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Congress is considering two proposals related to taxes and the internet, one that would facilitate state and local governments in exercising their tax authority, and another that would restrict it. The first, a very good idea, would allow state and local governments to require internet retailers (and other remote retailers) to collect sales taxes from customers, just as any bricks-and-mortar store is required to do. The second, a bad idea, would continue and possibly expand a federally imposed ban on state and local governments taxing internet access the same way they tax other services.

A bill in the Senate combines these two proposals as a compromise, but the future of that legislation is cloudy given the vortex of political maneuvering and obstruction in that chamber.

The Good Idea: The Marketplace Fairness Act

The Marketplace Fairness Act would allow state and local governments to require internet retailers and other remote sellers to collect sales taxes from customers, just as bricks-and-mortar stores are required to do.

If a sales tax applies to something you’re buying, you’re supposed to pay it regardless of whether you make the purchase at a store, over the internet, or through a mail order catalogue. But the Supreme Court decided in 1992 that state and local governments cannot require a remote seller (which could include an internet retailer like Amazon if it has no physical presence in a given state) to collect that tax.

So if you buy something online and you’re not charged whatever sales tax applies, you are supposed to send that sales tax payment to the state or local government on your own. Few people comply with that requirement or even know it exists so, in effect, the Supreme Court decision turned us into a nation of sales tax evaders.  

The Court did leave Congress the option of addressing this problem by allowing state and local governments to require remote sellers to collect sales taxes, which the Marketplace Fairness Act would do. The Senate approved the bill last year with 69 votes — including 21 Republicans, 46 Democrats, and 2 independents that caucus with the Democrats.

It’s obvious why the bill has bipartisan appeal. Unlike other bills that mention the word “tax,” this bill does not raise taxes but only makes it possible to collect taxes that are already due (but rarely paid) under existing state and local law. It also addresses a major source of unfairness. Internet retailers are given an unfair advantage over bricks-and-mortar stores because the former allow customers to evade sales tax.

Opposition to the Marketplace Fairness Act sometimes focuses on the complexity a multistate company faces if it must collect the different sales taxes levied by many different jurisdictions. But retailers like Wal-Mart and Home Depot, which sell goods online and also have a physical presence in most states, have been collecting sales taxes on online purchases for years.

The Bad Idea: The Internet Tax Freedom Act

The Internet Tax Freedom Act, first enacted in 1998, banned state and local governments from taxing internet access. This seemed like a bad idea from the very beginning. Some of the same lawmakers who insist that the federal government not interfere with the economy and not intrude upon states’ rights rushed to restrict states’ taxing authority in a way that favored the internet relative to other services. The law was extended several times and is now scheduled to expire on December 11.

If anyone thought in 1998 that the internet was an “infant industry” that needed to be nurtured and subsidized, that argument is surely even weaker today than it was then.

In July, the House approved the Permanent Internet Tax Freedom Act. In addition to making the ban permanent, this bill would also repeal the grandfather provision that allowed seven states that had enacted Internet taxes prior to 1998 to keep those laws in place. This move would cost those states half a billion dollars in revenue each year. And the remaining states would collectively forgo billions in revenue that they could otherwise raise each year.

The Possible Compromise: The Marketplace and Internet Tax Fairness Act

The Marketplace Fairness Act has not advanced in the House and the Permanent Internet Tax Freedom Act has not advanced in the Senate. A group of Democratic and Republican Senators introduced the Marketplace and Internet Tax Fairness Act (MITFA) as a compromise. The bill essentially attaches the Marketplace Fairness Act to a 10-year extension of the ban on taxing internet access, leaving in place the grandfathering provisions for the seven states that levied such a tax before 1998.

As Senate Majority Leader Harry Reid began to advance MITFA in the Senate, House Speaker John Boehner signaled that he will not bring such a compromise to the House floor. It is unclear how this will be resolved. The worst possible outcome would be an extension or expansion of the ban on taxing internet access without action on the Marketplace Fairness Act. Given that Senate supporters of the latter are more than numerous enough to block passage of the former, they should ensure this does not happen.