A MODEST, SELF-HELP PROPOSAL ENABLING INDIVIDUAL STATES TO ADDRESS THE REMOTE SELLER TAX PROBLEM AND MUCH MORE

As the States’ and any Congressional responses to the United States Supreme Court’s 5-4 ruling in the remote seller sales tax enforcement case of South Dakota v. Wayfair, Inc., et al, 585 U.S.___ (2018) begin to emerge, this is to describe a simple proposal by which any individual state can effectively enforce its use tax on remote sales, mitigate the related compliance concerns of remote sellers AND enable its pursuit of other major state tax policy objectives.

Thus, in a profoundly “win-win” manner precisely because the proposal improves states’ use tax compliance outcomes it also potentially allows remote and on-line sellers to avoid the worst aspects of the administrative nightmare they regularly invoked in challenging imposition on them of tax collection duties by a vast array of state and local jurisdictions.[2]  Moreover, this proposal is also designed to ameliorate the perceived threat of state border competition which, otherwise, greatly limits the flexibility of individual states to employ consumption tax base expansion and rate increases in addressing not only insufficient revenue capacity, but, more importantly, in pursuing structural reform of their tax systems to the end of greater competitiveness.[3]

Specifically, this simple but potentially game-changing proposal is designed first as an effective and efficient enforcement bulwark against chronic non-compliance with states’ existing consumption taxes due to their heretofore legal inability to require many remote, internet vendors to collect such taxes on sales to their residents.  Simply described, the proposal is for a state to require most of its resident income tax filers to pay its use tax in an amount equal to a fixed portion of the annual amount of sales or use tax otherwise due on purchases they are presumed/implied to have made based on their income level and family size.  If the concept underlying that measure sounds familiar, that is because it is the one currently used in the optional tables for itemized deductions of state and local sales and uses taxes for federal income tax purposes.[4]

Since this proposal simply involves an innovative way to enforce existing use tax obligations, it can be effected without requiring anything more in terms of tax return filing changes than revisions to the portions of state income tax returns currently devoted to self reporting of that same use tax.  Specifically, to implement such an improved use tax enforcement process, a state would enact legislation which requires most of its income tax filers to pay an amount equal to some fixed percentage of the applicable federal sales tax table deduction amount less credits for such taxes actually paid to any jurisdiction.

Since those tables are based on taxpayers’ federal adjusted gross income levels, they are inherently progressive, but, to make this implied purchases use tax enforcement method even more so, the state law could exempt from its operation all those taxpayers whose federal taxable income is below any given level the state’s legislature selects.

Under the proposal, each resident of the state thus subject to the implied purchases use tax enforcement rule for a given year would be required, as a part of their state income tax return process, to compute his/her/their implied purchases use tax amount based on the federal tables and embodied in instructions from the state revenue agency.  Thus, each taxpayer would report their implied purchases use tax liability, less a credit against that liability for the cumulative amount of the sales or use taxes he/she/they actually paid during the same annual period to vendors in their home state or in any other US jurisdiction.  Any remaining uncredited balance of implied purchases tax shown to be due on the return would then be remitted to the state after combining it with any remaining state income tax liability or overpayment.

As a practical matter, precisely because credits under the proposal would be granted for consumption taxes paid to other jurisdictions, fiscal prudence militates against actually paying refunds of implied purchases use tax if the amount of a given taxpayer’s claimed credits exceed the amount of that tax determined from the tables.  A state might, however, if it is willing to bear a degree of administrative complexity, actually pay refunds to taxpayers whose credits for actual payments of its own sales tax alone exceed the implied purchases use tax amount for a given period.  The importance of such a nuance in the scheme would likely turn on such factors as the number of reporting taxpayers (determined by the level of income exempted) and by the percentage of the sales tax amounts on the federal sales tax tables selected in determining that state’s implied purchases use tax liability.  Obviously, the higher the level of income exempted from liability for the implied purchases tax, and the lower the percentage of federal table tax used in measuring that liability, the less weight would be given to an argument for making such refunds.

Another important administrative aspect, which would also turn largely on those same factors, would be whether copies of sales receipts showing actual time-of-sale payment of consumption taxes would be required to accompany the implied purchases use tax return when claiming credits for such payments.  A simpler alternative would be to just require a taxpayer’s retention of those receipts to be later produced in the case of state revenue agency audits of randomly-selected returns. Again, the higher the exempted income levels, and the lower the percentage of federal table taxes used for state use tax collection purposes, the fewer the number of taxpayers who would bear the practical burden for keeping paper sales receipts.

Potentially there would also be a small number of higher income taxpayers who would favor convenience over relatively modest tax savings and, as a result, simply not go to the trouble of maintaining the supporting sales tax records and claiming all (or any) credits.[5] Presumably the availability of actual refunds, when such credits exceed the computed implied purchases use tax amount, would also influence both a given taxpayer’s incentive to consistently keep such records, and the state’s interest in enforcing the requirements for maintaining the same.

Of course, a key to the practical efficacy of the proposal is the continued availability of the optional federal sales tax tables which are annually updated for each state.  One might ask whether that crucial data source can be expected to remain available going forward, given the recently enacted Tax Cuts and Jobs Act, which, among other things, limits the itemized deduction for state and local taxes to $10,000.00.  However, absent further major changes in that aspect of the governing federal income tax laws, since the highest maximum deductible amount listed on such tables is no more than about one-third of  that new SALT deduction limit, the need for them should remain.

Aside from such practical administrative considerations, skeptics about the viability of this proposal will, no doubt, raise largely philosophical questions about the very concept of tying consumption taxes, traditionally based on actual transactions, to the mere implication of engaging in a taxable transaction based on income level and family size.  However, one might simply observe that, as to the traditional reliance on actual purchases to trigger the tax, such arguments based on “that’s the way we’ve always done it” are not grounded on any substantive principle found in the state and federal constitutional provisions authorizing exercise of the sovereign’s taxing power.[6]

Moreover, no one has seriously questioned the constitutionality of using the optional federal sales tax tables to determine itemized deductions for federal income tax purposes.  Indeed, since the conceptual underpinning of the progressive income tax itself is the economic theory of the diminishing margin utility (i.e. purchasing power) of each additional dollar of income, the conceptual nexus between having a certain level of income and the implied spending of a given part of it is beyond debate.[7]

For that very reason, well-founded characterizations of the regressive tendency of any consumption tax are based on the relative amounts of income different individuals have available to make purchases of life’s necessities.  Thus, it is incontrovertible that income levels, and the use of that income to make purchases, are mutually integral.  As a result any tax, which is based on objectively measured and statistically massive samples to coordinate individual income levels with expected individual spending levels, is conceptually sound.

Importantly, there is nothing in the proposal which contemplates elimination of the long standing (and, now in Wayfair, confirmed) vendor collection responsibilities of nexus-satisfying sellers. However, due to the reduced state reliance under the proposal on such vendor collections to effect payment of the taxes, a far less onerous compliance regime enforcing such responsibilities may be adopted.

Moreover, by allowing its residents to claim credits against the implied purchases tax for payment of other jurisdiction’s sales and use taxes, the proposal also manifestly honors both the nexus principles of federalism, and the growing use of market-based sourcing of transactions for consumption tax administration purposes.

Thus, this proposal offers a simple and administratively straight-forward way by which a state, acting unilaterally, can avoid both the loss of future state consumption tax revenue and the corollary threat to local, bricks and mortar merchants’ competitiveness.  At the same time, it can also provide states with an opportunity to spare the on-line, remote seller community from the nightmare of administrative burdens their advocates have long lamented when multiple jurisdictions’ sales and use tax collection responsibilities are imposed upon them (as the ruling in Wayfair now authorizes).

Specifically, at the least, the proposal’s independent capacity, to assure use tax compliance for a state’s residents’ retail purchases from remote sellers, readily justifies that state’s adoption of the far less onerous compliance parameters embodied in South Dakota’s statute and effectively blessed as constitutional by the Wayfair ruling. [8] Indeed, given the high degree of resident use tax compliance inherently achieved through separate means under the proposal, even more liberal vendor compliance rules would still easily fall within the range of responsible public revenue practices.

Importantly, the proposal should also significantly mitigate the fear of inter-state border tax competition which often constrains structural state tax reform efforts.  Thus, for the cohort of a state’s taxpayer population, which would be generally subject to its implied purchases use tax enforcement method, it inherently eliminates any financial incentive to travel to an adjoining jurisdiction to purchase items simply because they are either not taxable or are  taxed at a lower rate there.

Of course, the lower the income level threshold set, and the higher the percentage of sales tax table used, for application of a state’s implied purchases use tax method, the larger the number of in-state consumers who would thus be dissuaded from crossing the border to shop in a lower tax jurisdiction.  In addition, due to the inherent and strong correlation between an individual’s income level and the value he or she attributes to personal convenience, the greater would also be the sales tax payment credits earned for in-state purchases (whether claimed or not) against higher income individuals’ implied purchases use tax liability.

Far more important, than the precisely optimum level of those structural details within an implied purchases use tax enforcement scheme, is its potential to enable such major competitiveness-enhancing reforms as gradual replacement of a state’s income tax with a far more broadly-based (and, perhaps, higher rate) general consumption tax.[9]  While, thorough use tax audits of business purchases, combined with  market-based sourcing rules, largely limit the “border competition” concern to that involving retail purchases of goods, that is still the same economically massive part of the overall market which the states claim has heretofore been disrupted and unfairly exploited by no-nexus remote sellers.

To meet that concern, a progressive creditable implied purchases use tax enforcement system offers each state the unilateral opportunity to protect both its tax base and its in-state merchants, while more freely reforming its entire tax structure to achieve improved competitiveness.  Moreover, as to each such state, members of the on-line remote seller community could, as a part of the proposal’s implementing legislation, also be freed from some, if not most, of the potential administrative hassles of vendor collection/remittance responsibilities.  As a result, their lobbying efforts, advocating adoption of the proposal, would be prudently directed to every state whose market they seek to exploit.

Finally, in considering the advisability of adopting this proposal it is essential to never lose sight of the fact that it does not involve imposition of a new tax, but, rather, provides a far more efficient and effective method for enforcing a long-existing, but often ignored, current tax. Indeed, when its adoption in a given state also enables comprehensive reform of the state’s tax system by allowing the gradual replacement of state income tax with a broader-based consumption tax system, it will also serve the important end of tax administration and compliance simplification.

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[1] © 2018 Tuscarora Institute for Enterprise Studies & Advancement, LLC

[2] E.g. Transcript of oral argument on April 17, 2018 before the Supreme Court of the United States in  South Dakota v. Wayfair, Inc. et al, Id.  Heritage Reporting Corporation, Washington, DC.

[3] E.g. “Consumption Tax vs. Income Tax: Why More States Are Opting to Collect Consumption Taxes Only,” by    Amanda Grossman, March 16, 2015; www.howmoneywalks.com. (April 3, 2017)​

[4] IRC §164(b)(5)(H)(ii); “Instructions for Schedule A, Form 1040,” Internal Revenue Service.

[5]  Given such a possibility, a state, which relies on the random audit approach to assure accuracy of claimed credits, would, to discourage taxpayers from playing “audit roulette,” be prudent to include, in its implementing legislation, a fairly stiff penalty for a credit-claiming taxpayer’s failure to produce sales receipts if audited.

[6] Indeed, to contend otherwise, suggests the same purely academic, but impractical perspective such as that seen in the contention that the enforcement of vendor sales and use tax collection responsibilities is technically not authorized under states’ taxing powers.  E.g. “Tax Collection Obligation is Not a Taxing Power Issue.” James Edward Maule,  (Nov. 9, 2012).

[7] See, Alfred Marshall, Principles of Economics, (1890).

[8] The South Dakota statute was not retroactive, and it created a safe harbor for those who transact only limited business in the state. In addition, since South Dakota is a signatory to the Streamlined Sales and Use Tax Agreement, it provides standardized sales and use tax procedures all  to reduce administrative and compliance costs, and it allows sellers access to state sales tax administration software, and provides sales and use tax audit immunity for those who use it.​

[9] The concept, underlying the Progressive Creditable Implied Purchases Tax was first developed to mitigate such “border competition” concerns as described on pages 25-26 of the author’s “Fair 55 Tax Reform Plan for West Virginia,” co-published by the Tuscarora Institute for Enterprise Studies & Advancement, LLC and the Public Policy Foundation of West Virginia, Inc. in 2016.  See,  and  www.ppfwv.org.  The basic premise of the Fair 55 Tax Reform Plan is that if West Virginia had a broader-base (but lower rate) consumption tax system, it could, in a fiscally responsible manner, phase-out and repeal all its taxes on income and tangible personal property, and, thus, become one of the most economically competitive states in the USA.

Have a tax question? Contact Michael Caryl.