The Federalism Project

American Enterprise Institute

Opportunity Rings

By Michael Greve and Jessica Melugin

On July 28, President Clinton signed into law the Mobile Telecommunications Sourcing Act (H.R. 4391), which will govern the state and local taxation of cell phone calls. This being an election year, the act is a pleasant surprise--a sensible, efficient, and federalism-friendly solution to a tricky problem. What's more, the Act suggests a very promising approach to the seemingly intractable problem of e-commerce taxation.

Suppose a Miami businessman, traveling through Maryland, places a cellular call to a customer in California: who gets to tax the call? Tax calls on the basis of their destination, and phone companies must collect and remit taxes for millions of calls into hundreds of jurisdictions, all imposing a different rate. Make the tax depend on the customer's location at the time of the call, and phone companies will still face tax collection obligations in countless jurisdictions-while also having to track their customers' whereabouts.

The Mobile Source Act cuts through this mess and assigns taxing authority exclusively to the "primary service area"--in the vast majority of cases, the caller's billing address. This regulatory regime promotes efficiency (by designating a single taxing authority) and, at the same time, government accountability and competition. Our Miami businessman has no political vote or voice in Maryland or California; he can, however, make himself heard in Miami on the subject of communications taxes. 

Sales taxes share many features of telephone taxes. But, largely for historical reasons, sales across state lines are based on the destination of each sale, not its origin. Sellers must collect, calculate, and record sales taxes and remit the appropriate amounts to every state or local jurisdiction where they have a "nexus" or physical presence, such as a store. Complicating matters for retailers, there are 45 states and approximately 7,000 local jurisdictions impose varying sales tax rates, product classifications and exemptions. Sellers who have no nexus to the destination jurisdiction, such as pure e-commerce firms, escape the tax collection obligation. The customer then owes a use tax to his state of residence. However, states only collect use taxes from their own citizens for easily traceable, big-ticket items, such as cars and boats. 

No one is happy with this regime. Businesses complain bitterly (and justifiably) about legal uncertainty and extravagant compliance costs. Brick-and-mortar retailers point to the unfairness of taxing a book sale at the corner store while leaving the same sale through effectively untaxed. State and local government associations have sounded alarms over a possible erosion of their tax base if customers and businesses are allowed to escape into "tax-free" cyberspace. 

Led by the National Governors Association (NGA), the government lobbies want to extend the existing sales tax regime to interstate e-commerce. Their proposal should be rejected. It would require the centralized collection of data on all Internet sales by a kind of junior league IRS, which raises very serious privacy concerns. Moreover, the NGA proposal would exacerbate the accountability problems of a sales tax system that authorizes each local jurisdiction to impose tax collection obligations on businesses outside its borders. (Virtually all states exempt their own businesses.) The export of tax collection obligations is just about as odious as taxation without representation, for essentially the same reasons.

The just-enacted mobile call statute supplies the principle that addresses these problems: tax all transactions, regardless of their destination or the channel through which they are conducted, at their origin-in the sales tax case, the seller's home state and principal place of business. Amazon's book sales could be taxed like any ordinary retailer's, but only in the state of Washington. 

An origin-based tax would minimize compliance costs and privacy problems. No business would be subject to reporting and collection requirements in more than one place, and none would need to track its customers' location. Tax exports would be a thing of the past. Instead of a sales tax cartel, we would have tax competition. Businesses in places with high sales taxes (and not much else to offer) would contemplate a move, thus disciplining state and local taxation. 

In the heated debate over Internet sales taxes, proposals for origin-based sales taxes have been drowned out in interest groups brawls and shouting over "tax flight," "favoritism," and "No Internet Tax" slogans. The Mobile Telecommunications Sourcing Act is a good reminder that there is a better way. 

Michael Greve, Ph.D., is a Resident Scholar at the American Enterprise Institute. Jessica Melugin is a Policy Analyst at the Competitive Enterprise Institute.