Internet sales tax gives e-commerce companies a stake in local government

Employees sort packages at the Amazon distribution center

As our economy becomes increasingly digitized, more transactions are moving online and outside of local tax jurisdictions, costing states billions in lost sales tax revenue. The recent U.S. Supreme Court decision in South Dakota v. Wayfair has opened the door for states to collect sales tax on online purchases made at out-of-state businesses. Applying state taxes on interstate commerce could not only recover lost revenues, but also make national e-commerce companies more invested in state government. Going forward, these companies will have the opportunity to make the case to lawmakers and voters on local sales taxes.

On June 21, the U.S. Supreme Court removed one of the largest advantages that e-commerce sites have in their competition with brick-and-mortar stores. The 5-4 decision in South Dakota v. Wayfair overturns the Supreme Court’s 1996 decision in Quill v. North Dakota that forced catalog companies to collect sales tax in states where they had a physical presence. This precedent had governed e-commerce sites for over two decades, during which time e-commerce has taken off. Subscriptions for Amazon Prime, a two-day delivery service, will have grown from 23 percent of American households in 2015 to an estimated 51 percent of households by the end of 2018. The boon for e-commerce companies, however, has cost state governments tax revenue. The Government Accountability Office estimates that states have lost as much as $13 billion in sales taxes in 2017 alone.

The majority opinion contrasted the physical presence requirement set out in the Quill decision with the broader “substantial nexus” standard on which it was based. The South Dakota tax, which only applies to businesses that make over 200 transactions or $100,000 in sales in the state annually, was deemed to have met the substantial nexus requirement. Under Quill, customers were expected to calculate sales tax and send those taxes to their state, but compliance was predictably low. The South Dakota decision compels online businesses to collect state taxes just as a brick-and-mortar store would. The dissenting opinion in the case argued that Congress has the ultimate authority over interstate commerce and is better suited to determine taxation powers for states.

Sell anywhere, tax anywhere

The internet dramatically expands the geographic reach of any business to anyone in the United States with internet access, a bank account, and a physical address. This allows e-commerce companies to locate strategically to minimize shipping distances and employ talented workforces. A company may establish a physical presence in only a handful of states and cities while serving the entire country. Meanwhile, brick-and-mortar businesses serving local markets struggle to compete against national e-commerce companies. State and local governments lose not only sales tax revenue from out-of-state purchases, but also property and payroll taxes from closing local businesses.

The South Dakota ruling will surely extend online sales taxes to more states. Calculating, collecting, and remitting taxes to each state could complicate e-commerce businesses’ operations, but a shipping address already contains the relevant information for assessing local taxes. Although small vendors may have a harder time collecting local taxes, they likely also fall underneath the thresholds set by states to qualify as having a “substantial nexus.” Sellers already use third-party e-commerce platforms like e-Bay, Etsy, and Amazon Marketplace to reach more customers and fulfill orders; similar tools could also simplify sending sales tax to states.

E-commerce companies might respond in a number of ways. They may choose to set up shop in more states to qualify for better tax rates, bringing jobs with them. Another strategy, pioneered by transportation network companies like Uber, is to mobilize customers to voice their opinions on local regulations. When e-commerce sites begin collecting taxes in more states, they may want a say on future sales tax increases or on how sales taxes are spent. Regardless of where companies locate, they will soon have a financial stake in every state where they do businesses. E-commerce companies will have to focus on the states even as they sell their goods nationally.

Miku Fujita contributed research to this blog post.