States on Drugs and the Net

Any federal system will have to live with frictional losses and transaction costs, on account of the difficulty of deciding out what belongs to which state and who can tax or regulate what to whom. We decide to bear those costs because they are outweighed, or so we hope, by the benefits of competition (relative to a fully nationalized system). There remains the task of figuring out and enforcing rules that will minimize the friction and make competition thrive. We are lousy at that—not because the right rules are terribly complicated, but because they would do what they’re supposed to do: discipline government at all levels.

Yesterdays’ Wall Street Journal has two pieces that illustrate the point: an article on state lawsuits over the marketing of pharmaceutical drugs, and another on Senate action on internet sales taxes. There’s also an op-ed by eBay CEO John Donahoe on the subject.

For some time now, state AGs have been suing pharmaceutical firms over marketing practices that are allegedly prohibited under open-ended state consumer protection laws. The lawsuits allege that the drug wasn’t really “safe and effective,” its federal label notwithstanding; or that the company impermissibly told some doctors about potentially beneficial off-label use. The possibilities are endless. Defendants used to be able to settle these cases for a relative pittance (say, $100 million), in multi-state settlements. No more: individual states are now racking up billion-dollar settlements.

In these cases, there are no injured consumers. The lawsuits punish marketing practices, in violation of highly detailed federal regulations and guidance documents, that have been reported to, detected by, and (more commonly than appropriate) punished by federal agencies (the FDA, or HHS). State AGs scour the federal documents, rephrase the violations as state consumer fraud, drag the companies in front of a state jury in Hellhole County, Arkansas, and collect. Rinse and repeat. Theses cases have no social benefit whatever, and they have nothing to do with law: they’re a form of tax farming.

Meanwhile in Washington, the U.S. Senate has voted to open debate on the “Marketplace Fairness Act,” which (true to congressional practice) would help neither markets nor fairness. The idea here is that internet sales (by “remote” sellers who have no nexus to the customer’s state) often go “tax-free,” while comparable sales by bricks-and-mortar outfits are taxed. The MFA would restore tax “neutrality” by allowing state and local tax jurisdictions—an estimated 9,600 of them—compel remote sellers to assess, collect, and remit the applicable tax.

Newsflash: there’s no tax neutrality problem at all.  In all states, internet sales are subject to a use tax, identical to the local sales tax and payable, like the sales tax, by the purchaser. Except, government don’t like to collect the tax or compel taxpayers to report it. So this is an enforcement problem. States propose to solve it by constructing an interstate tax cartel on a principle of pure extraterritoriality: you harass my sellers and I harass yours, and we’ll all be better off.

This debate has droned on for over a decade. To date, the cartel project has foundered on the opposition of small states without a sales tax (e.g., Montana), as well as internet outfits that are often located in those states. What’s changed, first, is that outfits like Amazon, tired of fighting over whether they do or don’t have a “nexus” that would subject them to collection obligations in this, that, or the other state, now support the cartel proposal. (Truth be told, so does eBay: it just wants a bigger exemption for small sellers. All in the name of neutrality.) What’s changed, second, is that states need every nickel to shore up their near-insolvent pension systems, along with the transfer programs that allow them to wheedle money out of Washington. Use tax dollars would help; they slip through the cracks because neither state and local governments nor Amazon & Co particularly care to collect them. The natural response is to collude. Tax neutrality, you know.

Some time ago, I suggested that this sort of thing comes with and from a Constitution of Affluence; and I suggested that the end of affluence might prompt us to curtail practices we really can’t afford. I concede that the opposite is just as likely, and perhaps more so. As governments can no longer finance the transfer state through the ordinary means of taxing their own citizens, they resort to extraordinary means. Desperate times call for desperate measures.