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Supreme Court Can't Solve the Internet Sales Tax Problem

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As the Supreme Court discusses the pros and cons of overriding the precedent set in the case of Quill vs. North Dakota, small sellers and platforms like Etsy (ETSY - Free Report) and eBay (EBAY - Free Report) that support them have started doing all they can to rouse public opinion against it.

In that case, the High Court upheld the decision of a lower court that only retailers with a physical presence in a state need to collect the state sales tax.

Now, South Dakota is looking to challenge the decision/precedent/effective law with a 2016 law of its own. Accordingly, out-of-state sellers doing more than $100,000 of business in the state or more than 200 transactions annually have to collect state sales tax and deposit it with the concerned state authority. And online sellers Overstock.com, Wayfair and Newegg are caught in the crossfire.

The current law makes it easy for micro operations to leverage online marketplaces to sell their wares to a wider clientele. Since they obviously don’t have a physical presence in all the states to which they are delivering, they don’t collect or pay any sales tax. The lack of complications and relatively lower price (that don’t include the sales tax) therefore allowed them to prosper.

Three Perceived Problems

First, it hits revenue in the states where the goods are sold since the sales aren’t taxed.

Second, the relative affordability of online products compared to brick and mortar operations in the state that have to include the sales tax in the price leads to even lower revenue for the states. So this is something of a double-whammy for states.

Third, for brick and mortar operations, this is unfair competition.

So it isn’t surprising that around 40 states are looking to override the precedent, with some support from lawmakers. President Trump is with the states, but that’s not the issue here.    

Judges Scratching Their Heads

Some justices are going with the Trump administration (and the states), expressing concern over the financial condition of states and how they need every bit of revenue that’s owed to them.

Others are wary of the obvious problem that a change would badly hit small sellers, who have limited resources to tackle the separate tax laws across an estimated 12,000 state and local jurisdictions. A counter-argument is that if forced, suitable software would come into being that would take care of things. But whatever the case, it would drive up costs for small sellers that could include middlemen to handle the tax issue.

Another thought is that small sellers, if pushed by the law, could be driven straight to big online platforms like Amazon’s (AMZN - Free Report) that could handle the complexity for a small fee. In the words of Justice Elena Kagan, “There’s something a little bit ironic in saying the problem with Quill is that it benefited all these companies, so now we’re going to overturn Quill so that we can benefit the exact same companies.”

The fourth argument (in support of just letting things be) is that states, upon finding no recourse in courts, have already started adopting workarounds. Online merchants in Colorado for example, are required to report their transactions so the state can collect from buyers directly, according to Justice Neil Gorsuch.

Fifth, Chief Justice John Roberts also supports status quo because since the big online retailers are already covered, it is a diminishing problem.

No Solution at This Point

Everyone realizes that the states are losing revenue, but the real question is how much. And some justices have raised the issue of limited information on how much money is at stake.

The states basically need to do a lot more homework. It’s one thing to say that a state is losing revenue to another state, but the opposite is also true: that that other state is also losing revenue at its expense. Because small sellers are there in every state. So when claiming monetary loss, the gains have to be deducted. And at the end of the day, some will obviously be making gains versus others making losses. So the problem may boil down to a difference in tax rates or value of goods instead.

Second, tax layers and rates vary across states, so there could be inequalities among states in this respect as well.

Third, the value of goods supplied can vary between states with more processed items in general having more value added. So states selling less processed goods can earn relatively less unless they charge a higher rate.  

The problem arises because the current system recognizes the sale in the state in which it occurs. If all sales by a seller were simply taxed in the state of his/her residence, the problem would be solved.

Overhauling the tax law or making any changes in it is a function of the legislature and not the judiciary, which is entrusted with its interpretation only.  So it’s difficult for the court to solve the problem.

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