The Supreme Court’s 5-4 ruling in South Dakota v. Wayfair last week empowers states to establish a level playing field for the taxation of goods sold by in-state and out-of-state sellers. The court overturned two precedents, dating back to 1967 and 1992, that imposed an artificial physical presence rule on state sales tax systems.
Under those precedents, a state could not require sellers without a physical presence in the state to collect and remit tax on sales to the state’s residents. Such sellers received an artificial advantage because states could not otherwise generally collect the taxes due on their sales.
{mosads}As Justice Anthony Kennedy, who was joined by Justices Clarence Thomas, Ruth Bader Ginsburg, Samuel Alito and Neil Gorsuch, stated in his opinion for the court, the physical presence rule was “wrong on its own terms” in 1992 and “the internet revolution has made its earlier error all the more egregious and harmful.”
The opinion echoed points made in numerous amicus briefs calling on the court to overturn the physical presence rule, including a brief that we filed with Michael Knoll of the University of Pennsylvania and Ruth Mason of the University of Virginia. Strikingly, even the four dissenters acknowledged that the physical presence rule was “wrongly decided” and merely argued that the court should adhere to prior precedents.
The new ruling does not give states carte blanche. The court’s decision reiterates the longstanding principle that states cannot impose excessive compliance burdens on out-of-state sellers. If states do not restrain themselves, the courts stand ready to rein them in.
States should take their cues from South Dakota. Its sales tax law went out of its way to ease compliance burdens on sellers with no physical presence in the state. It only applied to sellers that made $100,000 of sales, or 200 separate sales, to South Dakota residents per year, and it did not try to collect back taxes on past sales.
South Dakota is also one of more than 20 states that participates in the Streamlined Sales and Use Tax Agreement, which simplifies sales tax systems and helps sellers comply by establishing a centralized computer system for registering and remitting payments. Under the agreement, out-of-state sellers can use tax administration software, paid for by the state, and are not liable for any mistakes made by the software.
Congress should now exercise its power to set clear rules for tax collection from out-of-state sellers, reducing the number of issues that need to be litigated in the courts. For example, Congress should prohibit states from trying to collect back taxes on past sales. Critics of the decision claim it will impede the growth of online sellers and mom-and-pop businesses that reflect the entrepreneurial spirit of America. In reality, the ruling paves the way for a fairer and more neutral tax system.
On this level playing field, the tax code will not drive buying decisions. Instead, American businesses will compete based on the quality of the goods and services they provide and the prices they charge. The Supreme Court wisely recognized the advantages of South Dakota’s fair and reasonable rules for taxing out-of-state sellers.
Alex Brill is a resident fellow at the American Enterprise Institute. He was previously chief economist for the House Ways and Means Committee. Alan Viard is a resident scholar at the American Enterprise Institute. He was previously as an economist at the Federal Reserve Bank of Dallas.