Economy & Business

The Supreme Court Just Gave States Power to Tax Online Sales

(Toby Melville/Reuters)
Congress should have acted to fix this problem before, and it should still act now.

Unlike many conservatives, I absolutely loathe the fact that much online commerce is in effect tax-free. There is no legitimate reason that Walmart and Target, but not Newegg and Overstock.com, should have to collect taxes from me as a customer. It’s a system that distorts economic activity and facilitates tax evasion, as individuals who shop online almost invariably fail to pay the “use tax” that most states charge as a substitute for sales taxes on such transactions.

The Supreme Court addressed this problem yesterday in South Dakota v. Wayfair, opening the door for states to require retailers located elsewhere to collect sales tax. But this isn’t the right way to handle online sales, either. It’s something that Congress needs to address, no matter what the states and the courts are up to.

The root of the issue here is the Constitution’s commerce clause, which gives Congress the authority to “regulate Commerce . . . among the several States.” The Supreme Court has long seen in these words a “dormant commerce clause” as well — the idea that if Congress is authorized to act in this area, states are limited in their ability to do so even when Congress is silent. This isn’t a categorical prohibition, but an attempt to make sure that states can’t, say, discriminate against sellers located elsewhere or levy taxes on companies that don’t do business in the state. A 1988 ruling even explicitly said that “interstate commerce may be required to pay its fair share of state taxes.”

In two decisions, however — Bellas Hess (1967) and Quill (1992) — the Supreme Court imposed a “physical presence” requirement for sales taxes: If a company has no physical presence such as a warehouse or storefront in your state, you can’t require it to collect taxes, no matter how much stuff it’s shipping state residents or how much money it’s making from doing so. As the Internet has made it easier and easier to buy items from sellers in other states, the result has been an unfair advantage for online sellers and a dramatic hit to states’ budgets in the form of lost tax revenue.

Congress failed to respond, so states forced the issue. Being challenged in the new case was a South Dakota law that flagrantly violated Quill, requiring sales-tax collection from all companies that sold at least $100,000 in merchandise and services or 200 separate orders to South Dakota addresses annually. The Supreme Court overruled Quill and upheld the law. Anthony Kennedy wrote the majority opinion, joined by Clarence Thomas, Samuel Alito, Neil Gorsuch, and Ruth Bader Ginsburg.

The first key question here, of course, is whether Bellas Hess and Quill were wrongly decided. Incredibly, the actual decisions had precisely zero defenders on the entire Supreme Court. The majority opinion said the “physical presence” requirement was arbitrary and unworkable, especially in the modern economy, and applied a different test from Complete Auto Transit, one that requires a “substantial nexus” rather than specifically a physical one (among other fairness and nondiscrimination requirements). In separate concurrences, Thomas and Gorsuch indicated that they might consider killing or revamping the entire concept of the dormant commerce clause, as “Congress has the authority to do X” does not necessarily imply that states are forbidden to do X if Congress doesn’t, or that courts get to set the limits of state policy.

Congress uses the interstate-commerce clause as an excuse to regulate the cultivation of marijuana for private use, for crying out loud. It might as well use it to, you know, regulate interstate commerce, too.

I’m not sure it’s all that crazy to say that since the Constitution gives authority over interstate commerce to Congress, states aren’t allowed to tax out-of-state businesses unless Congress says so. But even the dissent, written by Chief Justice John Roberts and joined by three of the Court’s liberals, agreed that Bellas Hess was wrongly decided, though it nevertheless urged against overturning decades’ worth of precedent and disrupting a major part of the economy, especially given that Congress can step in and change the longstanding status quo any time it feels like it.

The situation will only get trickier going forward. While it may be easy to say that South Dakota’s law is in-bounds — it exempts small sellers, and the state participates in the Streamlined Sales and Use Tax Agreement, which standardizes tax systems across states — other cases will be harder. Courts may have to decide, for example, whether an insanely complicated sales-tax system (e.g., one that taxes yarn for art projects but not for sweaters — an example noted in the dissent) discriminates against out-of-state sellers, who can’t be expected to learn such details for the nation’s thousands of state and local tax jurisdictions. Or they may have to figure out exactly how much sales volume is required to constitute a “substantial nexus” between a company and a state.

These are highly subjective questions of the type that legislators, not judges, should answer. But the majority nonetheless decided that “the potential for such issues to arise in some later case cannot justify retaining an artificial, anachronistic rule that deprives States of vast revenues from major businesses.”

In the end, Congress’s ineptitude is far and away the most obnoxious aspect of the current state of affairs; for years the legislature stood by doing nothing to fix this problem. There are ideas galore for a nationwide system of online sales taxes (including one I wrote about at length in 2016, for The American Conservative). Most require companies to collect sales tax and remit it to the states their customers live in, while requiring participating states to simplify their sales-tax regimes to facilitate compliance. Some conservatives prefer a “point of origin” system, in which companies remit all sales taxes to their home states, including on sales they made to customers elsewhere (though I am not personally a fan of this setup, for reasons I laid out in the TAC piece linked above). Just about anything would be better than a system that treats different sellers differently and facilitates tax evasion on a massive scale.

Yet Congress never managed to tell us what the regulations on interstate commerce should be, so we defaulted to the Supreme Court’s baseline of what happens when there’s no federal regulation at all. For years this meant that state sales taxes magically didn’t apply to online sales; now it means that states can do whatever they want until the next court challenge, at which point the judicial branch will have to flesh out the gory details of the nation’s sales-tax regime even further. (In the interim, as the dissent also notes, the problem actually waned somewhat: Amazon, for example, now collects state sales taxes throughout the country thanks to the nexuses created by its extensive warehouse network and “affiliate” programs.)

Justice Kennedy writes that “it is inconsistent with this Court’s proper role to ask Congress to address a false constitutional premise of this Court’s own creation.” Fair enough, I guess. But the Founders envisioned a country where Congress — not the courts, and not the states acting alone — would set the ground rules for interstate commerce. Congress should have done that right after Quill, it really should have done that once the Internet made it clear how big a tax shelter the physical-presence rule had created, and it should still do it today, before states run wild with their newfound freedom to hammer other states’ businesses with complicated taxes.

Congress uses the interstate-commerce clause as an excuse to regulate the cultivation of marijuana for private use, for crying out loud. It might as well use it to, you know, regulate interstate commerce, too.

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