The Supreme Court struck an important blow for fairness Thursday when it ruled that a state could require online retailers to collect sales taxes even if they had no offices or employees within its borders. But before you can understand what the ruling did, you have to understand what it did not do.
The divided court’s opinion in South Dakota vs. Wayfair, et al. did not impose taxes on internet sales. Nor did it tax online retailers. Nor did it require online shoppers to pay more taxes than they already owe.
In other words, it didn’t do any of the things that online retailers and their allies have been warning about for years, as Congress and state legislatures have wrestled with this issue.
Instead, the opinion by Justice Anthony M. Kennedy — which overturned court rulings from 1967 and 1992 in cases involving mail-order sales — focused solely on the sales and use taxes that state and local governments already impose but don’t do a good job of collecting.
In all 45 states with statewide sales taxes, residents already owe taxes on the products they buy in or have delivered to that state, whether they’re doing so in person or through the internet. If the taxes aren’t collected by the seller at the time of the sale, the shopper is expected to pay them when he or she files an annual tax return.
But states don’t have an effective way of enforcing that requirement. In California, for example, less than one-half of 1% of taxpayers complied in 2011, according to state officials. And online retailers that have refused to collect taxes from buyers have at least helped, if not encouraged, them to become tax cheats.
Up until Thursday’s ruling, some online retailers had a solid legal argument for not collecting sales taxes from distant shoppers. In 1967 and 1992, the Supreme Court had held that a state could not compel a retailer that did business within its borders to collect sales taxes from its residents unless the retailer had a “physical presence” in the state — that is, offices or employees. That’s drawn an artificial line between online retailers too. For example, Amazon has warehouses and employees in almost every state and so collects sales taxes on the items it sells, but many other online retailers — including some that use Amazon’s platform to sell their own goods — do not.
Kennedy wrote that the court never should have imposed the physical-presence requirement. It’s true that a state can impose a tax only on activities that have a substantial connection with that state, but as Kennedy noted, a company can meet that threshold without having a physical presence there — for example, by making substantial sales to the state’s residents.
The earlier rulings provided an improper tax shelter of sorts, helping online shoppers evade billions of dollars in taxes (the General Accounting Office estimated that state and local governments in California alone have lost $1 billion to $1.7 billion annually). They also enabled online retailers to tout “tax free” sales in states where they had no physical presence, giving them an unfair advantage over local retailers. And they provided a perverse incentive for companies to put no offices or employees in the states with the biggest retail markets.
Beyond all that, shielding online retailers from having to collect sales taxes also distorts the mix of revenue sources that state governments rely on to pay their bills. Sales taxes are regressive, but they’re also a more stable source of revenue than California’s boom-and-bust income tax system.
There are plenty of questions about how to implement the Supreme Court’s new decision. States are still prohibited by other Supreme Court rulings from imposing undue burdens on interstate commerce. And collecting taxes from shoppers in thousands of different communities with unique sales-tax requirements (not just different rates, but different definitions of what’s taxable) is a daunting task for retailers.
But just as online shopping has grown from novelty to norm, so have technologies emerged to automate the calculation and collection of local sales taxes. What might be an undue burden for a small independent seller shouldn’t faze the operators of the online sales platforms that those sellers often use, such as Amazon and EBay. California policymakers should move quickly to clarify that online companies doing substantial business with California consumers must collect the same sales taxes that in-state retailers do.
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