Shifting Arizona Taxes: Will Online Sales Tax Become a Reality?

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Are Arizona taxes about to shift in a big way? The state’s House of Representatives passed legislation in March that would lower the income tax if the state begins collecting additional sales tax revenue from purchases made from out-of-state sellers. Revenue generated from the income tax rates would be reduced by an amount equal to this new revenue stream.

Ineffective Tax Collection

In 45 states and the District of Columbia, in-state buyers are lawfully required to pay a sales tax on any goods purchased remotely (i.e., via the Internet) from out-of-state sellers. Not everyone complies, however. While a state can require in-state sellers to collect sales tax from buyers on behalf of that state, they do not possess the power under the Constitution to force a seller with no physical presence in their state to act as a collections agent. As such, sales taxes payable on these transactions must be transferred directly from the buyer to the state government.

Of course, enforcing the law on millions of individual buyers is practically impossible. As a result, out-of-state sellers operate with an effective 5–10 percent artificial price advantage. Sales tax revenues shrink as consumers purchase from remote sellers, because they know they will not be prosecuted for failing to pay taxes owed under state law. Furthermore, brick-and-mortar retailers end up negatively impacted as greater numbers of consumers purchase goods online to collect this sizable discount. The problem is compounded as fixed costs for maintaining stores remain constant, rendering some businesses unprofitable.

Congress may attempt to remedy this problem by using its power under the Commerce Clause to permit states to require out-of-state sellers to collect any sales tax owed by an in-state buyer on goods. Various versions of the Marketplace Fairness Act have been proposed; enactment in the next few years is a strong possibility.

Swapping Income Tax for Sales Tax

The proposal by the Arizona House would mitigate the negative effects on in-state retailers caused by the current system. If the state does begin collecting lawfully owed sales taxes on remote purchases, both in-state and out-of-state businesses will be forced to compete in a truly free market environment based on price, quality, and service. The artificially created tax loophole that currently favors some businesses at the expense of others will disappear. At the same time, by adjusting income taxes down by an equal amount of dollars, the bill ensures that collecting this revenue will not expand the size of government. Overall, the amount of Arizona taxes collected should remain unchanged under this legislation.

In addition to addressing this specific problem, the Arizona House bill also moves the state closer to a consumption-based tax system. By taxing a person based on consumption (a sales tax) rather than on earnings (an income tax), individuals benefit through increased take-home pay. Because necessities such as food are not typically taxed, the poor are not penalized in this taxation shift. Importantly, increased savings and investments are realized, benefiting the entire state economy as these funds flow into business growth and creation.