An Analysis of the "Streamlined Sales and Use Tax Administration Act"

At the request of state Rep. Leon Drolet, Mackinac Center for Public Policy Policy Analyst Michael LaFaive prepared an analysis of a bill aimed at "streamlining" Michigan's sales and use tax system.  LaFaive found that the bill potentially would result in additional burdens on taxpayers in the form of taxes on e-commerce and other purchases made from out-of-state vendors.

June 20, 2001

The Honorable Leon Drolet
33rd District
Michigan House of Representatives
Lansing, MI 48909-7514

Dear Rep. Drolet:

Thank you for contacting the Mackinac Center for Public Policy about Senate Bill (S.B.) 433, the proposed "Streamlined Sales and Use Tax Administration Act." I appreciate the opportunity to share my thoughts with you on this issue.

On its face, this legislation is a tool for the state to simplify the collection of sales and use taxes. There are thousands of taxing jurisdictions in the United States, and many define, and therefore tax, identical products differently. For instance, some jurisdictions consider orange juice to be a drink while others classify it as a fruit. S.B. 433, and similar legislation in other states, is being sold as a way to simplify the often confusing and complex issues involving how and whether or not to tax certain items.

A closer look at the bill, however, suggests that simplifying or "'harmonizing" state sales taxes may lead to a de facto—or even an explicit—national retail sales tax as more and more states adopt such legislation. It's true that S.B. 433 does not give the state the power to directly mandate tax collection from purchases made by Michigan consumers from out-of-state businesses. But it does establish a framework for doing so.

How does it work? First, if S.B. 433 becomes law, Michigan will have a mechanism at its disposal for a broader collection of use-tax revenue than it currently has. At first, the mechanism would be voluntary. But many observers believe that, once established, it would facilitate mandatory taxation by Michigan on remote sales, creating a de facto national retail sales tax as other states passed similar legislation. (Currently, more than 30 states are working to pass nearly identical legislation.)

Grant Gulibon, a senior policy analyst with the Commonwealth Foundation in Pennsylvania, notes, "Internet tax supporters hope that ... the system they create will be so successful that Congress will give them [the states] the authority to make it mandatory."

Currently, states may not tax out-of-state purchases made by Michigan citizens. But it is not too far-fetched to suggest that when and if Congress does allow states to tax remote sales, it may demand that states tack on an extra penny for Uncle Sam.

The 1992 court decision Quill v. North Dakota has declared that catalog and Internet retailers need not collect sales taxes from purchasers outside of states in which they do not have a substantial physical presence or "nexus." Why? Because it would create an undue burden on businesses to collect and remit sales taxes to any one or more of the 7,500 taxing jurisdictions in the United States, in violation of the U.S. Constitution's Commerce Clause.

This gets to an age-old question economists have debated, regarding the "incidence" of a tax. It is true that the consumer appears to pay the full tax at the point of purchase, but that's not the same as saying that the incidence of such a tax is entirely on the consumer. If that were the case, then the seller is unaffected by the imposition of the tax and simply passes the full cost on to the consumer with no effect on sales. Unfortunately, this is not the case. There is fairly clear evidence to suggest Internet, catalog, and 1-800 businesses will see a dramatic drop in business as a result of such a tax. Even though these businesses are not themselves being taxed directly, the tax is nevertheless taxing on their livelihoods.

As a state of Michigan Office of Revenue and Tax Analysis report notes, Congress may be able to "remove the Commerce Clause barrier and allow states to force mail order and Internet firms to collect sales tax on purchases from their customers" provided states can simplify their existing sales and use tax laws, which is exactly what S.B. 433 is designed to do.

Another danger of S.B. 433 is the number of jobs that could potentially be lost as a result of increased tax collection. Estimates show that broadening Michigan's tax revenue base to include the mandated collection of use taxes would kill between 1,500 and 4,700 Michigan jobs in the first three years of such a mandate. These estimates were calculated using an econometric model designed for the Mackinac Center for Public Policy by the Beacon Hill Institute of Suffolk University in Massachusetts. The model, the State Tax Analysis Modeling Program (STAMP), was specifically tailored to calculate the impact of tax increases and decreases on the Michigan economy.

In order to estimate these job losses, this author employed estimates of tax revenue losses to Michigan from its failure to collect use taxes on out-of-state purchases made by Michigan residents. The estimates are from the General Accounting Office review of sales taxes on e-commerce and other remote sales. According to the GAO report, the state of Michigan "loses" between $109 million and $343 million each year in use taxes because Michigan citizens largely avoid reporting their out-of-state purchases.

According to STAMP, raising this additional revenue by mandate would eliminate up to 4,700 Michigan jobs because people no longer have this money to invest in their own futures. It is effectively a tax increase on economic development. Unless S.B. 433 proponents are prepared to acknowledge and defend this tax increase, they should at least offer a corresponding tax reduction in some form so as to not do injury to Michigan's economy.

An irony of S.B. 433 is that the extension of use taxes to Internet commerce is a direct contradiction of Gov. Engler's "economic development"' policies. The state of Michigan, led by the Michigan Economic Development Corporation (MEDC), has been aggressively pursuing technology-based economic development recently. For instance, it has created special low-tax "SmartZones" in 11 selected geographical areas to "stimulate the growth of technology-based businesses and jobs." Last year, the Legislature allowed the Michigan Economic Growth Authority (MEGA), through an amended statute, to provide Single Business Tax credits to small high-tech firms. And the MEDC is currently attempting to organize an angel investor network in Michigan to fund technology startups.

Why bother making the effort to encourage economic development in technology on the one hand and hamper it on the other? University of Chicago economist Austan Goolsbee found that applying sales taxes to e-commerce would reduce the number of online buyers by 24 percent. Once again the state of Michigan's left mitten doesn't seem to know or care what its right mitten is doing.

Gov. Engler's position is that it is simply unfair to tax traditional "bricks and mortar" businesses 6 percent on their sales while exempting sales over the Internet from the same sales taxes. The "fairness" argument is a common one among proponents of Internet taxation. But it is also a deeply flawed one. What Gov. Engler may not realize is that basing his case for taxing Internet purchases on the "fairness" or "uniformity" argument undermines other taxation positions his administration has taken.  For example, the Engler administration often has bestowed special breaks, favors, and even direct subsidies on certain businesses at the expense of fairness and uniformity, and then praised the policy as promoting Michigan's "economic development."  That is what the MEDC does routinely.

For example, in December of 1999, MEGA officials authorized a $23.4-million incentive package for Webvan Group Inc., of San Francisco.  Webvan runs the Internet web site Webvan.com, which operates as an electronic grocery store.  The e-store receives orders over the Internet and fills and delivers them to its clients free of charge.  The Webvan site has claimed that its prices, "on average, are up to 5 percent less than in local grocery stores."  Giving special breaks to Webvan, then, clearly violates Gov. Engler's stated desire for fair treatment of all businesses—particularly in this case, Michigan's traditional "mom-and-pop" grocery stores.

The bottom line is that S.B. 433 is more of a long-term revenue bill disguised as a tax simplification bill.  Why else would special-interest groups that would otherwise have no interest in whether or not orange juice is a fruit or a drink be the first to testify in favor of it, just as they have?

At a time when Michigan and the nation's economy is slowing, and technology firms are struggling just to keep their doors open for business, S.B. 433 and similar legislation takes Michigan and the rest of the country in the wrong direction.

Sincerely,

Michael D. LaFaive
Policy Analyst

For more information, please see the Mackinac Center for Public Policy report, "Internet Purchases: To Tax or Not to Tax, Here Are the Questions."