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<i>The Week In Public Finance:</i> Supreme Court Clears Way for States to Tax Online Sales

The landmark decision could boost state governments' revenues by tens of billions of dollars a year. But first, they have to decide how to take advantage of it. Some hope the ruling will spur Congress to pass national rules.

(AP/Jenny Kane)
Last Updated at 5:25 p.m. ET

In a landmark ruling that could provide a big boost to state and local revenues, the U.S. Supreme Court overturned a two-decade-old ruling on Thursday that barred states from collecting sales taxes for online purchases.

The decision is one of the most significant state and local finance rulings in the modern era and comes at a time when sales tax revenues have been steadily shrinking thanks in part to more purchases being made online.

Calling the old precedent “flawed” and a "tax shelter for businesses,” the 5-4 decision does away with the notion that governments can only collect sales taxes on purchases made from retailers with a physical presence in the state. In doing so, the court overturns two previous rulings that predated the world of e-commerce: the 1992 case, Quill Corp. v. North Dakota, that dealt with out-of-state taxes collected on catalog purchases, and the 1967 case, National Bellas Hess Inc. v. Department of Revenue of Illinois.

By some estimates, states are collectively missing out on anywhere from $13 billion to $23 billion a year in potential online sales tax revenue. “By giving some online retailers an arbitrary advantage over their competitors who collect state sales taxes,” the opinion said, “Quill’s physical presence rule has limited States’ ability to seek long-term prosperity and has prevented market participants from competing on an even playing field.”

The decision was immediately celebrated by state and local governments and brick-and-mortar retailers. “Today is just the beginning,” says South Dakota state Sen. Deb Peters.

Peters authored the internet sales tax legislation in 2016 that was the basis for Thursday’s ruling in South Dakota v. Wayfair. "They took the 1967 and the 1992 case and they threw them out," she says. "That was the best case scenario ever -- not in a million years did I think they'd wipe the slate clean."

The majority agreed that South Dakota's argument for an economic presence -- not a physical one --should be the basis for taxing a sale. But the court did not say at what threshold businesses should be required to comply. In South Dakota's legislation, internet vendors with at least 200 transactions or $100,000 in sales to South Dakota residents must collect a sales tax.

Meanwhile, those opposed to an internet sales tax are warning that the ruling could hurt businesses as they struggle to comply. “Small web businesses will be hardest hit, particularly those with only a single location, because they can’t afford the overhead to comply with thousands of different tax rules across the country," said Chris Cox, outside counsel for e-commerce trade association NetChoice, in a statement.


Revenue Boost Expected

The revenue implications are likely to play a greater role in states that don't have an income tax and, as a result, rely more on their sales tax to fund their budget.

Sales taxes account for more than half of all revenues in six states, according to Fitch Ratings. Among those six states, featured in the table below, they could see anywhere from a 1.1 to 1.7 percent revenue boost:

Florida        $758 million
Nevada        $134 million
South Dakota        $47 million
Tennessee        $363 million
Texas        $1.2 billion
Washington        $453 million
Source: Fitch Ratings

But, says Brian Kirkell, a principal at the firm RSM, some states might look to give the new revenue back to residents. They could lower "the sales tax rate or make more significant investments in infrastructure which creates jobs," he says. "At the local level, you'd probably see property tax freezes or reductions."


Next Steps

Over the past two years, nearly two dozen states have moved to pass bills or change regulations in ways that deliberately invite lawsuits from internet retailers. In other words, many states are poised to adopt legislation that will allow them to tax online purchases.

Although many state legislatures are wrapping up for the year, the Government Finance Officers Association's Emily Brock says some may reconvene. "When you're talking about this kind of revenue potential," she says, "I'd say that's definitely reason for legislatures to want to call a special session." 

But observers are concerned about the implications of such legislation for small businesses and the cost of complying with the more than 10,000 jurisdictions across the country that levy a sales tax. "Essentially what we're talking about is a process nightmare for everyone involved," Kirkell says.

Those concerns may be overblown, says Mick Bullock, director of public affairs for the National Conference of State Legislatures. "Everybody needs a certain amount of time to adjust to new requirements," he wrote in an email.

Additionally, 24 states have already laid the groundwork with the Streamlined Sales and Use Tax Agreement. Under it, member states have uniformly streamlined their sales tax codes. These states also have access to software for sellers under the agreement which automatically collects and remits sales taxes for every sale in a state. "This is the type of coordination and work that you can expect from sales tax states going forward," Bullock says.


Looking to Congress

Some are hoping Congress will instead step in to create national legislation. It should "follow the court’s lead and pass legislation implementing uniform national rules that provide consistency and clarity for retailers across the country,” the National Retail Federation said in a statement.

South Dakota v. Wayfair was the culmination of efforts over the past decade in which states have tried to get Congress to consider a national law that would require online retailers to remit a sales tax for purchases made in states where that retailer doesn’t have a physical presence. Proposed federal legislation has taken various forms over the years, but no bill ever gained much traction despite bipartisan support.

In 2013, states got a huge victory when the U.S. Senate passed the so-called Marketplace Fairness Act. The bill, however, died in the House.

Liz Farmer, a former Governing staff writer covering fiscal policy, helps lead the Pew Charitable Trusts’ state fiscal health project’s Fiscal 50 online resource.
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