State of the State: States Need a Federal Solution for Online Tax Collection

Jun 1, 2012

Jamey Dunn
Credit mattpenning.com 2014 / WUIS/Illinois Issues
A year after Gov. Pat Quinn signed a bill aimed at collecting sales tax from online retailers, the state is still struggling to get revenues from sellers such as Amazon.com, and it seems that Illinois and other states may be out of luck until a federal solution can be found. 

The U.S. Supreme Court ruled in 1992 that states could not make businesses outside of their borders collect tax on purchases made by state residents. But if a business has a brick and mortar presence in a state, such as a store, it must collect state taxes on catalog and Internet sales in the state, too. 

Last year, the Illinois legislature passed and Quinn signed a law requiring out-of-state Internet retailers to collect a tax — known as a use tax — on all of their Illinois sales if they had relationships with in-state marketing companies that drove business their way. As a result, Amazon and Overstock.com cut those ties with such Illinois businesses, causing some to leave the state. 

A Cook County circuit judge struck down the law this spring. Judge Robert Lopez Cepero ruled that the relationship between out-of-state sellers and marketers in the state was not enough to require the online retailers to collect state tax. Cepero tossed out Illinois’ law, saying that it violated the commerce clause of the U.S. Constitution. Performance Marketing Association, a Los Angeles-based group that represents Internet advertising sites, filed the suit against Illinois. 

Illinoisans who make tax-free purchases online still owe tax to the state and are expected to report such purchases on their income tax returns and pay up. However, many residents ignore or are simply unaware of the requirement. The Illinois Department of Revenue estimates that $153 million in tax revenues go uncollected annually. According to the department, residents declared their purchases on about 270,000 returns in 2011, bringing in an estimated $11 million.

David Vite, president of the Retail Merchants Association, says expecting customers to keep track of their online purchases — as well as differentiate between a seller such as Target that does collect the sales tax because it has stores in the state and one such as Amazon that doesn’t — isn’t realistic, and the consequences for getting it wrong are too dire. “They are confronted with possible perjury charges. They are filing a false income tax return. That’s not fair to the customer. That’s not fair to the citizens,” he says. Vite represents brick and mortar retailers who argue that Web companies get an unfair advantage by not collecting tax because it makes their prices appear to be less than prices at physical stores that include tax. Vite and other backers of Illinois’ law hope the court’s decision will be overturned. The Department of Revenue disagrees with the ruling and is considering its options in regards to an appeal. 

Meanwhile, as Illinois gets further away from getting Internet sellers to collect taxes, Amazon has been striking deals with other states in recent months. The retailer already collects taxes in five states. It has made deals with eight states, including Texas and California, to collect taxes in the future. But as it stands now, Amazon has shown little interest in inking such a deal with Illinois.

The deals Amazon is making with states concern some supporters of a federal solution, which has already languished for years in Congress. The worry is that as more agreements are struck, the urgency to pass a law will wane. But the ultimate solution lies with Congress. The U.S. Supreme Court said as much in its 1992 ruling, which tied the hands of the states. “The underlying issue is not only one that Congress may be better qualified to resolve, but also one that Congress has the ultimate power to resolve. No matter how we evaluate the burdens that use taxes impose on interstate commerce, Congress remains free to disagree with our conclusions. … Accordingly, Congress is now free to decide whether, when, and to what extent the states may burden interstate mail order concerns with a duty to collect use taxes.”

Piecemeal agreements will not ensure that each state gets the tax revenue it is due. And Amazon is just one online retailer — albeit a behemoth — in an ever-growing field. “Amazon may be the big fish, but it’s still a big pond,” Jason Brewer, a spokesman with the Retail Industry Leaders Association, told Politico. “There are thousands and thousands of online retailers that are not collecting today. The simplicity that will come with a federal bill would benefit everyone.”

At a recent U.S. Senate committee hearing on state and local taxes, witnesses representing several schools of thought on tax policy urged Congress to approve a national solution to the Internet sales tax problem. “When you have new technologies and new developments, you’ve got to update the rules of the road,” said U.S. Sen. Ron Wyden, an Oregon Democrat. “We’ve got smart phones today and dumb tax polices — tax policies that have not kept up with the times.” Joseph Henchman, vice president of legal and state projects at the Washington, D.C.-based Tax Foundation, said states have a long history of trying to tax entities beyond their borders. “States will put their own interest ahead of the federal interest every time,” Henchman told the committee. “Absent guidelines from Congress or the courts, states have an incentive to shift tax burdens from physically present individuals and businesses to those who are beyond their borders.”

Henchman observed that cash-strapped states try to lay claim to any tax revenue they can.

“Today, with new technologies, even the smallest business can sell their products and services in all 50 states,” he said. “The temptation is great to treat interstate commerce like a golden goose to be squeezed. This temptation can only be countered by well-thought-out uniform rules imposed and enforced at the federal level.”

But to cash in on online tax revenues, the consensus seems to be that states must agree to simplify their tax codes — making it easier for nationwide retailers to keep track of rules from taxing district to taxing district. Henchman says there are about 9,600 sales tax jurisdictions in America, and the number grows by a few hundred every year. Last year about 400 were added. 

U.S. Sen. Ben Cardin, a Democrat from Maryland, accused businesses of using variations in the tax code as an excuse to drag their feet on a national solution. But Henchman said that the complexity must be addressed. “To me it’s not an excuse for inaction. It’s an excuse for the right kind of action.” Amazon has been slow to come to the table but in recent years has thrown its full weight behind the concept of federal regulation. 

Streamlining sales tax requirements would be worth the effort for states. The National Conference of State Legislatures estimates that a national solution, such as the Marketplace Fairness Act proposed by Illinois Democratic Sen. Richard Durbin, could bring in a total of $23 billion to state coffers. According to the Center on Budget and Policy Priorities, states face a combined budget shortfall this year of $103 billion.

“Congressional action to help coordinate this seems like a no brainer,” said Kim Rueben, a senior fellow for the Tax Policy Center, which is a joint venture between the Urban Institute and the Brookings Institution. 

NCLS, the National Association of Counties (NACo) and about 200 other organizations back Durbin’s bill. “There isn’t going to be another Recovery Act coming from Washington any time soon. There just isn’t the support in Congress for it. But there is a proposal before Congress that has bipartisan support that will help states and counties balance their budgets without raising taxes and without adding a dime to the federal deficit,” Durbin said at NACo’s 2012 legislative conference in Washington, D.C. 

The legislation is a version of a proposal Durbin has been carrying for years, except the Marketplace Fairness Act offers more flexibility for states. It also has an exemption for small businesses. Durbin has found some support for his revamped plan. “As hard as it is to believe, we are seeing an outbreak of bipartisanship in the United States Senate, at least on this issue. When we introduced the Marketplace Fairness Act in October, we had 10 co-sponsors: five Democrats and five Republicans,” he says. “This isn’t a partisan issue. It’s a matter of fiscal responsibility and basic fairness.”

The challenge that the bill faces — other than a highly partisan Congress that seems capable of reaching a deadlock over almost any issue — is that it could be branded as a new tax. Groups such as Americans for Tax Reform argue that states should lower other tax rates if they are going to bring in more revenues under the act. Such groups are also hinting that they may accuse legislators who signed pledges saying they would not raise taxes of breaking their vow if they vote for the bill. (One example of why such blanket pledges are silly election season pandering that does not consider the nuance of reasonable public policy decisions. But that is another matter altogether.) Politicoreported that 238 House members and 41 senators signed a “no new taxes” pledge form created by Americans for Tax Reform. However, some supporters do not seem to think that the plan violates the pledge. U.S. Sen. Lamar Alexander, a Republican from Tennessee, and Sen. Mike Enzi, a Republican from Wyoming, signed the pledge and are also sponsors on the Marketplace Fairness Act.

The tax isn’t new. It is already owed. The only differences under a federal solution would be that Internet retailers would be required to collect it — just like any brick and mortar store in the state — and a lot fewer Illinoisans would be lying on their tax returns.

Illinois Issues, June 2012