The Free Market Argument for Taxing Online Purchases

The Supreme Court has ruled that states may assess sales taxes on online purchases.  Previously, a business had to have a physical presence in a state before it could be assessed sales taxes.  But now, purchasers will have to pay the tax based on where they live.

“Oh, no!” you may be thinking.  “Since I haven’t had to pay sales tax, I’ve been saving lots of money buying stuff online instead of going to the local shops.  This is going to cost me!  I might as well go downtown to do my shopping.  Blasted government, raising my taxes!”

But free market conservatives are praising the decision.

The free market works best when there is a level playing field and when there is a minimum of distortion from government interference.  That interference and that distortion can take the form of a bad tax code.

Exempting online transactions from sales taxes makes the playing field unlevel–brick and mortar stores, mom and pop operations, and other small businesses are at a disadvantage when competing against mega-corporations like Amazon.  Furthermore, the tax code becomes dysfunctional as states and municipalities try to make up for lost sales-tax revenue by raising other taxes.

To make up for the lost revenue, local and state governments have been raising sales tax rates.  Which sets up a vicious circles, as higher sales tax rates make people buy online even more!  States are also raising income tax rates, a tax that is more detrimental to the economy than sales taxes are.

Josh Barro, writing in Business Insider, explains:

I get it: You liked not having to pay sales tax on some of the things you bought. But random loopholes are not the hallmark of a good tax code.

A sales tax is supposed to be a broad tax on consumption: You buy and use things, you pay tax. When you create a way for people to avoid the tax, you distort their behavior (pushing them to buy online when they might otherwise buy in a store) and you reduce tax collections.

That means the government either has to cut back on services or it has to raise taxes on something else.

We’ve seen that over the decades: Since 1970s, sales tax rates have gone up by a couple of points on average around the country, but sales tax collections have stayed about flat as a share of the economy. That’s because more and more of our spending has been on things that aren’t taxed — mostly because the economy is shifting away from taxed goods towards untaxed services, but also partly because of the online sales tax loophole.

This court decision will create a fairer playing field for retailers and make it easier for governments to continue financing themselves effectively through sales tax. . . .

Over the decades, states have faced growing problems with tax adequacy. Sales taxes have suffered base erosion, as I discussed above. Property taxes have come under major political pressure: Taxpayers have revolted against increases in this inflexible tax, voting to impose caps that have in some states kept revenue growth well below economic growth.

These pressures have pushed states in two main directions: raising sales tax rates, and relying more on income taxes, especially (in recent years) on high earners.

Higher sales tax rates hurt the economy, and since sales taxes focus mostly on goods, they tend to take a larger bite out of low-income Americans’ wallets. Income taxes can be more progressive, but they also hurt the economy as rates rise, and income tax revenue volatility in recessions has worsened the severity of state budget crises.

This court decision makes it possible for states to raise somewhat more sales tax revenue without raising tax rates — an outcome that should be good for the economy and good for people who rely on services from state governments, which is all of us.

[Keep reading. . .]

Maybe cutting down the built-in price advantage that online sellers have enjoyed will help local businesses come back to life.

Online sellers should have a price disadvantage with the cost of shipping, though if an online corporation like Amazon is big enough, it can absorb some of those expenses, or, better yet, get people to pay them upfront with membership programs like Prime.

But since small businesses provide most of the jobs and economic vitality in local communities, we should be glad when they get a break.

On the other hand, small online businesses will be hurt.  Having to navigate the thousands of jurisdictions, each with its own sales tax rate, will be a nightmare.  Amazon already charges sales tax, since that company has physical operations in most states.  I suspect it will offer its sales-tax-tracking software more broadly, forcing independent operators to become third-party sellers who pay Amazon a commission.

Illustration via MaxPixel, CC0, Public Domain

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