The U.S. Supreme Court ruled 5-4 in the South Dakota v. Wayfair Inc. case to overturn precedents that established the physical presence rule on internet sales tax. In doing so, it decided the fate of smaller online retailers across the country.
South Dakota recently passed a law allowing itself to tax online retailers that sell into the state but do not have a physical presence. Though South Dakota legislators knew the law flew in the face of current Supreme Court precedent, states have long desired to overturn that precedent in the pursuit of more revenue.
In the past, the Supreme Court has consistently ruled that businesses should not be held liable for sales tax collection in states where they do not have sales representatives or own warehouses, stores or offices. This precedent was set in the landmark case National Bellas Hess, Inc. v. Department of Revenue back in 1967, in which the Court ruled that a state cannot collect taxes from remote retailers without a physical presence in the state.
The Court reaffirmed its decision in the 1992 Quill Corp. v. North Dakota case, holding that states cannot impose sales taxes on retailers that do not have a physical presence in the state. This commonsense standard allows small businesses to operate nationwide without having to employ an army of lawyers to ensure compliance with every tax jurisdiction.
However, the longstanding rule was overturned when the Court decided to validate the South Dakota law permitting out-of-state internet vendors to collect state sales tax from South Dakota residents. Disintegrating the physical presence rule could cause chaos in online retail because businesses would have to deal with as many as 12,000 tax jurisdictions across the nation. The burden of nationwide tax collection forced on smaller online retailers would restrict entrepreneurs’ ability to expand.
The effect of increased compliance issues is not just a hassle, but could also result in businesses cutting out states that have these laws. Some online retailers may choose not to do business in certain states in order to avoid the immense burden of sales tax compliance if the compliance expenses are greater than the potential benefits. It would deter online sellers from expanding their sales, and some sellers might go out of business completely.
Small online businesses instead of big online retailers would bear most of the burden because digital giants have already started collecting sales taxes across the nation. Already, the regulatory cost of tax compliance is greater for small businesses than large ones—a 2014 study by the National Association of Manufacturers found that the cost of tax compliance per employee was more than 50 percent higher for businesses with fewer than 50 employees than it was for businesses of any size.
Forcing smaller online retailers to comply with a host of different tax regimes would only exacerbate this imbalance. Larger online retailers such as Amazon have already been collecting sales tax in every state for some time.
Regardless of how such a policy is labeled, public opinion is strongly opposed to it. According to a National Taxpayers Union poll earlier this year, 65% of Americans are against such schemes, including strong majorities of both Republicans and Democrats. The Court’s ruling to dismantle limits on the tax power of states over interstate commerce could also undermine some of the benefits received by the general public from the Tax Cuts and Jobs Act that just became law last year.
The reality, though, is that states will not receive as much additional revenues as they hope. According to the Census Bureau, online sales accounted for only 8.9% of total sales in 2017, and most such sales are conducted by large retailers that already collect sales taxes. The compliance burden associated with such a scheme may well outstrip the additional revenue for states.
The Supreme Court should have adhered to precedent by upholding the physical presence requirement. Expanding states’ taxing authority would trigger tax hikes on American taxpayers and harm small online retailers.