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Morici: It's Time to Start Taxing Online Sales

Peter Morici

NEW YORK ( TheStreet) -- The Senate recently passed a bill that would require internet retailers to collect sales taxes on behalf of local governments. This bill has flaws that could be fixed in the House, and should be passed.

I don't like the idea of the state and local governments collecting more taxes -- they know no limits to their capacity to tax and squander our hard earned dollars -- but the current situation is unfair and bad economic policy.

In 1992, the Supreme Court held that states did not have the power to levy taxes on on-line sales, unless the retailer has a physical presence in their state. Large retailers, like L.L. Bean, routinely charge the appropriate state taxes where they have a store or warehouse but not on sales in states where they do not.

Main Street retailers complain this places them at an unfair disadvantage -- and they are absolutely correct. No business would like the government giving a 5% price advantage to out of state competitors.

However, small retailers behave as if requiring internet retailers to charge sales tax would be a salvation for their flagging fortunes -- it wouldn't be.

Most local retailers, competing with internet businesses and big box stores, lack the scale to offer the variety of products an increasingly diverse American population demands, and the scale to get favorable prices at wholesale.

Taxing internet sales would make this problem worse by consolidating online competitors. The online bookstore in Tuscaloosa is much less menacing to the small bookstore in Boston than Amazon.com . However, the Senate bill would drive out the Alabama retailer and enlarge giants like Amazon.com.

The Senate bill would require all retailers with more than $1 million dollars in sales to collect and remit sales taxes to every state and local jurisdiction. That would require coding each sale by zip code and remitting to the states the appropriate taxes -- those often vary not just by state but also city and county and by products covered.

In the end, local vendors would have to rely on software or services comparable to the payroll services that now cut paychecks and remit withholding taxes on income, social security and unemployment insurances to state and local governments.

As anyone owning a small business knows those services are far from perfect. Many have received erroneous assessments and penalties, owing to mistakes made by payroll services, and those take some considerable time and effort to resolve.

For payroll purposes, small businesses must deal with their home state and a few neighboring jurisdictions, but for the purposes of sales taxes the potential expands to more than 5,000 state, city and county governments. Imagine running a rare books store in Boston with an online presence and receiving a few hundred erroneous notices of assessment from jurisdictions as far away as Alaska.

Not surprisingly, Amazon.com is in favor of the legislation. It could handle these issues much as Xerox handles employee payroll taxes all across the country -- its small competitors could not. Paying sales taxes in all 50 states adds to its costs but the benefits to its bottom line of driving out small competitors easily makes up the difference -- with a big profit.

The Senate bill excludes retailers with annual sales less than $1 million but that is a pittance in retailing, and bears no parallel to definitions of small business in other federal legislation. For example, local restaurants and other businesses with fewer than 50 employees are exempt from Obama Care mandates to provide employee health insurance, and supporting 50 employees can easily require sales north of $10 million dollars.

Although it is far from a perfect solution, raising the threshold for retailers that must collect sales taxes outside their jurisdiction to $10 million would do a lot to more to preserve small businesses -- including brick and mortar retailers -- than requiring virtually all retailers to comply.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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