In April, the U.S. Supreme Court will hear a case that could affect the future of online commerce, specifically small online sellers and those who purchase their products online.
In South Dakota v. Wayfair, Inc., the court will determine whether state government officials may collect an Internet sales tax on purchases coming from a seller that is not physically present in a consumer’s state.
Revenue-hungry state and local officials and retail giants have lobbied members of Congress for nearly two decades to eliminate the physical presence limit on state taxing powers. These politicians would love to tax sellers in other states, who can’t vote them out of office, while retail giants welcome any policy that will squash their competition.
But when it comes to protecting consumers and the rule of law, it would be better for everyone if the Supreme Court resists the special interests of state politicians and retail lobbyists, upholds the physical presence standard, and relies on Congress to address this issue.
It’s a fundamental tenet of federalism that a state’s powers are limited to its own state and citizens. States should not and cannot impose their will on other states, but instead should compete for residents and businesses based on the wisdom or folly of their political choices.
The problem with Internet sales taxes is that they’re anti-competitive and would likely be experienced as a tax hike on consumers. They also give states the opportunity to create a makeshift tax cartel, something that’s prohibited by the Constitution.
There would be no way for an online buyer to avoid the tax, which means the long-term effect of this arrangement would be that states would lessen downward pressure on taxes between jurisdictions. Consumers would be forced to wear their home jurisdiction like a tax albatross when they shop online.
Think about the difference in gas taxes between Virginia and Washington, D.C. That difference leads many people to drive across state lines into Virginia to pay less for gas. This keeps at least some downward pressure on tax rates.
If D.C. made its rate high enough, then everyone within reasonable distance would exit and fill up their tanks in Virginia. But if we apply the Internet sales tax plan to gas taxes, a Virginia gas station would have to charge you D.C. gas taxes if your car had D.C. plates.
An Internet sales tax would also drown small, online businesses and entrepreneurs, like those on eBay and Etsy, with compliance costs since they’d have to deal with the costs and complications of figuring out approximately 10,000 distinct sales tax jurisdictions. These independent sellers would also be subject to audits from up to 46 states, the current number of states that impose a sales tax.
Big box retail stores, like Target, Best Buy, and Walmart, support this new tax because it’s a way to burden small competitors, potentially putting some out of business. Even Amazon, who used to oppose these tax expansion efforts, has switched sides now that it owns warehouses across the country to improve delivery times, which also happens to trigger sales tax compliance in many states.
Proponents of an Internet sales tax point to free government-provided tax-calculating software as a way to reduce these compliance burdens. But there are serious concerns with the performance of that software and there are no allowances made for costs associated with testing or integrating these systems.
The current, physical presence standard protects business owners from what amounts to taxation without representation, since a state cannot impose its sales tax on purchases if the seller has no store, warehouse, or office located in the state.
This protection is in line with one of the most important aspects of competitive federalism: protecting individuals from overreaching states and states from each other. The Constitution doesn’t bar state Internet sales taxes; it permits them so long as they’re approved by Congress through federal legislation or through approval of a multi-state agreement.
And if these taxes are really in the public interest, then there’s no reason to think that Congress won’t act. But states should not be able to undo the physical presence rule on their own, as South Dakota is attempting to do in its Supreme Court case.
There is a better way. Consider a congressionally enacted (or approved) online sales tax system which was origin-based. It would assess a tax based on the point of purchase; that is, an online seller located in South Dakota would be subject to that state’s tax, just like brick-and-mortar sellers in that state.
In short, online and main street sellers would be treated identically. And most importantly, such an approach would promote healthy competition among the states, and keep politicians accountable to those they tax. A state that imposed a very high tax on sellers located within its borders would risk losing those businesses to lower-tax states.
This approach is vastly superior to a Supreme Court ruling that took the decision about the physical presence rule away from Congress. If that were to happen, it would surely lead to the destruction of many small, online businesses and a tax hike on Americans, leaving us with less money in our pockets and fewer choices online.