This past week Governors Bobby Jindal and Dave Heineman of Louisiana and Nebraska, respectively, have called for the abolition of their state's income and corporate taxes. These plans are picking up steam in many more states. The plans propose to make up for this lost revenue through increasing state sales tax. While tax reform is essential to our country's economy and our long-term debt issues, replacing sate income and corporate tax rates purely with sales tax is doomed to failure.
Putting aside the debates between the effectiveness of supply-side economics and whether an increase in sales tax would disproportionately negatively impact the poor, state sales tax only plans cannot make up for the lost revenue under current laws. The reason?
Online shopping is continuing to grow at exceptional rates and year over year is taking a larger percentage of total American retail. The rapid growth of the tablet market and larger smart phones will help drive this trend further and further over the coming years.
While current laws for taxing online purchases vary by state, the general rule of thumb is that sales tax is only collected if the online retailer has a physical presence in the state -- a brick and mortar store, a warehouse, a sales team, or an office. You can find a more detailed account of how it works as well as a state-by-state guide here. This is a result of the 1992 Supreme Court Ruling of Quill Corp. vs. North Dakota.
Many states have enacted laws to collect sales tax from online retailers like Amazon, but most of these have been mired in litigation and appeals. Amazon has agreed to collect sales tax in some states like New York, but this does not apply to the third party retailers on Amazon or other websites, and Amazon has been one of the biggest plaintiffs in trying to overturn these laws.
By the way, neither Louisiana nor Nebraska are among the states that have enacted laws to collect sales tax on out-of-state online purchases.
Trouble overturning Quill Corp. vs. North Dakota
In the 1992 ruling, the Supreme Court stated that Congress could enact legislation to overturn the decision. The last few years have seen a number of attempts at passing such legislation, most coming from Senator Dick Durbin, but to no avail. In December of 2012, the "Market Place Fairness Act" was rejected as an amendment to the 2013 National Defense Authorization Act. While the act has support from some members of both parties, it's unlikely that the legislation will be turned into law this year. Especially considering the fight House Republicans put up against increasing income taxes to avoid the Fiscal Cliff. Even with major reductions in spending, they will have a hard time justifying to their constituents why they fought tooth and nail to stop tax increases for the wealthiest of Americans while passing legislation to greatly increase taxes for all citizens.
If last year's backlash against and failure of SOPA and SUPPORT IP is a barometer for the web industry's ability to take on established business lobbies and politicians, the road is even harder.
In the off-chance that the "Market Place Fairness Act" or something similar is passed this year, the legislation will undoubtedly face many legal battles both from online retailers and potentially class action suits from online shoppers.
If a Federal law overturning Quill Corp. vs. North Dakota is not enacted, then the states will continue an uphill battle to collect online sales tax.
If states do pass their own versions of these laws, they face lengthy legal battles where the Supreme Court has already sided against their arguments and are going up against some of the biggest retailers and drivers of the economy. A costly endeavor that has the potential to slow the economy down further and create a lot of enemies that are currently only gaining in power and marketshare.
If they don't, then they are faced with having to lure these very same companies to set up a physical presence in their state. While no corporate income tax is certainly a nice incentive, the more states that replicate the policy, the less of an incentive it becomes and something even bigger will be needed. If Nebraska gets rid of corporate and income tax, its neighbor Kansas, which cut income taxes last year and is considering cutting them further, will surely follow suit. But these companies do not need or want a physical presence in every state -- brick and mortar stores are dying for a reason. In fact, Amazon Prime's free 2-day shipping works perfectly fine with a physical presence in only 13 states.
The bottom line is abolishing state corporate and income taxes will create even more massive holes in state budgets that simply cannot be closed by an increase in state sales taxes in the digital age, let alone close the gap on current deficits.