Tax Shenaniganery

Can authorities force businesses in one state to collect another state’s taxes?

That’s the question facing US and EU policymakers as two controversial tax proposals return to the headlines.

At issue in the US is the Marketplace Fairness Act (MFA), which passed a preliminary Senate vote 74-20 Monday. MFA tries to address the long-running issue of Internet sales tax avoidance by forcing online retailers with revenues exceeding $1 million annually to collect sales tax according to each user’s local rate. Historically, Internet retailers haven’t collected sales tax, thanks to judicial precedent established by the Supreme Court’s 1992 decision in Quill v. North Dakota, which ruled businesses needn’t collect taxes applicable in jurisdictions where they lack a physical presence. Some larger retailers have started collecting taxes in recent months, but the onus is largely on consumers to track purchases, calculate sales taxes and remit payments to the appropriate authorities. But most folks don’t, and authorities have generally turned a blind eye. Now, however, lawmakers want to raise revenue without raising tax rates, and Internet commerce is low-hanging fruit.

Enforcing tax laws is a fine aim—Greece and Italy show how rampant tax avoidance can whack economies as governments try to compensate with higher rates. But MFA seems a terrible solution—it distorts competition. For one, since there are around 9,600 different state and local sales tax systems, compliance will be costly and complicated. The largest Internet retailers likely adapt, but smaller firms may decide it’s not worth the hassle, potentially hollowing out online commerce. The $1 million revenue threshold doesn’t guard against this—revenues don’t necessarily reflect a retailer’s size. A tiny retailer could sell seven $12,000 greenhouses per month and top $1 million in annual revenues, while a behemoth could get the same top line selling 2 million old Zimbabwean banknotes a year at 50¢ each.

Despite what MFA’s supporters claim, it also distorts competition between Internet and brick-and-mortar retailers. Imagine two retailers based in sales-tax-free Oregon—brick-and-mortar Widgets R Us, and the online Gidget’s Widgets. Widgets R Us doesn’t have to ask each customer where they’re from and, if necessary, figure out which of the 9,600 sales tax regimes applies to them. But Gidget’s Widgets would! Or they’d have to buy software to do it—software needing countless updates as tax rates change. If they goofed, they’d get dinged. Handicapping online retailers is picking winners and losers, not leveling the playing field.

Topping things off, online retailers would be subject to laws in states where owners/employees lack a physical presence or voting rights—taxation without representation.

On the bright side, MFA likely dies in the House. Thank goodness for gridlock.

Meanwhile, across the pond, opposition is mounting against 11 EU states’ planned financial transactions tax (FTT), raising the likelihood it gets watered down or killed. The tax, conceived as a levy on securities and derivatives trades in the participating nations, raised hackles globally when the European Commission announced it would apply to every security issued or domiciled in any participating state, regardless of where the transaction occurs—i.e., a US investor trading an ADR of a German company would have to pay. Trade bodies, investors and officials from the US, UK, Japan, Australia and others denounced the plan, arguing it contravenes G20 agreements banning measures with “extraterritorial effects.” Italy’s and France’s debt agencies warned it could raise the cost of issuing sovereign debt, drain treasury market liquidity and push up yields. Italy’s pushing for a full exemption for sovereign bonds, calling it a nonnegotiable issue.

And last Friday, the UK government launched a legal challenge at the European Court of Justice, arguing the tax’s regulatory overreach disproportionately wallops London (home to about three-fourths of EU capital markets activity). Luxembourg officials offered to testify on their behalf, and the US Chamber of Commerce chief’s vowed he “will not allow the FTT to happen,” suggesting the US may follow suit (pun intended).

The European Commission claims these challenges shouldn’t disrupt the tax’s January 2014 implementation, but we have our doubts. Taxes aren’t much good if you can’t collect them. The EU learned this last year, when countries opposed to its airline carbon emissions tax made it illegal for their airlines to pay, effectively killing it. FTT opponents could similarly bar their Financials from paying. Or the US and Japan could make abandoning the FTT a prerequisite for continuing free trade talks. Or the European Court could side with the UK. Regardless of the means, given the opposition within and outside the FTT zone, the endgame seems fairly obvious.

With both FTT and MFA likely doomed, the answer to our opening question seems a resounding “No.” Good thing, too—the global economy doesn’t need this heaping pile of tax shenaniganery.