Beyond Wayfair, Can Nations and States Cooperate in Collecting Taxes?

This column first appeared on TaxVox.

The brilliant Tax Notes columnist Marty Sullivan once summarized one of the great dilemmas in taxation: “It’s simply impossible to put a precise geographical subscript around ‘where’ taxes should be collected.” He mainly had in mind locating the source of capital income, but geography again reared its head recently when the Supreme Court’s South Dakota v. Wayfair, Inc. decision tackled the question of when states can require online retailers to collect sales taxes.

In both cases, it is difficult, if not impossible, for taxing jurisdictions to resolve these issues on their own. But they create important opportunities for these authorities to work together to develop solutions that are fair to taxpayers while assuring that government collects tax that is legitimately owed.

The issues are not easy to resolve. Countries struggle to sort out where a firm’s income is earned when its headquarters, production, marketing, research, and patents can be located anywhere in the world, when its sales routinely cross borders, and when some goods and services can be transferred or sold multiple times as intermediate products along the way toward a final sale.

This environment even affects charities, many of which routinely violate state and national laws simply by maintaining websites that can receive donations from anywhere but have not registered in every jurisdiction that might require it.

The Supreme Court’s Wayfair decision added to these boundary disputes. The Court ruled that states can obligate an on-line retailer to collect and remit sales taxes even if that firm’s website and physical facilities (such as manufacturing and headquarters sites) reside outside their jurisdiction.

Senator Heidi Heitkamp (D-ND) at a recent Tax Policy Center (TPC) event, as well as my colleague, Howard Gleckman, have noted how, for decades, Congress has failed to enact federal legislation to smooth out the administrative nightmares that online and catalog sales can create. But neither have the 50 states been able to agree on a coherent collections model.

However, there are examples of progress both internationally and among the US states.

My TPC colleagues Richard Auxier and Kim Rueben have detailed the various state efforts to use a streamlined sales tax agreement to address common measurement and registration issues caused by the evolution of on-line sales taxes.

Internationally, the OECD and G20 Base Erosion and Profit Shifting (BEPS) project laid out fifteen actions that nations can employ to increase transparency and adopt common standards for treating issues such as interest income, transfer pricing, and controlled foreign corporations.

So far, most of these multilateral efforts have been voluntary. Governments could be more aggressive in developing common practices if legislation or treaties made them mandatory. That big step is often opposed by those who benefit from the status quo, either through existing legislative favoritism or their ability to evade/avoid the laws. Yet pressure to resolve these issues continues to grow.

For example, the federal government could pre-empt some state actions by adopting a nationwide retail tax that it shares with the states according to a fixed formula. For many years, the federal government granted a credit against federal estate tax of up to 100 percent for payments of a state estate tax that included certain features. That gave states a significant incentive to adopt a common estate tax base since failing to do so effectively meant turning revenue over to the federal government.

Similarly, the European Union aims for a standardized tax base for the value-added tax, though its member countries may still set their own rates and are allowed some flexibility in defining their tax base.

In the face of growing complexity, even businesses are embracing common standards, at least up to a point. For instance, brick-and mortar retail firms have complained about their competitive disadvantage when on-line sellers do not collect tax for selling the same goods and services. In a sense, these firms are arguing for a common tax base to apply to both physical and on-line or mail-order sales.

Many firms’ finance and accounting officers complain about having to comply with a wide range of rules for defining income or sales tax bases among multiple jurisdictions. A multinational firm, for instance, may have to file income, sales, and value-added tax reports in thousands of jurisdictions. Even without foreign sales, a US firm may file hundreds of tax returns in the 50 states and numerous cities and counties. To address these concerns, third-party providers and software firms have jumped into this market by selling products to ease the burden on taxpayers and governments alike.

The evolution of the modern economy is only increasing pressure on taxing jurisdictions to cooperate and for federal systems to adopt laws or treaties that encourage or even require such cooperation among sub-national governments. Such efforts extend to registration, filing requirements, reporting, transparency, and definition of tax bases, and, sometimes, minimum tax rates.

These efforts always will be incomplete and ongoing, given legitimate pressures for tax competition and jurisdictional independence. But South Dakota v Wayfair, Inc. is an important step along this meandering path toward sometimes-workable conformity.