For years, states shied away from implementing internet sales taxes on persons or businesses without a physical presence in the state. However, this all changed in June 2018, when the U.S. Supreme Court upheld South Dakota’s internet sales tax law in South Dakota v. Wayfair, Inc. In effect, the ruling overturned the 25-year-old “physical presence” standard set in Quill Corp. v. North Dakota.
The Wayfair decision upturned decades of sales tax laws and opens the floodgates for a torrent of new sales taxes that states can impose on online businesses and consumers. In response to the decision, Alaska local governments are considering a new plan that would allow cities and boroughs in the state to collect from online purchases. Alaska, which has no state sales tax, would become the first state where local governments would be allowed to collect internet sales tax revenue.
There are currently 106 sales tax jurisdictions in Alaska, varying widely in rates, demographics, location, and implementation. This represents a microcosm of the problems internet sales taxes would cause throughout the nation. The Alaska tax plan attempts to address these issues by instituting a cooperative agreement that would create a statewide sales tax commission administered by the Alaska Municipal League.
Like many states considering an internet sales tax, Alaska lawmakers modeled their legislation after South Dakota’s. Under South Dakota’s law, all online retailers pay state sales taxes, regardless of whether the seller has a presence in the state. South Dakota’s internet sales tax includes concessions for small businesses and only applies the tax to retailers that generate more than $100,000 per year in gross revenue from South Dakota customers or conduct more than 200 transactions per year in the state. If passed, the Alaska plan would go into effect in 2020 in cities that decide to enforce the new tax.
Unfortunately, Alaska sets its thresholds even lower than South Dakota’s. Under the Alaska bill, companies with at least 100 transactions or sales exceeding $100,000 in Alaska would be required to collect online sales taxes. As they stand, the Alaska thresholds would wreak havoc upon far too many small businesses and will almost undoubtedly damage the state’s economy.
While several states have adopted South Dakota’s model, others have expanded the thresholds to exempt most small businesses. Alabama, Connecticut, Georgia, and Mississippi have set their threshold at $250,000. In Massachusetts and Tennessee, the threshold is $500,000. If a state chooses to impose an internet sales tax, it should set the threshold as high as possible. This would protect small businesses, which are the backbone of local economies.
Applying sales taxes to internet transactions produces several negative consequences. First, the power governments wield over retailers outside their borders would dramatically expand. Second, because individual states have different definitions and rules on sales taxes, confusion and uncertainty for out-of-state buyers and sellers is inevitable. Third, the imposition of sales taxes on internet transactions would slow the development of e-commerce, one of the key growth sectors of the American economy.
From onerous licensing laws to heavy fees and burdensome regulations, small businesses already face a battery of barriers. Adding an internet sales tax would increase the strain on small businesses. According to the Tax Foundation, there are more than 10,800 sales tax jurisdictions in the United States. Although tax software can help online sellers navigate this leviathan, it remains very difficult to properly allocate the various sales tax levies—especially when rates change frequently.
Although the ideal approach to internet sales taxes is to avoid them altogether and stop forcing out-of-state businesses to serve as government tax collectors, state legislators can at least negate their detrimental effects. At the very least, state lawmakers should set the revenue threshold (or the transaction threshold) as high as possible. By doing so, the tax is less likely to impede small businesses, which are the driving force of the U.S. economic engine.
The following documents examine state internet sales taxes in greater detail.
What Does the Wayfair Decision Really Mean for States, Businesses, and Consumers?
https://taxfoundation.org/what-does-the-wayfair-decision-really-mean-for-states-businesses-and-consumers/
In this “Q&A,” Joseph Bishop-Henchman of the Tax Foundation discusses the Wayfair decision and the potential effects it could have on states.
Understanding an Internet Sales Tax
https://cei.org/content/understanding-internet-sales-tax
Jessica Melugin of the Competitive Enterprise Institute examines the effort by states to expand their internet sales taxes to draw more revenue from taxpayers. Melugin argues in favor of the origin approach of taxation, a sales tax system where the sales tax is determined based on where the product was sold.
Taxes on Remote Sales
https://heartland.org/publications-resources/publications/taxes-on-remote-sales
This election brief from the Kem C. Gardner Policy Institute at the University of Utah examines the complexity of online sales, including the legal context and the growth of online sales, and provides some policy options for consideration.
Research & Commentary: Internet Sales Taxes
https://heartland.org/publications-resources/publications/research–commentary-internet-sales-taxes
This Heartland Institute 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.”
An “Original” Solution to Taxation of Online Sales
https://heartland.org/publications-resources/publications/an-original-solution-to-taxation-of-online-sales?source=policybot
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.”
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 considers an overlooked issue in the internet sales tax debate: the often-unenforced use tax. Currently, if a product is purchased from a “remote” seller with 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.
Marketplace Fairness: Leveling the Playing Field for Small Business
https://heartland.org/publications-resources/publications/marketplace-fairness-leveling-the-playing-field-for-small-business?source=policybot
In written testimony before the U.S. Senate Commerce, Science, and Transportation Committee, Kelly Cobb of Americans for Tax Reform discusses remote-state sales tax collection and physical presence in light of the oft proposed Marketplace Fairness Act. “The effects on taxpayers of the Marketplace Fairness Act and similar legislation would be dramatic,” Cobb said. “From a taxpayer perspective, any bill that touches remote sales taxes must preserve the physical presence standard and protect consumers on net from a higher tax burden. Unfortunately, the federal online sales tax bills miss the mark widely on both fronts.”
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 Budget & Tax News website, The Heartland Institute’s website, and PolicyBot, Heartland’s free online research database.
The Heartland Institute can send an expert to your state to testify or brief your caucus, host an event in your state, or send you further information on a topic. Please don’t hesitate to contact us if we can be of assistance! If you have any questions or comments, contact Heartland’s government relations team at [email protected] or 312/377-4000.
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance.
