Internet sales tax battle shaping up in Congress

Most Americans could pay more local and state sales taxes on items they buy online if pro-tax forces win a fight in Congress underway this week. But will the bill run afoul of the same constitutional problem that affected the health care decision last June?

On one side of the battle is a group that includes a majority of U.S. senators, President Obama, Internet retailer Amazon. Walmart, a group representing national retailers, and a cadre of state governors (including New Jersey's Chris Christie).

The other side includes digital giants eBay, Facebook, Yahoo, and Expedia; tax fighter Grover Norquist; the Heritage Foundation; direct marketing interests; and conservative House Republicans.

And the Commerce Clause, which played a key role in the Supreme Court's health care decision, could make a cameo appearance at the end of the fight.

At stake is an estimated $23 billion a year in local and state sales taxes that, in theory, could be collected if consumers in 45 states and the District of Columbia were required to pay sales taxes for online purchases.

On Monday, the White House said President Obama supports the Marketplace Fairness Act. The law proposed by Mike Enzi (R-Wyoming) would let states collect sales taxes from residents who buy online from out-of-state retailers. The retailers would collect the tax at the point of purchase, and remit the taxes to the eligible states and local municipalities.

So for example, if you live in Illinois and buy a pair of sneakers on eBay, you would pay a direct sales tax for your state (6.25 percent) and if applicable, your city (as much as 3 percent).

Currently, some states have similar agreements with retailers like Amazon. Others require people to report an annual use tax to estimate how much they spend online each year. The problem is that compliance is low on reporting the use tax. The new law shifts the role of tax collector from the state to the retailer.

The Senate is expected to pass the bill as soon as this week, with greater support than it gave gun-control measures last week.

But will it pass the House, where the measure could be seen as a tax hike?

That answer is uncertain. Some House Republicans might have problems with any law that suggests a tax hike, even though the act's supporters claim they just want to see the proper amount of taxes collected.

There is an exemption for small businesses that earn less than $1 million annually from out-of-state sales.

John Donahoe, the CEO of eBay, wants the exemption raised to $10 million in annual sales for small businesses or companies with fewer than 50 employees.

"I am writing to ask for your help in telling Congress 'No!' to new sales taxes and burdens for small businesses," Donahoe said in an email to eBay customers on Monday. "We believe this is a reasonable exemption to protect small online businesses."

The issue of who decides the Internet sales tax question goes back to 1992, when the Supreme Court put the ball in the lap of Congress in a ruling that predated the modern commercial Internet.

During the past 20 years, many online businesses have cited that 1992 Supreme Court ruling, Quill Corp. v. Heitkamp, as proof that online retailers don't have to charge—and collect—sales taxes in states where they don't have a physical business.

Quill was an out-of-state mail-order house that sold products without having a store or sales staff in North Dakota.

The Supreme Court found that states had a right under the Due Process Clause of the Constitution to collect sales taxes, but the burden placed on out-of-state businesses to collect the taxes ran afoul of the Commerce Clause.

"The State's enforcement of the use tax against Quill places an unconstitutional burden on interstate commerce," said Justice John Paul Stevens.

The court then said that the "underlying issue here is one that Congress may be better qualified to resolve, and one that it has the ultimate power to resolve."

The key issue is how effectively a computerized system can be established to collect taxes not only from 45 states and the District of Columbia, but also additional local sales taxes, and get the revenue in the hands of the correct people, without imposing a huge cost or burden on small businesses.

Supporters of efforts such as the Streamlined Sales and Use Tax Agreement, which has been adopted by 24 states, say it's an issue of fairness, in addition to states losing out on tax revenue.

House Judiciary Committee Chairman Bob Goodlatte (R-Virginia) will be one key player in getting the law passed after its likely approval in the Senate.

"While it attempts to make tax collection simpler, it still has a long way to go," Goodlatte said. "There is still not uniformity on definitions and tax rates, so businesses would still be forced to wade through potentially hundreds of tax rates and a host of different tax codes and definitions."

Goodlatte and others have concerns about the potential reach of such a law. The Securities Industry and Financial Markets Association, in particular, says the bill could set a precedent that would allow states to collect taxes on other out-of-state activities.

In the end, it could be the ease of use (and power) of a software system that could get the Marketplace Fairness Act past the Commerce Clause concerns in the 1992 court ruling.

That system would need to account for about 9,600 local taxes, in addition to 45 states and the District of Columbia, without imposing a burden on retailers.

The Congressional Research Service analyzed the issue earlier this month as part of a report for Congress.

It says the under the precedent set by Quill, a connection, or nexus, must be established that shows that "(1) the state has provided some benefit for which it may ask something in return and (2) the seller has fair warning that its activities may be subject to the state's jurisdiction."

In addition to this connection, "the Commerce Clause prohibits state laws that discriminate against interstate commerce," the CRS says. That includes the concept that "a state law that subject[s] remote sellers to tax-related burdens not imposed on in-state sellers would appear to be facially discriminatory and, therefore, subject to a high level of judicial scrutiny."

Scott Bomboy is the editor-in-chief of the National Constitution Center.