When the tax costs of operating in New York are only a fifth of the cost of locating the same operation in Wyoming, something unusual is going on. Yet that’s exactly what we find for new research and development (R&D...
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- Do You Owe Sales Tax on Your Cyber Monday Purchases?
Do You Owe Sales Tax on Your Cyber Monday Purchases?
Today is Cyber Monday, with consumers spending as much as $2 billion online today, up a third from last year. As you buy things online, some retailers will charge you sales tax and some will not. It all depends on what state you’re in and whether the seller has a physical presence (property or employees) in that state.
Why? The story of Internet sales taxes actually begins in 1787, when the Framers proposed the U.S. Constitution to replace the Articles of Confederation. One of the driving forces was the recent experience of states imposing trade barriers, tariffs, and punitive taxes on each other. As states did serious damage to the country and each other, the central government had no power to stop them. The new Constitution included several provisions permitting the feds to limit state tax powers when they harm the national economy: the Tonnage Clause, the Privileges & Immunities Clause, and the Commerce Clause.
So bitter was this experience of unlimited state tax powers that for most of the first two centuries of our country, states could not tax interstate commerce at all. State power to tax ended at their borders, just as state services generally end at their borders. This began to break down in the 1950s and 1960s as more multistate and multinational companies began engaging in interstate commerce. Just because a company sells across state lines, went the thinking, that didn’t mean they shouldn’t pay their fair share of supporting local services where they have property and employees. In 1977, the Supreme Court formally abandoned the old prohibition on all state taxation of interstate commerce, replacing it with a rule that states could impose non-discriminatory, fairly apportioned, service-related taxes on businesses with substantial presence (“nexus”) in the state.
Nexus means physical presence in the state, as the Supreme Court has ruled on multiple occasions. If a company has property or employees in the state, you can subject to them to taxes and tax collection obligations. If they don’t, the state can’t. Otherwise, the Supreme Court explained, states could impose the compliance burdens of thousands of tax jurisdictions on every seller in the country with no democratic recourse.
States obviously dislike this rule; they prefer to have unlimited tax authority. Some sought to change the rule, setting up the Streamlined Sales Tax Project (SSTP) to bring some rationality to states' 9,600 sales tax jurisdictions, multiple audits and forms, inconsistent definitions, and badly designed administrative procedures. While they achieved some notable successes on uniformity, SSTP remains hamstrung by most states refusing to join and their own failure to tackle simplification.
Some states tried to defy the Supreme Court, passing laws that expanded nexus beyond strict physical presence. Arkansas, California, Connecticut, Georgia, Illinois, Maine, Minnesota, New York, North Carolina, Rhode Island, and Vermont have passed variations on so-called “Amazon tax” laws that require collection by retailers even if they have no property or employees in the state. (The laws usually claim that commission-based website referrers are the equivalent of in-state employees.) Most of the laws have generated zero revenue, with the Illinois law in particular causing an outbound flight of Internet companies. The Illinois law and a related Colorado law have been declared unconstitutional by the courts, while the New York law has survived a facial challenge. The U.S. Supreme Court may decide today whether it will hear an appeal about the New York law.
Enter the Marketplace Fairness Act, which has passed the Senate and is pending in the House. While the law ends the physical presence requirement for sales taxes, it does require states to designate one entity in each state for sales tax collection, auditing, and filing. Each state must provide free calculation software to retailers, a rates database, a database containing information about the taxability of different products, liability waiver for errors dependent on the state, and notification when the rate changes. The bill is missing common definitions for products, notification when the base changes, a blended sales tax rate option for each state, and, crucially, an enforcement mechanism. The bill exempts sellers with less than $1 million in annual online sales.
Is this tradeoff worth it? Big box retailers think so, as they must collect sales tax from their customers while their online competitors do not. States hungry for more revenue also think so (although new experience in California and New York shows the standard estimates of “lost revenue” are off by some 80 percent). Some scholars pitch alternatives to the MFA, including a national Internet sales tax or “origin-based” taxation (taxing sales based on where the seller is located). Consumers, who technically owe their home state a “use tax” for goods upon which sales tax has not been paid, generally don’t know they are supposed to pay or don’t want to. (Keep this in mind as you buy online today!)
We’ve been working to educate policymakers, the media, business owners, and taxpayers about this issue and the proposed alternatives. As the Internet grows as a share of commerce, pressure to expand state tax authority will grow with it. We want to make sure that state powers remain limited and clearly defined and avoid doing damage to our national economy.
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The Tax Policy Blog is the official blog of the Tax Foundation, a non-partisan, non-profit research organization that has monitored tax policy at the federal, state and local levels since 1937. Our economists welcome your feedback. If you would like to send an e-mail to the author of a blog post, please click on that person's name to locate his or her e-mail address or visit our staff page here.