The Problem of Taxing Online Sales

State and local governments have lost $23.3 billion in uncollected tax revenue due to the difficulty of collecting taxes associated with online commercial activity, according to Gordon Gray and Joseph Kessler of the American Action Forum.

Currently, online sellers are not required to collect taxes on sales to citizens outside of their states, as long as those sellers do not have “nexus” (physical presence) with those states. This rule comes from a 1992 decision from the Supreme Court, Quill Corp. v. North Carolina. To change it, Congress would need to pass a law allowing states to require sales tax collections by out-of-state retailers.

Why are states losing revenue, if online sellers are not required to collect sales taxes? Because consumers are required to pay use taxes on goods purchased from out-of-state vendors. In practice, however, most people do not pay use taxes.

When it comes to drafting legislation to allow for online sales tax collection, establishing the location of the sale is important. In a standard sales tax situation, a vendor located in a taxing state collects sales tax from a customer and remits it back to the state. But in the case of online sales, lawmakers must decide whether to use destination sourcing or origin sourcing.

Consider the sale of a good from a business based in Kentucky to a person in Texas. Destination sourcing would require the Kentucky business to collect and remit the Texas sales tax.

– This approach is often preferred because there is no taxation without representation, and it gives taxpayers a stake in their state’s budget and taxing policies.
– However, destination sourcing would require businesses to comply with sales tax regimes of every state in the country. Online tax proposals, however, have made efforts to simplify collection for vendors.

Origin sourcing, on the other hand, would require tax collection based on the location of the seller, requiring that the Kentucky business collect and remit the Kentucky sales tax.

– The approach is simpler for the vendor, because it only requires them to comply with one tax regime.
– However, businesses might move to states without sales taxes in order to reduce their collection burdens, leaving states to increase other forms of taxes, such as income or property taxes.
– Additionally, taxed consumers would not be able to voice their objections to the taxes through the ballot box.

Another approach, called “hybrid-origin sourcing,” would require the seller to collect sales tax according to the taxing regime of his own state and then remit that tax to the state in which the buyer is located.

More From NCPA: