Ponnuru explains how an Internet sales tax could foster competition among states

Ramesh Ponnuru is no fan of the Internet sales tax proposal under consideration on Capitol Hill. But he explains in the latest National Review how a revision to the proposal would make a major difference.

There is an alternative way to level the playing field between online and offline sales, but it has not received much attention in the debate over the bill. The Internet sales tax being proposed is “destination based”: The state where the customer lives and uses the product is the one that levies the tax. The tax on Internet sales, and on sales generally, could instead be “origin based”: The tax could, that is, be paid to the state where the seller is located.

Nothing would change under this regime for a brick-and-mortar store: The store would continue to pay the sales-tax rate of the place in which it is located, and it would continue not to matter what state the customer came from. Online sellers would have to pay the tax based on where they or their warehouses are located, also with no regard to where the customer lives.

Both the origin-based and the destination-based sales-tax regimes would be neutral between online and offline sales, but the origin-based regime would have two advantages. Its enforcement costs would be much lower: It would not make every online retailer charge all of the different sales-tax rates that apply throughout the country. And it would generate competitive pressure on state governments to keep sales taxes low.

Offline sales taxes already involve some competition among states. Massachusetts cannot hike its sales taxes too much without people in the area making more of their purchases elsewhere, and without companies making location decisions accordingly. Destination-based taxation of the Internet would largely eliminate such competition in online commerce: The only way to escape a state’s tax, however onerous, would be for the customer to move.

To escape an origin-based tax, he would merely have to buy from a supplier located in a low-sales-tax state — and online sellers would, all else equal, want to be located there. Because all else isn’t ever equal, sales-tax rates would not converge to zero. It stands to reason that they would nonetheless be lower than they would be in the absence of the relatively robust competition of an origin-based system.