Headlines last week suggested that the Supreme Court’s decision to allow states to collect sales taxes on e-commerce transactions would lead to a dramatic new era of Internet taxation. Papers called the decision in South Dakota v. Wayfair a “windfall” for government budgets, a way for states to “cash in” on Internet sales, and the end of the “party” for e-retailers that had previously escaped the taxman. The decision overturned a 26-year old precedent prohibiting states from collecting taxes on purchases made by residents from out-of-state retailers, but the Court’s ruling won’t amount to quite the bonanza that some headlines suggest. It may, however, be a prelude to more lawsuits, unless Congress steps in and establishes a national standard for what states can do.
The Court ruled in the 1992 Quill decision that state governments couldn’t require a retailer to collect sales taxes unless it had a physical presence within the state. However, as Internet retailing grew in volume, displacing some brick-and-mortar commerce, the Court began to reconsider its Quill precedent, as states complained that they were losing substantial tax revenues to online transactions. After Supreme Court Justice Anthony Kennedy wrote in a 2015 case that it was time for the Court to reassess Quill, South Dakota passed a law designed to challenge the precedent: it required out-of-state sellers with $100,000 or more in sales within the state, or 200 or more transactions with state residents, to collect sales taxes and remit that money. The law was crafted to target major Internet sellers but also to address the objection that taxation of Internet sales would be an intolerable burden on smaller merchants if they had to calculate and file taxes in multiple states. In its majority opinion overturning Quill, written by Kennedy and released last Thursday, the Court specifically praised limitations in the South Dakota bill, including its prohibition on retroactive tax collection. The Court also noted that South Dakota was one of 20 states that had joined together to create a standardized system for collecting taxes from remote retailers, in order to reduce the administrative burden on digital merchants.
The impact of the Wayfair ruling, then, if states were now to follow the model of the South Dakota legislation, might be modest. Though some advocates had argued that state and local governments were losing as much as $58 billion a year in sales tax under the old Quill standard, the nonpartisan Government Accountability Office estimated the missing tax revenues more realistically at $8 billion to $13 billion annually. That’s a small number when considered against the $386 billion in general sales taxes that state and local governments collected in 2017. More to the point, perhaps, is that even as states complained of the money they were losing, sales-tax collections continued growing steadily over the last 10 years; they’re up 29 percent, from $300 billion in 2007.
The real danger for merchants and consumers, however, is what comes next. The Wayfair decision may encourage some aggressive states (California and New York come to mind), and some states desperate to collect more taxes (New Jersey, Connecticut, and Illinois, for instance) to try to squeeze much more in revenue out of this ruling than South Dakota did. That’s because Kennedy’s opinion doesn’t use the South Dakota legislation as a standard for what constitutes a merchant’s tax “nexus”—that is, the point at which a state can start taxing a retailer. What Wayfair mainly does is admit that the old standard of physical presence is no longer adequate, which means that states can now set a much lower threshold for when they can start requiring a merchant to collect taxes.
In his dissent in Wayfair, Chief Justice John Roberts warned that it was far better to leave the matter to Congress than for the Court merely to overturn its precedent, and in the process unleash uncertainty. “I would let Congress decide whether to depart from the physical-presence rule that has governed this area for half a century,” Roberts wrote. House Judiciary Committee chairman Robert Goodlatte made a similar argument in an amicus brief that he and other representatives filed in support of Wayfair. “The Court should recognize that a lasting solution will require compromise, and respect and accommodate the ongoing, diligent efforts of Congress to find a fair solution consistent with Constitutional norms,” the brief noted.
Now that the Supreme Court has acted, it’s even more imperative that Congress use its constitutional power over interstate commerce to make clear, through legislation, what constitutes a sufficient nexus for a state to impose sales-tax obligations on a remote firm. A compromise bill would recognize the kinds of limitations that South Dakota put in its legislation and, in the process, stop states from constructing a patchwork of different sales-tax rates and practices throughout the country. Without federal legislation setting out such limits, it seems inevitable that this issue will come before the Court again. In the meantime, merchants and consumers face new headaches.