Following the Supreme Court’s decision in South Dakota v. Wayfair, one of the smallest states in the country — South Dakota, ranked 46th in population and 47th in GDP — has unfortunately been allowed to define what it means to be a big business or a small business when it comes to corporate sales taxes. Now, overzealous bureaucrats across the country are rushing to use the court’s decision to beef up state tax revenue.
Some background: Wayfair changed what constitutes a “taxable presence” for businesses in a given state. Where previously businesses needed to have a physical presence within a state, such as an office, warehouse, or employees, the Court decided in Wayfair that any out-of-state business can be forced to comply with a state’s laws if it passes a certain sales threshold in that state. The South Dakota legislation at the root of the case exempted sellers with less than $100,000 in sales and fewer than 200 transactions within the state. Writing for the majority, Justice Anthony Kennedy cited with approval this exemption, calling it a “safe harbor” protecting smaller businesses from onerous nationwide tax-compliance burdens.
But like a child who goes searching for the biggest bowl in the house when he’s told he can have a bowl of ice cream, tax bureaucrats from coast to coast are busily copying Wayfair’s new standard despite the fact that most states bear little resemblance to South Dakota in terms of population or economic activity. This threatens to ensnare many more — and much smaller — businesses in sinister tax-collection schemes than the Supreme Court may have realized.
Take New Jersey, a state more than ten times larger than South Dakota in terms of both GDP and population. Almost immediately following Wayfair, legislation was introduced in Trenton that would inflict state sales tax on out-of-state retailers with, you guessed it, $100,000 in annual in-state sales or 200 annual in-state transactions. A small online business would likely find itself hitting that threshold far sooner in New Jersey than in South Dakota. In fact, if one were to adjust the New Jersey law to account for the state’s size relative to South Dakota’s, it should really require around 2,050 annual in-state transactions or $1.2 million in annual in-state sales.
New Jersey’s not the only state copying South Dakota’s math. As of this writing, 18 of the other 28 states with online-sales-tax laws have thresholds exactly the same as South Dakota’s, despite nearly all of them being significantly larger than the Mount Rushmore State. Only seven states — Alabama, Connecticut, Georgia, Massachusetts, Mississippi, Ohio, and Tennessee — have higher revenue thresholds than South Dakota. Oklahoma, Pennsylvania, and Washington currently begin their tax obligations at a measly $10,000 in sales, an amount that could be exceeded by innumerable truly small businesses.
Why does it matter if these thresholds are too low? The lower the threshold, the smaller the businesses that get saddled with the hefty burden of complying with a state’s tax regime. Large online retailers such as Amazon were already collecting taxes in each state long before the Wayfair decision, leaving small businesses and independent sellers on sites such as Etsy and eBay to bear the brunt of the Wayfair decision. Reuters recently estimated that only 8 percent of midsize firms currently have the infrastructure in place to cope with the burdens of tax collection in the wake of the decision. Small businesses are undoubtedly even less prepared, and even businesses that come in below a state’s nominal threshold can often expect to face audits and reporting requirements enforced by state bureaucrats chasing every penny.
State legislators may be eager to snap up every tax dollar they can, but they should keep in mind the reality of the market. Though subjecting small businesses to burdensome tax liabilities may provide an initial sugar high of tax revenue, it will slow down the economy in the long run and damage the online-retail ecosystem. The Internet has long served as a booster to start-ups and entrepreneurs seeking a level playing field with established outlets. States should do their utmost to ensure it remains that way.