The Independent View: SCOTUS to Consider Online Retailers Challenge to Colorado Sales Tax Scheme

Some history. The Court in 1992 ruled in a Commerce Clause holding, Quill Corp. v. North Dakota, that the states cannot force mail-order retailers to collect sales (or use) tax on goods that they ship into the jurisdiction; the significance of that decision grew markedly with the rise of online commerce shortly after the Court’s ruling.

I was part of this ruling, representing the Global companies, Global Computer/Global Equipment, as their Director of MIS. The ruling said you had to collect sales tax in the state under the following conditions: maintain a store, warehouse, sales organization, outside sales representatives and today online affiliate sales (selling a book by linking to Amazon or Barnes&Noble).

The severity of the problem has increased steadily since 1992. State budgets are under increasing strain for all the reasons we know too well; this means that state policymakers are desperate for every sales tax dollar they can find. At the same time, the steady shift of commerce from brick-and-mortar retailers to online retailers means that each year a smaller share of the state’s economy is subject to the sales tax.

So most states have responded by enacting use taxes that require their residents to pay use taxes on goods that they purchase from out-of-state retailers. Unfortunately, as we all would admit after a moment of self-reflection, most of us do not voluntarily send in a use-tax return to our state of residence each year paying taxes on our online purchases from the previous year. Against that setting, Colorado adopted a statute that requires retailers to keep track of the sales they make to Colorado residents and at the end of each year send a statement of the total sales to each resident, with a copy to the state. With that information, the state readily can pursue residents who don’t pay the use tax voluntarily; the system is modeled directly on the IRS’s Form 1099 and well might turn out to be just as effective.

Direct Marketing Association v. Brohl drops the Court into a dispute between states and Internet retailers that has been simmering for the last twenty years. We’re all familiar with the meme that the “Internet wants to be free.” Putting the pathetic fallacy to the side, there is a basic truth to the idea that the Internet’s facilitation of remote interaction has made it much harder, in many contexts, for governments to exercise the degree of supervision and control that was customary for much of the last century. For the states, one of the most important areas in which this plays out is sales taxes. If you have a revenue model that depends on the collection of sales tax from retailers, the ability of online retailers to sell things to your residents without paying sales tax posed a serious threat from the earliest days of Internet commerce.

On Monday the Court will consider the litigation that results from Colorado’s creative statute. The retailers, predictably enough, complain that the Colorado tax system is a flagrant violation of the Commerce Clause, attempting to circumvent Quill by imposing a burden of information collection and reporting that applies only to out-of-state retailers. Colorado, just as predictably, regards the system as a routine and unexceptionable aspect of tax administration.

Unfortunately for first-year constitutional law teachers, this case will not resolve that dispute. Rather, it will answer a question more typical of a “federal courts” course: does the Tax Injunction Act (referred to in the briefs as the TIA) prevent the retailers from filing suit in federal court to challenge the Colorado tax scheme? The Tenth Circuit held that it did, and the Supreme Court granted review to address that question.

So I’ll be most interested to see what this case looks like at the argument next week. My best guess is that Colorado will have a hard time.

During the 1992 case, I presented in writing that if the states wanted me to become a tax collector, I would gladly offer my service for a piece of the action. We were a mail order company with four locations were we collected sales tax, but had a buying base across the United States. In 1994 we added online sales, so I knew what was coming.

UPDATE
The Justices had tough questions for both sides Monday morning in Direct Marketing Association v. Brohl. Although the legal issues seem relatively simple, several of the Justices appeared frustrated during the course of the argument, and the end result could be a decision that relies heavily on reasoning that neither side advanced.

One possibility is that several of the Justices would like to vote for DMA, but were frustrated that DMA’s lawyer would not agree with the argument they found most acceptable. On this reading, Justices Scalia, Kennedy, Breyer, and Kagan were unwilling to accept the broad reading of “collection” urged by Colorado. At the same time, they were not willing to endorse the “taxpayer/third party” distinction on which DMA relied. We can expect, several months from now, an opinion reversing the judgment of the court of appeals and ruling for DMA, but adopting little or none of the reasoning it offered.