On June 21, the Supreme Court decided the case South Dakota v. Wayfair, about the authority of states to collect sales tax on internet commerce. The decision, which approved of states collecting this sales tax, is likely going to have a major impact on both state budgets and businesses selling over the internet.
Underneath the discussion about the tax itself, and whether or not sales taxes should be limited to brick-and-mortar businesses, is a broader issue about the Court’s doctrine on the role of government in our economy. This doctrine has not been given much attention, not even after the infamous Kelo v. New London case. That decision allowed government to forcefully take property from one private citizen and provide that property to another private citizen if there was a reasonable expectation that government revenue would increase as a result.
In fact, in the Kelo case the Supreme Court explained, blatantly, that the pursuit of more tax revenue was justifiable since government could use the money to “benefit” the community:
The city’s determination that the area at issue was sufficiently distressed to justify a program of economic rejuvenation is entitled to deference. The city ash carefully formulated a development plan that it believes will provide appreciable benefits to the community, including, but not limited to, new jobs and increased tax revenue.
Even if the court did not explicitly associate growth in government revenue with increased prosperity, that was the message they sent. In the Court’s opinion, the pursuit of more tax revenue by government, in this case a city, is indisputably good for the economy.
This position is more pronounced in South Dakota v Wayfair. Technically, this case is about whether or not a state’s sales tax applies to commodities purchased by consumers over the internet. The Court unequivocally sides with the state, a decision that seems fair if one refrains from analyzing its opinion: after all, it is reasonable that all sellers on a market are treated equally by government at all instances, in other words taxation as well as regulation and so-called economic development.
Upon closer look, the Wayfair decision represents an outright statist analysis of the economic role of government. The Court opens for states to collect sales taxes on internet commerce, but not primarily to correct a market distortion. Their main argument is, instead, that states need to increase their revenue. Their opening salvo (Syllabus, p. 2):
The physical presence rule has long been criticized as giving out-of-state sellers an advantage. Each year, it becomes further removed from economic reality and results in significant revenue losses to the States. These critiques underscore that the rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.
They reinforce this point (Syllabus, p. 4):
The expansion of e-commerce has also increased the revenue shortfall faced by States seeking to collect their sales and use taxes, leading the South Dakota Legislature to declare an emergency.
In reality, the emergency was caused by overspending on behalf of the South Dakota state government. Courtesy of the National Association of State Budget Officers:
| Annual average, 2012-2017, SD State Spending | ||||
| General | Federal | Other | Bonds | Total |
| 5.2% | -1.1% | 6.8% | 23.9% | 2.9% |
It is a violation of the English language to suggest that a state government is in an emergency when it increases General Fund spending by an average of 5.2 percent per year for five years in a row, and when it can expand Other Funds spending by 6.8 percent per.
What matters is instead, that during the same period of time, the private sector of the South Dakota economy – the sector that pays the state’s tax revenue – increased by only 3.1 percent per year in current prices (the proper variable for tax-base analysis). This means, plain and simple, that the state of South Dakota was increasing its spending, in both the categories that are funded by in-state tax revenue, faster than their own tax base was growing.
Since it is this easy to demonstrate that the state had a spending problem, not a revenue problem, one has to raise the question whether or not the Supreme Court was at all interested in the spending side of the South Dakota budget. They were, but not in an impartial way (Opinion, p. 2):
Particularly because South Dakota has no state income tax, it must put substantial reliance on its sales and use taxes for the revenue necessary to fund essential services. Those taxes account for 60 percent of its general fund.
In other words, the Court is concerned that state government does not have enough revenue to pay for “essential services”. This immediately begs the question what government services, in the Court’s opinion, are “essential”. Evidently, since the Court had to add the qualifier “essential” to government spending, it is of the opinion that there is a difference between at least two categories in a state’s budget: essential and non-essential services.
By getting itself involved in the spending side of government finances, the Court opens a whole can of worms for future challenges. As written, the decision in the Wayfair case on the internet sales tax presumes that all government services are essential; a future legal challenge that involves government taxes and revenue, could bring up the “essential” term to narrow down a state’s ability to tax its residents. If it can be proven (as it can) that there is no need to increase appropriations for “essential” services at nearly the rate that overall government spending grows, then the Court’s revenue-based argument for the internet sales tax falls flat to the ground.
The only way the Court could then argue for an internet sales tax is through an ambition to avoid market distortions. However, if that were their lead argument, it would mandate the exact same tax rates on literally all products sold both through brick-and-mortar stores and online. Furthermore, it would open for an interesting challenge to the Court’s point about “essential” government services: it can be proven that services that are non-essential also distort markets by creating an unfair government presence, sometimes even monopoly.
In fact, it is entirely possible to construct an argument for the distinction between essential and non-essential services that actually defines the latter category as market-distorting.
This essential-services point is important, but since neutrality in taxation (avoidance of market distortions) is not the Court’s main argument for the internet sales tax, it is not the main take-away from the Wayfair decision. That, instead, is their unmitigated support for more tax revenue in the hands of government. Beyond making a general argument suggesting that more tax revenue in the hands of government creates prosperity, the Court specifically points to collection problems in today’s system, where the buyer of a product is responsible for paying a sales tax on internet purchases, where such taxes currently apply (Opinion, p. 2):
Under this Court’s decisions in Bellas Hess and Quill, South Dakota may not require a business to collect its sales tax if the business lacks a physical presence in the State. Without that physical presence, South Dakota instead must rely on its residents to pay the use tax owed on their purchases from out-of-state sellers. … And consumer compliance rates are notoriously low.
To drive home the point, the Court explains that the state of South Dakota estimates its “losses” to internet sales to $48-58 million per year (Opinion, p. 2). Internet-based sales erode the tax base (p. 3) of an “indispensable” revenue source (p. 12).
Referring specifically to the inability of state governments to pay for their spending, the Court explains that the expansion of consumer spending outside of traditional brick-and-mortar stores (Opinion, .19)
has also increased the revenue shortfall faced by States seeking to collect their sales and use taxes. In 1992, it was estimated that the States were losing between $694 million and $3 billion per year in sales tax revenues as a result of the physical presence rule. … Now estimates range from $8 to $33 billion.
As a side note, there was no public internet in 1992. The public was granted access in the spring of 1993, and e-commerce did not become mainstream until the late 1990s. In other words, the point about tax revenue losses 26 years ago applies to a different kind of remote-sales industry, namely catalog-based retail. That, on the other hand, was invented in the 19th century, already when railroads made interstate shipping possible.
In other words, in a historic context the current debate about the inability of states to collect tax revenue appears odd and misplaced. Its only motivating factor is that government has permanently outgrown its tax base.
Then, in a disturbing note on tax-created incentives, the Court opens a door that I hope they are willing to shut as soon as they become aware of it. Referring to an old case where the Court ruled in favor of a physical presence test for sales-tax liability, the Court calls that test (Syllabus, p. 3)
a judicially created tax shelter for businesses that limit their physical presence in a State but sell their goods and services to the State’s consumers, something that has become easier and more prevalent as technology has advanced. The rule also produces an incentive to avoid physical presence in multiple States, affecting development that might be efficient or desirable.
Desirable to whom? The Court has decided that states have the right to collect sales tax on internet sales because this gives states access to tax revenue they otherwise would not get their hands on. By the same token, it is “desirable” for that same state government to collect more from other sources, such as property taxes. Alaska, Arkansas, the District of Columbia, Montana, Vermont and Wyoming collect at least ten percent of their state revenue from property taxes; in DC and Vermont the share exceeds one third of total tax revenue.
Remote sellers, i.e., internet-based retailers, do not pay property taxes in the states where they have no physical presence. If
a) it is no longer required that a business has a physical presence in order to pay sales taxes;
b) the absence of an internet sales tax creates an incentive to stay away from a physical location;
c) the development that would come with a physical presence is “desirable”; and
d) the Court believes that prosperity grows with tax revenue (as it clearly suggests);
then is it now open to a state to introduce a “property tax equivalency” fee on internet-based retailers?
The Court does not even begin to address these problems. In fairness to the court, the reason is ostensibly that the lawyers who write and argue their cases never rely on economics expertise. This might also explain why the Court so summarily (or “breezily”, as Chief Justice Roberts puts it in his dissenting opinion) dismisses the costs that are associated with internet sales taxes. For example, on the problems that the internet sales tax creates for small businesses, the Court notes (Syllabus, p. 4):
other aspects of the Court’s Commerce Clause doctrine can protect against any undue burden on interstate commerce, taking into consideration the small businesses, startups, or others who engage in commerce across state lines. The potential for such issues to arise in some later case cannot justify retaining an artificial, anachronistic rule that deprives States of vast revenues from major businesses.
Chief Justice Roberts does not mince words in separating himself from the Court’s majority (Roberts, pp. 4-5):
The Court proceeds with an inexplicable sense of urgency. It asserts that the passage of time is only increasing the need to take the extraordinary step of overruling Bellas Hess and Quill … The factual predicates fo that assertion include a Government Accountability Office (GAO) estimate that, under the physical-presence rule, States lose billions of dollars annually in sales tax revenue. … But evidence in the same GAO report indicates that the pendulum is swinging in the opposite direction, and has been for some time. States and local governments are already able to collect approximately 80 percent of the tax revenue that would be available if there were no physical-presence rule.
Roberts also highlights the focus on tax revenue collection (Roberts, pp. 5-6):
The Court, for example, breezily disregard the costs that its decision will impose on retailers. Correctly calculating and remitting sales tax on all e-commerce sales will likely prove baffling for many retailers. Over 10,000 jurisdictions levy sales taxes, each with “different tax rates, different rules governing tax-exempt goods and services, different product category definitions, and different standards for determining whether an out-of-state seller has a substantial presence” in the jurisdiction.
Well said. It is important to note the intricacies in, but also the stark implications of, this case. Its underlying premise is that internet sales taxes are desirable because government needs more revenue for its “essential” services. Until someone successfully challenges the “essential” component and can convince the Court to dichotomize between essential and non-essential services, this decision has paved the way for a major, new tax grab by our states – and by local governments.
Hopefully, in the future the lawyers who take on the court to defend us against new tax grabs will try to broaden their reliance on expertise. Clearly, the Supreme Court needs some education on basic political economy. As things are now, this the highest judicial institution of our country has become a conduit for the maintenance and expansion of the egalitarian welfare state.
