SCOTUS’ online sales tax ruling crucial for many small businesses

Internet retailers — from e-commerce juggernauts like Amazon and eBay to specialist platforms like Wayfair and Overstock — are bleeding the “mom-and-pop” retailers on the main streets of South Dakota dry because sales taxes are not collected by out-of-state sellers on these platforms.

This was an important premise of the argument of Marty Jackley, South Dakota attorney general, when he explained to the Supreme Court on April 12 why the current standard requiring online retailers to collect state sales tax only if they have a physical presence in said state — the so-called Quill decision in 1992 — should be abolished.

{mosads}The state further argues that “times have changed” in the retail business such that “traditional physical presence is an increasingly poor proxy for a company’s nexus with any given market or state.” In the Senate Bill 106 passed in 2016, the state requires a retailer to collect sales tax based on its economic presence rather than its physical presence.

Times have indeed changed. When the Supreme Court ruled in favor of Quill in 1992, mail-order was the tech of the day, and the concept of online retailing was virtually unheard of. The first online sale was documented in 1994 — a compact disk.

Today, e-commerce represents 14 percent of 2017 retail sales and nearly half of the growth, according to U.S. Commerce Department. Consumers spent $453.46 billion purchasing goods online in 2017, a 16.0-percent increase compared to the previous year.

Brick-and-mortar retailers, particularly the large ones, have long blamed an uneven playing field created by the internet sales tax exemption, which arguably puts them at a pricing disadvantage against their online rivals.

State governments are also bemoaning the massive loss of potential tax dollars. According to the National Conference of State Legislatures, states have estimated that they lost $26 billion in sales tax revenues in 2015 from online and catalog sales.

Even President Trump has chimed in, attacking particularly Amazon for paying “little or no taxes to state and local governments” and “putting many thousands of retailers out of business.”

At first glance, data seem to support the argument for the retailer-killing effect of the Quill exemption: 662 retailers — ranging from small stores to over 20 national chains such as Toys R Us, Gander Mountain and RadioShack — filed for bankruptcy in 2017, and many more are on the death watch in 2018.

The past year also made a record for store closing, with over 7000 closing announcements made.

However, one needs to think long and hard about rolling back on the exemption. In fact, revoking it outright might hurt the very small retailers that the states are promising to protect. This is because many internet retailers are platforms for other, third-party retailers.

Take Amazon for example: On one hand, it directly procures and sells millions of products itself and is already collecting sales tax on them. Revoking the Quill exemption wouldn’t make any difference for this portion.

On the other hand, Amazon offers a platform (and often logistics support with its Fulfilled by Amazon service) for many small, third-party retailers. Sites like eBay, Etsy, etc. are devoted exclusively to these retailers. Revoking the Quill exemption will impact these retailers the most. 

Consider a hypothetical scenario with a small furniture retailer in South Dakota that buys from local manufacturers instead of cheaper foreign suppliers. Because of this, its prices are somewhat higher than large, import-heavy retailers like Walmart despite trying to run as efficient a business as possible.

To grow its business, it needs to expand its customer base beyond South Dakota into other states with larger populations and more demand. It opens up storefronts on Amazon and eBay and in this case, the state sales tax exemption gives it a fighting chance to price compete with big national chains like Walmart.

Today, scenarios like this happen more often than people think. Half of the items purchased on Amazon are now sold by third-party sellers. These are sole proprietorships, mom-and-pop shops and other types of small businesses.

In 2017 alone, 300,000 U.S.-based small businesses started selling on Amazon. The second largest player, eBay, which accounts for 6.8 percent of all dollars spent online, is almost entirely comprised of small and medium-sized retailers, many of whom might be your familiar store down the street.

Online marketplaces, with their brand name and large, national user bases, give small retailers access to a revenue base that they cannot easily tap into otherwise.

In these markets, the internet sales tax exemption gives them an advantage to compete more effectively with large national brick-and-mortar retailers like Walmart and Best Buy. Revoking the exemption, therefore, is bound to impact their margins and competitiveness.

Not to mention the added cost of compliance. In its 1992 decision, the Supreme Court expressed concern that mail-order retailers faced difficulties in complying with tax obligations from some 6,000 separate state and local taxing jurisdictions nationwide.

The number has since nearly doubled to 12,000, each of which might have different rates for different products. Large retailers like Walmart can have teams of lawyers and accountants to handle this type of complexity. Small retailers, often using tax software alone, can’t do this as efficiently.

Therefore, the major beneficiaries from the exemption repeal would likely be big retailers like Walmart, Best Buy and even Amazon itself. They are already killing in-state small retailers and should not be given extra ammunition.

Small businesses will end up paying the price, and worse yet, those that actually decided to sell online are usually the more adaptive and enterprising types. They should be helped and encouraged, rather than punished. 

One area where the states can intervene to protect their own retailers and industries, however, is considering to collect sales taxes from international sellers selling into the states. For example, over 30 percent of top 10,000 sellers on eBay are based in China.

These sellers are already importing cheaper goods, and on top of that, they are not paying any sales taxes. They should not be given such dual advantage over instate retailers.

The good news is that most online retailing platforms already have the data and infrastructure to implement this — the source of goods on eBay and Amazon, for example, are apparent from their shipping origins.

Eliminating this tax advantage can give instate retailers more incentive to procure from domestic suppliers, thereby propagating the benefit upstream to domestic manufacturers.

The Supreme Court’s decision on South Dakota vs. Mayfair will be watched closely by small retailers nationwide.

While upholding Quill vs. North Dakota, together with closing the tax loophole on foreign sellers, seem to be the right decision, more economic cost-and-benefit analysis and quantitative arguments are needed before making the most informed decision.

Jun Li is the Michael R. and Mary Kay Hallman fellow and assistant professor of technology and operations at the University of Michigan’s Ross School of Business. 

Andrew Wu is an assistant professor of technology and operations and an assistant professor of finance at the Ross School of Business.