The next tax reform: Internet sales tax

On Jan. 12, the U.S. Supreme Court decided to hear the case of South Dakota v. Wayfair Inc. If you haven’t been following along, this is a big deal and may affect households across the country — it’s about internet sales taxes.

The Wayfair case pits the “Kill Quill” movement  against internet retailers. As riveting as it sounds, this isn’t a new Quentin Tarantino film about sales taxes. The Kill Quill movement is a group of state tax administrators, brick-and-mortar retailers and their allies, whose goal is to overturn the ruling in the 1992 Supreme Court case of Quill Corp. v. North Dakota. With the current court agreeing to hear the Wayfair case, Quill looks to be on its last breath.

{mosads}Why has Quill attracted a whole aggressively named movement against it? The court’s decision in this case said that a state cannot make a retailer collect sales taxes if the retailer does not have a physical presence in the state. Quill is the reason you aren’t charged sales taxes on some internet purchases. It’s also the reason the states lose billions of sales tax revenues each year. A recent paper by University of Tennessee professors Donald Bruce, William F. Fox and LeAnn Luna observed that those losses were estimated to be $11.4 billion in 2012 and were “likely continue to grow rapidly, at least for the next several years.”

Not only that, one only has to look to the rise of Amazon to see how taking advantage of the physical presence rule gives internet retailers a leg up on their brick-and-mortar competition. Though Amazon now collects taxes in every state, other retailers — such as Wayfair, Newegg  and Overstock.com, the plaintiffs in the Wayfair case — still rely on the rule to avoid tax collection obligations.

Wait a second, you might be saying. If the Supreme Court overturns Quill, does that mean I’ll owe taxes on my internet purchases? Yes, but as it turns out, you already do. When a retailer fails to collect sales tax from you, you owe a complementary tax known as a use tax to the state. In theory, use taxes prevent erosion of the sales tax base, but in practice, consumer use tax compliance is exceedingly low — so low, in fact, that professor Adam Thimmesch at the University of Nebraska College of Law has termed them “taxes on honesty.”

We should be concerned when sales and use taxes go uncollected. As a result, the quality of state services such as roads and schools suffer, or other taxes go up to cover the losses. The legislated tax policy of the state is frustrated. Needless to say, it would be a lot easier on the states if they could require internet retailers to collect the taxes. And to do that, the physical presence rule needs to go.

Enter the Kill Quill movement. How does it win? First, it needs to convince the court that the physical presence rule isn’t helping the free-flow of interstate commerce, which the movement should be able to do. When the Quill case was decided, the court was concerned that requiring retailers to collect taxes in multiple states would be unduly burdensome and could stifle the national marketplace. Today, technological advances have significantly reduced retailers’ costs of complying with multiple states’ tax laws.

Evidence is mounting of the nationwide economic distortions that the physical presence rule creates. Simply put, the physical presence rule is a bad proxy for determining when state taxes impose undue burdens on retailers. Looking to the retailers’ activities in the taxing state would be a much better test.

Apart from debunking the wisdom of the physical presence rule for an increasingly digital economy, the Kill Quill movement also must convince the court to stop deferring to Congress, which it has done ever since deciding Quill. Congress is widely thought of as the best, first actor here. Most would not want the court to create nationwide rules regulating commerce based on the facts of only the one case before it. Congress is better situated to consider the broader situation and to craft appropriate policy.

The problem is that the court already acted first by establishing the physical presence rule, stacking the deck against any congressional action on the matter. The court should not wait for Congress to rework a broken rule.

On this issue, the Kill Quill movement already has won a significant victory. In taking the Wayfair case, the court has shown its willingness to stop using Congress as cover.

Hard work remains for the Kill Quill movement, but the end of its mission is in sight. I’d wager that the court is ready to put Quill to rest and establish more basic limitations on the states’ ability to tax internet sales. But even if the Kill Quill movement fails in the Wayfair case, you can expect the battle over internet sales taxes to continue — the movement is as tenacious as The Bride, the protagonist of Tarantino’s two-part “Kill Bill” movie. Keep an eye on this one, or maybe just on your online checkout carts.

Hayes Holderness is an assistant professor of law at the University of Richmond School of Law, who specializes in tax law, especially the field of state and local taxation.