Fate of Sales Taxes for Online Purchases

Why lawmakers should rethink the Marketplace Fairness Act

As many states struggle to solve the debt problems they created, in large part by their own fiscal irresponsibility and short-sightedness, they are looking ever more covetously at the revenues from online sales that in large part have escaped taxation. These numbers are not insignificant. Market research firm Forrester Research estimates that Americans spent $200 billion with Internet retailers in 2011. The firm forecasts that number will increase to $327 billion by 2016.

On July 24 the House Judiciary Committee will hold hearings on the Marketplace Fairness Act, the first major effort on the federal level to force “remote sellers,” that is Internet and catalogue merchants, to calculate and collect sales taxes from out-of-state consumers.

The legislation aims to undo the two Supreme Court decisions that pre-date the Internet yet undergird its sales tax-free character, Quill vs. North Dakota and National Bellas Hess vs. [Illinois] Department of Revenue.

Quill and Bellas Hess were mail-order catalogue merchants. Both decisions held that businesses needed to have a “nexus,” or specific physical presence, within a state before it could be forced to collect sales taxes in that state. Otherwise, both decisions said, forcing a remote seller to collect sales taxes from customers in tax jurisdictions throughout the country-which today totals 11,000-constitutes an undue burden on interstate commerce, the regulation of which is constitutionally delegated to the U.S. Congress.

The Quill decision, however, left the door open for a Congressional remedy.

The Marketplace Fairness Act, presumably, is just such an attempt. Yet the bill itself has problems. Foremost, it treats the “burden” language in both decisions as if it were an inadvertent technicality that can be solved with a bit of software programming.

Indeed, editorials and op-eds supporting the bill, such as in Arizona Daily Star and the Chicago Sun-Times, say it will close a “loophole” that allows Internet purchases to escape taxation. This is akin to saying the Supreme Court’s Miranda decision is a loophole for defendants to escape prosecution. No doubt some overzealous prosecutors may think so, but in truth, Miranda sharpened and affirmed the right of due process already present in the Fourth and Fifth Amendments. Likewise, in Quill and Bellas Haas, the courts sharpened and affirmed the Constitution’s commerce clause that prevents one state from taxing residents of another.

Seeing it as counterproductive to an interdependent economy, the Founders did not want states plundering each other’s residents and enterprises with taxes. Yet that’s exactly the environment the Marketplace Fairness Act sets up. New York State can tax residents of Illinois and the Prairie State can tax Hoosiers.

In doing so, the Marketplace Fairness Act ignores the constitutional underpinnings of the Quill and Bellas Hess decisions and treats the Internet sales tax issue as a procedural issue when the in fact the constitutional bar is set much higher. The giveaway, however, is the portion of the bill that requires states to simplify their state tax collection procedures before launching cross-border taxation. It’s an unusual quid pro quo, perhaps because Congress has to offer states the prerequisite of a buy-in. That’s because any attempt to impose a tax collection structure wholesale on the states would likely face a constitutional challenge on 10th Amendment grounds of state’s rights.

While proponents say the law will level the playing field for brick-and-mortar stores that collect taxes, it will actually fundamentally change the basis on which merchants collect sales tax. As of now, sales tax is calculated based on the retailer’s location. A New Jersey resident shopping on Manhattan’s Fifth Avenue pays sales tax to New York City. Does the Marketplace Fairness Act set up a legitimate sales tax claim by Trenton to any purchase made in any state by a Garden State resident? Don’t discount it. The logic behind the bill is “what applies to local retailers should apply to Internet retailers.” From there it’s easy to argue the reverse.

All the talk of loopholes and level playing fields diverts attention from the real issue. The Marketplace Fairness Act is not about the Internet, e-commerce, the marketplace or fairness-it’s about what the Constitution says about the power of state governments to tax citizens beyond their borders.

And, as with all tax questions, the solution starts with confronting state profligacy. For all the fear that constitution will be undone by a jackboot, the real danger to our unique political structure may be the staggering debts our states and cities are running up. More prosaic perhaps, but no less a threat. There’s no better example of these consequences than the tax overreach inherent in the Marketplace Fairness Act.

Steven Titch is a policy analyst at Reason Foundation.