20th Century Taxes in a 21st Century World

Many states are facing the hard reality that their tax systems are not keeping up with the modern world. While 43 states have a personal income tax (leaving 7 without), 46 states have a state sales tax (leaving only 4 without). In case you’re wondering, only one state has neither a sales tax nor a personal income tax – Alaska. This is possible due to unique circumstances (the State gets a lot of revenue from the oil companies extracting oil) and a desire to entice people to come to the state because the weather sure is not a major draw.

While most states (40 of the 50) have both a sales tax and a personal income tax, a majority of states tax collections come from sales tax. The problem is the modern economy is leaving the old practices that worked so well to collect such taxes wanting, or worse, resulting in the elimination of whole streams of income. For example, it is well known that states tax voice phone service, but they cannot tax the provision of internet service (due to the Federal law that says such service cannot be taxed). The problem is that the state taxes make voice service uncompetitive with alternatives such as Skype, Snapchat or Facetime conducted tax free over the internet.

This issue is happening with all sorts of goods sold over the internet. Companies that don’t have a “presence” in a state cannot be required to collect sales tax from its customers and remit it to the state. That is based on a court case that goes back decades and came from the era of snail mail catalog sales. Internet companies have used this position to successfully cut 5% – 10% off the price of a good which can go a long way toward paying for the free shipping cost in order to entice a customer to buy from you. Technically, residents of a state are supposed to file and pay the sales tax rate through a “use-tax” form, but reality is that unless there is a way for the state to know a purchase was made without paying sales tax like having to register a new car, there is no way for the state to enforce the use-tax law. The other issue is that most people don’t even know they have to pay use-tax. For the same reason income taxes are withheld form a paycheck, it is much easier for the state to require a business to collect the tax upfront rather than trying to collect it after the fact from the buyer.

States are attempting to stop the bleeding by defining new notions of a “presence” in a state. Court actions against Amazon have highlighted these efforts which have had mixed success to date. The real solution is for states to get together to change their laws to address the court case from decades ago. The reason the court said that states could not collect from companies without a presence in the state was that the complexities of the sales tax made it an undue burden on interstate commerce. Each state had their own definition of what was taxable and what wasn’t. Different rates might apply to different good that were taxable and so on. The solution is for states to adopt a uniform sales tax code that uses the same definitions for what is taxable with the only difference being the rate the state chooses to charge.

Asking states to adopt such a law can be difficult. States have to give up some autonomy and authority, but the reality is if they don’t the alternative is lower and lower collections compared to what they should be taking in and a continued imbalance in favor of out of state retailers. Is that is what is really best for each state?

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