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Senate Voting This Week on Expanding State Authority to Collect Internet Sales Taxes

4 min readBy: Joseph Bishop-Henchman

The U.S. Senate this week is voting on the Marketplace Fairness Act, which would grant each state the power to require collection of sales and use taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es by sellers with no physical presence in the state (primarily catalog and Internet-based sellers). The Senate approved a cloture vote yesterday, wresting the bill away from Sen. Max Baucus (D-MT), who is skeptical of the bill.

Update: The vote will now occur on May 6. Check out our table graphic here.

Confused about this issue? Here's the run-down from when I testified to Congress on the bill last year:

  • After the bitter experience of the Articles of Confederation, the Constitution empowered Congress with the responsibility to rein in state tax overreaching when it threatened to do harm to the national economy.
  • Consequently, states were not permitted to tax items in interstate commerce at all, from the Founding until approximately the 1950s.
  • Since then, as formally adopted by the U.S. Supreme Court in the Complete Auto decision (1977), states may tax interstate commerce so long as the tax is non-discriminatory, fairly apportioned, related to services, and applies only to businesses with substantial presence (nexus).
  • In a series of decisions, most recently the Quill decision of 1992, the U.S. Supreme Court explained that “substantial nexus” for sales/use tax purposes means physical presence of property or employees. The Court ruled that it exceeds to state powers for them to be able to demand use tax collection from companies that are not physically present in the state.
  • States have sought to overrule the Quill decision, either legislatively (“Streamlined”) or through defiance (“Amazon” tax statutes). The defiance approach in particular has caused significant disruption and uncertainty to the economy. The "lost" revenue for states from untaxed Internet transactions is somewhere around $3 billion nationwide.
  • Every state with a sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. also imposes a use tax, levied on taxable items upon which no sales tax has been paid. In other words, use taxes seek to thwart competitive pressure from other states with lower tax rates. Taxpayer compliance with these protectionist use taxes is minimal. (Use tax, with a few exceptions, is imposed on the consumer and not the seller.)
  • Congress has passed a number of statutes limiting the scope of state tax authority on interstate activities (“preemption”), carefully balancing (1) the ability of states to set tax policies in line with their interests and that allow interstate competition for citizens over baskets of taxes and services and (2) limiting state tax power to export tax burdens to non-residents or out-of-state companies, or policies that would excessively harm the free-flow of commerce in the national economy.
  • When a resident of a state purchases from a brick-and-mortar retailer, they generally must pay sales tax. When the same resident in the same state purchases the same product from an online retailer, they often do not pay sales tax.
  • Many large Internet retailers are expanding the number of states in which they have physical presence, to enable next-day delivery, but that is not the case for many smaller sellers that remain in just one location and use common carriers to deliver purchases.
  • There are approximately 9,600 jurisdictions in the United States that collect sales tax, a number that grows by several hundred each year. Subscription tax software is inadequate and can be expensive for occasional sellers, and few states provide adequate tax lookup or consolidated tax filing options. Sales tax can vary by product, by time, and by location in the state. In 7 states, local governments can have a different sales tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. from the state tax base.
  • Congress has five basic options on how it may proceed:
    • Reaffirm the physical presence rule for sales taxation, and by implication, the disparity of treatment between brick-and-mortar sales and Internet sales.
    • Reaffirm the physical presence rule but adopt a new tax approach that mitigates the disparity of treatment between brick-and-mortar sales and Internet sales (such as an origin-based system or a national sales tax on online purchases).
    • Modify the physical presence rule in the limited context of state collection of use tax from out-of-state sellers, by those states that have adopted simplified sales tax systems under minimal federal standards, to reduce the harm to interstate commerce. This trade-off would replace the check on state power provided at present by the physical presence rule.
    • Repeal the physical presence rule without conditions on the states, granting states unchecked authority to export tax burdens and damage interstate commerce.
    • Do nothing and risk the continued growth of unchecked and fragmented state authority to export tax burdens and damage interstate commerce.

The bill as proposed does that third option, although it's missing a few key things such as federal court jurisdiction, uniform definitions of terms, the option of blended sales tax rates for each state, and notification for sales tax base changes. More on that here.