The Online Sales Tax Controversy
State and local governments are at a nearly unprecedented level of underfunding and it might have something to do with our online shopping carts. In 2017, the Government Accountability Office estimated that state and local governments experienced a loss of anywhere from $8 billion to $13 billion due to the prohibition on collecting state sales taxes on online purchases. Online commerce accounts for 9.1% of total retail sales and continues to grow at an estimated rate three times faster than the retail industry. Per the Supreme Court’s holding in Quill Corp. v. North Dakota, a state may only compel a vendor to collect state and local sales taxes from state residents if the vendor has a physical presence, whether through an office, a warehouse, or a shop, in the state. This has allowed many online retailers to sell to customers in states that charge a sales tax without collecting these taxes. With the disparities between online retail and traditional retail only growing larger, several states have recognized how detrimental this loophole has been to adequately funding state and local budgets, Among these states is South Dakota, which passed a new law in 2016, SDCL § 10-64-2, that requires any retailer with gross annual revenue of $100,000 or 200 or more transactions for products or services delivered into the state to collect and remit South Dakota state sales tax. To resolve the clear conflict between this law and existing precedent, the Supreme Court granted South Dakota’s petition for a writ of certiorari in South Dakota v. Wayfair.
An Outdated Connection
The 1992 decision in Quill, which came just two years after the invention of the World Wide Web and the same year the first public and readily accessible web browser was launched, was aimed at regulating catalog retailers and pre-dates the founding of key online retailers like Amazon, eBay, and Etsy. Still, the Quill standard remains good law absent a more relevant standard for addressing our modern technological reality. Justice Thomas has repeatedly criticized the dormant commerce clause, on which the Quill standard is based, as a clause which “has proved unworkable in practice.” SDCL § 10-64-2 and South Dakota’s petition seem to answer Justice Kennedy’s call for “the legal system [to] find an appropriate case for this Court to reexamine Quill.” While no federal law mandating collection of online sales tax has been passed, there is bipartisan support for such a measure. South Dakota is just one of many state legislatures that has passed legislation as part of the “kill Quill” movement to try to force the Supreme Court to reconsider the physical presence standard.
Struggling States and Restrained Retail
Support for “kill Quill,” both from state governments and from traditional retailers, has not been hard to come by. State and community economies are facing a vicious cycle of raising sales taxes on in-state purchases, only to see consumers avoid the increases by turning to tax-free online alternatives. With other funding alternatives, like a proposed tax on access to the internet, permanently barred, states have shifted their attention back to the Supreme Court. Unsurprisingly, thirty-five states have voiced their support for South Dakota’s position to date through amici curiae and demonstrated their belief that judicial action is needed to place tax enforcement power back in the hands of state governments. Given that trends in ecommerce often set the tone for brick-and-mortar retail stores, state governments are not alone in their frustration with the physical presence rule. Traditional brick-and-mortar retail establishments, a record number of which were forced to close in 2017, have found themselves ill-equipped to compete with lower prices offered online. In a recent report published by The Economist Intelligence Unit, a global survey of 256 retail executives revealed that 66% of the executives surveyed have cut prices or plan to cut prices in coming years in response to price pressure from online-only rivals. Further, 71% of those surveyed have introduced some form of price matching to keep up with their exclusively ecommerce competitors. From the sheer overhead cost of running a business with a retail space to the need to charges sales tax, the physical presence rule has provided online retailers with a huge advantage.
Amazon Goes the Extra Mile
As support for “kill Quill” has been mounting, the opposition to instituting a new standard for internet-based transactions has dwindled. While several online retailers are opposing overturning the Quill standard, Amazon, which was responsible for 44% of all U.S. ecommerce last year, is not among them. Before you disable your Prime account, it’s important to note that the court’s decision will likely not affect Amazon. A decision by the company last April to begin collecting sales taxes from customers in all states with sales tax demonstrates an ecommerce trend that would eliminate obstacles to enforcing sales tax online. To keep up with increasing consumer demand for fast shipping and stringent delivery obligations, online retailers have had to create more fulfillment centers close to their wide customer bases, which is why customers in just four of the forty-five states that charge sales tax were impacted by Amazon’s decision. The ubiquity of local centers to fulfill online customer orders may mitigate the impact of an upcoming decision on online retailers, given that such centers already qualify as a physical presence within state borders.
Before You Proceed to Checkout
With the date set for arguments in Wayfair just a month away and tax law experts anticipating a decision by the end of June, what do we need to know about how this decision might shape the future of Cyber Monday? If the Supreme Court abolishes the physical presence rule for state tax collection, the cost of online shopping may increase, either in the form of tax at checkout or in price increases for retailers that choose to continue to offer a “tax-free” shopping experience. Though the price tag might seem a little higher, the actual amount customers will be responsible for paying will not change. All states with a sales tax also impose a tax on use of the item purchased, so the price increases reflect a mere close of a tax loophole that many Americans take advantage of when they fail to report untaxed online shopping on their tax returns. Accordingly, any shift in online prices will merely reflect collection of money that, for many customers, is already due. Further, absent a decision from the Supreme Court that would allow states to collect significant sales taxes from online vendors, many states will be forced to raise state income taxes or property taxes to finance state budgets. In short, whether it’s through the court’s decision in Wayfair or necessary changes to the tax structure in states unable to collect adequate sales tax, starving state economies are not keeping up and the time has come to pay the pied piper.