Off the Charts Blog | Center on Budget and Policy Priorities

On the heels of the Senate’s 69-27 approval of the Marketplace Fairness Act, which would enable states and localities to require all large Internet retailers to charge applicable sales taxes on their interstate sales, CBPP Senior Fellow Michael Mazerov debated the issue with Newsweek’s Megan McArdle on WHYY’s “Radio Times.”  As he explained:

State and local sales taxes . . . are about 25 percent of all state and local taxes . . . and they’re just essential to paying for schools, health care, child care, and all the things we want.  So, as long as we’re going to have them, we need to make them fair — and this [bill] is an aspect of making them fairer.

Click here for the full interview.

The Senate’s overwhelming (74-20) vote last night to open debate on the Marketplace Fairness Act (MFA) all but guarantees that it will soon approve the bill, which would enable states and localities to require all large Internet retailers to charge any applicable sales taxes on their interstate sales.

Right now, as a result of 1967 and 1992 Supreme Court decisions, a state can require out-of-state companies to charge its sales tax only if they have a physical presence in the state like a store, warehouse, or sales force.  The tax is still legally due, and consumers are supposed to pay it directly to their state, but few people know about or comply with this requirement.

MFA would largely solve the problem.  It authorizes states to require out-of-state sellers with more than $1 million in nationwide interstate sales to charge the applicable taxes — provided that states simplify their sales taxes and give merchants free software that automatically calculates the correct tax.

This long-overdue legislation would:

• Give state and local governments as much as $23 billion in annual revenues that they are owed under current law. That will help them maintain public services and possibly reinvest in services they cut during the recent recession — rehiring teachers, freezing college tuition increases, and resuming road and bridge maintenance, for example.

• Create a more level playing field for local store-based retailers. Because combined state and local sales tax rates typically range between 5 and 10 percent, Internet retailers that don’t collect sales taxes outside their home states start out with that much of a price advantage over their local competitors.  This makes it harder for Main Street merchants to create local jobs.  It also has a ripple effect on local economies, as depressed sales at the neighborhood book or musical instrument shop lead to fewer purchases by their owners and employees at the farmers’ market and dry cleaner.

• End the unfair sales tax treatment of consumers who don’t shop online. Low-income people who lack the computers, Internet access, or credit cards needed to conveniently shop online pay more than their fair share of sales taxes because online shoppers can avoid these taxes.

Last night’s vote is just the first step towards the MFA’s enactment.  Senate opponents will likely to offer amendments to weaken or kill it, and the measure will likely get a cooler reception in the House.  But, for now, kudos to the majority of senators from both parties who recognize that Internet retailers should play by the same tax rules as local retailers.

As Tax Day approaches, we’ve updated three backgrounders that explain the sources of federal tax revenues and how we spend both federal and state tax dollars.

Where Do Federal Tax Revenues Come From?

In fiscal year 2012, the federal government spent $3.5 trillion on the services it provides.  Of that $3.5 trillion, federal revenues financed close to $2.5 trillion. The remaining amount (about $1.1 trillion) was financed by borrowing; this deficit will ultimately be paid for by future taxpayers.

The three main sources of federal tax revenue are individual income taxes, payroll taxes, and corporate income taxes; other sources of tax revenue include excise taxes, the estate tax, and other taxes and fees (see chart).

Where Do Our Federal Tax Dollars Go?

In 2012, about three-fifths of federal expenditures went to three areas:  defense and international security assistance, Social Security, and the major health insurance programs (Medicare, Medicaid, and the Children’s Health Insurance Program).  Two other categories together — safety net programs and interest on the federal debt —accounted for another fifth of federal spending.  The remaining fifth of federal spending supported a wide variety of other public services, including providing health care and other benefits to veterans and retirement benefits to retired federal employees, assuring safe food and drugs, protecting the environment, and investing in education, scientific and medical research, and basic infrastructure such as roads, bridges, and airports.

Where Do Our State Tax Dollars Go?

By far the largest areas of state spending, on average, are education (both K-12 and higher education) and health care.  But states also fund a wide variety of other services, including transportation, corrections, pension and health benefits for public employees, care for persons with mental illness and developmental disabilities, assistance to low-income families, economic development, environmental projects, state police, parks and recreation, housing, and aid to local governments.

Click here for the backgrounder on where our federal tax dollars come from, here for the backgrounder on where our federal tax dollars go, and here for the backgrounder on where our state tax dollars go.

Today’s jobs report suggests that state and local public job losses may be leveling out, a more hopeful picture than last month.  States and localities gained a modest 7,000 jobs in March and have cut 28,000 jobs over the last 12 months, a much smaller amount than in recent one-year periods.  But states and localities will need much more than a few months of modest job gains to recover fully from the recession.

The country has 718,000 fewer state and local government employees than in August 2008, when employment peaked before the recession took hold (see graph).

This means fewer teachers, child abuse caseworkers, firefighters, and police officers ― at a time when needs remain high.  And the large-scale loss of public-sector jobs has slowed the nation’s recovery, just as private-sector job losses have.

Whether states and localities begin to recover depends in part on federal policymakers.  If they allow the “sequestration” budget cuts to remain in effect and even extend beyond this year, states and localities will lose federal funding for schools and other services, forcing more layoffs and service reductions.

And if policymakers impose even harsher cuts in funding for states and localities, as would occur under the House-passed Ryan budget, states and localities will lose even more jobs.

Earlier this week, I applauded a recent “test” vote in the U.S. Senate that signaled overwhelming and bipartisan support for pending legislation that would require large Internet merchants to collect state and local sales taxes.  Yesterday, New York’s high court upheld the constitutionality of a 2008 state law designed to achieve the same goal.

First, some background:  the U.S. Supreme Court ruled in 1992 that out-of-state sellers cannot be required to charge sales taxes on sales to residents of states in which the merchant lacks a “physical presence.”  (Buyers are obligated to pay the sales taxes directly to their states when the seller doesn’t charge them but, of course, very few do.)  But an earlier Supreme Court decision held that in-state independent sales representatives who solicit sales on behalf of out-of-state merchants can satisfy this physical presence requirement.

The New York law at issue asserts that online companies like Amazon and Overstock have that “physical presence” — that is, the cyberspace equivalent of door-to-door salesmen in the state — when they have marketing partners known as “affiliates” in New York; thus, they must charge sales tax on all sales in New York.  Affiliates are businesses and nonprofits that link to an Internet retailer from their own site and receive a commission when readers click on the link and then make a purchase at the retailer’s online store.

I’ve urged states with sales taxes to enact laws modeled on New York’s.  Eight states have done so (Arkansas, California, Connecticut, Georgia, Illinois, North Carolina, Rhode Island, and Vermont), and a ninth, Pennsylvania, is enforcing the same policy with respect to Internet retailers with in-state affiliates under its existing sales tax law.  Amazon or Overstock may appeal to the U.S. Supreme Court, but we hope that the final decision in the New York court system will encourage additional states to act.  The Supreme Court has declined to review several state court decisions on the obligations of out-of-state merchants to charge sales taxes since its 1992 decision; it’s likely to deny this case as well.

The New York law only partially solves the problem of interstate sales that escape taxation, because some Internet retailers don’t operate affiliate programs and because others have responded to these laws by terminating their programs in some states rather than collect sales taxes.  The federal legislation that the Senate endorsed in its recent vote is still needed to solve the problem comprehensively.  Policymakers should enact that legislation soon.  In the meantime, the remaining states should emulate New York’s law, and its court victory should be celebrated.