By Monisha Pahuja. Download as PDF. Under current law, states cannot collect sales taxes from out-of-state retailers and the rapid growth in e-commerce is diverting an increasing share of sales taxes revenues from strained state budgets. Although state residents are required to self-report untaxed Internet purchases on their annual returns, states lack the ability to enforce compliance. Only federal legislation can resolve the online sales tax problem. If adopted, the Marketplace Fairness Act of 2013 would finally authorize states to recoup these revenue losses.
Technological change has had a dramatic impact on the U.S economy. Low barriers to entry have allowed the number of e-commerce retailers to proliferate. The growth in online retail sales — from $193 billion, or 4.6 percent of total retail transactions, in 2011, to a projected $546 billion, or 9.5 percent of total retail, in 2020 — influences state and local economies in two ways.
First, state and local governments continue to see depressed tax revenues because of the inherent difficulty in collecting the tax revenues that are owed. The forty-five states that impose a sales tax also employ a complementary use tax. Individual online shoppers are responsible for self-reporting the total amount of online purchases on their annual state tax filings, and pay the equivalent in sales tax directly to the state. However, use tax compliance is exceptionally low.
At the same time, local brick and mortar stores suffer a competitive disadvantage to e-retailers because of the increasingly common practice of “showrooming.” Consumers window-shop in local retail stores, but make their purchases online where they can avoid sales tax.
The resulting impact on state and local economies is substantial. One estimate suggests that remote vendors cost the state of Massachusetts 1,971 jobs, $279 million in sales to local businesses, and $387 million in state tax revenue in 2011 alone.
Unfortunately, States have limited authority to address this issue due to a pre-internet Supreme Court precedent set in Quill Corp. v. North Dakota. Quill held that the United States Constitution’s Commerce Clause prohibits states from burdening out-of-state merchants with sales tax collection if they do not have a physical presence, or “nexus,” within the state. The Supreme Court invited Congress to rectify this Constitutional impediment that has deprived states of the authority to compel online retailers’ tax collection on resident purchases.
Twenty years of congressional inaction has prompted a number of states to enact so-called “Amazon laws.” In a creative attempt to circumvent the Commerce Clause restrictions on state authority, such laws use instate affiliates that direct online traffic to retailer sites to satisfy the nexus requirement. However, online retailers have responded by simply eliminating these affiliate programs. In the end, these laws may actually reduce intrastate commerce and cause greater harm to local economies. Furthermore, legislation of this kind remains constitutionally suspect.
In a separate but simultaneous effort, the National Governors Association initiated the Streamlined State Sales and Use Tax Agreement (SSTUA) that aims to ease the burden on remote sellers in sales tax administration. Participating states are required to enact sales tax reform conforming to the standards of the SSTUA. Presently, twenty-four states are fully participating members. However, because the compact requires that states sacrifice a substantial degree of tax policy autonomy, the SSTUA cannot entice every state to join.
Non-participating states still have an influential role in the fight over an online sales tax. With over 9,600 unique taxing jurisdiction nationwide, state and local sales taxes are notoriously complex. Since the financial and administrative burden on Internet retailers remains the primary objection against states taxing online purchases, legislatures must initiate reforms to simplify their state’s sales tax code and streamline its administration. Only such reforms can lend credibility to the many governors lobbying for Congressional action.
Accordingly, while the SSTUA still requires federal legislation as an enabling mechanism for state taxing authority on remote sellers, a comprehensive resolution must address the sales tax collection effort in non-participating states as well. A bill recently reintroduced in Congress, The Marketplace Fairness Act, is the most promising approach to resolve the online sales tax problem.
The Marketplace Fairness Act grants SSTUA member states taxing authority for Internet retailers, exempting small businesses with annual revenues less than one million dollars. The bill also grants an alternative route for non-member states that requires several tax code simplifications as a precondition for taxing authority. Balancing the concern in allowing state sales tax collection from Internet retailers without imposing an unacceptable burden on those sellers, The Marketplace Fairness Act offers more flexibility to states and greater certainty to Internet retailers.
Ultimately, the complexities that arise from the current state sales tax climate create market distortions and inequities that are no longer tolerable. The primary objective of any forthcoming resolution must be the simplification of states’ tax codes and the development and availability of technologies to implement these reforms. While the Marketplace Fairness Act would help stem states’ immediate budget shortfalls, governors and state legislatures must reevaluate state tax incentives and advocate for policies more conducive to the borderless economy of the Internet.
Monisha Pahuja is a second-year student at Suffolk University Law School, with an interest in economic and tax policy, healthcare policy, and corporate law. She received her B.S. in Business Administration from Boston University in 2011. She is seeking an opportunity to intern within the state legislature this summer as she prepares for her final year of law school.