Policy Documents

Research & Commentary: Supreme Court Rejects Internet Tax Case

December 16, 2013

A legal challenge to state “Amazon tax” laws was recently rejected for review by the United States Supreme Court. The U.S. Supreme Court’s 1992 decision in Quill Corp. v. North Dakota held a state must prove a company has a “substantial nexus” within a state before taxes can be imposed. Since this ruling the nexus or “physical presence” standard has been an important taxpayer protection. In recent years, however, states have begun to craft new laws attempting to widen the scope of the nexus standard, in hopes of increasing sales tax revenue. 

The two cases up for appearance before the court involved a 2008 law passed by the New York legislature that was designed to increase sales tax revenue from Internet sales. The New York law determined online retailers were required to collect state sales taxes if the company used a local resident to solicit business online even if the company did not have a physical presence in the state. This change to the nexus standard drew lawsuits from major online companies Amazon and Overstock. 

According to Braden Cox of NetChoice, the complaints focused on three violations of constitutional principles. First, they argued, the New York law violates the Commerce Clause of the Constitution because it forces companies operating out of state without local entities to pay the tax and does not sufficiently prove the new standards reach the level of significant physical presence. The law also violates due process and allows the state too much leeway under its overbroad standards and unfairly singles out their businesses, violating the principle of equal protection. 

Weakening the physical presence standard for sales taxes reduces states’ accountability to taxpayers. Consumers, who ultimately bear the burden of added costs, are the real losers in this scenario. Allowing one state to tax a resident of another state represents an expansion of state taxing powers, which logically end at the state’s borders. 

According to the Tax Foundation, 12 states have adopted new tax laws that allow the state to collect sales taxes from out-of-state Internet retailers, using rules similar to New York’s. A similar law in Illinois was recently struck down by the state supreme court. 

Instead of forcing out-of-state businesses to serve as government tax collectors, Congress and state legislators should improve the existing sales tax system, which is based on where the product was sold, known as an origin-based tax system. This would truly level the playing field, with both online and bricks-and-mortar retailers paying the same tax. 

The following articles examine state Internet sales taxes and the New York Amazon tax from multiple perspectives.

Supreme Court Declines to Hear State Sales Tax Case
http://www.pewstates.org/research/analysis/supreme-court-declines-to-hear-state-sales-tax-case-85899523662
Pewstates Stateline analyzes the U.S. Supreme Court’s decision not to hear the New York Amazon tax cases and the possible effects of its decision on similar laws across the country. 

Will the Supreme Court Hear the Online Tax Case?
http://taxfoundation.org/blog/will-supreme-court-hear-online-tax-case
Writing before the Court’s decision, Joseph Henchman of the Tax Foundation examines the New York cases and what would happen if the court declined to take them up: “If the Court declines to take the case, the status quo will continue. States will continue passing these problematic laws and the congressional bill may or may not pass. The Illinois law may get appealed next to the Supreme Court, and if they let that ruling stand, we’ll have the highest courts of Illinois and New York with opposite holdings. It’s not ideal.” 

Supreme Court Should Address Concerns about Federalism in New York’s Affiliate Nexus Law, says American Legislative Exchange Council
http://www.alec.org/new-york-amicus-brief/
In this amicus curiae brief, the American Legislative Exchange council calls on the Supreme Court to hear the challenge of the New York state law that considers an out-of-state company to be in-state for tax collection purposes if it receives a referral for a commission from in-state resident marketing “affiliates.” 

Overstock, Amazon Fight Online Sales Tax
http://news.heartland.org/newspaper-article/2008/08/01/overstock-amazon-fight-online-sales-tax
Writing for The Heartlander, Steven Titch of the Reason Foundation discusses the efforts by Overstock and Amazon to mount a legal challenge against the New York law that effectively defines them as state-based merchants, forcing them to collect sales tax on purchases made by consumers who reside in the Empire State.

Ten Principles of Telecom Policy
http://heartland.org/policy-documents/ten-principles-telecom-policy
In this Heartland Institute Legislative Principles booklet, Hance Haney and George Gilder examine the results of telecom reforms in Indiana, the advances made by other innovation leaders in the telecom market, and how other states can follow their lead to reap the rewards of new investment in telecommunications services.

Policy Tip Sheet: Myth vs. Fact—Internet Taxes
http://heartland.org/policy-documents/policy-tip-sheet-myth-vs-fact-internet-taxes
In this Heartland Institute Policy Tip Sheet, John Nothdurft examines several myths and facts about Internet taxes.

Research & Commentary: Amazon Taxes
http://heartland.org/policy-documents/research-commentary-amazon-taxes
Writing for The Heartland Institute Research & Commentary series, Elizabeth Henderson reports on the efforts of many state legislatures to enact legislation forcing out-of-state online and catalog retailers to collect and remit sales taxes on purchases made by residents in the state. Henderson argues these so-called “Amazon taxes” do not “level the playing field,” as proponents argue, but instead punish online retailers and stunt economic growth.

Research & Commentary: Internet Sales Taxes
http://heartland.org/policy-documents/research-commentary-internet-sales-taxes-0\
This Research & Commentary on Internet sales taxes explains how taxing the Internet hurts business and fails to bring in the revenues proponents hope for: “The new tax-remittance burden, however, would fall on online retailers. It would add to their costs and could demolish one of the last remaining redoubts of vibrant economic enterprise—the last thing any state needs during a deep recession.”

The Internet, Sales Taxes, and Tax Competition
http://heartland.org/policy-documents/internet-sales-taxes-and-tax-competition
Veronique de Rugy and Adam Thierer discuss the Main Street Fairness Act in this study from the Mercatus Center. The new legislation would force retailers to collect sales taxes for states that join a formal tax compact. The authors examine alternatives to the tax, including an origin-based sales tax.

An “Original” Solution to Taxation of Online Sales
http://heartland.org/policy-documents/original-solution-taxation-online-sales
Writing for the American Legislative Exchange Council, Andrew Moylan discusses the origin-based sourcing rule for Internet sales taxes and explains how it solves many of the problems created by destination sourcing: “Perhaps the most important advantage of origin sourcing, however, would be the infusion of tax competition it could engender. Under such a system, businesses would have an incentive to invest in lower-tax jurisdictions so as to attract price-conscious customers.” 

Congress Should Not Authorize States to Expand Collection of Taxes on Internet and Mail Order Sales
http://heartland.org/policy-documents/congress-should-not-authorize-states-expand-collection-taxes-internet-and-mail-orde
In this Heritage Foundation Backgrounder, David S. Addington considers current congressional efforts to override the Supreme Court’s Quill decision through S. 1832, the Marketplace Fairness Act. Addington argues enactment of S. 1832 would encourage state governments to “take more money from taxpayers and spend it instead of getting the size, scope, and cost of state governments under control.” 

States Already Can Tax Out-of-State Purchases, but Rarely Enforce those Laws
http://www.aei.org/article/economics/fiscal-policy/taxes/states-already-can-tax-out-of-state-purchases-but-rarely-enforce-those-laws/
Michael S. Greve of the American Enterprise Institute notes an overlooked issue in the Internet sales tax debate: the often unenforced use tax. Currently, if a product is purchased from a “remote” seller that has no contact with a consumer’s state, the sale is not “tax-free”—the consumer owes a “use tax” equivalent to the local sales tax. Many states do not enforce this tax.

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit The Heartlander’s Tech News Web site at http://news.heartland.org/tech, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org. 

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or mglans@heartland.org.