What’s wrong with “Hybrid-Origin” Sourcing?

January 21, 2015

On January 9, 2015, the National Conference of State Legislature‘s Task Force on State and Local Taxation convened a legislative hearing on the matter of remote sales tax collection. Testimony was provided by twelve witnesses including:

  1. Steve DelBianco from NetChoice
  2. Hamilton Davison from the American Catalog Association,
  3. Devin Whitney from PayPal
  4. Mike Massey from Massey’s Outfitters
  5. Craig Johnson from the SSTGB
  6. Fred Nicely from the Council on State Taxation
  7. Joseph Henchman from the Tax Foundation
  8. Joe Crosby from MultiState Associates
  9. Steve Kranz from McDermott Will & Emery
  10. Leslie Fox from the International Council of Shopping Centers
  11. Joe Rinzel from the Retail Industry Leaders Association
  12. Rachelle Bernstein from NRF

For those of you interested in viewing the complete testimony from the January 9 hearing, NCSL has uploaded videos (Part 1 and Part 2) available on the NCSL YouTube Channel.

We know that many of you are, like us, a bit on the sales tax geeky side of commerce, so today we are proud to share the complete prepared testimony of one of those witnesses, Mr. Craig Johnson, Executive Director of the Streamlined Sales Tax Governing Board.

Statement of Craig Johnson at the National Conference of State Legislature’s Task Force on State and Local Taxation in New Orleans, LA on January 9, 2015:

Thank you Senator Althoff, Delegate Hixson, Representative Perone, and Members of the NCSL Task Force on State and Local Taxation for the invitation to talk to you today.

Introduction

My name is Craig Johnson and I am the Executive Director of the Streamlined Sales Tax Governing Board. I appreciate the opportunity to talk with you today about some of the concerns and questions I and others from the Streamlined Sales Tax Governing Board have regarding the hybrid-origin sourcing concept being discussed as a possible alternative to the Marketplace Fairness Act or similar legislation; and also provide you some information on what the Streamlined Sales Tax Governing Board member states have already done to successfully simplify the collection, reporting and remittance of sales tax on remote sales using destination-based sourcing.

I want to stress that the goal of the Streamlined Sales Tax Governing Board is to find a federal solution that is fair to all of the players involved – remote sellers, purchasers and the states – and that is not subject to easy manipulation by sellers or purchasers. We firmly believe that what we have done through the Streamlined Sales and Use Tax Agreement has proven that destination-based sourcing works because of the simplifications and uniformity requirements contained in the Streamlined Sales and Use Tax Agreement and the services offered by our Certified Service Providers.

Hybrid-Origin Sourcing

Although I and others from the Streamlined Sales Tax Governing Board have met several times with one or more members of the Judiciary Committee staff to try to obtain legislative language – even draft language – we have not been provided anything more detailed than this diagram. Therefore, I want to make it clear that no legislative language related to the hybrid-origin sourcing concept has been provided to us to date (January 9, 2015) and the comments that I am providing are based solely on the verbal descriptions and communications we have had with Judiciary Committee staff and the general concept as described in Mr. Christopher Cox’s testimony before the House Judiciary Committee in March of 2014.

Concerns and Questions Related to Hybrid-Origin Sourcing:

The Streamlined Sales Tax Governing Board has a number of concerns and unanswered questions with the respect to the hybrid-origin sourcing concept.

1. The Compact – Why would a state join the Compact?

States must join the Compact in order to obtain this collection authority. Sure the states would have the option of joining or not joining and yes they might obtain some additional revenue that goes uncollected today – but only from remote sellers in the other states that also choose to join the Compact. However, by joining the Compact, states are also subjecting their own in-state sellers to the requirements that they:

  1. Collect tax on transactions that today they are not required to collect on (which will also put them at a competitive disadvantage with those sellers that are not located in a Compact state and don’t have to collect tax),
  2. Gather and maintain the necessary information to identify which zip code and which state is entitled to the tax along with the amount of tax, and
  3. Complete a more complex return where they will be required to list out each zip code and/or state into which they made a sale along with the amount of tax collected for each of those zip codes and/or states. Every state that joins the Compact will also have to figure out how to process returns with this additional information and implement a system to get this revenue to the proper state or clearinghouse that would need to be created.

It is very unlikely that the five non sales tax states would join the Compact because by joining they would be supporting a true tax increase on their own residents by requiring them to pay sales tax on any purchases they make from remote sellers located in other Compact states, when today, those same purchasers do not legally owe any sales tax on those purchases. If they joined the Compact, they would also be requiring their own in-state sellers to either start collecting, accounting for, reporting and paying sales taxes on any remote sales made to purchasers located in other Compact states or report the necessary information to the purchaser’s state so the purchaser’s state could pursue collecting the use tax due. Based on this, does anyone really think any of the five non-sales tax states would voluntarily choose to join this Compact?

It is not just the non-sales tax states that would be raising taxes on their own residents under this concept. States with a low sales tax rate would also be subjecting their residents to a tax increase on any purchases they make from a remote seller located in any other Compact state that has a higher sales tax rate. The fact is that the only state’s residents that could be guaranteed to not end up with a tax increase on their remote purchases are those residents located in the highest rate state. Otherwise, any purchaser from any state that purchased a taxable product from a remote seller located in the highest rate state would see a true tax increase.

Let me explain this a little further. For example, if we just take state sales tax rates into account, California had the highest state sales tax rate as of January 1, 2014 at 7.5%. If all the states join the Compact, purchasers in EVERY state that make a purchase from a remote seller located in California would see a tax increase under hybrid-origin sourcing. At the same time, every California purchaser that made a purchase from a remote seller in any other state would see a tax decrease. Although this might sound good to the residents of California, this ultimately could result in California’s sales tax revenues declining as more and more purchasers figure out that they can save sales taxes by making purchases from remote sellers located in any other state and they only have to pay the lower rate – and California is prohibited from requiring them to pay any additional tax on the transaction. Is it right that the State of California’s sales and use tax revenues could be severely affected by the actions of the legislators in another state? Would California really want to join the Compact and risk seeing their sales tax revenues go down? Would California want to put their remote sellers at this competitive disadvantage? Do you really think the other states would join the Compact knowing that they are likely approving a true tax increase on all of their own residents?

Under the Marketplace Fairness Act or similar legislation that utilizes the proven destination-based sourcing regime, purchasers in the same state would be required to pay the same amount of tax on purchases from remote sellers, regardless of where that remote seller is located. This would eliminate any true tax increase and allow each state to control its own sales and use tax revenues.

2. Sellers Will Move to Low or Non-Sales Tax States or States That Have Not Joined the Compact

Sellers know and understand the advantage they gain when they do not have to collect sales tax on a transaction but a competitor does. Likewise, many purchasers are willing to make their purchases while only looking for the lowest overall price – even if the only difference in the price is the sales tax. After all, unless I am buying something that I think I will need serviced after I purchase it, do I really care which seller I purchase it from? If ten vendors are selling the exact same product, most purchasers are going to look at which vendor they can get the product from for the lowest overall cost.

Under the hybrid-origin sourcing concept, any state that does not join the Compact will potentially become a tax haven for remote sellers – and purchasers will figure out who to buy from to legally avoid paying the tax. The end result of this over time will be that states that have joined the Compact or have a sales tax will likely see sellers making remote sales move to states that either have not joined the Compact (so they can continue to make their remote sales tax free) or to states with either no sales tax or very low sales taxes. Do we really want a system where remote sellers may choose which state to locate their business in based on whether or not they will have to collect sales tax on their remote sales?

Under the Marketplace Fairness Act or similar legislation that utilizes the proven destination-based sourcing regime, the location of the seller would have no effect on the amount of tax the remote seller would be required to collect. This would eliminate the collection of sales tax from being a factor in a seller’s decision of where to locate its business.

3. Purchasers Will Buy Products from Remote Sellers Located in Other Compact States That Do Not Impose Sales Tax on the Particular Product They Are Looking For – Compact States Will Eventually See Their Sales Tax Revenues Decline

Under the hybrid-origin concept, remote sellers will apply the sales and use tax laws, rules and regulations that are in effect for their own home state, regardless of what the laws, rules and regulations are in the purchaser’s state. At the same time, states will be prohibited from imposing use tax on the purchase of a product by a purchaser located in their state from a remote seller. This type of system is vulnerable to manipulation by the purchasers. Let me give you a simple example.

Let’s assume that every state joins the Compact. State A currently does not impose sales tax on clothing, but State B does. Purchasers will figure out that if they buy clothing from a remote seller located in State A, the remote seller is not required to collect any sales tax on the transaction. But if they purchase the same clothing from a remote seller located in State B, they are required to pay the tax. Eventually everyone will know that if they purchase clothing from a remote seller in State A, as opposed to State B, they will not have to pay any sales (or use) tax. Although State A’s remote seller’s business will likely flourish, State B’s remote seller’s business will likely suffer. In addition, the states in which the purchasers are located will eventually see their sales tax revenues decline because the purchasers have figured out a way to avoid paying sales tax on clothing. Under extreme circumstances, this effectively puts one states sales tax revenues partially under the control of another state’s legislature which may choose to exempt a particular product.

Again, under the Marketplace Fairness Act or similar legislation that utilizes the proven destination-based sourcing regime, purchasers would be required to pay the same amount of tax on purchases from remote sellers, regardless of whether the state in which that remote seller is located taxes or exempts the particular product.

4. Purchasers Will Be Required to Pay the Tax Based on the Seller’s Home State Even If the Purchaser is Located in a State that Does Not Impose Sales Tax

Under the hybrid-origin concept, purchasers are required to pay the tax that is imposed based on the seller’s home state laws, rules and regulations. This will result in purchasers located in states that exempt certain products being required to pay sales tax on their purchases from remote sellers of these products because the seller’s home state imposes tax on these products. This is another true tax increase that states that join the Compact would be approving.

Let’s assume again that every state has joined the Compact. A purchaser is located in State X and buys some clothing from a remote seller located in State Y. State Y imposes sales tax on clothing while State X does not. Although the purchaser is located in State X and the clothing is delivered to State X, under the hybrid-origin sourcing concept, this purchaser would be required to pay State Y’s sales tax on this transaction – when prior to State X joining the Compact, the purchaser would not have owed any tax to State X or State Y on this transaction. This is another example of a true tax increase that will result under the hybrid origin concept – but which would not occur under the Marketplace Fairness Act or similar destination-based sourcing legislation.

5. Multi-State Sellers Will Need to Have Multiple Sales Tax Calculation Systems in Place

Under the hybrid-origin sourcing concept, a seller that makes remote sales into another Compact member state would be required to apply its home state rules to those transactions – even though this may or may not even be the location from which the product is shipped. That same seller may also make sales to purchasers that are located in another Compact state in which the seller has nexus, but which is not its home state. For those transactions, the seller will have to have a system that applies the laws, rules and regulations of the state into which the product is shipped (i.e., destination-based sourcing rules). Finally, that same seller may also make remote sales to a purchaser that is located in a non-Compact state in which the seller does not have nexus or any physical presence and therefore is not required to collect any tax. Under the hybrid-origin sourcing concept, that seller will need to have multiple systems running parallel to account for each of the different scenarios the seller may encounter.

Under the under the Marketplace Fairness Act or similar legislation that utilizes the proven destination-based sourcing regime, sellers will only need to have one system in place that consistently applies the laws, rules and regulations of the state to which the product is delivered to the purchaser.

The above questions and concerns are just some of the issues that the Streamlined Sales Tax Governing Board has with respect to the hybrid-origin sourcing concept based on discussions with members of the Judiciary Committee staff and without having seen any specific legislative language. Additional questions or concerns may arise once legislative language is provided.

Editor’s note: Soon after the January 9 NCSL hearing, a Hybrid-Origin Discussion Draft bill was made available on January 15, 2015

Has Streamlined Ever Considered Origin Based Sourcing?

Although the discussion today is focused primarily on the hybrid-origin sourcing concept, I do think it is important that you also know that in the early stages of the development of Streamlined, the state legislators, administrators, attorneys, accountants and business community members involved did weigh the pros and cons of an origin based sourcing regime. In fact, there is an issue paper on our website from back in 2002 that discusses the various sourcing options. During those discussions, it was recognized that theoretically an origin-based system is a more manageable obligation strictly from the seller’s perspective for many of the same reasons proponents of the hybrid-origin concept are using. But when the pros and cons were all taken into account, it was determined that destination-based sourcing was the way to go and was already being followed with respect to interstate sales. At that time, some of the disadvantages of using an origin-based system that were identified included the following:

  • Origin sourcing has the same effect as an export duty and has all the disadvantages that go with it;
  • States using origin based sourcing would be burdening their own businesses with a tax that will potentially put them at a competitive disadvantage with others in the remote sales market that are located in states that don’t follow origin sourcing; and
  • Origin based sourcing will affect the decision of where a business locates and states don’t want to get into a downward spiral competition with other states on this issue – especially those states where sales tax is a significant source of their state’s revenue.

When the Project thought about these disadvantages, it came to the conclusion that

…the only way to avoid these practical impediments in an origin system is to require all jurisdictions to impose an origin sales and use tax on generally the same base and at generally the same rate. In this circumstance, there is no substantial disparity that follows from the origin of the goods or services coming into the destination State, at least for domestic, but not international, commerce. This requirement flies in the face of our federal form of government, however. ‘Our Federalism’ allows each State to determine its own tax policy, including a policy of not taxing consumption through a sales and use tax at all.

Throughout the above discussion, I have noted several times how the Marketplace Fairness Act or similar destination-based sourcing legislation eliminates the issues that can occur under the hybrid-origin concept (i.e., tax increases, having multiple systems to account for different types of transactions, preventing sellers from locating in one state or another to take advantage of not having to collect sales tax, tax havens, etc.).

Streamlined currently has over half of the states with a sales tax as members of the Streamlined Sales Tax Governing Board. We have over 2,300 retailers that have voluntarily agreed to collect and remit the taxes in our member states, regardless of whether the seller has nexus or a physical presence in one or more of the member states. Based on the amounts reported by member states, these sellers have collected and remitted over $1.7 billion of sales tax since October 2005 that may otherwise have gone uncollected. Because of the simplifications, uniformity provisions, rate and jurisdiction databases and taxability matrices that member states are required to provide, many of these sellers have even chosen to calculate, collect, report and make the required remittances completely on their own. If collecting the taxes was as costly as some of the opponents of Streamlined make it out to be, these sellers would not stay registered and continue to calculate, collect and remit the taxes in those states where they are voluntarily doing so – they would unregister and only collect in the states where they had a legal obligation to collect. The technology is there and has made calculation, collection and remittance of sales tax much easier and less burdensome for sellers than in the past.

In addition, for those sellers that don’t want to do this on their own, Streamlined has Certified Service Providers that our member states compensate to provide the software and services necessary to integrate their software with the seller’s systems and that take care of the tax calculations, compile the data and prepare the returns, file the returns, make the necessary remittances to each of the states and handle any audits of the remote sellers on the transactions they processed in the member states where the seller is voluntarily collecting the tax. And best of all – this is provided at no charge to the sellers for all of the member states in which the seller is voluntarily collecting and remitting the tax. Destination-based sourcing can and does work and our organization is living proof of it.

Conclusion:

The Streamlined Sales Tax Governing Board continues through the cooperative effort of state legislators, state tax administrators, accountants, attorneys, and the business community, to look for ways to make sales and use tax systems simpler and easier to administer from both the state’s and business’ perspective – while at the same time protecting state sovereignty and making it fair for all parties – sellers, purchasers and the states.

Unfortunately, the hybrid-origin sourcing concept is an attempt to turn the tried and true destination-based sourcing hierarchy upside down and will result in a tax increase on millions of Americans. This alone will prevent most if not all states from joining the Compact that would be required to obtain collection authority and would result in Congressional authority that few if any states would adopt – leaving states no choice but to continue to find creative ways to be able to compel sellers to collect their sales tax. States don’t want to have to do this and I don’t believe any business wants this either.

I thank you again for the opportunity to discuss some of the Streamlined Sales Tax Governing Board’s concerns and questions with respect to the hybrid-origin sourcing concept and the opportunity to briefly describe some of the successes of the Streamlined Sales Tax Governing Board.


Taxation without representation?

August 16, 2012

Since Senator Jim DeMint’s July 31 op-ed in the Wall Street Journal asserted that online sales tax collection is taxation without representation, we’ve been seeing this argument repeated all over the media. Even thoughtful articles that are trying to look at the topic objectively seem to be taken in by this red herring.

So what’s the truth about online sales tax and taxation without representation?

The three bills currently before Congress that call for online sales tax collection, including the Marketplace Fairness Act, require that that sales tax is destination-based. That means that the sales tax is applied based on where the consumer, not the store, is located. Why? Because consumers are the ones paying the tax, so they should a) get to vote on what the sales tax rate is and b) benefit from the services funded by sales tax.

In other words, if you live in Vermont and make a purchase from an online store located in California, you would pay Vermont sales tax. The store in California would collect the sales tax just as a local store would and remit it back to Vermont, where it would help to pay for police and fire departments, public roads, schools, libraries, and more. And as a resident of Vermont (or any state with sales tax), you have the opportunity to vote on the local sales tax rate and elect the state and local representatives who help administrate sales tax. Which means that destination-based sales tax is taxation with representation, despite what Senator DeMint said.

What’s the other option? Origin-based sales tax. This means that no matter where the customer is located, the sales tax is applied based on where the online store is located. If you live in Vermont and make a purchase from an online store based in California, you’d pay California sales tax that is remitted to California. Where, as a Vermont resident, you have no say in the sales tax rate, cannot vote for state and local representatives, and do not benefit from the services that sales tax helps fund.

In other words, it’s taxation without representation. It’s also, for our money, simply wrong—when you pay sales tax, you should benefit from the roads, schools, parks, and more that it funds.

What a good thing that none of the bills before Congress suggest that origin-based sales tax is the way to go.

So who is supporting origin-based sales tax (taxation without representation)? Ironically, it’s Senator Jim DeMint, along with Adam Thierer, a senior research fellow at the Mercatus Center at George Mason University, and others. Both Senator DeMint and Mr. Thierer have written editorials attacking destination-based sales tax as taxation without representation and proposing that origin-based sales tax is best.

But the facts just don’t hold up.

We’re not saying that there’s no reason to support origin-based sales tax. There is: It’s easier for online shops to apply just one sales tax rate, based on their own location, instead of applying various rates based on their customers’ locations. They also would get to remit all the sales tax on purchases made at their store to their own state, rather than sending it back to the state where the customer, who paid the tax, resides.

But let’s not kid ourselves. Origin-based sales tax is taxation without representation.

Destination-based sales tax—the kind proposed in the Marketplace Fairness Act—is not.