The Irony Of An Internet Tax That Demands Simplification

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The latest proposal to allow states to levy online sales tax is gaining traction because advocates say they have addressed one of the big objections to a federal law, namely the complexity of the current system of more than 9,500 separate taxing districts. As a result, Congress has designed the Marketplace Fairness Act so that states that wish to tax online transactions must agree to a simpler system that includes restrictions on audits and constraints on how often states can demand retailers file online sales tax returns. The bill even limits the liabilities of retailers in case of errors in calculating the tax in so many different places.

Congress is not a very self-critical place, so I doubt that many of its members note the irony in this bill gathering momentum so soon after the federal income tax filing deadline. Congress continues to show almost no interest in simplifying the Internal Revenue Code, now pushing 4 million words, even though the Internal Revenue Service's own taxpayer advocate calls the code a "significant, even unconscionable, burden on taxpayers."

You have to wonder, in fact,given how complex our federal income tax has become, with 5,000 changes in the last decade alone, whether anyone who signs onto the Marketplace Fairness Act in the hopes of resolving the internet tax issue with a simpler system isn't just taking a sucker's bet that the states won't act just like Congress, once given the power to do so.

Advocates of allowing the states to tax internet sales have long recognized that the complexity of the current patchwork system of state tax regimes and numerous municipal districts piled on top of each other was a significant barrier to any federal legislation. For a bricks and mortar retailer, the thousands of separate taxing entities around the country are generally not an issue. No matter where your customer is from, when he walks into your store you charge him the local sales tax rate. Not so for a virtual store that must negotiate a far more complex system.

About a decade ago the states attempted to resolve the issue by creating something called a Streamlined Sales and Use Tax Agreement, which limits the number of rates that a state can impose on out-of-state retailers and tries to set standards for what can be taxed. The agreement also centralized the registration of vendors and collection of taxes.

The latest law requires states to be a part of the streamlining effort in order to collect sales tax on internet transactions, or to create their own streamlined system based on minimum requirements outlined by the federal government.

The law also addresses specific objections to the complexity of the current system. In November of 2011 CEO Patrick Byrne testified before Congress that sales tax software was so expensive that any federal law should require the states to bear the cost of creating and updating adequate tracking programs. He also urged that firms not be subject to fines and penalties if they incorrectly figure their sales tax obligations thanks to glitches in the certified software. The new law incorporates both ideas.

Even so, and eBay continue to oppose the legislation because it only exempts retailers who do less than $1 million of online sales outside their home jurisdiction. Opponents like eBay are lobbying for a $10 million exemption. It argues that claims by states that technology can solve the complexity of sales taxation through miracle software packages is overstated, and that complying even with a simplified system would severely burden many smaller virtual retailers. Some opponents of the Marketplace Fairness Act estimate the cost for small firms to comply would equal 15 percent of the revenues collected. They call that an unfair burden. But taxpayers now spend an estimated $400 billion annually complying with a federal income tax that raises about $1.2 trillion. That's well above 15 percent.

An income tax, of course, is very different from a sales tax in its complexity. Federal income tax filers don't have to contend with thousands of separate taxing districts. But they must wrestle with tens of thousands of pages of rules and regulations that have become so complex that often even the IRS doesn't interpret them uniformly. One Government Accountability Office study estimated that the IRS incorrectly answers about 2.5 million questions every year on its own tax code. Still, legislators of both parties love the complexity of the tax code because they fancy themselves economic and social engineers, and taxation has become their principal tool.

That Congress would roll out the Marketplace Fairness Act while continuing to ignore the IRS code is a reminder that reforming the status quo is almost always harder than using the very same idea, in this case simplification, to sell yet another new tax or government program.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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