What’s the best way to tax online purchases?
Monday, March 20, 2017
It's widely known that consumers today are shopping less frequently in retail stores and more often on internet sites. Shopping online has become a much more efficient and effective experience than shopping at the local mall.
Online shopping offers the convenience of a larger number of selections, cheaper prices and — above all — no sales tax. Thus, one of the biggest budget issues facing state governments today is how to collect taxes on internet sales.
Online shopping has forced stores and malls to close
The natural consequence of this movement is less shopping at malls across the country and store closings. In 2014, several large retailers such as JC Penney and Radio Shack reported 50 percent less foot traffic than in previous years. This January, the giant retailer Macy's announced it was closing 68 of its stores and eliminating 10,000 jobs.
The other significant consequence of growing online commerce is the loss of state tax revenue. In a study conducted by the National Conference of State Legislatures, the NCSL estimated that the total online sales tax loss by all 50 states was approximately $23.3 billion in 2012. Internet sales are now well over $400 billion a year in North America and $1 trillion throughout the world.
This loss of tax revenue adversely affects law enforcement, fire, medical care and many other services provided by state and local governments. These services are funded by sales tax revenue.
Current laws prevent internet sales from taxation
The issue of taxing internet sales has been around for more than a decade. In 1998, the Internet Tax Freedom Act prevented taxation on access fees associated with the Internet. However, this federal law will expire in 2020 and does not address online sales taxes.
In 2005, the Streamlined Sales and Use Tax Act went into effect to simplify and modernize state sales and use taxes across the country. This act is based on four requirements:
- administration by each state,
- uniform tax base within the state,
- simplified tax rates, and
- uniform rules for taxing.
Each state has the option of abiding by this law. Currently, only 24 states have implemented it.
New law proposed to change state taxation on online purchases
The U.S. Constitution contains two provisions regarding taxation that are particularly relevant to this situation: the dormant commerce clause and the 14th Amendment's due process clause. Both provisions require that a retailer have a certain connection or nexus to the state before it can require tax payments.
The Supreme Court has held that the required nexus under the dormant commerce clause is the seller's "physical presence" in the state, while due process requires only that the seller have directed contact at state residents. The Supreme Court adjudicated this issue in 1992 in Quill Corporation v. North Dakota. The Court ruled that the seller must have a physical presence in the state where the buyer lives for that state to enforce sales tax policy.
The Marketplace Fairness Act of 2013 would enable state governments to collect sales and use taxes from remote retailers with no physical presence, or "nexus," in their state. But the states may collect online sales tax only after they simplify their existing sales tax laws.
This act has yet to pass either chamber of Congress. Otherwise, there is no other current federal law or major movement in Congress to address the topic of Internet sales taxes.
Some states collect online purchase taxes due to 'Amazon law'
The major online commerce company Amazon once relied on the commerce clause to avoid paying online taxes because it operates in all 50 states. However, New York's legal system challenged this strategy in 2008.
The Appellate Division of New York's Supreme Court ruled that New York could enforce sales tax on Amazon transactions because the goods were sold to New York residents. After the Appellate Court's ruling, New York amended its tax code to allow Amazon sales to be subject to state sales tax.
The new language expanded the definition of nexus to include what is termed "click-through nexus." If an online company has a presence of any kind in a state (e.g., warehouse, office or store) or operates through another company or person that does have an in-state presence, then the state can tax the sales of the online company's products.
Other states have adopted similar amendments to their tax code, known commonly as the "Amazon law." At this time, 32 states collect sales taxes from online purchases, using the Amazon law.
A new approach is needed
Amazon tax laws passed within various states have had a mixed reception in the courts. While the highest court in New York upheld that state's "click-through nexus" law on the commerce clause and due process grounds, a federal district judge struck down Colorado's notification law as violating the commerce clause.
With this taxation issue stalemated in Congress and not yet consistently clarified by the courts, it is time for a new approach. Instead of allowing states to struggle with how to tax online commerce individually and coming up with varying approaches, Congress should take control of this issue now.
Congress should impose a federal online commerce tax for all purchases made by Americans, no matter where the product actually is made or comes from. Amazon, as the leader in online sales with the most to lose, has already indicated it would be amenable to this approach as long as it was not complicated.
The federal government then would allocate each state a share of the online sales tax revenue based solely on the most recent Census Bureau state population figures. This approach is straightforward and would standardize the online tax rate. As a result, online sales taxes would be collected for all states to use and would enable them to continue providing essential government services.
The unacceptable alternative would be to continue the current system of a complicated collection of state taxes from online sales and usage. Consequently, state budgets would continue to suffer stress with the loss of online sales tax revenue.
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