Congress should beat the courts when it comes to taxing online retailers

Senate confirmation hearings for Neil Gorsuch focused on how he might rule on the Supreme Court on controversial issues like Roe v. Wade. But one matter that didn’t draw attention could change the landscape of the $400 billion e-commerce market now that Gorsuch has taken his seat on the court.

Like Justice Anthony Kennedy, for whom he clerked, Gorsuch has suggested it’s time to overturn court precedent that bans states from collecting taxes on transactions between their residents and out-of-state retailers. States, anxious to impose levies on e-commerce sales, have taken notice. As Gorsuch was being sworn in, Massachusetts announced it would demand that out-of-state retailers start collecting taxes on their sales to state residents. Massachusetts now joins half dozen states that have issued similar ultimatums, hoping to generate a court decision that overturns previous precedent and sparks a new era of e-commerce taxation. More states are expected to follow suit.

{mosads}Congress should take notice, because it would be more sensible to prescribe through legislation how that era arrives than to have it come via a decision that unleashes a state-by-state patchwork of new taxes.

The Constitution’s commerce clause gives Congress the right to regulate interstate trade. Washington has used that power to limit states from taxing any businesses located elsewhere unless the business has some local presence. But as technology has enabled distant companies to conduct business with local customers, states have tried to circumvent federal restrictions.

In a pivotal case, North Dakota tried to force Illinois catalog retailer Quill to collect taxes on transactions with North Dakota customers. Quill had established a “presence” in North Dakota, the state argued, by providing local buyers with customized ordering software. The Supreme Court ruled against the state in a 1992 decision which also acknowledged that as technology changed the nature of commerce, Congress could craft legislation to define how states could tax certain out-of-state merchants.

Congress, however, has declined to act, while the Internet has transformed e-commerce into a projected $500 billion market by 2020. States are now looking to the courts for relief—encouraged by a 2015 opinion by Justice Kennedy in Direct Marketing Association V. Brohl. There a group of e-commerce retailers challenged a Colorado law that sought to force them to provide the government with information on local customers so that Colorado could levy taxes on their online purchases. Though the Supreme Court ruled in a way that didn’t affect its Quill decision, Justice Kennedy filed a concurring opinion arguing that online retailing had grown so large that it was time to reevaluate Quill.

Gorsuch, while serving on the Tenth Circuit Court of Appeals, also had the opportunity to rule on Brohl, and he, too, argued for revisiting Quill. Given that the liberal bloc of the Supreme Court would likely side with states against businesses seeking to avoid taxation, it appears as if the court is heading toward overturning the 25-year-old precedent. Hopeful legislators in several states, including South Dakota, have passed laws taxing e-commerce transactions purposely to provoke court challenges.

Opponents have argued these taxes would put an enormous burden on smaller e-commerce retailers because more than 9,500 jurisdictions levy their own sales tax. Firms would have to track myriad tax rates and be exposed to audits by any of these taxing authorities. These objections helped stymie efforts by states to win passage in Congress of the Marketplace Fairness Act, which authorizes states to collect transaction taxes from remote retailers. 

Opponents of the legislation, including electronic retailers in the True Simplification of Taxation Coalition (TruST), urge Congress to craft more limiting legislation which would set out a common definition of which products are taxable or tax exempt, and would require states to employ a universal sales tax form that remote retailers could file. Several legislators have subsequently floated bills to address their concerns, including Rep. Bob Goodlatte’s (R-Va.) Online Sales Tax Simplification Act.

As technology transforms how America does business, Congress has even more work to do. Because Quill only restricted how states may impose sales and use taxes, states are aggressively taxing out-of-state firms in other ways, including by imposing corporate income and gross receipts levies on technology companies operating outside their borders. To do so states have expanded the definition of what constitutes physical presence. More than two dozen states, for instance, say that if a company’s website is hosted on a leased server located in-state, the business must pay state income taxes, even if it has no physical operations in the state. 

One proposal to address these levies, the Business Activity Tax Simplification Act, sponsored by Reps. Steve Chabot (R-Ohio) and Bobby Scott (D-Va.), would define which factors establish enough of a “presence” to justify a state levying corporate taxes on a remote business. The bill has gotten nowhere in Congress.

It’s clear that America needs a comprehensive updating of what constitutes tax nexus—that is, the authority of a state to tax an out-of-state firm—in the Internet age. Allowing this issue to be settled by court decision could create chaos.

Steven Malanga is senior editor for City Journal and the George M. Yeager Fellow at the nonprofit Manhattan Institute, which is celebrating its 40^th anniversary this year.

The views expressed by contributors are their own and are not the views of The Hill.