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Grover Norquist is Right to Oppose Internet Sales Taxes

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When I visited my brother in London a few years back, I toted a suitcase packed with tennis balls. I paid New York City's 8.5 percent sales tax to help my brother's tennis-mad family avoid the UK's 20 percent value-added tax, or VAT, Europe's big brother to our sales tax.

In the last 40 years, mostly at Republican initiative, many US states and localities have dramatically increased sales taxes at the expense of property taxes. Only four states, Delaware, New Hampshire, Oregon and Montana, have no sales taxes; southern states generally charge the most. (Arizona tops out with a combined state and local rates up to 13.7). Europe's VAT, introduced by France in 1954, is a national tax. European Union "tax harmonization" rules require member countries to charge a minimum of 15 percent; most EU members charge over 20 percent. (Hungary wins with 27 percent.)

So far the U.S. has resisted a national VAT, despite support from both right (businessman Steve Forbes) and left (economist Robert Frank). That may change with the expansion of sales taxes on internet sales.

The U.S. Senate just passed the Marketplace Fairness Act, enabling state governments to make internet companies like Amazon collect sales taxes from their customers -- just as local businesses have long done. Is this truly a victory for tax fairness? While Grover Norquist, the Heritage Foundation, and other extreme anti-tax ideologues continue to oppose the measure, many Republicans are waffling. Many good liberals positively jump with enthusiasm. New York Times business columnist Floyd Norris writes (5/13/13):

"It is nothing short of amazing to me that this proposal is controversial...What this would do is make tax compliance easier and provide badly needed revenue -- from their own citizens -- for struggling states and cities. It would also mean that local merchants -- the ones who pay property taxes -- would find it a little easier to be competitive with Internet merchants."

Alas, Floyd Norris misses the big picture: Sales taxes are simply terrible taxes. As Europe's gasping economy sinks into another recession, I think there's good case that the VAT aggravates the damage of misguided austerity policies.

As most of us know, sales taxes are "regressive." That is, when sales taxes are "passed on," they fall harder on poorer customers than on richer ones. That's why many states exempt food and medicine, as does New York, (except for restaurant food). But sales taxes are also "passed back" onto retailers and service providers. In fact, sales taxes are shared between customers and retailers in inverse proportion to their ability to shop or sell elsewhere.

It's the "passed back" portion of sales taxes that do the most damage, because -- unlike profit taxes -- they take a bite from gross revenues before expenses. Moreover, a uniform tax rate does not mean uniform impact. (As Anatole France wrote, "The law, in its majestic equality, forbids the rich as well as the poor to sleep under bridges, to beg in the streets, and to steal bread.") Sales (and VAT) taxes fall hardest on small, labor-intensive retailers, with high volume and low profit margins.

Consider two New York City businesses: One is a furniture store; the other is a Sabrett's hot dog cart. Assume for simplicity the "passed back" portion of the 8.5 percent sales tax is 5 percent. The furniture store invests $9,000 a year in an inventory of sofas, which it sells for $10,000, earning a $1,000 before-tax profit. 5 percent sales tax is $500, half of profit, and 5.5 percent of the $9,000 investment. The hot dog cart invests $200 a day in buns, dogs and labor. It earns $210 a day, or $76,650 a year in sales and $3,650 in profit. A 5 percent sales tax collects $3,833, wiping out profit and amounting to 1916 percent of the $200 investment! Moreover since most of the cost of the cart is labor, the tax adds 5 percent to the 18 percent or so in payroll taxes! In short, sales taxes kill small businesses -- precisely the kind which provide the most jobs per dollar invested. And by killing competition, sales taxes may drive prices up by more than the tax rate.

Sales taxes are also insidious -- it's always so tempting to politicians to raise them another quarter cent, and hope no one notices. Up to now, the threat of tax competition from neighboring states and localities has kept those politicians in check. That is, as long as customers can easily shop elsewhere, most of the tax will be "passed back" onto merchants -- whose complaints will make politicians think twice about increases. The European VAT has crept so high precisely because shoppers can't avoid it by crossing borders. (Tennis ball smuggling isn't cost-effective).

In recent years, the rise of effectively untaxed internet sales has helped check increases of state and local sales taxes. If the Marketplace Fairness Act passes the House, it will release that check on sales taxes, and lubricate our way towards European-style VAT taxes! "Fairness" shouldn't mean raising sales taxes on internet merchants, but reducing them on local businesses. For once, though for the wrong reason, Grover Norquist is right.