July 24, 2008

Taxing Amazon.com Complicated by Tangled Forest of Tax Laws

Should states be able to collect state sales tax on internet purchases and catalogue sales that cross state lines? That’s the issue that’s currently confronting state governments around the country desperate for revenues in these poor economic times. In theory, it is grossly unfair for a purchase that is made online to be taxed less than an identical item purchased at a “bricks and mortar” store (individuals are technically subject to use tax on their internet purchases but it is almost impossible to enforce). But in practice, taxation of remote sales falls victim to legal barriers as well as decentralized tax policies.

To this day, a company in question must be benefiting from the services which the state provides in order to be subject to sales tax levies. The Due Process clause has been interpreted for tax liability purposes as meaning the state must “give something for which it can ask return.” The Supreme Court has ruled that taxation of remote retailers is unconstitutional unless they have nexus or a physical presence within the state’s boundaries. But in the era of widespread e-commerce, the lines between a physical and virtual presence are blurring. Companies that buy and sell goods within a state are making use of that state’s infrastructure whether or not they physically own operations in the state.

The most recent Supreme Court decision to address this issue, Quill Corp. v. North Dakota in 1992, upheld previous limitations to the circumstances under which the state may collect taxes from a remote retailer. According to the Court, the Dormant Commerce Clause prevents states from placing undue burdens on interstate sales which was violated by North Dakota’s sales tax of Quill Corporation. Tax laws are so complicated and widely divergent between the 7,400 tax jurisdictions in the U.S. that the Court ruled it unreasonable for retailers to have to account for all the technicalities. It’s important to mention, however, that many observers including the chief executive of Netflix note the improvements in tax software in recent years have dramatically reduced the practical complexity of accounting for different tax policies.

Legal realities haven’t kept states from trying to tap this potentially large revenue source, upwards of $18 billion per year according to an estimate from the University of Tennessee. An organization of more than 20 states known as the Streamlined Sales Tax Project (SSTP) created in 2000 has been trying to streamline their tax codes enough so that determining tax liability is less burdensome. This will help convince Congress to change the law and allow states to tax internet sales, bypassing the Court decision. It’s probably fair to say they’ve only had limited success so far. This is due both to the difficulty of adopting a commonly accepted definition of taxable goods and services that doesn’t benefit some states while disadvantaging others and the difficulty of getting such a bill through Congress.

Thus presents the Amazon.com dilemma. Its “wholly owned subsidiaries” own thousands of square feet of distribution facilities in several states according to the Wall Street Journal. Although they are legally separate, there is a debate as to whether they constitute a nexus. It’s fairly common practice for companies to establish “shell companies” to take advantage of tax loopholes that allow them to expand operations without expanding tax liability. Several states, including Texas, are reviewing whether Amazon’s in-state operations should really be exempt from taxation.

Unfortunately, the prospect for expanding the tax base has dimmed as the State Board of Equalization in California has ruled that entities that refer customers by links to Amazon do not trigger nexus under California law. This is true even though the sites benefit financially from their relationship with Amazon, garnering a percentage of the sales made from the sponsored links.

New York has already passed a law requiring remote retailers to collect sales tax on purchases made in the state which Amazon has challenged, saying it unfairly targets Amazon. Amazon has a number of affiliates and advertisers that benefit financially from Amazon sales within the state (other companies such as Overstock.com cut ties to its New York affiliates rather than have to face sales tax liability). New York law states that companies that enter into financial arrangements with Amazon are considered Amazon vendors for sales tax purposes. The question is whether they are acting as agents of Amazon or whether they are primarily out for their own financial interests. It will be up to the courts to decide whether affiliates trigger nexus in New York or whether it’s back to the drawing board for advocates of equal tax treatment of e-commerce.

July 16, 2008

On Social Security, McCain Redefines "Middle Class"

In an entertaining interview with the Pittsburgh Tribune-Review this week, presidential candidate John McCain makes it clear that he won't fix Social Security through payroll tax hikes. In particular, McCain argues that it's a lousy idea to increase the cap (currently $102,000) on the amount of any individual's wages that can be subject to payroll taxes in a given year:
Trib: Do you favor raising the cap?
McCain: Pardon me?
Trib: Do you favor raising the cap?
McCain: No, and I think by doing so, as Sen. Obama wants to do, you are obviously putting a very, very big increased tax on ... middle income Americans who filing jointly and in other ways will be paying a very big increase.
McCain's response here is wrong in two important ways. First, as a CTJ analysis showed a couple of years back, only about 6.5% of Americans would be affected by a proposal that simply eliminates the cap on the federal payroll tax.

But more importantly, McCain's characterization of Obama's position on Social Security is flat-out wrong. What Obama has said is that he'd allow the payroll tax to apply to an individual's wages above $250,000, which is a very different thing from simply removing the cap and taxing wages above $102,000. Here's the Washington Post's nice explanation of Obama's position:
Under current law, income up to $102,000 a year is taxed for Social Security. Obama would create a "doughnut hole" by not imposing new Social Security taxes on income between $102,000 and $250,000. His aides said income exceeding $250,000 would be taxed at a rate of 2 percent to 4 percent, rather than the 6 percent tax that people pay toward Social Security on income below the $102,000 cutoff, which is matched by their employer's paying a 6 percent tax.
And as a recent CTJ analysis points out, the Obama proposal would only affect 1 percent of Americans-- none of whom could be described as "middle class." As for the alleged "very, very big" tax increase on these middle-class Americans... well, suppose you have a "middle class" friend whose salary was $275,000 (remember, income from sources other than wages don't count toward the payroll tax, so what matters is each individual's salary). That means that under Obama's plan, he would face a tax on his wages exceeding $250,000. His income exceeds $250K by $25,000, so his tax hike would be 2% of $25,000. That would be a $500 tax hike. If this sounds like somebody you know-- and if you consider this person "middle class"-- then McCain's characterization seems apt. Otherwise, his description of the Obama plan is screamingly, almost libelously wrong.

The $500 tax hike described above certainly would count as a "very, very big" tax hike for an average middle-income family-- but, unfortunately for McCain's truthiness, there's simply no way the Obama plan would ever apply to anyone who could reasonably be considered middle-class. Period.

To be perfectly clear about the way the Obama plan would work, a two-earner married couple would not pay more tax just because their combined income exceeded $250,000. Each spouse's salary must exceed $250K to get hit by the Obama plan. And capital gains, dividends, etc., don't count toward the $250K: what matters is your salary.

One could charitably attribute McCain's false statement to fuzziness in his understanding of exactly how the Obama plan would work. One could also say charitably that perhaps "middle class" has a very different meaning in Arizona than in the rest of the nation. But a more realistic interpretation would be that candidate McCain is willfully misrepresenting the truth in the hope that scare tactics are still a good substitute for honest policy debates.

McCain on Social Security: Everything on the Table?

I don't trust people whose fiscal policy platforms are built around "pledges." When an elected official says that he/she will never, ever raise taxes on anyone, this shouldn't be seen as a principled stand-- it should be understood as a cop-out, a signal that this particular elected official, when he takes office, will have checked his brain at the door. The first principle of fiscal policy should be that you put all the cards on the table, and face budget difficulties as they arise using tax changes or spending changes tailored to fit the specific budget circumstances you're facing. No pledges, no vows, just a nice rational deliberative process.

So I was impressed to see presidential candidate John McCain quoted on the New America Foundation's US Budget Blog as saying that when it comes to fixing Social Security's long-term funding imbalance,"you've got to say, 'Look, everything is on the table, let's sit down at the table.'"

Given McCain's recent tendency to vocally oppose tax increases of any kind, the natural follow-up to a comment like that is "you mean you're open to increasing the payroll tax?" Since the McCain quote came from a much longer interview with the Pittsburgh Tribune-Review, I was interested to see whether, in fact, the Trib's staff asked this follow-up question. And they did, sort of, by asking not whether McCain would support increasing the federal payroll tax rate, but by asking whether he would support a proposal that would increase the annual cap (currently $102,000) on the amount of wages that can be subject to the payroll tax in a given year. Here's the exchange:
Trib: Do you favor raising the cap?
McCain: Pardon me?
Trib: Do you favor raising the cap?
McCain: No, and I think by doing so, as Sen. Obama wants to do, you are obviously putting a very, very big increased tax on ... middle income Americans who filing jointly and in other ways will be paying a very big increase.
So the good news is that McCain isn't taking a no-taxes pledge on this point. But the bad news is that he's talking out of both sides of his mouth on this "cards on the table" approach. He tries to appear conciliatory by speaking the language of rational deliberation, then poisons the well by completely mischaracterizing the impact of a relatively tame tax hike on "middle-income Americans."

In other words, when McCain says "let's put all the cards on the table," what he really means is "let's have an honest discussion of all the ideas I agree with, and tell outright lies about the rest of them." Is this better than a "no new taxes" pledge? I'm not sure it is. Pretending to be reasonable is arguably even worse than just admitting you're irrational. The "no new taxes" gang is irrational at best, but at least they're honest about it.

For more details on why McCain's statement about raising the cap is wrong, go here.
You can read the whole Tribune-Review interview here.