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Guest view: Calculating a fair way to tax online purchases

Published: Thursday, Dec. 22, 2011 5:30 a.m. CDT • Updated: Thursday, Dec. 22, 2011 10:06 a.m. CDT

If you’re like millions of Americans, you’ve done some holiday shopping online.

The perfect gift for that special someone might come from an Internet megastore or a niche seller’s site, and you’ll think nothing of the difference between the two. But come next year, the online marketplace could look very different. A proposal percolating in Congress could effectively knock out smaller online retailers by putting them through a never-ending tax collection nightmare.

Currently, an online retailer must collect taxes on purchases made in only a state where they have physical operations. So an online store based in Chicago would collect taxes on purchases made by Illinoisans, but not on orders from other states.

This arrangement doesn’t sit well with traditional “brick-and-mortar” retailers who believe the status quo gives online sellers a significant price advantage.

In the storefront retailers’ corner is U.S. Sen. Dick Durbin, D-Ill. His “Main Street Fairness Act” is supposed to level the playing field by requiring remote retailers to collect and remit taxes for thousands of jurisdictions across the country.

But Durbin’s bill actually would hurt small businesses by tilting the playing field in favor of large retailers. Big-box stores would continue to benefit from complying with the one tax code of wherever the store is physically located. Major online sellers would gain a competitive advantage in absorbing the administrative costs of national tax compliance while smaller competitors couldn’t keep up. This is why Walmart and Amazon support the legislation while eBay remains firmly opposed.

For small online retailers, life would be like Bill Murray’s character in the movie “Groundhog Day,” except they’d wake up to find that each day is April 15 – tax filing day. Imagine trying to make sense of ever-changing state and local sales tax rates, varying product definitions and accounting and auditing requirements. While “small seller” exemptions have been floated in different versions of the legislation, these exemptions are either undefined or set far too low.

Also concerning is that Durbin’s bill hinges on a governing body made up of unelected state tax administrators, of which Illinois isn’t a member. We should stay far away from any proposals to give power for future state sales tax rules to a distant board focused primarily on revenue maximization.

Illinois law currently requires online shoppers to voluntarily pay taxes in April on their purchases in which the retailer didn’t collect the tax. Not everyone does this, so it’s true that – from the government’s point of view – money is being left on the table. Leaving aside the question of whether Springfield uses taxpayer funds responsibly, the amount of uncollected Illinois tax is usually pegged around $150 million. That’s less than half of 1 percent of the budget.

This isn’t money that will come from out-of-state retailers, but from Illinois families and businesses. Households are the biggest offender, accounting for more than three-fifths of the unpaid tax liability. Even so, the state’s department of revenue hasn’t put significant effort into taxpayer education or enforcement. Illinois had an online sales tax amnesty in place through October, but most folks never heard about it.

Even less effective has been Illinois’ new affiliate nexus law, also known as the “Amazon Tax,” which was sold as a state-centered solution to the problem of uncollected online sales taxes. But the real effect has been to push online entrepreneurs such as CouponCabin and FatWallet.com out of the state. The law should be dumped, but the question of how to set up a truly fair collection system still remains.

One idea that’s gaining ground is the idea of “origin-based sourcing,” which embodies the concept of selling globally, taxing locally. Under this approach, when a Chicago online retailer sells a product, Chicago sales taxes would be collected. Regardless of where the customer lives, the retailer just needs to know its rate.

“Origin-based sourcing would require every business – whether brick-and-mortar, online or catalog – to collect just one sales tax for the jurisdiction where they’re physically located,” said Andrew Moylan of the National Taxpayers Union, a nonpartisan fiscal advocacy organization. “This would level the playing field without flouting the Constitution, and it would encourage real competition for attracting businesses.”

Illinois online retailers already use an origin-based system to calculate tax for sales shipped to in-state purchasers, which would ease any transition. But the real bonus is that states and localities will have strong incentives to keep tax rates reasonable in order to attract more retailers within their borders. And that’s good news for beleaguered consumers, especially for those who will need to stretch their dollars this holiday season and beyond.

• Kristina Rasmussen is executive vice president of the Illinois Policy Institute.

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