Internet Sales Tax FAQ

sales-tax-santaWe’ve got a week of Internet politics-related topics queued up for you this week. Today we’ll take a look at the prospect of an internet sales tax. Later in the week we’ll discuss why The Great Gatsby still isn’t in the public domain, and then take an overview of the net neutrality debate. The FAQ’s below are a summary of this explainer from CNN.

What’s the current state of sales tax law? 

In the US Supreme Court’s last major decision on the issue (Quill Corp. v. North Dakota), it ruled that a retailer must have a physical presence in a state in order to be required to collect sales taxes in that state. Technically you are required to pay a use tax by your state if you order online from another state–just as you would be required to do so when purchasing physical goods outside your home state. But who actually does that? Virtually no one.

How much revenue would an online sales tax bring in?

The National Conference of State Legislatures estimated that states could gain $23 billion from sales taxes on internet commerce.

What’s going to change, and when? 

Last week the Senate voted 69-27 in favor of the so-called Marketplace Fairness Act. It now has to pass the House, where it will likely face more resistance. The Obama administration supports the bill, so if it passes the House it will become law. Even if passed the changes will go into effect no earlier than October 1, 2013. If you have any major online purchases in mind you may want to make them before then–another stimulus of sorts.

Taxes, Moonshine, and State Building

moonshine_still_sugar_valley2I have to admit an ulterior motive behind Friday’s post. We discussed the Alchian-Allen theorem, which states that adding a fixed cost (usually but not necessarily for transportation) to the price of a good leads consumers to purchase more of the high quality good relative to the lower quality one. Although I hope that discussion was interesting enough in its own right it also serves as background for today. This post discusses the role of postbellum US internal revenue system, whose liquor tax collection efforts in the Mountain South constitute a slow but eventually successful state-building effort.

We have talked about state building before, and this post continues in that vein. The post-Civil War Mountain South was an extraordinarily difficult-to-govern region, both because of its geography and its population’s unwillingness to cooperate with the central government. (Regular readers will recall that these two characteristics are often correlated.) Our discussion will largely be based on the paper, “The Revenue: Federal Law Enforcement in the Mountain South, 1870-1900” by Wilbur R. Miller (1989, JSTOR).

Here’s the connection with the Alchian-Allen theorem. Corn is a commodity, and the quality difference between any two cobs is negligible. However, distilling whiskey from corn both raises its value and makes it easier to transport. According to research from Cornell’s David Pimentel, “An acre of U.S. corn yields about 7,110 pounds of corn for processing into 328 gallons of ethanol.” That’s about 26.1 pounds of corn per gallon of pure alcohol.

Even if moonshine were only 100-proof (i.e. half alcohol), you have reduced the weight to be transported from 13 pounds of corn to around 8 pounds for a gallon of “mountain dew”–nearly a 40 percent reduction! Making higher proof could result in an over 60 percent weight reduction, drastically reducing transportation costs for Appalachian farmers. This also explains why bootleggers would try to achieve high alcohol contents for distribution and expect consumers to dilute the brew after it had been transported–it makes no sense to pay for shipping water content or other dilutions.

But all of these factors were in place long before the Union victory, so why did moonshining become more common afterward? The answer is taxes. From Miller’s article:

The beer tax, which remained low, was collected easily. There was some traffic in untaxed tobacco, but whiskey taxes were the most difficult to collect. Moonshining developed as soon as the excises were imposed, and so many distillers evaded whiskey taxes that in 1868 the commissioner of internal revenue requested reduction of the tax from $2.00 to fifty cents per gallon, thinking the lower excise would be easier to collect. Indeed, the lower rate resulted in increased revenues, but the government continued to lose potential revenue to moonshiners. (p. 197)

PE_BustinUpTheMoonshineStill_bw8x10_14bResistance to the taxes, even when they were reduced, had both an economic and a political logic:

Moonshiners argued that they could not afford to absorb a whiskey tax of ninety cents per gallon or to pass it on to their customers. They believed that economic survival depended on evading the tax, but illegal distilling exposed them to confiscation or destruction of their still or to imprisonment. Mountain dwellers resisted the tax. They believed that a man had a fundamental “right to do pretty much what he pleases,” arguing that “a farmer should have the same right to boil his corn into ‘sweet mash’ as to boil it into hominy.” (p. 200)

It did not help the government’s cause that revenue agents were often dishonest, responding to incentives of their own:

U.S. commissioners, who held preliminary hearings and issued warrants, and deputy marshals (often appointed as deputy revenue collectors), who served warrants and made arrests, received fees for each of their duties. Fee payment encouraged deputies to swear out warrants on doubtful testimony, leading to the arrest of innocent men. (p. 203)

Liquor taxes were serious business, though. The federal government carried a substantial amount of war debt and in 1895 the Supreme Court ruled that existing income taxes were unconstitutional, forcing the government to rely even more heavily on taxing goods like tobacco and whiskey:

The national government had developed a commitment to collecting taxes that it never had toward enforcing divil rights, because it was directly interested in the funds received. The whiskey tax became the largest domestic source of revenue. The excise on distilled spirits grew from 48 percent of all internal revenue in 1876 to 59 percent in 1982. (p. 214)

When Congress raised the whiskey tax to $1.10 (up from 90 cents) in response to the income tax decision, receipts immediately dropped and took five years to recover to their 1893 level. At the turn of the century states began to enact prohibition laws and made revenue collection and enforcement more difficult. Every “moonshine state” except Kentucky and Missouri was dry by 1916. Of course, this did not eliminate the moonshine business–it just made it that much more profitable.

For more on the topic of taxes, government control, and conflict, check out this working paper abstract from Anna Schultz, Nils Metternich, and Michael D. Ward (friends and colleagues, all). To follow up on the Alchian-Allen theorem and prohibition of various types see this post by azmytheconomics. If you want to know more about moonshiners in the 20th century, check out Last Call: The Rise and Fall of Prohibition by Dan Okrent and Bruce Yandle’s “Bootleggers and Baptists” theory (wikipdfpodcast).

More Unintended Consequences of Cigarette Taxes

Excise Taxes on Cigarettes, by State (from Wikipedia)

We have been talking about drug dealing this week, and today we turn our attention to the smuggling of a legal drug product: cigarettes. Differential state tax rates on cigarettes have unintended consequences, which we have discussed before. “Tobacco Road” used to refer to central North Carolina with its tobacco production and four universities with nationally competitive basketball teams. Now it is beginning to be used as a reference to I-95, which runs from some of the lowest-tax states for cigarettes (Virginia) to some of the highest (New York):

Because Virginia’s tobacco tax is the second-lowest in America, gangsters buy cigarettes there in bulk and sell them at enormous profit in New York and other high-tax states. At a minimum, they pocket a big chunk of the difference between what Virginia adds in tax—30 cents a packet—and the higher rates imposed elsewhere. New York’s tax, at $4.35 a packet, is the highest in the country.

The federal Bureau of Alcohol, Tobacco, Firearms and Explosives estimates that sales of illegal cigarettes cost government—local, state and federal—nearly $10 billion a year. For the smugglers, profits are better than those from cocaine, heroin, marijuana and guns, according to a report in September by the Virginia State Crime Commission. Moreover, the penalty for doing it—a maximum of five years in jail, under federal law—is considerably lighter than for selling drugs. If the smugglers were trafficking in heroin, they would face life in prison.

As tax rates continue to grow while remaining uneven across states, incentives for smuggling appear to be growing:

In New Jersey, where a packet of cigarettes carries a tax of $2.70, about 40% of all cigarettes are smuggled in from other states, according to the New Jersey Treasury Department. Maryland, Virginia’s neighbour to the north, reported a fourfold increase in seizures of illegal cigarettes between 2010 and 2012, though one official described the haul as the tip of the iceberg.

Anti-smoking activists love high cigarette taxes. But so do smugglers.

Further reading: Bruce Yandle’s “Bootleggers and Baptists” theory (wiki, pdf, podcast)

Statistics and Crime: “We are all criminals.”

Longtime readers will remember these posts on traffic laws. I’ve got another post coming down the pipe on traffic circles soon, and am also planning a post or two on the (mis)use of statistics and probability by political figures. However, this morning I was also reminded that statistics can be used for good by this post:

Where am I going with all these numbers? Over 100,000 people a day (about 112 thousand) receive a speeding ticket in the United States. That’s just speeding tickets – no parking tickets, no DUIs, just speeding. Now granted some of those tickets are going to be for driving crazy fast and doing stupid things, but at some point they start calling that behavior “reckless driving” which, again, isn’t part of the above statistic….

The 112,000 or so tickets given each day add up to over 41 million tickets per year – that’s 19.5% of the populous! Between 1 in 5 and 1 in 6 American citizens will be ticketed for speeding this year, and that’s not accounting for children or those who otherwise don’t drive. About 20% of the U.S. is below legal driving age so even if we say that ALL of the remaining 80% (166,996,430 approximately) of Americans drive a car regularly (they don’t) then that means 24.5% of Americans of driving age are ticketed every year.

[via @newsyc20]

The whole thing is recommended. I agree with the point that calling a behavior that is commonly engaged in by a substantial minority or even the majority of a population criminal is silly. This is because, in my view, the law should be a clarifier of expectations. Speed limits no longer (if they ever did) accurately express the expectations of most people that you won’t speed. Instead, most people recognize that 5-10 miles per hour above the limit is the commonly expected speed, at least in urban and suburban areas where going the speed limit can actually be dangerously slow.

On the other hand, I will point out that if cities and states lose the revenue from speeding tickets they will probably seek to make up for it elsewhere. Since it’s harder to raise taxes than to enforce ridiculous laws, this would probably lead to even more ridiculous practices. I’ve got a hypothesis in the back of my mind that much of government is about hiding costs–but that is the subject of another post.

But corporations don’t supply public goods!

One of the objections that could be raised to yesterday’s post is that corporations tend not to provide what are known as “public goods”–things that can be enjoyed by many people at the same time or over time without being consumed, and from which people cannot be excluded on the basis of some criterion such as having paid/not paid. While my personal response would be something like a listing of all of the positive externalities of corporations, Dr. Kuran’s talk provided a better answer. He discussed the role of waqfs in the Ottoman economy.

A waqf, as he explained it, is essentially a perpetual trust that can be used as a tax shelter for assets. Rather than investing all of his assets in another business partnership (which, as we discussed yesterday, were subject to more than market risk), he could purchase land to build a school, an inn for travelers (“caravanserai”), and the like. This carried with it the additional benefit of being seen as a pious act in Ottoman culture.

Caravanserai of Qaytbay, held in trust by a waqf

I found this private provision of public goods fascinating, since it was done on a decentralized basis. A merchant in the heart of Istanbul, for example, would have had very little idea where an inn might be needed on the eastern portions of the silk road. A trader who spent most of his time traveling between Cairo and Baghdad, on the other hand, would likely not have the inclination or knowledge necessary to set up a school in Damascus.

It turns out that this arrangement became inefficient as time went on because the assets could not be transferred out of the waqf or easily put to new uses. That meant that a caravanserai established during the era of land trade between Europe and China became almost useless after the circumnavigation of Africa, but the assets tied up in it could not be turned into a school or moved to another location. So what you have is private individuals providing public goods as a form of tax shelter, but institutional arrangements leading to economic inefficiency.

To bring this to our day, Ryan Pevnick (currently of NYU) has a working paper forthcoming in The Journal of Political Philosophy that looks at one possible way to foster decentralized charitable contributions. Here is the abstract:

 Current U.S. tax code renders all claimed donations to qualifying non-profit organizations exempt from taxable income. By foregoing this potential revenue, the state effectively sponsors the existing non-profit sector. While some critics have argued that there are reasons of distributive justice to reject this arrangement, such criticisms neglect the important non-redistributive functions of the non-profit sector and mistake a general criticism of the basic structure for a particular criticism of the non-profit sector. After dismissing this distributive criticism, I argue that the existing system for funding the non-profit sector is inconsistent with a commitment to political equality because it prioritizes the donations of high-income donors and allows such donors to effectively determine the ends at which government aims. Accordingly, I advocate moving to a voucher-based system that retains many of the benefits of the deduction-based system, but distributes the ability to direct public support of nonprofits equally across the citizenry.

I am not prepared to endorse this proposal yet (although on a first reading I’m not opposed to it) but it does seem to indicate that decentralized distribution of charitable contributions could lead to more efficient outcomes and reduce the disproportionate influence of contributions that OWS protestors find so distasteful. It has the added advantage of being flexible across time, which the waqf approach did not. These two aspects–decentralization and flexibility–are elements of pragmatism, which I will leave as a topic for future posts.