Illustration by André Da Loba

Tax Amazon, Other E-Commerce at Source: Ramesh Ponnuru

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(Corrects to note that legislation has not been introduced yet in eighth paragraph.)

July 26 (Bloomberg) -- Danny Diaz, spokesman for the Alliance for Main Street Fairness, was recently in Tennessee for one of his daughter’s basketball games. “The strip malls are empty,” he said.

“There are for-lease signs everywhere. When do we get to the point where these retailers just close up shop? What the hell do we do with that square footage? It is critical that we let these small employers compete.”

What Diaz is hyperbolizing about -- and the alliance’s reason for being -- is what he considers an unfair subsidy for companies, such as Inc., that sell products over the Internet. Go to your local bookstore, if you can find one, and you’ll pay the local sales tax. Order a book online from an out-of-state vendor and you will owe your home state a sales tax on it, too -- but nobody will collect it. The Supreme Court has ruled, most recently in 1992, that states cannot order out-of-state companies to collect these taxes.

This disparity is indeed unfair both to the mom-and-pop retailers that Amazon’s critics like to talk about and to the larger companies, such as Wal-Mart Stores Inc. and Target Corp., that provide much of those critics’ financial support. Worse, it distorts the economy, because it means that Internet-based companies do better for reasons unrelated to their ability to provide good products to consumers at low cost.

A Real Problem

Although Amazon’s critics have identified a real problem, their solution is a mistake. They want an Amazon tax that replaces one type of unfairness with others, and imposes costs on the economy out of proportion with any revenue it might generate. There’s a better solution, although not one that proponents of the Amazon tax like.

Over the past two years, state governments have considered instituting such a tax as a way to help them balance their budgets. Eight states have already done so. Some of these are liberal states such as Illinois and California. But the Texas legislature passed the most recent of these laws, and by overwhelming margins.

These states tax Amazon, which is based in Seattle, and other Internet businesses when they have affiliates or distribution centers inside their borders. But whether states may use this maneuver is the subject of litigation that seems likely to last a long time, and Amazon has sometimes responded by cutting off its affiliates or threatening to move its distribution centers.

'National Solution'

Nobody, by contrast, questions the legal power of Congress to allow the states to tax e-commerce. So Senators Dick Durbin, an Illinois Democrat, and Mike Enzi, a Wyoming Republican, plan to introduce legislation authorizing states to form a compact. Internet-based companies would have to collect taxes when selling to a customer in any of the states that belong to it.

Some governors, such as Tennessee Republican Bill Haslam, are fans of this “national solution” to the taxation of Internet commerce. But this has serious downsides.

Consider, for starters, the different compliance costs Internet vendors will face. A brick-and-mortar company doesn’t have to ask whether its customer is from out of state, much less to discover the sales-tax regime that applies there. Internet companies will have to keep track of sales-tax rates and exemptions for each of thousands of localities.

Or let’s say you live by the border of a state with a lower sales tax than your state’s. You can drive across the border, buy goods and pay a lower tax rate. If the Amazon tax is in effect, though, ordering online from out of state won’t yield any tax savings. How is that fairer than the status quo?

A 2006 PricewaterhouseCoopers study found that small retailers have pretty high compliance costs: about 17 cents for each dollar of revenue. Diaz’s group favors exempting these small retailers from the collection mandate. If they do, the rationale of minimizing distortions to the economy is gone.

A Better Plan

There are dueling studies about how much revenue state and local governments forgo by not collecting taxes from Internet sales. But experience seems to side with the low estimates. Rhode Island imposed an Amazon tax in 2009 -- and its officials say that it has generated no revenue at all.

A far better solution would be for states to levy sales taxes based on where products are coming from rather than on where they’re going -- or for Congress to tell them to do so. Under an origin-based tax rather than a destination-based tax, for example, Washington state would have the power to tax’s sales. For physical stores, sales taxes would keep being collected as before.

This would be a much simpler tax system with lower compliance costs. It would tend to constrain sales taxes by increasing competition among the states: A state that raised its rates too high would induce businesses, particularly catalog or Internet businesses that can sell remotely, to locate elsewhere.

Feature, Not Bug

To my mind, that’s a feature, not a bug. State governments that are eager to tax Amazon and other e-businesses because they want cash, rather than because they want fair tax rules, will doubtless see it differently.

To hear proponents of the Amazon tax talk, you would think that the principal flaw of an otherwise pure sales-tax system in this country is its inability to collect taxes from Internet businesses. In the real world sales taxes are a chaotic mess, inefficient and unfair. States and localities often tax services one way, food and clothing another, and all other goods still another. They observe arbitrary tax holidays.

Origin-based sales taxes would eliminate the different treatment of Internet sales. They also might get state and local governments to rely less on sales taxes altogether -- which would be a good thing.

(Ramesh Ponnuru is a senior editor at National Review and a Bloomberg View columnist. The opinions expressed are his own.)

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