An End to Online Retailers’ Immaculate Tax Exception?

Most people probably don’t take the absence of  sales taxes into account when they buy online. Shipping costs often offset at least some of the tax savings, bringing costs more in line with neighborhood-based competitors. But for higher-priced items – say, a laptop computer — the $50 or $60 in foregone online sales tax starts to affect purchase decisions. Who wouldn’t want to pocket that money, or use it to buy some extra frills for the laptop?

Multiply that savings by millions of buyers and it becomes easy to see why revenue-starved states want to scotch what they see as a blatant tax loophole – their inability to tax sales made to in-state consumers. Some estimates show states lose about $23 billion in online sales taxes annually. California alone, now suffering a huge budget hole, loses about $1.5 billion a year. But now it’s not just some states that want to level the sales tax playing field. Big bricks-and-mortar retailers like Walmart, Target and Best Buy are lobbying Congress, saying they are tired of their online competitors enjoying an unfair advantage. They want the sales taxes equalized for all.

At present, no U.S. interstate commerce laws require online retailers to collect sales taxes, although seven states now try to do so and about a dozen others are considering similar laws. A 1992 Supreme Court decision ruled that online retailers should collect sales taxes, but only in states where they maintain a physical presence. So, Best Buy, for example, collects taxes for online purchases in states where it has stores. Dealing with 50 complicated state tax codes was deemed too onerous for strictly online retailers. Now, some federal lawmakers are pushing legislation that will streamline the regulatory process to make sales tax collection easier.

Ebay continues to oppose efforts towards online taxation, arguing it would hurt its many small business partners. Amazon, the 800-pound gorilla of online retailing, could lose $653 million, or 2.7% of its North American revenues for this year if sales taxes were imposed, according to Credit Suisse. Amazon has also fought state sales taxation efforts ferociously, but now suggests it would support federal rules for more even-handed sales tax treatment so long as they are applied fairly and are not too complicated.

But the issue of complicated rules is a straw man, says Wharton management professor Stephen J. Kobrin. The technical challenges around online taxation are “not insurmountable” and will notput small businesses at a disadvantage.”

He points out that “aside from the small number of transactions paid in cash or by check, every purchase on the web is cleared, one way or another, through a credit card company. There are a finite number of tax jurisdictions in the U.S., and setting up a procedure to add the tax as the payment is processed and then remitting it to the appropriate jurisdiction would not seem to be rocket science.” At the same time, “while pure digital purchases may pose more of a problem,” like music downloads, for example, “all physical goods are delivered to an address that is within a given tax jurisdiction.”

More generally, however, “avoiding legitimate taxes is not a valid reason for preferring to purchase online,” Kobrin says. So, in some ways the question of online sales taxes is one of fairness. “This is not about whether or not buyers should pay state sales tax on goods ordered online; rather, the question is whether buyers should be allowed to continue avoiding paying these taxes.”

As for big retailers like Amazon, Wharton’s Eric Clemons, a professor of operations and information management, says that “Amazon has a great business model, one that is definitely not based largely on avoiding state sales tax and one that will survive any change to state sales tax laws. Instead, Amazon’s attraction lies in price competitiveness, a seamless online ordering process, a reputation for standing behind products and the more general convenience of ordering online.

“I understand the proposed change, but it seems quite arbitrary, and ultimately the FTC (Federal Trade Commission) may indeed need to get involved as a regulator of interstate commerce,” Clemons adds. “The most natural change, of course, would be to treat online sales as if they were physical sales, and impose the sales tax of the selling state upon all online purchases. This would result in taxes of 6.5% for Amazon and 6.86% for Zappos. Although this would be the simplest change to explain in the courts, it would be especially embarrassing for eBay. With a state sales tax of 8.25%, among the highest in the nation, eBay might have to rethink its location. It might want to move to New York, as long as it avoided New York City or Utica.”

Most observers say, however, that implementation of any new sales tax rules would take at least a couple of years.

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