What the Senate Could Learn from Illinois about Internet Sales Taxes

by Whitney Pitcher

The Senate  is poised to vote on the Orwellian-sounding “Marketplace Fairness Act” next week. This bill would institute an “internet sales tax” and could be seen as a gateway to a national sales tax. Also, in many ways it would allow federal government to expand individual states’ powers over businesses outside of a state. As the Heritage Foundation explains:

They seek enactment of [the Marketplace Fairness Act] so that states can prefer in-state businesses over out-of-state businesses in the kind of anti-competitive economic discrimination the U.S. Constitution was in part adopted to prevent. As the U.S. Supreme Court has stated, “[p]reservation of local industry by protecting it from the rigors of interstate competition is the hallmark of the economic protectionism that the Commerce Clause prohibits.”

This bill would require that states without a state sales tax to collect sales taxes on internet purchase on behalf of states that have sales taxes. This additional regulation is of great expense to smaller businesses. When the bill was introduced in the previous session of Congress, then Senator Jim DeMint cautioned against it:

The burden on Internet entrepreneurs could be staggering. There are already nearly 10,000 state, local and municipal tax jurisdictions to navigate nationwide.

Just complying with a single state’s tax laws costs small businesses disproportionately more than larger firms that can afford accounting and technology teams to help them work through these arcane laws. A 2006 PricewaterhouseCoopers study found that tax-compliance costs for small businesses (those having $1 million to $10 million in annual sales) are nearly 2.5 times greater than those of larger firms. For businesses under $1 million in sales, those costs explode to 16 cents on every dollar of revenue.

And woe to online sellers if they have a dispute with one of the many states that will be unleashed to tax them. A small business owner in South Carolina could face simultaneous audits from California, New Jersey and Hawaii, with no political recourse.

Proponents of the bill point to exemptions for businesses with less than a million dollars in annual sales, but as Senator DeMint referenced, the impact on small businesses making $1 to $10 million annually is more onerous than for bigger businesses. Even Democratic Senators, like Oregon’s Ron Wyden, have seen the potential for such taxation to not only make government bigger, but also to drive businesses out of the country:

 “What concerns me, especially after the legal analysis I received from the Congressional Research Service, is I think the way this bill is going to work, people are going to end up calling it the shop Canada bill or maybe the shop Mexico bill or, what is even more ominous, the shop China bill.”

The Senate needs to look no further than the home state of one of bill’s co-sponsors, Dick Durbin. In 2011, Illinois passed a similar law called the Main Street Fairness Act. What did the bill do? It drove businesses out of Illinois and generated far less state revenue (tax dollars) than expected, as an Illinois Policy Institute op-ed in the Chicago Tribune early this month notes: 

 After the law was enacted, businesses fled. Overstock.com and Amazon.com ended their relationships with Illinois-based marketing affiliates. Chicago-based CouponCabin moved to Indiana. And FatWallet.com, which had been headquartered near Rockford for three years, skipped the border to Wisconsin.

“The so-called Amazon tax was misguided,” said Brent Shelton, a spokesman for FatWallet.com. “(It) did little to increase the competitiveness of the local merchants it was purportedly designed to protect. It’s primary result was to cause businesses like ours to leave the state.” Each of these companies took with them people, jobs and money.

And the $150 million?

The actual money generated by the law was much less.

According to the Illinois Department of Revenue, the law generated just $3.8 million between July 2011 and January 2012. The state was on pace to net $6.4 million from the tax by the end of the fiscal year. This law, billed by one of Illinois’ top political leaders as a step toward solving Illinois’ economic and fiscal problems, failed to achieve even 5 percent of its intended target.

Just as Senator Wyden noted, the “Marketplace Fairness Act” could drive businesses overseas. Illinois has shown that a similar state law has driven businesses across state borders. What’s to say that a federal law wouldn’t do the same? Also, as with many forms of taxation, revenues rarely reach anticipated amounts. Why should states collect taxes on behalf of other states? What about potential constitutional violations,which the Heritage Foundation warns against and the state of Illinois experienced? Those are all questions we should ask the 75 Senators who voted in favor of a non-binding resolution for internet sales taxation last month. Let’s hope they’ll learn a lesson from the microcosm of America’s financial problems–Illinois–and vote “no” on the actual bill.