Commentary

Will SCOTUS Grant States Extraterritorial Tax Powers?

Daniel Mitchell
By Daniel Mitchell | April 23, 2018 | 3:21 PM EDT

U.S. Supreme Court building (Screenshot)

On April 17, the Supreme Court heard oral arguments in South Dakota v. Wayfair, Inc., a case dealing with whether states should have the power to levy taxes on companies in other states.

Most observers see this issue as a fight over taxing the Internet, taxing online sales, or a battle between Main Street merchants and Silicon Valley tech firms. Those are all parts of the story, but I’ve explained that this also is a contest between two competing approaches to taxation.

On one side are pro-market people who favor origin-based taxation, which is based on the notion that sales should be taxed where the merchant is based.

On the other side are pro-government people who want destination-based taxation, which is based on the notion that sales should be taxed where the consumer lives.

Needless to say, I’m not on the pro-government side of the battle. Here’s some of what I wrote when I was at the Heritage Foundation way back in 2001.

“Requests to establish this destination-based tax authority should be denied. Such a regime would create an anti-consumer sales tax cartel for the benefit of profligate governments. It also would undermine privacy by requiring the collection of data on individual purchases. And it would violate important constitutional principles by giving state and local governments the power to impose their own taxes on businesses in other states.”

All of that is still true today, but let’s look at some more recent analysis of the issue, all of which is tied to last week’s hearing at the Supreme Court.

George Will opines on South Dakota’s revenue grab for the Washington Post.

“South Dakota has enacted a law contradicting a 26-year-old court decision concerning interstate commerce, and a law Congress passed and extended 10 times. It wants to tax purchases that are made online from vendors that have no physical presence in the state. South Dakota wants to increase its revenue and mollify its Main Street merchants. … In 1992, in the Internet’s infancy, the court held that retailers are required to collect a state’s sales taxes only when the retailers have a ‘substantial nexus’ — basically, a physical, brick-and-mortar presence — in the state where the item sold is purchased. Such a nexus would mean that the retailer benefits from, and should pay for, local government services. Absent such a nexus, however, states’ taxation of sales would violate the Constitution, which vests in Congress alone the power to impose such burdens on interstate commerce. … Internet commerce … could not have flourished if vendors bore the burden of deciphering and complying with the tax policies of 12,000 state and local taxing jurisdictions, with different goods exempted from taxation. … the Internet Tax Freedom Act … is intended to shield small Internet sellers from discriminatory taxes and compliance burdens. … South Dakota is seeking the court’s permission for its extraterritorial grasping. … Governments often are reflexively reactionary when new technologies discomfort established interests with which the political class has comfortable relations of mutual support. The state’s sales-tax revenue has grown faster than the state’s economy even as Internet retailing has grown. … Traditional retailing will … prosper or not depending on market forces, meaning Americans’ preferences. State governments should not try to prevent this wholesome churning from going where it will.”

 

The Wall Street Journal also has opined in favor of limits on the ability of states to impose their laws outside their borders.

“The Supreme Court’s landmark 1992 Quill decision protects small businesses across the country from tax-grubbing politicians across the country. … At issue in South Dakota v. Wayfair is whether governments can tax and regulate remote retailers that don’t enjoy the state’s representation or benefit from its public services. … Fast forward 25 years. States complain that online commerce is eroding their tax base. Brick-and-mortar stores grouse that remote retailers are dodging taxes, putting them at a competitive disadvantage. … Politicians would prefer to soak out-of-state retailers rather than their own taxpayers. But America’s founders devised the Commerce Clause to prevent states from burdening interstate commerce and making long-arm tax grabs.”

Here’s a troubling tidbit from the WSJ editorial. The Trump Administration is siding with South Dakota politicians, using the same statist rationale as the European politicians who are trying to grab more money from high-tech American companies.

“The Justice Department has filed a brief supporting South Dakota… Seriously? According to Justice, businesses that operate a website have a ‘virtual’ presence everywhere. The European Commission has invoked the same argument to impose a digital tax on Silicon Valley tech giants, which the Trump Administration has denounced as an extraterritorial tax grab.”

Wow, the incompetence is staggering. The Stupid Party strikes again.

Veronique de Rugy explains in her Reason column that state governments want to overturn Quill because they don’t want tax competition.

“If you think internet companies aren’t paying any taxes for online sales and that’s killing bricks-and-mortar retailers and states’ budgets, you, my friend, have been duped. Nothing could be further from the truth. … Most state lawmakers want to see Quill overturned, allowing them to force out-of-state companies to collect sales taxes on their behalf. This argument was just heard by the Supreme Court  If the states were to win, they would be able to reach into the pockets of that mom selling her paintings on Etsy, even though she may live on the other side of the country, didn’t elect other states’ officials, and never agreed to those states’ tax laws. … tax competition among states would also be lost if Quill were overturned. Under the new regime, online consumers—no matter where they shop or what they buy—would lose the ability to shop around for a better tax system. Without the competitive pressure and the fear of losing consumers to lower-tax states, lawmakers would not feel the need to try to rein in their sales tax burden. It’s that pressure, which limits their tax grabbing abilities, that these lawmakers resent and want the Supreme Court to put an end to. … There is a lot to be lost in the Wayfair case. If Quill were to be overturned, compliance costs could skyrocket for many retailers, and good principles of taxation would be thrown out the window. Healthy tax competition is at stake. Let’s hope the highest court in the land makes the right decision.”

In a column for the Wall Street Journal, Chris Cox, former Congressman and former Chairman of the Securities and Exchange Commission, debunks the notion that states are suffering for a loss of tax revenue.

“‘Our states are losing massive sales-tax revenues that we need for education, health care, and infrastructure,’ South Dakota’s Attorney General Marty Jackley told the U.S. Supreme Court … His state’s Supreme Court opined that sales tax revenues have ‘declined.’ The state Legislature, citing its own ‘finding’ to this effect, enacted a law requiring out-of-state retailers to collect sales tax on purchases shipped to South Dakota.”

Here’s the data debunking Jackley’s claim about South Dakota “losing massive sales-tax revenues.”

“… the law is based on a false premise. The state’s own data show that sales and use tax revenue grew from $787.7 million in 2013 to $974.7 in 2017—considerably faster than the state’s rate of economic growth. The governor’s budget for 2018 projects the state’s sales and use tax revenue will be more than $1 billion, 4% higher than last year, with no change in rate. That’s 29% higher than five years earlier. Sales-tax revenues have been booming in other states, too.”

In other words, politicians are greedy and they’re willing to prevaricate. They want more and more revenue, and they don’t want to face competitive pressure that might limit their ability to extract more money that can be used to buy votes.

Is anyone shocked?

P.S. The fight between “origin-based” and “destination-based” approaches to consumption taxation is very analogous to the fight between “territorial” and “worldwide” approaches to income taxation.

P.P.S. Given that it arguably has the best (or least-destructive) tax system of any state, it’s disappointing to see South Dakota politicians taking a lead role in an effort that would undermine tax competition.

Daniel J. Mitchell is a top expert on tax reform and supply-side tax policy and is Chairman of the Center for Freedom and Prosperity. Mitchell is a strong advocate of a flat tax and international tax competition.

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