported to which state, determine how much is owed and transmit the payments. State taxing agencies already have enough difficulties collecting their own taxes. They have no incentive and no capacity to develop systems that would remit tax payments to other states.

Second, the hybrid solution wouldn’t relieve sellers of the compliance burden.  Under the hybrid solution, they would still need complex systems to track and report sales by taxing jurisdiction. The reporting would need to be accurate and detailed enough for the state to divide the tax payment among other tax agencies. Under the Marketplace Fairness Act, a large portion of this reporting capacity would be provided by commercial companies, which in turn would be compensated by the recipient states. Under the hybrid solution, the entire cost of reporting systems would fall on the commercial retailer. Compliance would be significantly more expensive.

Third, the hybrid system would result in higher taxes because it would incentivize sellers to relocate to low tax states. The recipient state (where the buyer is located) would receive taxes collected according to lower state tax rates. Because the buyer’s state would collect less revenue, it would have to raise taxes to make up any shortfall. For example, if a seller were located in a low-tax state, and the buyer were located in California, the seller state would remit reduced taxes to California. Unable to collect enough taxes from the seller or buyer, California would realize a shortfall in taxes collected from online sales and would have to compensate by increasing other state taxes.

Fourth, the hybrid solution would encourage arbitrage between states. Just imagine an enterprising middleman located in a low rate state such as Colorado.  He could purchase goods on behalf of the buyer, and because he made the purchase for purpose of resale, the purchase would be tax free.  When the middleman turns around and resells the item to the buyer, he would only collect the Colorado rate of 2.9%, saving California buyers nearly 7% in sales tax.  Now, imagine if the name of that enterprising middleman was “Amazon”.

Many readers will object to these arguments on the grounds that I, the author, am associated with Exactor, a company that stands to benefit from Marketplace Fairness Act. The truth is that Exactor would benefit regardless of which bill passes – Marketplace Fairness Act, source-based or hybrid rules. We’re a technology company that helps businesses navigate the complexity of state and local sales taxes. Because we’ve been in the trenches, we know what sellers need and how states operate. The above arguments are informed from experience and my hope for a functional sales tax system.

Proponents and opponents of the Marketplace Fairness Act both acknowledge that the Internet cannot remain a tax-free zone. While I contend that sellers and states will be far better off with the Marketplace Fairness Act than a hybrid solution, the debate will continue until the President signs a bill. For opponents of the Marketplace Fairness Act, either it’s time to propose a realistic alternative, or it’s time to let Congress adapt our tax system to the digital age. Until then, some business will remain less equal than others.

Jonathan Barsade, is CEO of Exactor.

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