After states win on internet tax, Congress must ensure fairness

After states win on internet tax, Congress must ensure fairness
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Anthony Kennedy has a message for Congress. Justice Kennedy wrote the majority opinion this week in South Dakota v. Wayfair, the decision opening a path for states to more freely tax sales over the internet. While states are winners for now, the Supreme Court also issued invitations for federal legislative action. Congress should act promptly to give certainty to retailers and their customers, prevent the need for further litigation, and make sure that all the states play fairly in the new legal environment.

Wayfair tossed out a longstanding rule that had the effect of making many internet retail sales tax free. Under the old rule, states could impose a tax on sales to customers within their borders, but could not compel the retailer to collect that tax unless the retailer had a “physical presence” in the state. States thus depended on buyers to voluntarily report their purchases, which very few ever did. Businesses openly advertised the opportunity to evade local sales tax as a reason to shop on their site.

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Why would the court have ever adopted such a rule? It was first decided in 1967, half a decade before the introduction of the first microprocessor. The idea was that sales tax compliance is costly for retailers. There are thousands of different local governments in the United States with the power to impose sales taxes, many with their own unique rates and rules. For any retailer, the time and expense of learning these rules was as effective a barrier to entry as any tariff.

As the court ultimately recognized in the Wayfair case, technology has transformed this story. The internet made it easier to sell products without a showroom or salesperson within a thousand miles. Software now marketed by several companies allows merchants to look up tax rates and rules with nothing more than a customer address. But software is not a cure all. For one thing, it is not free, with subscriptions to the most sophisticated systems running thousands of dollars annually.

Merchants selling new or complex products may have to hire consultants to help them match their inventory to the categories built into the software. Beyond compliance issues, political and economic pressures could lead states to overgraze the new internet sales commons. State laws remain complex and offer ample opportunities to favor state interests over outsiders. Software might help merchants cope with complexity, but it is little help to voters who must decide whether their laws are fair.

State laws seeking to enlist remote retailers as tax collectors still face potential challenges in court. The Wayfair decision requires a state to have “some definite link” or “some minimum connection” to the commerce it aims to tax. State laws cannot discriminate against or impose “undue burdens” on interstate commerce. Some retailers are already threatening to press claims under these theories. Also looming is the question whether a state can pursue retailers for uncollected back taxes, though South Dakota and several other states have pledged not to.

The Marketplace Fairness Act, passed by the Senate in 2017 but stalled in the House, could largely resolve these issues. For technical legal reasons, Congress cannot modify the “minimum connection” requirement, but it has authority to rule out other challenges, and even to modify or outright overrule the Wayfair decision. The Marketplace Fairness Act uses that authority to condition the power of states to compel tax collection on membership in the Streamlined Sales and Use Tax Agreement.

Member states agree to simplified rules that make compliance easier and discrimination more difficult. Member states pay the costs of compliance software for remote sellers and promise not to impose penalties for legal errors caused by the software provider. The Marketplace Fairness Act prohibits states from imposing new tax collection obligations until after it is in place, eliminating any retroactive tax liability.

The Marketplace Fairness Act also requires states to exempt sellers with less than $1 million in annual sales. That is a much higher threshold than anything suggested by the Wayfair opinion, and technological improvements and state compensation will make compliance fairly easy even for relatively small sellers. But it may be a reasonable compromise if it secures much needed national harmonization and simplification.

All is not lost if Congress fails to act. The Wayfair opinion suggests that membership in the agreement would very likely blunt most other legal challenges to state tax collection. That may well incentivize states to join the agreement, which already has more than 20 members. Federal involvement will strengthen the agreement and help it keep to its goals. Again, legislation will prevent a period of extended uncertainty and hefty legal bills. But if Congress is quiet, there is a path forward.

Brian Galle is a professor at Georgetown University Law Center. He is a cosigner of an amicus brief cited in the South Dakota v. Wayfair opinion.