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Shay: Antiquated Tax Laws Fail to Address Web

If there is one issue that unites an otherwise deeply divided Washington, it is that fundamental tax reform is critical to restoring sustainable economic growth and job creation.

President Barack Obama and Speaker John Boehner (R-Ohio) have called on the Joint Committee on Deficit Reduction to seize the opportunity to get the ball rolling on a major, bipartisan overhaul of America’s tax code.

The Tax Reform Act of 1986 — the last true grand bargain on taxes, where lower rates were traded for fewer loopholes — is showing its age. The simplified system that emerged from that bill has become riddled with tax exemptions, credits and deductions that do not effectively serve the cause of economic growth. The loopholes have grown so complex that Washington’s tax experts cannot even agree on how many there are; the U.S. Treasury counts 172, while the Joint Committee on Taxation catalogs more than 300.

One key step toward fundamental tax reform doesn’t even involve the U.S. tax code. Instead, the document in question is the U.S. Constitution and the glaring failure of our Founding Fathers to anticipate the rise of the information age economy and the widespread availability of instantaneous Internet access.

Inaction in Congress — with an assist from a generation-old decision at the U.S. Supreme Court — has now helped to perpetuate a major distortion in the economy that is picking winners and losers among retailers and costing jobs in local communities.

Giant online retailers enjoy a significant advantage over Main Street small-business owners and other brick-and-mortar stores because they do not have to collect sales taxes on most sales made over the Web. This tax policy distortion stems from a Supreme Court ruling that “remote” retailers did not have to collect sales taxes from out-of-state customers if they did not have a physical presence — such as a store, distribution center or office — in the customer’s state.

That ruling was handed down in 1992, two years before Netscape launched the first Web browser and three years before sold its first book, which might as well have been the Stone Age as far as its suitability for today’s economy is concerned.

If a city tried to impose taxes on books bought on Main Street but collected no sales tax on books purchased on Oak Street, everyone would instantly decry the unfairness of the system. In our era of always-connected consumers, where retail competitors are just as likely to be a mouse click away as around the corner, this is exactly what the Supreme Court’s ruling has done. And every year of inaction in Congress makes the problem more acute.

The result of the Supreme Court ruling is that no sales tax is collected on 38 percent of online retail purchases nationwide, and the uneven treatment of sales tax collection means that states will lose as much as $24 billion in sales tax revenue in 2012. That would total nearly a quarter of a trillion dollars over the next decade.

Three bills that would fix this market distortion and level the playing field for all retail competitors are the Main Street Fairness Act, the Marketplace Equity Act and a new measure expected to be introduced soon by Sens. Dick Durbin (D-Ill.), Mike Enzi (R-Wyo.) and Lamar Alexander (R-Tenn.).

While each varies somewhat in its approach, all of these measures would allow states to apply the same sales tax rules to Internet and out-of-state sales as they do to Main Street retailers and other small businesses.

The Supreme Court’s 1992 decision hinged in part on the complexity of requiring retailers to navigate 45 state and 7,600 local sales tax systems across the nation. Yet modern software, which allows for easy sales tax collection across multiple jurisdictions, has rendered this objection mostly obsolete.

The three pending bills not only level the playing field but also advance a fundamental principle of pro-growth tax reform. By allowing states to finally expand their tax base to all retail sales within their borders, they would create an opportunity for governors and state legislatures to consider lower sales tax rates.

Economists note that relying on sales tax rates of 9 percent or 10 percent from a narrowing base of taxable goods distorts consumer behavior and puts pressure on states to raise revenues from other sources such as income or property taxes.

This distorted policy also gives rational consumers a reason to abandon community-based retailers in favor of remote sellers. Reasonable people can debate the ideal combination of tax rates and tax base, but in the meantime Main Street retailers are caught in the crossfire and jobs are at stake.

Supporters of the status quo claim that online retailers should be exempt from sales taxes because they do not benefit from local schools, police or fire departments, but this is a red herring. Sales taxes are not a business tax, they are a consumption tax. They are intended to raise revenues off a broad base, not shift consumption from one retailer to another.

As the super committee looks for ways to not only reduce our deficit but lift economic growth, it should consider making a down payment on fundamental tax reform by closing arbitrary loopholes and enabling government at all levels to broaden the tax base and hopefully lower tax rates.

Tax laws should be free of distortions that capriciously reward some businesses at the expense of others. If Congress wants to make a statement against taxes, perhaps they should consider a prohibition on all sales taxes. Otherwise, it’s time to fix this broken system so that retailers can compete against each other fairly.

Matthew Shay is president and CEO of the National Retail Federation.