Will California Residents Begin Paying North Dakota Taxes Too?

Bartlett Cleland
Senior Fellow in tech and innovation at the Pacific Research Institute

A Supreme Court case to be decided by the end of June could require California residents to pay taxes to a variety states, counties, cities and even mosquito abatement districts across the country.

South Dakota v. Wayfair is a case that asks whether there are limits on state taxing authority or whether such authority to tax and regulate is as deep and broad as the internet. The case is centered around the notion that an entity must have a physical presence in a jurisdiction before it can be taxed or forced to collect taxes for the state. That question is as old as our country – are we okay with taxation without representation?

The South Dakota statute at issue requires that retailers, even if they have no physical presence in the state such as property or employees, collect and remit South Dakota’s sales and use tax.  Currently, physical nexus is the primary factor to determine if a state tax, audit, and regulation obligation is triggered, which was determined in the Quill decision of 1992.

South Dakota argues that an economic, or ephemeral, nexus triggers tax obligations at a much lower threshold, such as when a mere pop-up ad is seen by a consumer in the state. Changing this standard at a time when so much of the relationship between governmental authority and internet-based business models is being questioned would result in the radical expansion of government power and hurt employers small and large. Entrepreneurs and small businesses would be reduced to spending significant time and resources being forced to be a national tax collector.

But the situation gets worse for California. If the Court opts to go in the direction of an ephemeral presence standard – a seismic shift in constitutional doctrine – California is a state that would likely suffer economically. States with more online entrepreneurs, and larger, more productive populations, will be the hardest hit. Smaller, less productive states would be able to survive by looting larger state economies under the new standard. History shows what will happen.

The U.S. Constitution was written, in part, after the failure of the Articles of Confederation to solve this very problem. The Commerce Clause was included in the Constitution to prevent overly aggressive states from imposing barriers to trade on the citizens of other states. The Constitution never granted the power to tax out of state but did empower states to protect their citizens from other governments.

Other than as a money grab, a tax on remote sellers or protectionism run amok, these tax administrators are woefully behind the times in crafting their new scheme. The fact is that the clear trend in retail is an “omnichannel model.” That is some combination of a physical presence and an online presence is becoming dominant because customers prefer it. This necessarily leads to expanded physical presence, and more revenue for taxing jurisdictions without the dramatic effect of expansive government control and growth. Remember these are the same state governments that court technology businesses to their states even as they move to burden them with their claims that taxes should be paid because of “ephemeral interaction.”

The right move for the Golden State is for Congress to adopt a “bright line standard”, removing ambiguity about nexus. This move would support the continued development of the borderless marketplace, a development where California gains given its place in the technology and internet worlds. A company should have to be present within a taxing jurisdiction before being subjected to its taxes.

We must not formalize a system of allowing states to loot thy neighbor of legally instituting “Do not tax me, do not thee, tax the man behind the tree.”

Without a physical presence standard, residents of California could be subjected to South Dakota state taxes along with the nearly 12,000 other taxing jurisdictions just within the United States. If that happens, the California Gold Rush of 1849 will be dwarfed by the California Tax Rush of 2019.

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