The Supreme Court’s decision in Quill v. North Dakota restricting states from mandating that all “remote sellers” collect sales tax on out-of-state purchases, coupled with recent increases in internet sales has resulted in a troubling decrease in sales tax revenues. Many states are experiencing heavy budget crises just as their sales tax revenues–which help to pay for state-funded programs such as infrastructure, education, and public services–are being undercut. While states may currently attempt sales taxation on remote sales through use taxes, corresponding tax revenues are minimal as use taxes historically go largely unenforced and use tax compliance remains at disquieting lows.
One common concern over the Quill decision is that states will continue to suffer substantial revenue losses as a result of the decision and that they will be unable to overcome these losses in today’s economic climate. The provision of state-funded services will then continue to decay due to these declining revenues. Additional concern stems from the fact that many small brick and mortar businesses will continue to struggle as they compete directly against remote sellers who generate higher profits solely due to their customers’ tax savings. These same in-state sellers also remain responsible for the arduous task of abiding by existing sales tax compliance laws while the remote sellers receive a uniform exemption from this chore.
Lastly, unlike the vast majority of online buyers who often do not self-report their use tax liability, customers of brick-and-mortar retailers must always pay required sales and use taxes at the time of purchase. This creates an inequity when considering elderly and low-income taxpayers who often have limited internet access. Proponents of online sales taxation have argued that the Quill physical presence requirement leads to economic discrimination in favor of wealthy consumers with internet access.
The Quill decision has thus led to a thorny, costly and complicated sales tax situation. However, although the Supreme Court held that states could not impose sales and use tax obligations on remote sellers without an in-state physical presence, it also established that Congress had the ultimate power to compel remote sellers to abide by tax obligations based on its authority to regulate interstate commerce. Despite this ultimate power, a legislative solution has not been achieved. The variety of interests, extensive layers of the law, and vast incongruence between traditional remote sales taxation laws and internet remote sales taxation laws involved have resulted in a virtual standstill with no consensus.
The Marketplace Fairness Act has emerged as one potential solution, albeit with its share of detractors with concerns and conflicting objectives that run deep. The scope of this article is to review the Marketplace Fairness Act, along with the few innovative ideas that currently exist beyond this proposed legislation. After a brief background of the Streamlined Sales and Use Tax Act and the Marketplace Fairness Act, this article addresses the relative interests of the states, businesses, and Congress with the ultimate objectives of analyzing why Congress has not been able to resolve the remote seller sales taxation dilemma with legislation such as the Marketplace Fairness Act as of yet, and reviewing the viability of its alternatives.
The Marketplace Fairness Act
As early as 1999, concerns over anticipated decreasing revenues and an unfair playing field resulted in the Streamlined Sales Tax Project (SSTP), which was established as an effort to simplify state sales tax. It included uniform definitions of product categories coupled with the provision of state independence on whom and what to tax for states, with authorities to impose only a single sales tax rate on each specific good. Ultimately, the SSTP led to several legislative proposals, the most recent action being the Senate passage of The Marketplace Fairness Act in 2013.
The Marketplace Fairness Act establishes guidelines and procedures under which both member and non-member states of the Streamlined Sales and Use Tax Agreement (SSUTA) are permitted to require remote sellers to collect and remit sales and use taxes. Under the proposal, member states can secure collection and remittance from remote vendors, while non-member states can secure collection and remittance authorization on remote vendors only if they adopt and implement several minimum simplification requirements. Under the Marketplace Fairness Act, a state would have the right to require a seller without a physical presence in the state to collect sales tax. In addition, the bill contains a popular, yet controversial small seller exception, requiring that states exempt remote sellers with less than $1 million in annual nationwide remote sales from having to collect sales and use taxes.
The general position taken by those who favor the SSUTA and the Marketplace Fairness Act is that the end result will ensure that all retailers can conduct business in a streamlined, equitable, and competitive setting, and that states will now fully collect on taxes already due. Supporters, who include many large retailers, argue that “systemic failures” in the use tax system have resulted in the general economic view that the remote sellers exemption results in a noticeable sales price differential with respect to the same goods sold in state. They believe this negatively affects the competitiveness of in-state businesses and local economies which could be corrected by the Marketplace Fairness Act. However, opponents argue that it still does not promote state uniformity between the states concerning the specific transactions that are taxable, that enormous compliance costs remain for small and medium remote sellers who may be likely to have customers in many states, and that the law is a massive and permanent intrusion into the privacy rights of all customers.
The proposal arguably does not increase, expand or create taxes (the taxes are already owed), yet it stalled in the House of Representatives over concerns that it simply serves as yet another tax increase and that it does not ease the burden for small online businesses. As Walter Hellerstein and John A. Swain noted in the National Tax Journal:
“[T]he nexus-expansion feature of streamlining will be [indeed has been] labeled a tax increase by the remote selling industry and hard-line anti-tax groups. Further, beyond the abstract level, this “tax increase” will be highly visible to constituents who make remote purchases.”
For many, the current situation is seen as helping to accelerate the rate at which current in-state businesses are downsizing or closing, as they operate at a disadvantage when compared to online sellers, whose competitive advantage from not paying sales tax ranges from a 4 to 9 percent price differential over local stores. Second, online merchants face fewer administrative costs because they do not face the responsibility of sales tax collection and filing. Third, the public remains at a disadvantage because they are required to pay use taxes on their individual state tax returns, yet many do not know how this, and so run the risk of perennial noncompliance. Fourth, state and local governments are compromised because they do not receive the tax revenue for public and social services just as many are suffering serious budget crunches. According to a 2009 University of Tennessee study, the financial impact of uncollected state sales taxes is estimated at $7.7 billion as of 2008. Lastly, attempts to regain the losses by the states via use taxes are feeble and do not seem likely to improve anytime soon.
The Individual States
The negative economic impact of Quill on the states is vast, particularly in light of the ever-increasing volume of internet sales. Consumers have learned that they can avoid sales taxation by simply making their purchases online. A prominent study found that an estimated 1 percentage point increase in a state’s sales tax rate will yield an estimated 2 percent increase in online purchases out-of-state sellers. Other statistical studies have estimated even larger impacts, so the states have little opportunity to regain lost revenue through raising tax rates
Notwithstanding these bleak estimates, how immediate is the impact of Quill on the states, and is the impact limited to less sales tax revenue? First, the revenue loss due the states’ inability to fully collect sales tax is instantaneous as corresponding, current use tax collections do not cover the gap in lost revenue. Additionally, use tax enforcement adds another layer of administration expense for the states which is largely considered uneconomical. States have historically found that use tax enforcement onindividuals is impractical and hard to enforce, often involving smallamounts owed on a large number of transactions, and the costs of collection are enormous. Strikingly, the estimated nationwide direct revenue loss was $11.4 billion in 2012. While there may be some debate as to the actual specific amount of revenue loss, there is no doubt that the economic impact is a colossal, immediate and permanent economic loss which is not offset by increased use tax revenues, and is now viewed as the primary factor behind lost state tax revenue, estimated to range between $2 billion and $22 billion per year.
Second, the states have often been compelled to react to Quill in non-business-friendly ways such as “stretching” traditional definitions of physical presence. This has been attempted through the incorporation of click-through nexus rules in which a remote seller is considered to have established a physical presence in-state if the remote seller enters into a commission agreement with an in-state resident referring customers to the seller’s website. It has also caused the states to enact laws that incorporate reporting requirements designed to foster increased use tax compliance. States have consistently voiced concern over required usage of these laws as they result in an increased potential to limit business expansions and operations in-state affecting employment, expansion, revenue, etc. Accordingly, many states have shown strong support in favor of the Marketplace Fairness Act.
The largest online retailer, Amazon’s position has evolved over time. Recently, it has shown increasing support for legislation such as The Marketplace Fairness Act as well as for the proposed exemption for online annual sellers from having to collect sales taxes on amounts less than $1 million in sales. Amazon and many other large remote sellers have displayed a keen and continued interest in having the Marketplace Fairness Act enacted, even with the $1 million dollar threshold all the while pushing for a condition that businesses that operate under the seller-collective business model not be excluded from sales and use tax reporting obligations in any manner by the act. And the States have shown a willingness to compromise with respect to these conditions. However, Amazon’s chief competitor eBay does not support much of the Marketplace Fairness Act nor its proposed small business exemption, arguing that it does not truly cover small businesses, pushing for the threshold to be raised to at least $10 million.
In addition to eBay, there are several segments of the business community that oppose this legislation, arguing that the measure will flood them with red tape and compel compliance with over 9,000 state and local tax codes. Additionally, the potential for a dramatic and unrecoverable loss in business sales as a direct result of passage of the Marketplace Fairness Act is a concern to many. There are also apprehensions that the Marketplace Fairness Act will have a disproportionately negative effect on minority and women-owned businesses. In a study funded by eBay, these concerns culminated with a resounding opposition of both the $1 million threshold and the small business definition concluding that the proposed law fails to be flexible in defining small business, with many would-be small businesses elsewhere counted as large businesses under the act.
Additionally, many business owners have further concern that any abandonment of the Court’s physical presence test, with respect to sales and use taxes, may “spill over into the [laws governing] the business activity tax.”Further still, they argue that expanding the taxing authority by the states will allow for the potential to cross state borders to collect on other taxes. Proponents counter these concerns by recognizing the many related positives such as that many small retailers would be exempted from sales tax reporting, filing and remissions, the Act’s requirement of the provision of expedient software to businesses for the calculation of sales tax and the requirement that the states must “create a simplified system for tax reporting” thus providing businesses an efficient, streamlined approach to of state and local filings.
Perhaps most prominently, is the concern that although the states may need the revenue they are currently losing, the real issue is that states have made it increasingly difficult to comply with sales and use tax laws and regulations and that, simply stated, the fundamental issue of how to simplify (and necessarily increase) tax compliance is overlooked. Thus a consensus is forming among many business owners that what states need is not new streamlining legislation, but a simple reduction in the complexity of the sales tax laws.
Congress does not have a consistent track record with respect to state taxation issues and the same holds true with attempted legislation after Quill.. There is a long list of failed or aborted attempts to enact legislation in response to the Court’s ruling.
A distinction between the current Marketplace Fairness Act and past attempts to deal with state sales tax issues is that the Marketplace Fairness Act is arguably more bipartisan in nature, yet still functions to allow states to collect taxes owed from remote retailers in a more streamlined and equitable manner. The majority of Congressional leaders view this as an enormous benefit to the states with many reasonable limitations protecting existing businesses. States also have immense latitude within the Marketplace Fairness Act with virtually no guidelines to the establishing of rates. Moreover, several states, including Ohio and Wisconsin, have pledged to reduce overall tax rates should the law be enacted emphasizing their support of more consistent enforcement. Senate support underscores the view that many find this to be a relatively balanced bill.
Congressional opposition to the bill stresses the inordinate costs and concerns with respect to collections, compounded when considering the interests of small online retailers who maintain that these costs will force them to terminate or reduce operations. Many anti-tax groups argue that the act will result in large job losses, especially in the small business retail sector. Congressional opponents also argue that the bill violates the long-standing minimum contacts test by “authorizing the enforcement” of use tax laws on remote sellers to collect and remit use tax when sellers have not even met the threshold of the minimum contacts test. And although much of the act’s opposition is from states that do not levy sales tax,the bill’s opponents are nonetheless making their collective voices heard as they try to dissuade Speaker John Boehner from reviving it. With opposition remaining steadfast, if the Marketplace Fairness Act does not succeed, what are the alternatives?
Alternatives to the Marketplace Fairness Act
A Federal Use Tax Enforcement and Collection Program
One alternative proposal to the Marketplace Fairness Act is for existing use tax laws to be completely revamped with comprehensive strengthening and federal administration. Despite the view that depressed sales tax revenues are due to a lack of state enforcement, this option is viewed by many as potentially increasing revenues in a cost-effective manner by the states with minimal impact on existing business operations and minimal intrusion into citizens’ privacy.
Specifically, this option would involve the federal government formally assisting the states through the implementation of a federal use tax enforcement program. A related idea was proposed at a fiscal policy meeting on the potential for federal legislation which called for the federal government to enact a program to assist the states in enforcing the use tax. This has become increasingly popular amid the growing concern that states have not been enforcing their use tax requirements. This federal assistance is not without parallels, being similar to other federal assistance programs, such as how the EPA handles registration of chemicals and the issuing of pollution permits.
Notably, the proposal referenced, has the IRS, among other obligations, collecting the use tax and then remitting it to the states, “with some portion [of the tax] used to cover” the costs. The main role of the federal government in this approach would be to act as a conduit to the states after the use tax is paid. However, critics of this approach contend that it would give unprecedented access to taxpayers’ personal information to federal authorities, something that the MFA does not do. Currently, the federal government does not have a hand in use tax enforcement, use tax reporting or use tax collections. Additionally, congressional opposition would likely again stress inordinate costs to small businesses as they would have increased obligations at the point of sale as well as the heavy administrative costs that would be incurred by the federal government.
Implementation of a Hybrid Origin System
A second, more problematic approach would be for all sales, remote and otherwise, to be sourced via the taxing jurisdiction of the seller. This approach, called hybrid origin-sourcing, has been raised as an alternative to current sales tax destination-sourcing rules in general, as well as to the existing Marketplace Fairness Act. This proposal would work like this:[Assume] a Rhode Island (7 percent state sales tax) consumer purchases an item on the Internet from a seller located in Washington State (6.5 percent state sales tax plus local sales taxes averaging 2.38 percent). Under the current destination-sourcing rule, the sale is sourced to Rhode Island, and a 7 percent tax is due. Under an origin-sourcing system, the sale is sourced to Washington State and a tax of 6.5 percent plus the local sales tax is due. Under the HOS system, the sale is sourced to Washington State and a tax of 6.5 percent plus the local sales tax is due, but the money is remitted to Rhode Island.
A similar approach was actually successfully implemented in the International Fuel Tax Agreement (IFTA) and as such, hybrid origin sourcing resembles the current system used in gasoline tax. However, although Congress has ultimate power over interstate commerce, the Supreme Court generally frowns on laws that compel states “into actions that are generally left to the states in [the] federalist system.” Since hybrid origin sourcing involves states’ transforming the intrastate taxation of their own residents and changing the liability of who owes sales tax, the courts could view this approach as problematic and the federal government as exceeding its authority.
Additional concerns with hybrid origin-sourcing run deep and well beyond interstate commerce concerns–First, this type of sourcing would involve the transformation of the current sales and use tax–which is a tax currently charged to consumers-into a business tax, both legally and economically, transforming a less economically harmful consumption tax into a more harmful business tax. Additionally, sellers would still have similar compliance obligations, a source of much distress for many holdouts of the MFA. The result is that there would be an extraordinary amount of incentive for businesses to arbitrage their location based on tax planning rather than solid business planning as the determination of the amount of tax liability would hinge on where a business chooses to have its origin.
As Quill ultimately illustrates, legislation governing state taxation must comply with the commerce clause as well as the due process clause of the Constitution. Under hybrid origin sourcing, tax liability would be created for both remote sellers and consumers who do not have the requisite minimum contacts with the jurisdiction in violation of the due process clause. Thus, for example, a New York resident would be required to pay Virginia state sales tax rates despite the fact that he or she may have no other contacts with Virginia. Unless the sourcing proposal would make the business responsible for the tax obligation, courts may construe this as unconstitutional.
A Federal Remote Sales Reporting Program Via 1099s
Perhaps the most viable available option would be to enact legislation that addresses use tax in a proactive manner through the federal gathering of remote sales reports for in-state purchases. An analysis of this legislation was recently conducted and proposed with the recommendation of enacting a new law involving Consumer Private Reporting (CPR) which resolves to have taxable purchases reported in “a Form 1099-style [document].” Additionally, the measure has a built-in enforcement measure in that if a purchaser fails to file a use tax return, an initial notice letter to the taxpayer would be generated.
Under the proposed CPR law, a Form 1099-style document would be generated by the IRS and forwarded to both the state and the purchaser to help with use tax assessments and payments. One of the benefits of this program is that the same state-approved software providers, suggested within the Marketplace Fairness Act, could be used to assist with use tax assessments and payments by the remote seller. It could be implemented to minimize the amount of personal information provided to and from the remote vendor, limiting the information to the remote purchase amount. This reporting would be conducted via a proposed, new national database including yearly taxable purchase information from all remote vendors to determine total taxable purchases for each purchaser with both the purchaser and state receiving a Form 1099-style document.
From that point, the remote seller would essentially be required to self-report with the states being able to audit for compliance issues, but states would not have the ability to audit additionally under normal procedures, unless the remote seller had a nexus with the state. Again, this form of federal assistance is not without parallels as the EPA often assists the states in regulatory affairs proactively such as in the Clean Air Act. In addition, the EPA has the authority to issue notices to the state government “informing the state that there is an instance of non-compliance” and the same could be administered with CPR. Thus, when the purchaser fails to file a use tax return, notice could be issued, informing the purchaser of non-compliance (eventually leading to collections procedures).
The potential benefits of this system are many. First, it motivates remote sellers to assist with sales and use tax reporting and collection, without an unfettered intrusion into existing business. Second, it bridges the gap between the current laws and the enormous losses that states currently incur while mitigating the potential negative effects on small businesses that may result from implementation of the Marketplace Fairness Act. Third, states would have some self-imposed limitations bypassing the predicament of giving the states full jurisdiction over all remote sales, yet the states would still have enforcement authority with respect to sales and use tax law compliance. Fourth, it is a large first step towards consistency in state taxation of remote sales.
Of course, one of the biggest concerns with this approach would be its cost. While more research would have to be conducted in regards to the actual costs of such a program, current proposals fund it through the states and their increased state revenue from implementing this program. Additionally, forcing the seller to undergo any additional burdens remains troublesome in light of the fact that current sales and use tax approaches have worked relatively well (save for the remote sales taxation predicament) and the fact that there are clear, existing use tax laws that go largely unenforced. However, existing enforcement costs are exorbitant and they yield very little in increased use taxes. With an enforcement program that contains real enforcement and uniformity, consistent increased collections levels would likely tip the cost-benefit in favor of the CPR law.
Another perceived concern is the possible intrusion on privacy. There would be likely be public outcry among taxpayers and consumer advocate groups over states having access to “detailed information of individual customer purchases.” However, this concern is largely muted when reviewing the actual CPR law as currently proposed. The system would not actually keep detailed records of specific items purchased from online sellers as the national database and the states do not get any information on what was actually purchased. The current proposal only requires reporting of the name of the purchaser and the taxable amount purchased. This is similar to what is currently required under most use tax laws and, again, is arguably less burdensome than what the Marketplace Fairness Act would require.
Well-established economic policy dictates that “governments should strive towards minimizing tax and administrative burdens on businesses.” Requiring remote sellers to collect use taxes from every buyer without the requisite presence seems to trouble many and to some, deeply conflicts with current policy. Yet, if the Marketplace Fairness Act remains stalled, the chaos will increase, state revenues will continue to decline, necessary state services will remain compromised and both businesses and taxpayers will suffer. In the event that the Marketplace Fairness Act is not enacted, perhaps it is time to consider bridging the collections gap by enforcing the existing use tax laws on a national scale via a balanced, cost-effective and competent program.