The Marketplace Fairness Act, a misguided attempt to allow expanded sales tax collection online, passed the Senate on Monday, though its fate in the House is less clear. Also less clear is whether the law passes constitutional muster. At the very least it severely undermines the federalist system established by our founding document.
Central to the formation of the United States was the division of powers not only between the different branches of the federal government, but also between the federal government and the states, and among the states themselves. This balance of shared governmental sovereignty is known as federalism, and it protects voters from the dangers that inevitably arise when too much power is centralized in any single body.
Federalism is what ensures that states can only tax within their own borders. Applying this concept to the internet era was the landmark 1992 Supreme Court decision Quill Corporation v. North Dakota, which essentially ruled that businesses could not be forced to serve as sales tax collectors for states in which they have no physical presence. In so ruling, the Court considered the Due Process Clause of the Fourteenth Amendment and the Dormant Commerce Clause principle, which is derived from its namesake clause and holds that the converse of the Constitutional grant for the federal government to regulate interstate commerce is a restriction on states from improperly burdening the same.
Quill held that while Due Process allows states to tax transactions with any out-of-state business that “purposefully avails itself of the benefits of an economic market in the forum State,” such taxation is also limited by the Dormant Commerce Clause to just those businesses with a “substantial nexus with the taxing State,” which more often than not requires a physical presence. A bipartisan group of Senators warned in a letter against “usurping this standard” by passing the Marketplace Fairness Act and “undermin[ing] an important limitation of the Commerce Clause: the nexus requirement.”
Supporters of the Marketplace Fairness Act want to override Quill and pave the way for extraterritorial taxation by the states. As a practical matter, this imposition of cross-border sales tax collection would be a disaster for small businesses and internet entrepreneurs. There are over 9,600 separate taxing jurisdictions in the U.S., each with their own tax rates and product definitions. To force small businesses, and possibly even some individuals selling products on eBay or Etsy, to bear the financial and legal burden of navigating this sales tax morass would stifle e-commerce and do nothing to promote fairness.
Eroding federalism by promoting extraterritorial state level sales taxation would furthermore undermine tax competition, which protects consumers and taxpayers from political excess by encouraging states to compete against one another to attract citizens and businesses, which promtoes the provision of robust, simplified rules, quality services and reasonable tax rates. Tax competition is a key feature of the federalist system as established by the Constitution, and has played a significant role in promoting American prosperity. The principles of federalism and jurisdictional tax competition undermined by the Marketplace Fairness Act should be protected from this misguided law.
