SSTP: Out of the Great Swamp, But Whither? A Plea to ...

Volume 2002 Number 1 January 2002

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SSTP: Out of the Great Swamp, But Whither?A Plea to Rationalize the State Sales Tax *

Charles E. McLure, Jr.Hoover Institution, Stanford University

I. Introduction in the Form of a DreamLast night I dreamed I was sitting on a promontory watching events unfold below.

A group of travelers bound for Salt Lake City entered a clearing, followed by a strangebeast that kept nipping at their heels. From the logo on the travelers’ sweatshirts, “SSTP2001,” I could see that they were bound for the Inaugural Meeting of the ImplementingStates of the Streamlined Sales Tax Project, not the Winter Olympics.

The beast looked a bit like the centipede at the annual Bay-to-Breakers race in SanFrancisco — a creature composed of individuals covered by a common green skin, butit had neither head nor tail. Like the members of the San Francisco centipede, thecomponents of this beast seemed to have their own agendas. Now and then one wouldbreak free and whisper something to one of the travelers, while others would shout, “It’snot fair.” The beast responded to carrots and sticks, but not much else. On its side wereemblazoned the words, “US ECONOMY.”

The travelers were considering three paths, each leading to alternative policies forthe future.

The first continued the trail that brought the group to the clearing. Itwas marked by a sign that warned, “Great Swamp. Your pack animal muststill carry an excessively heavy load if you continue here. Footing istreacherous and there are many pitfalls.”

On the right of the clearing, marking the second path, was a sign thatproclaimed, “Elegant Simplicity, nine yards.1 You can remove the excessburdens from your pack animal. Footing is as good as it gets.”

The third path, which lay between the other two, was marked by a signthat said, “Lesser bog, just a few steps. You can remove some of theburden from your pack animal, but most will remain. Footing is good,but not great. Rely on technology to get out of a fix.”

Continued on page 6

*I have made a few additions and minor substantive changes, as well as numerous expositional changes that donot affect the substance, to the “presentation draft” of this address that I delivered in Salt Lake City. I identifythe most important additions in the notes. I have benefitted from comments Walter Hellerstein made on anearlier draft of this address.

2 Multistate Tax Commission January 2002

Published by: Multistate Tax CommissionChair : Elizabeth Harchenko

Director, OR Department of RevenueExecutive Director: Dan R. BucksEditors: René Y. Blocker

Elliott Dubin

Subscriptions:At present, the Review will be issued as acomplimentary publication. At some time inthe future, the Commission may institutepaid subscriptions. The balance of existingsubscription payments will be refundedwithin six to eight weeks.

Please contact Teresa Nelson, ProductionEditor, with questions concerning new orexisting subscriptions, at (202) 624-8699 [email protected].

Contributions:Submissions by readers of articles, articleideas, suggestions, and criticisms arewelcome. Please send them to the editor atthe address listed on the back. We alsowelcome information concerning changes inemployment status of persons active in statetaxation in both the public and privatesectors.

The opinions expressed in the Review arethose of the authors and do not necessarilyrepresent the official position of theMultistate Tax Commission or any of itsMember States.

MTC Officers, FY 2001-02Chair: Elizabeth Harchenko, Director

OR Department of RevenueVice Chair: R. Bruce Johnson, Commissioner

UT State Tax CommissionTreasurer: Carol Fischer, Director

Missouri Department of Revenue

Executive Committee MembersMark Murray, State TreasurerMichigan Department of TreasuryCarole Keeton Rylander, ComptrollerTexas Comptroller of Public AccountsRick Clayburgh, State Tax Commissioner NDOffice of State Tax Commissioner

Executive Committee Members, ex officioGerald H. Goldberg, Executive OfficerCalifornia Franchise Tax BoardTimothy Leathers, Deputy DirectorArkansas Department of Finance and Administration

Multistate Tax Commission ReviewA Journal on State Taxation of Multijurisdictional Commerce

SSTP: Out of the Great Swamp, But Whither? A Plea toRationalize the State Sales Tax, by Charles E. McLure, Jr.,Hoover Institution, Stanford University ....................... 1

Words from Our Executive Director .......................... 3

News Release: “New” Economy Prompts Series of“Risk” Seminars to Look at State Concerns Over TaxingAuthority ................................................................... 4

Federalism at Risk Schedule ........................................ 5

Draft Article on 4R for MTC Review ......................... 16

Uniformity Matters at Hearing .................................. 21

MTC Deregulation Project, by Ken Beier, DeregulationProject Manager .......................................................... 22

Recent Amicus Curiae Briefs Filed by the Multistate TaxCommission, by Frank D. Katz, MTC Deputy GeneralCounsel ....................................................................... 23

Nexus Update, by Beau Baez, Counsel, MTC NationalNexus Program ........................................................... 26

Bibliography of MTC Review Articles ....................... 28

Multistate Tax Commission Training Courses .......... 32

Calendar of Events ..................................................... 33

Table of Contents

Multistate Tax Commission 3January 2002

Words from ourExecutive Director

Dan R. Bucks, Executive Director


WASHINGTON, DC; December 10, 2001—TheMultistate Tax Commission announces a seminar thatwill investigate the realities that state and local govern-ments face in meeting the challenges presented by the“new” economy and the benefits and limitations of statetaxes. In addition, the seminar features a session thatwill provide an assessment of the fiscal impact on thestates of new national security concerns.

The seminar will be held Friday, January 18, 2002, from8:30 a.m. – 5:00 p.m. at the U.S. Grant Hotel in SanDiego, CA. This seminar is one in a series sponsored bythe MTC titled, Federalism at Risk.

“The Internet has and will continue to fundamentallychange the way business is done around the globe. Stateand local governments now have to move with alldeliberate speed to re-examine tax systems that wereimplemented to serve the ‘old’ economy to determinewhether these systems meet the challenges presented bythe ‘new’ economy,” said Elizabeth Harchenko, Directorof the Oregon Department of Revenue and Chair of theMTC.

This seminar will investigate the tension between statesand the federal government in exercising taxing author-ity in the modern economy. It will also provide a forumfor the states to examine the fiscal impacts of the recentterrorist attacks and to discuss their preparation forpotential future attacks. Nationally recognized tax policyexperts will assess the future of sales and use taxes in theage of electronic commerce and forecast the impact ofnational security improvements on state and localgovernment revenues and expenditures.

Specifically, the seminar will seek to answer the follow-ing questions:

n What are the specific issues surroundingtaxation and the Internet?

n How will state actions on national securityissues affect their revenues and expenditures?

n What are the state revenue and expenditureimpacts of recent shocks to the economy,including layoffs and changes in consumerspending?

n How does the federal-state relationship work in“ordinary” times and in times of crisis?

n What must states do to save the sales tax andtheir taxing authority?

The series began July 26, 2001, at the MTC AnnualMeeting in Bismarck, North Dakota, with an overviewof the status of state and local taxation. In addition tothe upcoming January session on sales taxes, there willbe a seminar on business activity taxes in late-Februaryin Washington, D.C., a session on other taxes and ongeneral administrative issues on Friday, April 26, 2002,in Denver, Colorado, and a June 2002 session on prop-erty taxes. A major review and assessment of the recordcreated by the series of seminars will be conducted atthe MTC’s Annual Meeting on August 1, 2002, inMadison, WI.

“We consider this series to be a critical undertaking foran organization like ours,” said Ms. Harchenko. “The[Multistate Tax] Compact, our defining document,anticipates the states and the MTC conducting this kindof comprehensive study of state and local tax systems.”

“New” Economy PromptsSeries of “Risk” Seminars to Look at

State Concerns Over Taxing Authority

Seminar also to examine the fiscal impact on the statesof new national security concerns


“If through this inquiry, more state, local and federalofficials and other stakeholders become more knowl-edgeable about the benefits of and the need for work-able tax systems, we will have sown the seeds for thegrowth of innovative solutions for improving state andlocal tax policies and developing permanent cooperativerelationships among the states, the federal governmentand taxpayers,” said Ms. Harchenko.

The MTC has made a general call for papers, partici-pants, presenters and observers to all individuals andorganizations interested in contributing to the record ofthe inquiry and dialogue. At the conclusion of the series,

the Commission will publish an edited report on theproceedings, which may include findings and recom-mendations of the Commission.

“This inquiry and dialogue is really about the future ofstate and local governments,” Ms. Harchenko noted. “Wethink the states and localities will benefit most from thisseries if we can bring the knowledge and viewpoints of awide variety of sources together in a single forum.”

Additional information about “Federalism at Risk” isavailable via the Internet at www.mtc.gov or by callingthe MTC headquarters office at (202) 624-8699.

Federalism at Risk Schedule


Suggesting that the signs had been written by arefugee from a Chinese fortune cookie factory, thetravelers seemed puzzled. When they said they thoughtthe passage through the Great Swamp had not beenparticularly onerous, there were howls of protest fromthe great beast. The travelers had heard that the LesserBog, with all its “gee whiz” technological gimmicks,might be preferable to the Great Swamp, but they hadnever considered going the full nine yards to reachElegant Simplicity. Nor had they noticed that their beastof burden was, indeed, excessively laden or that theburden was not evenly spread. They asked whetheranyone could help them understand their options. Thatis when I awoke.

In my remarks today I will describe the GreatSwamp, tell you how to achieve Elegant Simplicity bydraining the swamp, and comment briefly on the LesserBog.

II. Mapping the Great Swamp: the CurrentSales TaxThe current sales tax “system” is extraordinarily

complex — literally a compliance swamp, especially forvendors who must collect tax on sales to customerslocated in multiple states. The US Supreme Court hasruled twice — in National Belas Hess in 1967 and againin Quill in 1992 — that the sales tax is so complex thatstates cannot require an out-of-state (remote) vendor tocollect the tax unless the vendor has a physical presencein the state.2 The purpose of the SSTP is to simplifycompliance, especially for multistate sellers, and therebygain approval (from either the Congress or the SupremeCourt) of an expanded duty for remote vendors tocollect tax.3

The practical inability to collect tax on many remotesales to individuals implies that revenues are lost or thattax rates must be higher than otherwise. In addition,the sales tax distorts economic decisions, therebycreating burdens that exceed those of a neutral system.As in the dream, the extra burdens created bycomplexity and discrimination are not borne equally byall parts of the economy.

A. ComplexityThe primary purpose of the SSTP is to reduce

the complexity encountered by vendors who mustcollect tax on sales to customers located in multiple

states. But vendors operating in only one state alsoencounter complexity. It is useful to understand thisfirst level of complexity before considering thecomplexity multistate vendors face.

1. Complexity for single-state vendorsExemption of products. Most sales tax states tax

most tangible products (goods), by enumerating thosethat are exempt, and exempt most services, byenumerating those that are taxed; most states implicitlyexempt intangible products, including digitized content— the hallmark of electronic commerce, since they arenot tangible. (Note that “products” includes servicesand intangible products, as well as tangible products,also called goods.) While the dividing line betweentaxed and exempt products is usually clear, this is notalways the case. Exemptions for food are notoriouslyambiguous, since they typically exclude such ill-definedcategories as “candy,” “prepared food,” and “soft drinks.”Thus Kit Kat candy bars, which are chocolate-coveredwafer cookies, may be taxable, even though “chocolate-covered wafer cookies” are explicitly exempt, anddeodorant and antiperspirants may be treateddifferently. Also, various states may require that, to beclassified as fruit juice, and therefore exempt, a beveragemust contain 10, 25, 50, or 100 percent juice. Nor doesthe result always make sense, as when raw peanuts,salted peanuts, and sugar-roasted peanuts are treateddifferently. Distinctions such as these inevitablycomplicate compliance.

Caps and thresholds.4 Rather than taxing orexempting all purchases of particular products, somestates employ caps and thresholds, exempting onlypurchases (e.g., of meals and clothing) that do notexceed a cap or taxing only those that exceed athreshold. Besides inviting manipulation (for example,buying pants and a matching coat separately to benefitfrom an exemption for clothing with a value below thethreshold), caps and thresholds create complexity.

Exemption of sales for resale. Recognizing thedistortions and inequities caused by pyramiding —levying tax on a product repeatedly as it moves throughthe production-distribution process — all states exemptsales for resale. States typically also exempt productsthat are physically incorporated in goods for resale, aswell as some other business purchases to be mentionedlater. Problems of interpretation abound in this area.For example, does a fast-food restaurant “resell” to itscustomers the napkins, plastic utensils, and containersthat it purchases? Is the coke used to fire a blast furnace

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physically incorporated in the steel that is produced, oris it merely a fuel?

Exemptions of sales for resale are, in the firstinstance, generally administered by having the purchaserprovide a resale exemption certificate to each of itssuppliers. The supplier is sometimes held liable for taxif the purchaser files a fraudulent exemption certificateor uses the goods purchased for a non-exempt purpose,unless it can demonstrate that it accepted the certificatein “good faith” — an amorphous standard that provideslittle certainty for the vendor.

Sales to and by tax-exempt organizations. Statesgenerally allow tax-exempt organizations to makepurchases required for the conduct of the activities forwhich their tax-exemption has been granted withoutpaying sales tax, utilizing procedures similar to those forsales for resale. In addition, states generally exempt salessuch organizations make in the conduct of theseactivities (e.g., tuition charged by universities);exemption of sales of taxable physical property is notcommon.

Sales tax holidays. A particularly perniciousform of complexity that has sprung up in recent years isthe sales tax holiday — a tax exemption for specifiedproducts such as children’s clothing and school suppliesbought during a specified period, usually just before thecommencement of the school year. Holidays raisedefinitional problems of the type already identified.Exactly what are “children’s clothing” and “back-to-school supplies?” Moreover, holidays may be grantedonly for purchases that do not exceed a cap, creatingcomplexity of the type already identified. Holidaysannounced without adequate notice impose onerousburdens on merchants, who must reprogram computerson a crash basis to deal with the exemptions.5

Local sales taxes. Local governments in aboutthree dozen states levy sales taxes. The existence of localsales taxes generally complicates life only marginally forvendors operating in just one state. Ordinarily localsales taxes take the form of surcharges levied on thesame base as the state tax and collected by the stategovernment. Since the vendor knows in which localjurisdictions its outlets are located, it is a relativelysimple matter to comply with such “piggybacked” localtaxes. An exception to this generalization may occurwhen a vendor makes a sale to a customer in a differentlocal jurisdiction in the same state. Depending on thestate, such sales may be subject to tax in the jurisdictionwhere the customer is located or in the jurisdictionwhere the vendor is located. Some states allow local use

taxes (some on a base that differs from the base of thelocal sales tax), but others prohibit them.6

The complexity created by local sales taxes is evengreater if local governments can levy tax on a base thatdiffers from that of the state tax or if they can requirethat taxpayers register and file tax returns with them.Either of these anomalous provisions can considerablyincrease compliance burdens, even for vendors makingsales in just one state.

2. Complexity for multi-state vendorsIf a vendor operates in only one state the

complexities mentioned thus far can be overcome, if noteasily. The real problem arises when a vendor mustcollect the sales or use taxes of many states. First, itmust address each of the problems identified in everystate where it operates. Second, it must deal with thelegal and administrative systems of each state. Theresulting complexity may be overwhelming, especiallyfor small remote vendors — of which there arepotentially many in electronic commerce.

Exemption of products. The fact that differentstates may tax and exempt different products is only thetip of the iceberg of complexity; they may also defineparticular products differently. Thus, even if the taxbase is ostensibly the same, it may actually be quitedifferent. A vendor must know the definitions of taxand exempt products in each state (and in each locality,in some states) where it must collect tax and be familiarwith relevant caps and thresholds. (One might liken thetax base of a given state to Swiss cheese. The holes ineach of the 45 state systems are different.)

Exemption of sales for resale. Some states aremore liberal than others in their exemptions forbusiness purchases. Some exempt only products thatare physically incorporated in the production process, inaddition to sales for resale. Others exempt materialsused or consumed in manufacturing or processingtaxable tangible products, even if not physicallyincorporated in the final product. Still others exemptmachinery and equipment used in manufacturingtaxable products. Some states also exempt industrialfuels, and some exempt sales of seed and fertilizer tofarmers. And, of course, definitions differ from state tostate. For example, in some states the exemption foringredients incorporated in the production processapplies only when the “primary purpose” of acquiringthe ingredient is to incorporate it into the final product;in others the exemption applies as long as a “substantial

Continued on page 8


portion” of the ingredient ends up in the final product;and in still others it applies as long as the ingredient isnecessary to production of the final product, regardlessof how minuscule the amount of the ingredient in thefinal product. Similarly, in some states the exemptionfor machinery used in manufacturing applies only whenthe machinery or equipment effects a “physical” changein the product or is “directly” used in manufacturing,whereas in other states the exemption applies to anymachinery or equipment that is part of an “integratedplant.” Multistate vendors must contend with thesevarious definitions.

Sales to and by tax-exempt organizations. Anon-profit organization that operates in multiple statesmust comply with the laws of each regarding itspurchases and its sales. Also, a firm selling to a non-profit in another state must know the exemption rulesof that state if it has nexus there. As with other aspectsof the sales tax considered thus far, there is nouniformity from state to state.

Sales tax holidays. The problems sales taxholidays create for vendors operating in one state arecompounded by the need to deal with temporarychanges in tax bases of more than one state, includingcaps on the temporary exemptions, and by the fact thatdefinitions of products that are eligible for thetemporary exemption can differ from state to state.

Local sales taxes. Local sales taxes can beparticularly burdensome for remote vendors, assumingthey have taxable nexus, because vendors must, at thevery least, identify the local jurisdictions of destinationand collect the appropriate local taxes. Levying a“blended” use tax rate that reflects the average of salestax rates throughout the state has been found to beunconstitutional, since the blended rate inevitablyexceeds the local tax rate in some jurisdictions.Moreover, a blended rate does not solve the problem of“sourcing” sales to local jurisdictions. Standard five-digit zip codes are not adequate for that, becauseboundaries of zip codes and local jurisdictions need notcoincide. (Use of 9-digit zip codes offers morepromise.)

If the local tax is collected as a surcharge on thestate tax these complications — which can be significant— are the only ones encountered. But in some states itis necessary to determine whether a sale is taxable orexempt when made to a particular locality and/orcomply with the administrative requirements of thejurisdictions of destination.

Legal structure and administrative procedures.Each state has its own statutes, regulations, andinterpretations thereof. Moreover, each state also has itsown administrative procedures — registrationrequirements; resale and other exemption certificates;requirements for filing tax returns, making remittances(including vendor discounts), and retaining records;procedures for audit, handling disputes, adjudication,etc. Thus a multistate vendor must know the legalframework and administrative procedures in each of thestates where it has a duty to collect tax.

Cumulative effects of state decisions. If a vendoroperated in only two states or made remote sales intoonly one state, it would need to contend with only twostate sales tax systems. But if a vendor made sales in alarge number of the 45 sales tax states and had to dealwith the sales and use taxes of each, the complexitycould be overwhelming. The problem would beaggravated by the need to trace sales to localjurisdictions and (in a few states) contend with localdeviations from the state sales tax base and/or localadministrative requirements.

B. Economic Distortions and InequitiesComplexity creates the Great Swamp and is a

significant part of the burden borne by the beast in thedream. But it is not the only burden. The current salestax system also creates considerable economicdistortion.7 In reality, as in the dream, all do not bearthese burdens equally. Thus the system is also unfair.

1. Consumption choicesBecause most goods are taxed and most services

are exempt, the sales tax system tilts consumer choices infavor of services, creating an avoidable loss of economicwelfare. It also discriminates against low incomehouseholds, who prefer to consume goods, and favorsthe more affluent, who prefer services.

2. Production-distribution decisionsThe economics of taxation teaches that no

legitimate costs of production and distribution shouldbe taxed, whether they be for goods bought for resale,intermediate products that enter the productionprocess, capital equipment, fuel, office supplies,transportation costs, or whatever.8 This principle isreflected in the sale for resale exemption mentionedearlier,9 but, as indicated, sales tax exemptions for salesto business are far from universal. It has been estimatedthat as much as 20 to 70 percent of sales tax revenues are



not derived from sales to individuals, depending on theparticular state.10 Thus the problem is not a minor one

Taxing business purchases has several adverseeffects. First, it distorts decisions on techniques ofproduction and distribution away from the mostefficient toward those that minimize tax on purchasedinputs.11 The advent of electronic commerce is likely toaggravate these distortions, by making markets forbusiness inputs function more efficiently than before.Second, it is unfair to place unequal burdens on firmsthat buy from other firms.

Third, the hidden tax costs inherent in the failureto exempt business purchases reduces the ability ofAmerican producers to compete, in both foreign anddomestic markets. Imports from Europe (and othernations that impose a VAT) bear little of no hidden taxcosts, due to the rebate of value added tax on exports.12

Because they bear hidden tax costs, American exports toEurope or to third countries are at a competitivedisadvantage. Eliminating these hidden costs wouldreduce imports and boost exports.13

Fourth, seen from the perspective of producers inan individual state, these hidden sales tax costs are aburden that domestic competitors do not bear. (Thispoint may require some clarification. Competitors fromsome states may face hidden tax costs that equal orexceed those of the state in question. But, seen from theviewpoint of any one state, those hidden tax costs are nomore relevant than any other costs incurred in otherstates. Competitors from states that have no sales taxeswill face few, if any, such hidden tax costs.) A policy ofimposing hidden tax costs on in-state producers seemsstrangely perverse, especially at a time when most statesare looking for ways to get a foot up on theircompetitors.14

Finally, when business inputs are taxed, part of thecost of government is hidden. Suppose that the salestax rate is 6 percent, but that 40 percent of sales taxrevenues are derived from sales to business. Thisimplies that the real cost of government financed withthe sales tax is 10 percent of sales, not 6 percent.

3. Discrimination against local merchantsAs noted earlier, the U.S. Supreme Court has ruled

that a state can require a remote vendor to collect its usetax only if the vendor has a physical presence in thestate. This de facto exemption of remote sales createsincentives for inefficient distribution of products — forexample, sending individual packages into a state, ratherthan sending boxes of products to local stores.15

Moreover, it is obviously unfair — to both localmerchants and their clientele — to exempt remote salesfrom taxes that are collected on sales by localmerchants.16 No wonder that Main Street componentsof the beast scream that the system is unfair.

C. How We Got into The Great SwampThe present sales tax system is not the product of

conscious policy; rather it is reflects historicalevolution. During the Great Depression, when revenuesfrom other taxes were declining, states were castingabout to find alternative sources of revenues and hitupon the sales tax. By the beginning of World War IIabout half the states levied sales taxes, and over timeother states adopted the tax, until now all but a handfulutilize it.17

Both the American economy and what we knowabout the adverse effects of unwise sales taxes were verydifferent 60 years ago. First, goods were far moreimportant than services, and the loss of revenue,economic distortions, and inequities caused by nottaxing services were much smaller and received littlethought. Second, ignorance of the economic cost oftaxing business inputs, demagoguery — the demandthat business should pay tax if families do, and thedesire to hide the tax led politicians to tax sales tobusiness.

Third, most retail sales were made by localmerchants that operated in only one state. Thuscomplexity for multistate vendors — and especially forremote vendors — was much less of a concern thannow. Responding to political pressures that played outdifferently in various states, each state actedindependently in deciding its tax base, establishing itslegal structure, and designing its administrativeprocedures. It is hardly surprising that the exercise offiscal sovereignty by individual states has created asystem that is so complicated that remote vendorscannot be expected to comply with it.

D. A Personal Comment on QuillThe physical presence rule of Quill produces

distortions and inequities that are undesirable — Imight even say unconscionable. This does not, however,mean that Quill was decided wrongly. The states hadhad 25 years, since the 1967 decision in National BelasHess, to simplify their sales taxes, by making them morenearly uniform. Instead, they continued to forcevendors with taxable nexus in multiple states to trudge

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through the Great Swamp. I have no doubt that wewould be stuck in that swamp forever if the SupremeCourt had ruled for the state in Quill. But the Courtprovided directions on how to escape the swamp. If thestates can simplify their sales taxes enough, either theCongress, acting pursuant to the Commerce Clause, orthe Court itself may eliminate the physical presencetest.18 That brings us to the question before theImplementing States of the SSTP: how to drain theswamp.

III. Draining the Sales Tax Swamp:Starting from First Principles

The best way to make massive improvements in taxpolicy — which is what the SSTP will need toaccomplish if either the Congress or the Supreme Courtis to ratify its work — is to start with a clear picture ofthe conceptual ideal. A conceptually principled retailsales tax, which might be described as an “economicallyneutral and compliance-friendly system,” would followseveral simple rules:19

If a product is sold to consumers, it is subject totax.

If a product is sold to a business, it is exempt.20

States would administer local sales and use taxes,using procedures that would allow vendors toidentify the local jurisdictions of destination(e.g., based on zip codes).

These rules would apply equally to localmerchants and to remote vendors, subject tode minimis rule. That is, remote vendorswould be required to collect tax if its sales tocustomers in a given state exceeded a deminimis amount.21

The legal framework and administrativeprocedures of all states would be identical.(Many of these features, which I cannotdiscuss in detail, might follow the outlines ofthe SSTP proposals.)

Multi-state “one-stop” administrative procedures(e.g., for registration, filing tax returns,payment of tax, and audit) should beemployed to the extent possible.

Under this approach states would retain full sovereigntyover the choice of state sales tax rates and could allowlocal autonomy over local rates. Differences in tax rates,even among localities, is not what causes complexity; it

is differences in tax bases between states (and withinstates in a few cases) and the need to determine the localjurisdiction of destination of remote sales. (Of course,as noted above in the discussion of sales tax holidays,changes in rates made frequently or without adequatenotice can cause complexity.)

A. Curtailing ComplexityThe proposed system is “compliance-friendly” and

would achieve Elegant Simplicity. It addresses a concernheard repeatedly in discussions of the SSTP, that “thedevil is in the details,” by simply eliminating many of theneedless details that complicate compliance and createthe current sales tax swamp.

There would be no need to define products,since liability for tax would depend solely onthe nature of the buyer, not on the nature ofthe product. (If products such as prescriptiondrugs and medical services are to be exempt,exemptions and definitions of exemptproducts should be identical in all states.)

All sales to business purchasers would beexempt; it would not be necessary for thevendor to inquire into the intended use of theproduct.22

Nexus would depend on the volume of sales in astate, not the fuzzy standard of physicalpresence.23

Businesses and tax exempt organizations that areeligible to make tax-exempt purchases wouldbe identified in a central registry, which coulduse digital certification and digital signaturetechnology to certify eligibility.

State and local sales tax bases would be identical.Vendors would need to deal with only one tax

administration in each state. Indeed, theywould conduct many transactions with themulti-state “one-stop” administrative shop.

Being based on sound principles, instead ofexpediency, the system would minimize the“sacred cow” problem (states holding out forretention of pet provisions), increasing thelikelihood of agreement on a common systemwithin two years, and there would be no needto change it in responses to future changes inthe economy.

Under this “elegantly simple” system a vendor located inany state, by knowing the sales tax law of its own state,



the nature of the buyer (consumer, business, or tax-exempt organization), and the location of the buyer,could comply with the law of any other state or localgovernment. Compliance software would presumablybe employed to implement the system, but it could bevastly simpler than that needed to implement the SSTPproposal described in the next section, let alone currentlaw.

B. Eliminating Distortions and InequitiesThis system is not only compliance-friendly; it is

economically neutral and fair.

All consumption would be treated identically.No business purchases would be taxed. There

would be no pyramiding..Local merchants and remote vendors would be

treated identically.Hidden taxes would not place local producers at

a competitive disadvantage in either domesticor foreign markets

The cost of government would be moretransparent.

C. Loss of State Fiscal SovereigntyAchievement of the economically neutral and

compliance-friendly system would entail some loss ofstate sovereignty (and of local autonomy) over taxpolicy. The question, then, is whether this loss ofsovereignty is acceptable. I believe that it is.

First, recall that the basic outline of the presentchaotic system — taxation of business inputs,exemption of services, and mind-numbing complexity— which results in the constitutional inability to requireremote vendors to collect tax — is the result of historicalevolution that began in a world that no longer exists.Fighting to retain elements of that antiquated systemthat are undesirable (or even unconscionable) is hardlya responsible exercise of fiscal sovereignty.

Second, not all decisions on sales tax policy areequally important. The most important decision is thechoice of tax rates; that is basically what determines theamount of revenue a tax yields. States (and localgovernments) should retain control over tax rates.

The second most important choice is whether or notto tax or exempt certain broad categories of products,such as food and clothing. While the desire to exemptthese products on social grounds is perhapsunderstandable, sales tax exemptions are an incrediblyblunt instrument to use for this purpose. Loss of

sovereignty in this area would not be much of a loss.Supposing that some products are to be exempt,

definitions that are uniform across (and within) statesare required to minimize complexity. For example, foodshould be defined the same way in all states. Theinability of a state to define food in one of 45 differentways is really a small loss of sovereignty. Similarcomments can be made about many of the other sourcesof complexity in the current sales tax, such asdifferential treatment of specific products (e.g., candyand soft drinks), legal structure, and administrativeprocedures. These secondary elements of sovereigntycome at too high a price: needless complexity, unfaircompetition local merchants experience, and loss ofrevenues.

Before leaving the subject of fiscal sovereignty it isworthwhile to note briefly the experience of theEuropean Union (EU). Under the Treaty of Rome, the“constitution” of the EU, agreement on tax mattersrequires unanimous approval of all members; it is hardto imagine more fiscal sovereignty than that. Yet, inorder to create a single market, the members of the EUlong ago ceded the sovereignty implied in this vetopower to create a sales tax system (the value added taxor VAT) that is much more nearly uniform in importantrespects than that found in the United States, as well asbeing more nearly economically neutral.24 (Membersretain the power to set tax rates.) If the nations ofEurope, which have repeatedly been engaged in warsagainst each other, are willing to accept mutual limits ontheir sovereignty in order to achieve this level ofuniformity, why cannot the American states do so?

IV. SSTP: Must a Lesser Bog Be theDestination?The Streamlined Sales Tax Project has made amazing

progress in achieving simplification. Its proposal wouldsubstantially drain the sales tax swamp.25 Yet it wouldnot achieve either Elegant Simplicity or economicneutrality because of unwillingness to go the full nineyards.

There are two variants of draft legislation emanatingfrom the Project, the “SSTP draft” approved by the SSTPin December 2000 and the “NCSL draft” approved bythe executive committee of NCSL in January 2001.What I call “the SSTP approach,” which involvessimplifying just enough to pass muster in the Congressor the Supreme Court, without rationalizing the system,underlies both.



A. SimplificationI cannot comment on all the simplifications

proposed by the SSTP.26 Rather, I will comment only onthe features that most markedly distinguish the SSTPapproach from the economically neutral andcompliance-friendly system described earlier. This doesnot, however, mean that the SSTP simplifications that Ido not discuss are unimportant; indeed, they arerequired to drain the swamp. Also, some reforms thatare important in their own right, such as the eliminationof tax on sales to business, might not be required topersuade the Supreme Court or the Congress to approvean expanded duty of remote sellers to collect tax, eventhough they would contribute to simplification.

Exemption of products. Rather than adoptingthe conceptually correct approach, in which all productswould be treated the same and taxation or exemptionwould depend solely on the status of the purchaser, theSSTP draft would maintain the present approach, inwhich some products are taxed and some are exempt. Itwould simplify compliance by providing uniformdefinitions of broad categories of products from whicheach state could construct its tax base, by taxing orexempting the category. The NCSL draft follows thesame approach, but would not achieve even this degreeof simplification.

Exemption of sales to business. The SSTP andNCSL drafts would also maintain the present approachto the treatment of business inputs, in which onlyselected business purchases are exempt. They wouldeliminate the “good faith” requirement for acceptance ofcertificates of exemption for resale, but would nototherwise simplify the determination (by the buyer) ofwhether or not a purchase made by a business in a givenstate is exempt.

Local taxes. The SSTP draft requires uniformityof the state and local tax bases in each state; bycomparison, the NCSL draft would allow local tax basesto deviate from the state base. While softwarecompanies are confident that they can handle localdifferences in tax rates (and the need to channel revenueto the right local jurisdiction), they are understandablyless sanguine about their ability to handle localdifferences in tax bases.27

B. Remaining Distortions and InequitiesMany of the important distortions of economic

decisions and inequities that characterize the currentsystem would remain under the SSTP approach. In

particular, sales taxes would continue to punishproducers, sellers, and purchasers of taxable productsand reward producers, sellers, and purchasers of exemptones. They would continue to distort decisions onproduction and distribution and to discriminate againstproducers who must pay tax on their purchases. Ibelieve that these are major shortcomings of the SSTP.On the other hand, if something like the SSTP draftwere adopted the existing de facto discriminationagainst local merchants might be eliminated. I addressthat issue now.

V. The Political and Judicial FutureLess than two weeks ago the Congress voted to

extend the Internet Tax Freedom Act for two years. Itdid not provide any assurance that it would eliminatethe physical presence test of nexus if the states simplifiedtheir sales taxes. The question, then, is whethersimplification is worth the candle.

The answer, it seems, is a resounding “Yes.” First,even if there were no question of nexus for remotevendors, it is unconscionable that there is so littleuniformity in the state sales taxes. The existing diversitycreates overwhelming complexity, with little real gain instate sovereignty. I would urge the Implementing Statesof the SSTP to simplify the system because it is the rightthing to do.

But there is a question of nexus for remote vendors.Here I would argue that the issue is not so much one ofrevenue, although revenue losses may become moreimportant with the maturation of electronic commerce.Rather, I believe that the primary issue is one ofeconomic neutrality and fairness. It is neither sensiblenor fair to place Main Street merchants at a competitivedisadvantage, relative to remote vendors.28 If thedistortions and inequities created by the physicalpresence rule are to be eliminated, state and local salestaxes must be simplified.

There are two ways the physical presence rule mightbe overturned: by an act of Congress or by the SupremeCourt reversing Quill. There is no way of predictinghow much simplification is enough for either of thesebodies. Prediction is difficult in the case of the Congressbecause it involves weighing the relative influence ofrepresentatives of state and local governments and oflobbyists for the various business groups that reformwould affect differently. In the case of the SupremeCourt the key question is the relative weight the Courtwould place on eliminating artificial influences oninterstate trade and on stare decisis (let the decision



stand), the doctrine that seems to have been soimportant in the Quill case — and, of course, the extentto which simplification had been achieved.

Though one cannot be sure, I believe that the Courtwould find the “economically neutral and compliance-friendly system” described earlier would provide enoughsimplification that it would choose neutrality andfairness over blind allegiance to stare decisis. I am lessconfident that it would reach the same decision ifconfronted with the SSTP draft. If it did, we might beout of the Great Swamp, but we would not have reachedElegant Simplicity. (It probably would not — andshould not — find that the NCSL draft providedenough uniformity.)

This leaves the question of how to achieve multi-state agreement on a more uniform sales tax system. Iwould, of course, hope that I have made a case for theeconomically neutral and compliance-friendly systemthat is so convincing that all the sales-tax states wouldimmediately sign on and proceed directly to ElegantSimplicity. It is probably more realistic to hope that acore group of states will form a nucleus around whichother states will coalesce.29 Once enough states haveagreed on a common system that is more nearlyuniform, and thus simpler, “ tipping” may occur, asother states join. (Congressional or judicial sanction ofa system, indicated by allowing an expanded duty of

remote vendors to collect the use taxes of statesadopting the common system, would almost certainlycreate tipping.) In that case, I hope the core group willsee the light and choose Elegant Simplicity over theLesser Bog.

VI. Concluding Remarks: Still DreamingAs I return to my perch above the clearing I see a

group of men and women who have an opportunity —and a challenge — that few have had in our nation’shistory. They have the opportunity to lay thegroundwork for an “elegantly simple” sales tax systemthat is appropriate for the 21st century. In a sense theyare being asked to create a miniature “economicconstitution” that will free the American economy fromthe burden of complexity and economic distortionunder which it has long labored because of the chaoticand illogical structure of the sales tax — and to strike ablow for fairness in the bargain — much as theEuropean Union did almost 40 years ago when itdecided to adopt the VAT. But they will need to resistthe temptation merely to tinker that is inherent in“politics as usual” and go the full nine yards. I hopethey are up to the challenge.

Cline, Robert J., and Thomas S. Neubig (2000). Mastersof Complexity and Bearers if Great Burden: TheSales Tax System and Compliance Costs forMultistate Retailers, State Tax Notes, Vol. 18(January 24), pp. 297-313.

Diamond, Peter A., and James A. Mirrlees (1971).“Optimal Taxation and Public Production II: TaxRules,” American Economic Review, Vol. 61, No. 2(June), pp. 261-78..

Due, John F., and John L. Mikesell (1994). SalesTaxation: State and Local Structure andAdministration. 2nd ed. Washington: UrbanInstitute Press.

Hellerstein, Walter (1996). “Commerce ClauseRestraints on State Business DevelopmentIncentives,” Cornell Law Review, Vol. 81, No. 4(May), pp. 789-878.

REFERENCES

Hellerstein, Walter (1997). “State Taxation of ElectronicCommerce.” Tax Law Review, Vol.. 52, No. 3(Spring), pp. 425-506.

Hellerstein, Walter, and Charles E. McLure, Jr. (2001).“Sales Taxation of Electronic Commerce: WhatJohn Due Knew All Along,” State Tax Notes, Vol. 20,No. 4 (January 1), pp. 41-46; also in theproceedings of the 93rd annual conference ontaxation of the National Tax Association, Santa Fe,November 11, 2000, pp. 216-22.

McLure, Charles E., Jr. (1987). The Value Added Tax: Keyto Deficit Reduction? Washington: AmericanEnterprise Institute.

McLure, Charles E., Jr. (1998a). “Electronic Commerceand the Tax Assignment Problem: Preserving StateSovereignty in a Digital World.” State Tax Notes,Vol. 14 (April 13), pp. 1169-81.


McLure, Charles E., Jr. (1998b). “Achieving a LevelPlaying Field for Electronic Commerce.” State TaxNotes, Vol. 14 (June 1), pp. 1767-83.

McLure, Charles E., Jr. (2000). “The Taxation ofElectronic Commerce Background and Proposal.”In Public Policy and the Internet Privacy, Taxes andContracts, Nicholas Imparato (ed.). Stanford, CA:Hoover Institution Press, pp. 49-113.

McLure, Charles E. Jr. (forthcoming, a). “TaxingElectronic Commerce: Legal, Economic,Administrative and Political Issues,” prepared forpresentation at the Annual Meeting of theAssociation of American Law Schools, SanFrancisco, January 5, 2001, Urban Lawyer.

McLure, Charles E. Jr. (forthcoming, b). “Taxation of

1In the presentation draft this trail was marked “Terra Firma.”I have renamed it in response to Governor Mike Leavitt’splea for a plan that is “elegantly simple.”

2I will generally use the generic term “sales tax,” instead of thetechnically more accurate term “sales and use tax,” but willuse “use tax” where context requires it. Strictly speaking,states can impose sales tax only on sales that occur withinthe state. They can impose use tax on the use of productsbought outside the state for use in the state, to compensatefor the constitutional inability to levy sales taxes on suchtransactions. Under the typical state statute a vendor doingbusiness in the state has an obligation to collect sales or usetax due with respect to products sold to in-state purchasers,with liability imposed on the purchaser if the vendor fails tocollect the tax. Because such vendors will almost alwayshave constitutional “nexus” with the state when sales occurswithin the state, the state can ordinarily require the vendorto collect the sales tax on sales to local purchasers. As notedin the text, however, the U.S. Supreme Court has ruled thata state cannot require an out-of-state vendor to collect thetax imposed with respect to the sale — technically the “use”tax — unless the vendor has a physical presence in the state.In principle, the state could collect use taxes directly fromlocal consumers, who are legally liable for the tax. It is,however, generally infeasible (or at least not cost-effective)for states to collect use taxes directly from purchasers,except in the case of business purchasers (who are subjectto audit) and goods that must be registered to be used, suchas automobiles. The only potentially effective way to collectuse taxes on most remote sales to individuals is for vendorsto collect them.

Electronic Commerce in the European Union,”prepared for presentation at a conference on“Tax Policy in the European Union.” held at theResearch Center for Economic Policy, ErasmusUniversity, Rotterdam, October 17-19, 2001.

Ring, Raymond J., Jr. (1999).”Consumers’ Share andProducers’ Share in the General Sales Tax,”National Tax Journal Vol. 52 (March), pp. 79-90.”.

Rosen, Arthur R. (McDermott, Will & Emery), andSusan K. Haffield (Andersen LLP), (2001) “TheStreamlined Sales Tax: An Effort That WillProfoundly Effect All American Businesses.”

Shoup, Carl S. (1969). “Experience with Value AddedTax in Denmark, and Prospects in Sweden,”Finanzarchiv (March), pp. 236-52.

ENDNOTES

Under current law “vendors who must collect tax onsales to customers located in multiple states” would be onlythose that have a physical presence where their customersare located. But in reading these words from the text it isuseful to consider the hypothetical situation in whichremote vendors who do not have a physical presence arerequired to collect the tax of the states where their custom-ers are located.

3Acting pursuant to the Commerce Clause of the Constitution,the Congress could eliminate the physical presence require-ment. Or the Supreme Court could rule that the system hasbeen simplified enough that the physical presence rule is nolonger appropriate.

4This point does not appear in the presentation draft.5See Cline and Neubig (2000).6See Due and Mikesell (1994).7For further discussion, see McLure (1998a), (1998b).8The obligatory reference is Diamond and Mirrlees (1971).9The principle is also respected in the income tax. It would be

rare to find someone arguing that deductions should not beallowed for all legitimate business expenses.

10See Ring (1999).11The most obvious example occurs when a firm provides its

own supplies instead of purchasing them — a form ofvertical integration. Beginning in the late 1960s themembers of the European Union replaced their taxes ongross receipts, which were levied every time a product wassold (thus the term “turnover tax”), with value added taxes,which provide a credit for tax paid on purchases. Beforethat textbooks commonly decried the distortions such taxescreated, including the tendency toward vertical integration.


Although the exemption of sales for resale greatly reducesthese distortion, extant state sales taxes nevertheless containan important element of turnover taxation. For evidencethat this problem has been recognized in Americanundergraduate textbooks for at least 40 years, seeHellerstein and McLure (2001).

12Those unfamiliar with the mechanics of the VAT mightconsult McLure (1987).

13Over time this effect might be mitigated by changes inexchange rates. But exchange rates reflect many influences.Elimination of the hidden tax, even if combined with achange in exchange rates, would leave those sectors that arecurrently most adversely affected by the hidden tax in animproved position, relative to others. This implies thatproducers in states that currently impose the greatesthidden tax burden have the most to gain from rationaliza-tion of tax policy in this area.

14States often resort to techniques of attracting business thatare patently unconstitutional under the Commerce Clause;see Hellerstein (1996). By comparison, encouraging in-state production by eliminating sales tax on businesspurchases is a clearly constitutional.

15To illustrate the point, consider the following particularlymindless and fallacious argument for exempting sales byremote vendors — that drivers of UPS and FedEx deliverytrucks would create economic activity, for example, bybuying lunches. (Purchases of trucks, tires, and fuel couldhave been added to the list to swell the supposed economicbenefits.) Carrying that argument to the extreme, wewould simply ban all sales by local merchants, so thateverything would be delivered directly to consumers fromout-of state. Of course, doing so would entail enormouseconomic costs. Deliberately imposing a tax penalty onlocal merchants (except as required to avoid an unconstitu-tional burden on interstate commerce) is merely a lessextreme form of this madness. For refutation of otherfallacious arguments see McLure (2000).

16Another fallacious argument is that remote vendors shouldnot be required to collect tax because they do not benefitfrom services provided by the states and localities wheretheir customers are located. (This argument is sometimescombined with an argument for “no taxation withoutrepresentation.”) But remote vendors merely collect thetax; they do not “pay” it. Their customers, who do benefitfrom public services (and do have representation), pay thetax.

17For more on the evolution of the sales tax, see Due andMikesell (1994).

18It is important that the Court based its decision in Quill onthe Commerce Clause. If it had based it on the Due ProcessClause, Congress could not eliminate the physical presencetest.

19I describe this system in greater detail in McLure (2000).20A similar approach would be used for exempt purchases by

non-profit organizations, which would properly be exempt,

whether made for use in the activities for which theorganization is granted exempt status or for businesspurposes.

21This point does not appear in the presentation draft. Nexusin a state would create nexus in all local jurisdictions in thestate.

22It would, of course, be necessary to prevent the diversion toconsumption of products bought on a tax-exempt basis.Under a single-stage sales tax this can be achieved onlythrough audits of the purchaser, which would involveverification of the business purpose of exempt purchases. Abasic difference between the RST and the VAT is that, in thefirst instance, the purchaser need only lie to its supplier toevade the RST on “business inputs” intended for personaluse, whereas it must lie to the tax authorities to evade theVAT; see Shoup (1969). It would be possible to construct ahybrid “RST with credits” that would combine the featuresof the current RST and the VAT. Thus some business inputscould continue to be taxed, as now, but business purchaserscould be allowed credit for tax on inputs, as under the VAT.Such a scheme could be used to ease the revenue cost oftransition to exemption of all business purchases, byallowing only partial credits for taxes on business pur-chases.

23This point does not appear in the presentation draft.24Services are taxed, businesses are allowed credit for tax paid

on purchases, and remote sales of tangible products tohouseholds in excess of a threshold are subject to the VATof the destination state. The primary conceptual defect inthe VATs levied in the EU is the treatment of remote sales ofservices, which includes digital content; see McLure(forthcoming, b).

25See the SSTP Website, http://www.geocities.com/stream-lined2000/, for valuable references, including the texts ofthe two variants of the legislation. See McLure (forthcom-ing, a) for an early appraisal of the draft legislation andRosen and Haffield (2001) for a current analysis.

26See, however, McLure (forthcoming, a).27See Rosen and Haffield (2001).28To see this, consider the outcry that would ensue if there

were a national sales tax that did not apply to imports fromabroad. Yet that is exactly analogous to the de factosituation that prevails under state sales taxes, because of theQuill decision.

29In one sense this is what happened in Europe. The originalmembers of the European Common Market (the pre-cursorof the EU) adopted the VAT and any new members wererequired to adopt that system as a condition of member-ship. The obvious and important difference is that thevarious states are already part of the United States and willnot be booted out of the Union simply because they do notadopt a sales tax system that is adopted by other states. Butthey may be denied the right to impose an expanded dutyto collect use tax.


The 4R ActThe 4R Act was enacted to protect the then financiallydistressed railroad industry from potential discrimina-tory1 property tax treatment by individual states. The4R Act provided the railroad industry with the impor-tant benefit of bypassing state courts—and allowingrailroad companies to take their claims directly to thefederal courts—to contest allegedly discriminatory stateproperty taxes. However, since the 4R Act was enacted,the political and legal climate regarding congressionalpreemption of state sovereignty has undergone sweep-ing change. The single largest change has been fueled bya string of decisions rendered by the U.S. SupremeCourt since 1996, which undermine the constitutionalbases for congressional power to impose the 4R man-date on the States in a jurisdictional and, potentially, asubstantive sense.

Constitutionality of Grant ofFederal Court Jurisdiction

Commerce ClauseIn 1996, the U.S. Supreme Court released its decision inSeminole Tribes of Florida v. Florida, [cite] in which itexplicitly overturned established precedent and ruledthat Congress does not have the power under the U.S.Constitution’s Indian Commerce Clause to abrogate aState’s 11th Amendment sovereign immunity from suitin federal court—i.e., to force States to defend them-selves against a legislatively created federal cause ofaction in federal court. Any attempt by Congress to do

so overreaches its legislative authority, and is thereforeunconstitutional. Significantly, the Court also ruled thatno one aspect of the Commerce Clause—i.e., Indian,Interstate or Foreign—is more authoritative thananother in terms of the reach of and the limits tocongressional power over the States. So, althoughSeminole was not a state tax case, its implication forcongressional authority to abrogate the States’ 11th

Amendment sovereign immunity from suit in federalcourt under other aspects of the Commerce Clause isunmistakably clear: The 4R Act’s grant of jurisdiction tofederal courts over a railroad’s state tax challenge maywell be nullified because it is so clearly based on theinterstate Commerce Clause.

Fourteenth AmendmentAfter the Seminole decision, however, the railroadsmade the alternative argument that because the 4R Actis concerned with the “discriminatory” tax treatment ofrailroads, Congress could have invoked its powers underthe 14th Amendment to force States to submit to federalcourt jurisdiction in 4R cases. On its face, this argumenthas some appeal, since the 14th Amendment, as inter-preted by the Court, confers upon Congress the author-ity to enact all laws “necessary and proper” to secureagainst State noncompliance the rights guaranteed bythat Amendment, including that granting a private rightof action against States in federal courts. Although theU.S. Supreme Court has in the past declared thatcongressional power to address state recalcitrance underthe Amendment is quite broad, see, e.g., Dennis v.Higgins, 498 U.S. 439, 444 (1991), recent decisions hold

Draft Article on 4R for MTC ReviewIn recent years, the U.S. Supreme Court has issued a number of opinions concerning

federalism issues, which purport to clarify the balance of power between the states and the

federal government, in both a jurisdictional and substantive sense. While none of these deci-

sions dealt with matters of state taxing authority, they could nevertheless have a fairly substan-

tial impact on the scope and power of such authority in the face of federal preemption. Despite

the magnitude of the issue, the U.S. Supreme Court has refused to review two 9th Circuit cases

that squarely presented the question of reach of congressional power to preempt the state tax

power in the context of property taxation.


that that power is not unlimited. Since 1997, the Courthas released opinions that cast serious doubt on therailroads’ assertions that the congressional grant ofjurisdiction over 4R challenges brought in federal courtremains valid due to the reach of the 14th Amendment.

In City of Boerne v. Flores [cite](1997), the Court ruledthat the congressional legislative power under the 14th

Amendment is remedial and limited in scope. Congres-sional legislation may only be used to redress historical,deliberate and ongoing constitutional wrongs that aredefined by the Court under the substance of theAmendment. The text of the remedial legislation mustclearly state the Congress’ findings regarding these“historical wrongs” and document the difficulty inaddressing these wrongs without federal legislation.Without sanction by the Court, any remedial legislationintended to redress alleged constitutional wrongs isvoid. Although not before the Court, the implication ofthe Boerne decision is that the inclusion of a grant offederal jurisdiction to hear claims brought under such astatute is likewise void.

Although Boerne, like Seminole, is not a state tax case,application of the Boerne Court’s logic to the 4R Actcould imply that Congress had no authority to grantrailroads a protected status allowing for private a rightof action against the States, whether in a state or federalforum. Congress cannot provide for a private right ofaction under the 14th Amendment because 1) the Courthas not interpreted the 14th Amendment as extendingprotection to the railroad industry as a class of persons;and 2) the legislative history of the 4R Act thereforecontains no findings of either historical or ongoingunconstitutional tax actions against the railroad indus-try. This conclusion about congressional power underthe 14th Amendment does not impact the power ofCongress under the Commerce Clause, a whole differentbasis for congressional legislation, with the exception ofthe lack of any power to create federal court jurisdictionunder the Commerce Clause.

If the Boerne decision left doubts as to the Court’sthinking regarding congressional power under the 14th

Amendment to establish a right to bring a claim againstStates, Kimel v. Florida Board of Regents, No. 98-791(2000) dispelled that uncertainty (at least outside thecontext of state taxation). The Kimel Court once againconsidered the extent of congressional power under the14th Amendment to authorize statutorily created private

rights of action against States and found it lacking.Reviewing the legislative history of the Age Discrimina-tion Act, the Court noted the congressional findingsevinced no evidence that the States had engaged inunconstitutional conduct that required a federal remedy.It also restated its Boerne premise that it is the SupremeCourt, not Congress, that has the authority to determinethe substantive rights guaranteed by the 14th Amend-ment. The Kimel plaintiffs, the beneficiaries of Congress’protection from State action were not a class of personsdetermined by the Court—either historically or in thiscase—as being in need of such protections. Finally, theCourt noted that the Kimel plaintiffs were not leftwithout remedy, because a similar action could be hadat state law.

As applied to the 4R Act, Kimel unequivocally reinforcesthe logic of Boerne—Congress has no power under the14th Amendment to provide the railroad industry with aprivate right of action or access to federal courts toremedy the States’ alleged unconstitutional behaviorwith respect to property taxation. Railroads are notprotected as a “special class” within the meaning of the14th Amendment that would justify close scrutiny by theSupreme Courtunder existing precedent of the SupremeCourt. Additionally, the 4R legislation documents noinstances of historic or current unconstitutional behav-ior by States with regard to state taxation of railroads.Because it is not a “suspect” (or protected) class, thestandard of scrutiny given to state tax laws pertaining tothe railroad industry is much lower than the strictscrutiny courts are required to give state laws applicableto a protected class of persons. Since the railroadindustry is not a suspect class, it follows Congress lacksauthority to grant the industry federal protection.Therefore, the grant of a private right of action andjurisdiction to the federal courts over 4R violations isnecessarily void under the 14th Amendment.

Boerne and Kimel illuminate another aspect of thequestion of whether Congress could have enacted the4R Act using its 14th Amendment powers. Both casesstress that before congressional remedial power underthe 14th Amendment can be invoked, the State’s conducttoward a certain class of persons must have been (or be)unconstitutional and States must have engaged in thisunconstitutional behavior in a historical and currentcontext. In assessing whether there is existence ofpossible unconstitutional behavior, the Court employstwo standards of review.2



The first standard of review is the “standard scrutiny”approach that recognizes that States are generally free tocreate different classes of persons for a variety ofpurposes. Thus, a 14th Amendment equal protectionchallenge to state law will be rejected as long as theclassification resulting in differential treatment ofpersons under the law is rationally related to a legitimategovernment purpose and the adopted legislation uses areasonable means to achieve the State’s goal. In mostinstances, the standard scrutiny is not a particularlydifficult hurdle for a state law to overcome. This isespecially true in the tax context; state legislatures createdifferent classes persons, property and activities andsubject these classes to different rates, different taxes, etc.These tax classifications, though discriminatory, gener-ally do not rise to the level of constitutional equalprotection violations.3 In the tax context, discriminationbetween different classes of taxpayers is generallyconstitutional; discrimination between taxpayers withina specified class is generally unconstitutional. Moreover,before the 4R Act was passed, the U.S. Supreme Courtruled that the then existing differential (i.e., discrimina-tory) treatment of railroad property, as opposed toother types of property, was not unconstitutional.4

Regardless of the constitutionality of state taxingsystems prior to passage of the 4R Act, one can note thatthe methods of taxation of railroads have changed toleave no doubt as to their constitutional muster underthe 14th Amendment.

Thus, if it is accepted for argument’s sake that the 4R Actwas passed pursuant to Congress’ 14th Amendmentpower, Boerne and Kimel strongly suggest that Congressoverreached its constitutional authority in authorizingaccess to the federal courts to bring a private right ofaction under the 14th Amendment’s constitutionalprotections. Congress might invoke its other powersgranted by the Constitution (Commerce Clause, etc.) torender illegal (or , under the Supremacy Clause, uncon-stitutional) conduct that passes 14th Amendmentconstitutional muster, but it cannot then invoke § 5 ofthe Amendment to provide access to a federal forum fortaxpayers to litigate its claims. Stated another way, withthe passage of 4R Act, Congress made existing stateproperty tax systems as applied to railroads illegal, andhence unconstitutional, under the Commerce Clause,but it did not—and could not—make such conduct adenial of equal protection. Therefore, since the pre-4RAct tax treatment of railroad property was not a viola-

tion of 14th Amendment guarantees, there existed nobasis on which Congress could have invoked its 14th

Amendment powers when enacting 4R Act to over-ride a State’s 11th Amendment sovereign immunityfrom suit in federal courts.

State Court JurisdictionAnother jurisdictional issue to be considered iswhether a railroad can mount a challenge under the4R Act in state court. While the answer to this ques-tion may appear obvious, there is reason to believethat it might not be so clear. In National Truck Coun.v. Okla. Tax Comm’n, 515 U.S. 582 (1995), the Courtruled that state courts are not required to provideinjunctive or declaratory relief in state tax casesbrought pursuant to 42 U.S.C. § 1983 (Federal CivilRights Act) where there exist adequate remedies atstate law. Citing the “strong background principle of[federal] noninterference with state taxation”, theCourt observed that since 1871, it has consistentlyheld that federal courts cannot enjoin the collection ofstate taxes when an adequate remedy at law is avail-able. This same principle is equally applicable to §1983 state tax cases brought in state court. The Courtdeclared that in enacting § 1983, “Congress simply didnot authorize the disruption of state tax administra-tion in this way.” The 4R Act explicitly permits federalcourts to grant taxpayers injunctive and declaratoryrelief from a state tax deemed in violation of the Act.But the Court’s National Truck Council ruling un-equivocally bars federal courts from taking suchaction pursuant to the Act, and by extension appearsto bar state courts from doing the same. Of course,taxpaying railroads could still challenge any state taximposed on them in violation of the 4R Act usingexisting adequate state tax remedies to raise thesubstantive arguments.

Substantive State Tax Policy andInterstate Commerce

Fourteenth AmendmentAs the preceding discussion on the legality of Con-gress granting federal court jurisdiction over a 4Rclaim notes, the Boerne and Kimel decisions alsosuggest that the 4R Act itself is substantively invalid asan exercise of congressional power under the 14th

Amendment. (See below for a discussion of thesubstantive validity of the Act under the Commerce



Clause.) Both decisions stress that the 14th Amendmentpower is limited to protecting substantive rights definedby the Court against erosion through carefully craftedlegislation. Boerne and Kimel thus went far beyondSeminole by striking down the substance of the legisla-tion and not merely the grant of access to the federalcourts to bring suit against the State. In the context ofthe 4R Act, extending the logic of Boerne and Kimelcould mean that without some basis for claiming Statetaxation of railroads results in constitutional violations,Congress had no authority under the 14th Amendmentto fashion protective legislation, much less grant accessto federal courts, for the benefit of that class.

Commerce ClauseThe substantive validity of the 4R Act’s under theCommerce Clause most likely remains unimpaired. Along line of U.S. Supreme Court precedent holds thatthe Commerce Clause gives Congress plenary power toregulate interstate commerce, and a state’s authority totax such commerce is subject to that power.

Action by the U.S. Supreme Courtin 4R Act Cases

In its 1999 term, the Court refused to address thejurisdictional and substantive 4R Act issues. The Court,without comment, denied certiorari in two 4R casesfrom the 9th Circuit, in which two different appellatepanels reached opposite conclusions on the federaljurisdictional issue. What is especially interesting aboutthese cases is that the two 9th Circuit judgementsstemmed from one consolidated case that was bifur-cated on appeal. In Southern Pacific Ry. v. Board ofEqualization, No. 98-15320 (9th Cir. 7/6/98) (unpub-lished), a 9th Circuit panel summarily vacated thejudgement and remanded the matter to the districtcourt for reconsideration in light of Oregon Short LineR.R. Co. v. Oregon Department of Revenue, 139 F. 3d1259 (1998) (ruling that the 4R Act is a valid exercise ofCongress’ 14th Amendment powers). Yet in Atchison,Topeka and Sante Fe Railroad Co. v. Board of Equaliza-tion, No. 98-16128 (9th Cir. 11/13/98) (unpublished),another panel summarily affirmed the holding of thedistrict court, which ruled—after a thorough analysis—that the 4R Act could only have been based on theCommerce Clause and not the 14th Amendment, so thatfederal court jurisdiction over the case is invalidated. Itis also interesting to note that a 10th Circuit appellate

panel sitting in Utah upheld the 4R Act as an exercise ofCongress’ 14th Amendment powers, but a district courtsitting in Wyoming adjudicated a separate, earlier casethat was not appealed, and reached the opposite conclu-sion.5 The unwillingness of the Court to address theseissues means that they will continue to be played out infederal and state courts.6

Response of the Lower Courts

A review of the 4R cases rendered since the U.S. Su-preme Court’s Boerne and Kimel decisions in 1997 and1998, respectively, reveal some division in the federalcircuits on the question of the applicability these casesto the 4R jurisdictional issue7. Some courts opinionsgive only superficial treatment to the 14th Amendmentarguments, justifying congressional action on thegrounds that 4R was enacted to cure discriminatorystate tax practices with respect to railroad property.8

Because of the lack of analysis in these opinions, itappears that the courts reached these conclusions basedon the use of the term “discriminatory” in the text of theAct; in none of these cases does the court analyze thejurisdictional arguments in light of Boerne and Kimel.Other courts have managed to avoid the questionentirely by ruling that the challenged levy was a fee, nota tax, and therefore not within the province of 4R.9 Ahandful of courts have evinced thoughtful reasoning intheir determination of the jurisdictional issue; notsurprisingly, these courts have found that the 14th

Amendment does not support the grant of federaljurisdiction over 4R cases.10

One should not read too much into the SupremeCourt’s refusal to hear the 9th Circuit 4R cases. A denialof a petition for certiorari is not the same as a decisionon the merits. One can speculate on a number ofreasons why the Court declined to review the cases, butultimately it always comes down to the fact that theJustices could not muster enough votes to grant certio-rari. Perhaps the Court is reluctant to extend the logic ofthese decisions that do not involve property issues tocases concerning court jurisdiction over otherwiseconstitutional state action that diminishes a person’srights in property.11 It should be noted that at presentmore federal appellate courts than not have decided that4R’s grant of federal jurisdiction remains valid underthe 14th Amendment. Unfortunately, it is unlikely thatthe Supreme Court will revisit the issue anytime soon.


ENDNOTES

7Following Seminole, all of the lower courts have invalidatedfederal court jurisdiction over 4R Act challenges based onthe Commerce Clause.

8 For example, Oregon Short Line (see main text for citation).9 Wheeling & Lake Erie Railway Co. v. Public Utility Commis-

sion of the Commonwealth of Pennsylvania, 141 F. 33d 88(1998), cert. denied 120 S.Ct. 324 (1999).

10 Indeed, a conversation with the counsel of record in CSXTransportation, Inc. v. Board of Public Works, West Virginia,No. 97-1296 (D.C. W. Va.) case revealed that the districtjudge hearing the matter believed that the state’s argumentsfor lack of jurisdiction were worth exploring. While thestate lost the case, the judge said that it was more becausehe felt constrained by the earlier ruling of the 4th Circuitthan because he believed that the state’s arguments wereincorrect.

11 It has been suggested that review was denied because theCourt believed the Circuit Courts were capable of reachingthe right reason (federal court jurisdiction does notsurvive) if they only used a modicum of legal reasoning.The fact that the Circuits Courts in most instances havereached the opposite conclusion indicates that the courtsare using more like a scintilla of legal reasoning. If theCircuit Courts are wrong, then the Supreme Court needs tosay so.

5 Union Pacific Railroad Co. v. Utah, 198 F.3d 1201 (10th Cir.1999) and Union Pacific Railroad Co. v. Burton, (D.C. Wyo.1996), respectively.

6 The 9th and 10th Circuit opinions dealt only with the questionof federal jurisdiction. To date, no court—federal or state—has dealt with the continued substantive validity of 4R, i.e.,the creation of a private right of action against the Statesunder the 14th Amendment.

1The term “discriminatory”, as used here, requires someclarification. Discriminatory treatment in the tax contextdoes not necessarily have the same connotation as it does inother ares of law, such as civil rights. Every tax system thatsorts individuals, property, etc. into different classes withdifferent tax treatment is discriminatory. In other words,discriminatory treatment is often just another way ofindicating that the tax treatment of particular class oftaxpayers i different from that afforded another class. In theproperty tax context, property used for agriculturalpruspoes is generally treated differently from property usedfor residential housing, or landfills, or commercial enter-prises. This differential or discriminatory treatment doesnot alwasys rise to the level of a constitutional violation;constitutional violations generally occur when a stateengages in differential tax treatment of members of thesame class. See discussion at p.3, below.

2 Only a brief mention is necessary of the second standard ofreview under the 14th Amendment. This is the “special class”scrutiny that is reserved for groups that have historicallybeen subject to significant periods of invidious discrimina-tion justifying a closer examination of the state purposesfor enact legislation that differentiates on the basis of thissuspect classification. Railroads simply do not have anyhistorical antecedent that would justify application of thespecial class scrutiny reserved for some others. Thus, thespecial class scrutiny standard is inapplicable to determin-ing whether unconstitutional discrimination within themeaning of the 14th Amendment had occurred against therailroads historically or currently.

3 See, e.g., Nordlinger v. Hahn, 505 U.S. 1 (1992)4 Nashville v. Browning, 310 U.S. 362 (1940).


Uniformity Matters at Hearing


Electric utilities are joining the world of compe-tition that already exists for airlines, trucking, railroad,natural gas, and telecommunications. The financialservices industry is undergoing major changes inresponse federal legislation and mergers of majorbanking and insurance companies. Industry structuresand products categories that seemed permanent fiveyears ago are becoming archaic—and this can leave statetax structures seriously outdated. The MTC Deregula-tion, Industry Change and Taxation Project was estab-lished in 1999 to assist the states as they adopt their taxsystems to major industry changes. The project iscurrently supported by the following states: Alabama,Arkansas, Colorado, Idaho, Kentucky, Missouri, Oregon,and Washington.

Inspired by deregulation accomplishments inother industries and efforts to restructure the Britishelectric utility industry, the California legislature passedelectric utility restructuring in 1996. Approximatelyone-half of the states have followed with plans thatunbundle the elements of electric utility service, provideretail customers with a choice of electric supplier, and inmost cases, call for divestiture of most electric genera-tion assets by regulated utilities. These state effortsfollowed earlier federal legislation and regulatory effortsto introduce competition in wholesale electric markets.

Federally imposed barriers between insurance,securities, commercial banking, and investment bankinghave existed since 1933. With the Gramm-Leach-BlileyAct (GLB, 1999) congress allowed for all of theseactivities to be undertaken by financial holding compa-nies (FHCs). But it retained the current system offunctional regulation, where the states to continue toregulate insurance, the Securities and Exchange Com-

mission regulates securities activities, the Comptrollerof the Currency regulates national banks, and theFederal Home Loan Bank Board regulates savings andloan businesses. The Federal Reserve is now the um-brella supervisor of financial holding companies. GLBlegitimized the Citicorp-Travellers merger and permit-ted other major mergers that have occurred since 1999,such as the J.P. Morgan-Chase Manhattan merger. TheFederal Reserve and Treasury are also consideringregulations that further define “financial activities” thatcan be undertaken by FHCs. These may include somedata processing activities and possibly, real estateactivities.

The Deregulation Project has issued 19 editionsof Deregulation Update, provided technical assistance tothe states, and presented two Deregulation Seminars.The Deregulation Update provides reports on currentindustry change and state tax events. The seminars haveprovided an excellent forum for presentations by publicand private sector industry specialists to state taxpersonnel. And the project has provided valuableindustry insights and data to the states for legislativeand audit work. The project has also advised states onpending legislation. Through the Deregulation Project,the Commission is a partner in the National Conferenceof State Legislatures (NCSL) Electric Utility TaxationProject. This project, which got underway in June 2001,will provide advice for legislators on tax policy optionsfor the restructuring electric utility industry.

In 2002, the MTC Deregulation Project willpresent its third deregulation seminar (see the an-nouncement elsewhere in the Review) and issue a taxpolicy advisory on financial services for the projectstates. Activities beyond that date will depend on thedirection provided by the project states.

MTC Deregulation ProjectKen Beier, Deregulation Project Manager

Deregulation SeminarMarch 21-22, 2002

Tucson, Arizona

The third MTC Deregulation Seminar, to be held at the end of the winter program committeemeetings, will adress topics in financial services, energy utilities, and telecommunications. Forfurther details and registration information, see the Training Section of the MTC website,www.mtc.gov


Recent Amicus Curiae Briefs Filed byThe Multistate Tax CommissionFrank D. Katz, MTC Deputy General Counsel

In the last two years, the Multistate Tax Commission has been unusuallyprolific in authoring amicus briefs. Ten briefs have been filed, half inthe United States Supreme Court.


Goldberg v. Ellett; Sorenson v. Artiglio– U.S. Supreme Court Docket No. 01-731.Amicus brief on Petition for Certiorari filed December2001.

Two debtors reopened their bankruptcy cases seekinginjunctions under Ex parte Young barring California taxadministrators from collecting taxes purportedlydischarged in bankruptcies in which California did notparticipate. The Ninth Circuit upheld federal jurisdic-tion and the issuance of the injunctions. It also held thatbankruptcy discharges are binding on States even whenthey do not participate in the bankruptcy proceeding.

The Commission’s brief argued that the Tax InjunctionAct represents explicit congressional intent to restrictfederal court jurisdiction so long as state remedies areadequate. Under Seminole Tribe of Florida v. Florida,congressional intent to restrict federal remedies over-rides broader, judge-made remedies available under Exparte Young. The brief also argued that Eleventh Amend-ment sovereign immunity denies debtors bankruptcycourt jurisdiction over States. If States choose not towaive their immunity and participate in the bankruptcyaction and share in the bankruptcy estate, the dischargeis not binding on them and they may pursue collectionfrom the debtor’s post-bankruptcy property.

Rylander v. Dow Chemical Company –

U.S. Supreme Court Docket No. 01-442.Amicus brief on Petition for Certiorari filed October2001.

Texas sought to impose tax on insureds measured bypremiums paid for insurance independently procuredand paid for out of state from non-admitted insurerscovering in-state risk. The Texas Court of Appealsbelieved itself bound by the Supreme Court decision inState Bd. of Ins. v. Todd Shipyards finding insufficientnexus. Todd Shipyards held that the McCarran-FergusonAct, which exempted the business of insurance fromdormant commerce clause limitations, actually intendedto incorporate then-existing due process nexus limita-tions as a commerce-clause based preemption of statetaxes on this independently procured out-of-stateinsurance.

The Commissions brief proposed that the SupremeCourt reassess its holding in Todd Shipyards in light ofthe clear statement doctrine (there was no mention ofpreemption of state tax in the McCarran-Ferguson Act)and the Court’s jurisprudence that multijurisdictionalcommerce should pay its fair share of state taxes. Thebrief further suggested narrow readings of Todd Ship-yards that would effectively distinguish the Dow Chemi-cal case.

The Court denied certiorari on October 29, 2001.

Franchise Tax Board v. Hyatt – Nevada

Supreme Court Docket No. 36390.Amicus brief on review of motion to dismiss tort claimby Nevada resident against California tax auditors.

A former California resident resisted efforts by Califor-nia auditors to determine when he moved to Nevada



and, therefore, whether certain large items of incomewere subject to California income tax. He filed tortclaims against the Franchise Tax Board in Nevada courtschallenging their audit activities. The trial course deniedCalifornia’s motion to dismiss. California petitioned theNevada Supreme Court for review.

The Commission’s brief argued that the interests ofcooperative federalism and discretionary comity amongstates along with the reliance interests and reasonableexpectations of the parties weighed in favor of leavingthis litigation to California. The Commission’s role inworking for harmony and cooperation among state taxsystems supported its plea for comity.

The Nevada Supreme Court agreed and grantedCalifornia’s petition to dismiss.

Kmart Properties Inc v. Taxation andRevenue Department of the State ofNew Mexico – New Mexico Court of Appeals

Docket No. 21,140. Amicus brief to review the decisionof the Administrative Hearing Officer.

Kmart Corporation employed the tax planning devise ofa trademark holding company subsidiary to shelterincome earned in States where Kmart stores are located.Kmart transferred its trademarks to Kmart PropertiesInc (KPI), which, in turn, licensed them back to Kmartfor substantial royalties. The result was large deductionsfrom Kmart income in New Mexico (and other States)and shifting of that income to KPI in Michigan whichdoes not tax income from intangibles. New Mexicoassessed KPI income tax as well as its gross receipts(sales) tax on royalties attributable to in-state use of itstrademarks. The Hearing Officer first held that physicalpresence was necessary for income tax nexus underQuill Corp v. North Dakota but then affirmed assessmentof both taxes on the basis that Kmart acted in NewMexico as KPI’s representative to protect and promotethe goodwill associated with KPI’s trademarks.

The Commission’s brief focused primarily on theincome tax nexus standard arguing that the physicalpresence nexus requirement in Quill for use tax collec-tion obligations did not extend to income tax. The briefalso noted the physical presence test of Quill was notintended to protect a trademark holding company that

was self-dealing with its own affiliate.The Court of Appeals decision agreed with the Com-mission and held the physical presence standard wasinapplicable to income tax nexus, overruling the hearingofficer. The court affirmed imposition of the grossreceipts tax on the basis of representational nexus.Importantly for other matters like dot.com affiliates andremote selling of electricity, the court also acknowledgedthat the KPI arrangement did not raise the same sort ofburdens that were the concern of the Supreme Court inQuill.

Johnson v. J.C. Penney Nat’l Bank – U.S.Supreme Court Docket No. 00-205. Amicus Brief onPetition for Certiorari filed September 2001.

J.C. Penney Corp. established an affiliated credit cardbank allegedly with no physical presence in Tennessee.Most of the Bank’s 11,000-17,000 Tennessee credit cardholders came from solicitation of J.C. Penney’s Tennes-see customers. The Bank retained ownership of thecredit cards and hired attorneys to pursue collectionfrom delinquent cardholders in local courts. Tennesseeassessed an apportioned income tax on the Bank’sincome that represented its Tennessee sourced income.The Tennessee Court of Appeal held income tax nexusrequired physical presence and found none.

Tennessee petitioned for certiorari only on the legalissue of whether physical presence was necessary forincome tax nexus. The Commission’s amicus brieffocused on the need to get this important issue resolvedand the consequence of leaving this nexus stand-offsimmer unchanged. It also sought help from the Su-preme Court to encourage state courts not to abdicatetheir responsibility to decide federal constitutionalissues relating to state tax matters.

The Court denied certiorari October 10, 2000.

Director of Revenue v. CoBank ABC –U.S. Supreme Court No. 99-1792.Amicus brief on the merits filed August 2000.

The issue before the Court was whether various farmcredit agencies denoted in statute as instrumentalities ofthe United States were exempt from State income tax.The Commission’s amicus brief focused on Congress’s


long-time intent that these entities be subject to tax oncethey were fully privately owned, and that such intentcontrolled even when the specific statutory language wasrepealed in 1985.

The Court upheld the position of Missouri and theMTC that these farm credit agencies were taxable. 531U.S. 316, 121 S.Ct. 941 (2000)

In re Intercard – Kansas Supreme Court No.83,802. Amicus brief on the merits filed June 2000.

Intercard sold card readers to Kinko’s for their copyingmachines and sent in technicians to install each of thecard readers. Intercard then sold cards and other itemsrelating to the use of the card readers. The issue waswhether Intercard had the requisite physical presencefor nexus to impose the use tax collection obligation onIntercard under Quill for these sales to Kinko’s. TheKansas Board of Tax Appeals (BOTA) held insufficientnexus.

The Commission argued that Intercard had undisputedphysical presence in Kansas when it installed the cardreaders. This presence enhanced its ability to sell itsgoods in Kansas, thereby providing nexus that was notde minimis. Moreover, this nexus applied to the sales ofcards after installation was completed and Intercard nolonger had physical presence.

The Kansas Supreme Court affirmed the BOTA deci-sion, reviewing many cases but doing little analysis ofhow they applied to the facts. The court, in upholdingBOTA’s findings, summarily concluded “that Intercard’s11 incursions to install cardreaders in Kansas wereisolated, sporadic, and insufficient to establish a sub-stantial nexus to Kansas.” 14 P.3d 1111 (Ks 2000)

Union Pacific Corp. v. Idaho State TaxCommission – Idaho Supreme Court Docket No.

25876. Amicus brief on the merits filed April 2000.

Along with the grant of right of way for the railroad,Union Pacific (UP) was granted substantial adjacentlands for development to support the cost of the rail-road. UP entered into a joint venture to develop a tronamine and mill. At issue was whether the dividends fromthe joint venture constituted business income.

The Commission’s amicus brief argued that the businessincome definition in UDITPA contained both a transac-tional and a functional test and that uniformity ininterpretation was essential to avoid duplicative taxa-tion.

The Idaho Supreme Court agreed that the businessincome definition contained both tests and remandedfor a determination whether the dividend income metthe functional test. 28 P.3d 375 (Id. 2001).

Furnitureland South v. Comptroller ofthe Treasury – Amicus brief on the merits beforethe Maryland’s highest court, the Court of Appeals,August, 2000.

Furnitureland, a furniture retailer in North Carolina,sold its merchandise all over the country. In a declara-tory judgment action, the Maryland tax administratorssought to impose the duty to collect use tax on sales toMaryland customers, alleging that the company thattransported the furniture, sometimes set it up andperformed other tasks for Furnitureland, therebyproviding the physical presence nexus required by Quill.Furnitureland argued that the delivery company was acommon carrier protected by the safe harbor of Quilland National Bellas Hess. The lower court found suffi-cient additional activity by the delivery company toprovide nexus to Furnitureland.

The Commission’s amicus brief argued that a remoteseller that utilized a third party carrier on a customizedbasis to deliver its product and to perform other relatedservices had left the safe harbor established by Quill.The Commission noted that this kind of carrier did notconstitute a “common carrier” within the meaning ofQuill’s safe harbor.

The court dismissed the appeal for failure to exhaustadministrative remedies avoiding a decision on themerits. 771 A.2d 1061 (Md. 2001)


CaliforniaAppeal of Sanjay Narayan , No. 79538 (California State Board of Equalization,April 19, 2001). The Board determined that a student that left California for overone year remained a California resident and was not eligible to file a part-yearresident personal income tax return. The taxpayer left California in August 1995for Alaska, where he resided and worked until returning to California on Septem-ber 15, 1996. Rejecting the taxpayer’s California part-time resident position, theBoard explained that the term resident includes “every individual domiciled inthis state who is outside the state for a temporary or transitory purpose.” Califor-nia Rev. & Tax. Code, Section 17014(a). The Board noted that during thetaxpayer’s absence from California he did get an Alaska driver’s license though heapparently never surrendered his California driver’s license, he maintained bankaccounts using a California address, and returned to California to sit for theCalifornia Bar Exam. The legal test for changing domicile is an actual move to anew residence and an intention to “remain there permanently or indefinitely.”Since the taxpayer did not provide sufficient evidence to establish that he hadchanged his domicile California was entitled to tax all of the income he earned inAlaska. (Note: Though intention to change residence is a subjective standard it isgenerally possible to prove through objective evidence such as: a driver’s license,church membership, social club membership, voter registration, bank account,automobile registration, and any other items that people tend to change when theyintend to change their permanent residence).

New MexicoKmart Properties, Inc. v. New Mexico , No. 21,140 (New Mexico Court ofAppeals, November 27, 2001). The Court held that licensing of trademarks inNew Mexico is sufficient for the state to impose its net income tax and sales taxon an out-of-state company. Kmart Properties Inc. (“KPI”) is the wholly ownedsubsidiary of Kmart corporation that holds title and manages all of Kmart’strademarks, trade names, and service marks. KPI organized its business so thatits office was in Michigan, all contracts were signed in Michigan, its employeesnever left Michigan, and it maintained tangible personal property solely inMichigan. The Court explained that KPI does not need to be physically presentin New Mexico for the state to impose its net income tax, but rather “the use ofKPI’s marks within New Mexico’s economic market, for the purpose of generatingsubstantial income for KPI, establishes a sufficient nexus between that incomeand the legitimate interests of the state and justifies the imposition of a stateincome tax.” Moving to the sales tax, the Court noted that physical presence isneeded for the imposition of a sales tax under the U.S. Supreme Court’s holdingin Quill v. North Dakota. KPI was held to be physically present in New Mexicothrough the use of its trademarks on Kmart store signs and on employee uniforms.(Note: This case is important because it holds that physical presence is not needed forthe imposition of a state net income tax, and for the proposition that intellectualproperty used in a state can create physical presence for sales tax purposes).

Nexus UpdateH. Beau Baez, Counsel, MTC National Nexus Program

This case is importantbecause it holds thatphysical presence isnot needed for theimposition of a statenet income tax, and forthe proposition thatintellectual propertyused in a state cancreate physical presencefor sales tax purposes.


New YorkIn the Matter of Edward A. and Doris Zelinsky , No. 817065 (New YorkState Tax Appeals Tribunal, November 21, 2001). The New York Tax AppealsTribunal has held that an out-of-state resident must allocate 100 percent of hissalary to New York even on days when the out-of-state resident works in his stateof residence. Mr. Zelinsky is a law professor in a New York City based law school.Three days during the week he would drive in from his home in Connecticut toteach classes and meet with students. Two days during the week he would workfrom home where he conducted scholarly research and writing. Zelinsky arguedthat New York should allow him to apportion his income between New York andConnecticut, since Connecticut law required him to apportion his income basedon the number of days he worked in Connecticut – New York refused. TheTribunal quoted New York law saying “any allowance claimed for days workedoutside New York State must be based upon the performance of services whichof necessity, as distinguished from convenience, obligate the employee to out-of-state duties in the service of his employer.” 20 NYCRR 132.18[a]. This rule,known as the convenience of the employer rule, disallows apportionment ofincome and treats a salary as completely earned in New York where the employeris in New York and the job function could be performed in New York. RejectingMr. Zelinsky’s double taxation concern, the Tribunal noted that if Connecticutadopts the New York rule on employer convenience then there would be nodouble taxation problem.

OhioOhio has released four documents dealing with nexus standards for Use Tax,Corporate Franchise Tax, Personal Income Tax, and Pass-Through entities. Theyare referenced as follows: Use Tax Nexus Standards, ST 2001-01; CorporateFranchise Tax, CFT 2001-02; Personal Income Tax, PIT 2001-01; and Pass-Through Entities, PIT 2001-02. The goal behind these documents is to assist out-of-state people and businesses in determining their tax obligations in the State ofOhio. One interesting feature in several of these documents is the use of the“affiliated group” concept to create nexus. An affiliated group “means two ormore persons related in such a way that one person owns or controls the busi-ness operation of another member of the group. In the case of corporationswith stock, one corporation owns or controls another if it owns more than fiftyper cent of the other corporation’s common stock with voting rights.” Thus, asapplied to the Use Tax an out-of-state affiliated corporation that does not havenexus with Ohio would nonetheless be required to collect Ohio’s Use Tax if itsin-state affiliate helps it to establish and maintain a marketplace in Ohio. (Note:As States release published nexus standards, tax professionals can better help theirclients determine their state filing obligations).

As States releasepublished nexus

standards, tax profes-sionals can better help

their cl ientsdetermine their

state filingobligations.


Bibliography of MTC Review Articles1981-2001

March 1981Making Federalism Work-A California Perspective, by

Gerald Goldberg, p1.

November 1981The Attribution of the Net Income of Multistate-

Multinational Corporations for States Taxes on orMeasured by Net Income, by William D. Dexter, inthree parts: p5, Jun 1982 p3, and Feb 1985 p8.

MTC Mileage Reimbursement Survey, p14.MTC Moves Ahead, by Gene Corrigan, p1.

March 1982Combined Reporting from the Point of View of a

Novice State, by Stephen J. Murray, p8.GAO Reports IRS “Arm’s Length” Method Fails to

Collect Taxes from Multinationals; Suggests States’“Formula” Approach as Alternative, by JamesRosapepe, p10.

Inside the MTC Audit Program, by Eugene Fisher, p7.Study [by Council of State Planning Agencies] Con-

cludes that Tax Incentives Have Insignificant Effect,p11.

June 1982Combination Tribulation, by Gene Corrigan, p14.Comments on State Income Tax Cases Before the

Supreme Court by William D. Dexter, p1.The Compliance Rule - A Solution to “Taxability in

Another State”, by Frederick J. Czerwionka, p11.Supreme Court Hearings in Retrospect, by Gene

Corrigan, p2.Unitary Score Sheet, p13.Unitary Taxation Will Bring More Fairness to System, by

Rep. John Tomlinson (Minn.), p12.

October 1982Caterpillar Tractor Restored for Re-Argument -Why?, by

Lloyd Foster, p15.The MTC: A Business Perspective, by Michael T. Clancy,

p4.A Proposal for a Uniform State Tax Treatment of Safe

Harbor Leases, by F. Edwin Denniston, p8.

February 1983Current Issues in Multistate Income Taxation, by

Theodore W. De Loose, p1.

December 1983Container Effects, by Gene Corrigan, p1.Life After ASARCO/Woolworth, by Alan Friedman, p4.Life After Container and CBI, by Lloyd Foster, p4.The Myth of an “International Standard” in Taxation of

Multinationals, by Jim Rosapepe, p2.Reflections on the Container Decision, by William D.

Dexter, p8.Rethinking Interjurisdictional Competition, by William

D. Dexter, p8.Wasting Corporate Assets, by Gene Corrigan, p1.

October 1984Aspects of Unitary Apportionment, by Gene Corrigan,

p21.Course of Working Group Efforts; Nature and Signifi-

cance of Results, by Gene Corrigan, p16.Evasion and Avoidance of U.S. Taxation Through

Foreign Transactions, by Richard A. Gordon, p11.State Tax Reform for the Eighties: The New York Tax

Study Commission, by Richard D. Pomp, p1.

November 1984State Revenues Endangered by Mathias Bill, Jim

Rosapepe, p4.

February 1985Fiscal Incentives: How Powerful a Stimulus to Economic

Development?, by Frederick D. Stocker, p4.Fiscal Incentives: How Powerful a Stimulus to Economic

Development?, by Frederick D. Stocker, p4.Review Auditor’s Role, by Gerry Birk , p3.The State “Unitary Tax Dispute”, by Byron Dorgan, p7.

August 1985A New York Perspective on Tax Incentives, by Richard D.

Pomp, p1.


November 1985Applying Federal Income Attribution Concepts at the

State Level, by Sandra B. McCray, in three parts; p9,Feb 1986 p8 and May 1986 p12.

Comment on Kellogg v. Herrington, by William D.Dexter, p13.

Potential Federal Legislation to Help States Collect UseTaxes, by Gene Corrigan, p18.

A State Perspective on the Worldwide Unitary TaxationWorking Group and Task Force, by Benjamin F.Miller, in three parts: p1, Feb 1986 p1, and May 1986p5.

May 1986Combination States Update, p11.Former Treasury Insider Debunks Claims that an

International Arm’s Length Norm Exists, by GeneCorrigan, p1.

Perspective from Washington, by Leo Rennert, p22[Reprinted from the California Journal of January1986].

August 1986The Competent Authority System - Problems in Apply-

ing the Arm’s Length Concept, by Sandra B. McCray,p1.

MTC [1986] Annual Meeting Highlights, by GeneCorrigan, p4.

November 1986IDC Survey Update, by Gene Corrigan, p 5.Mail Order Tax Dilemma, by Alan Friedman, p 1.Tax Jurisdiction Revisited by Sandra McCray, p 6.Throwback Sales, by Robert Kessel, p1.

June 1987Recent Developments in Railroad Tax Litigation, by

Julian O. Standen, p18.Taxation of Multistate Businesses: Lessons for the States

from the Federal Tax Reform Act, by Sandra B.McCray, p 1.

Weighting the Sales Factor, by Gene Corrigan, p 9.

September 1987MTC [1987] Annual Meeting Highlights, by Gene

Corrigan, p7.State Corporate Income Taxes: The Illogical Deduction

for Income Taxes Paid to Other States, by Richard D.Pomp, p1.

December 1987Direct Marketers Should Support the Dorgan/Brooks

Bill, by Gene Corrigan, p1.Unitary vs. Non-Unitary, Sorting the Wheat from the

Chaff by Gene Corrigan, p7.

May 1988Tax Competition: Patent Medicine for Economic

Anxiety, by Dan R. Bucks, p1.Throwbacks and Throwouts, Redux, by Gene Corrigan,

p9.A Unitary Primer, by Gene Corrigan, p1.

October 1988MTC [1988] Annual Meeting, by Gene Corrigan, p1.Seller Beware: Nexus Considerations for the Interstate

Marketer, by M.K. Heidi Heitkamp and Alan Fried-man, p18.

March 1989A Final Review, by Gene Corrigan, p1.IRS Proposal Assumes States Tax Foreign Income, by

Dan R. Bucks, p14.Limitations on the States’ Jurisdiction to Impose Net

Income Based Taxes, by Fred O. Marcus, p1.Proposed Regulation for the Attribution of the Income

of Financial Institutions p17.The Puzzle of State Tax Revenue-Opening Thoughts, by

Dan R. Bucks, p3.

March 1990The Application of the Uniform Commercial Code to

the Concept of Nexus for Use Tax Collection Pur-poses, p26.

Case Reports by Paull Mines, p20.A Common Tax for the States, by Alice M. Rivlin, p18.Current Status of Proposed Adoption of Multistate Tax

Commission Regulation IV.18(h) (Television andRadio Broadcasting) by Alan Friedman, p14.

The Global Remote-Control Economy: A Challenge toEffective State Taxation - Highlights of the 1989Annual Conference, Wichita, Kansas, p1.

IRS Continues to Finalize Regulation Under IRC Section861 by Paull Mines, p16.

MTC Uniformity Committee Activities, p25.MTC Uniformity Proposal Dealing with Sales Taxation

of Drop Shipments Based on Transactional Nexus ,by Paull Mines, p10.

Shaping the Future of Multistate Taxation by John James, p1.


March 1991Congress Disrupts State Taxation of Air Carriers

Through Passage of 49 U.S.C. §1513(f), by PaullMines, p1.

Interim Report of Hearing Officer Regarding Adoptionof Proposed MTC Regulation IV.18.(i): Attribution ofIncome from the Business of a Financial Institution,p37.

Litigation Under Section 306 of the Railroad Revitaliza-tion and Regulatory Reform Act of 1976: A Reviewand Critique, by Mary Jane Egr, p1.

Model Telecommunications (Transactional) Excise TaxAct, p25.

MTC Considers Endorsing Modified MoSCITA, by PaullMines, p30.

MTC Regulation Art. IV.18(h): Television and RadioBroadcasting, p17

The National Nexus Program: A Status Report, by AlanFriedman, p23.

Nebraska Supreme Court Overturns State’s Efforts toPreserve Personal Property Tax, p15.

Resolution Regarding Adoption of Proposed Allocationand Apportionment Regulation IV.18.(h), p16.

Resolution of the Executive Committee of the MultistateTax Commission on Interim Report of HearingOfficer Regarding Proposed MTC RegulationIV.18(i): Attribution of Income from the Business ofa Financial Institution, p38.

Uniform Protest Statute, p29.Uniformity Matters Now Pending Before the Multistate

Tax Commission, p21, Dec 1992 p28; Apr 1994 p28;Oct 1994 p28.

December 1992The Current Status of the Financial Institutions Income

Apportionment Effort, by Alan H. Friedman, p26.Limited Liability Companies: What Are They, and What

Are Their Implications for State Taxation? Two parts,Part I p1.

Multistate Tax Commission Joint Audit ProgramUpdate, by Les Koenig, p18.

National Nexus Program Update, p30.Supreme Court Decisions in Allied-Signal and Kraft

Push States to Consider Combined Reporting, byPaull Mines, p1.

Transactional Taxation of Interstate Commerce, by PaullMines, p19.

Uniform Interstate Sales and Use Tax Act (Second Draft,September 1992), p 23.

Uniform Sales & Use Tax Certificate is Revised, p32.

Updated Publications on State Corporate IncomeTaxation Available, p27.

April 1994Alabama Becomes Twentienth MTC Member, p3.In Memoriam: George Kinnear, p4.Limited Liability Companies: What Are They, and What

Are Their Implications for State Taxation? Two parts,Part I Dec 1992 p1, PartII Apr 1994 p1.

Mail Order Legislation Introduced; MTC in Support,p3.

MTC Files Amicus Briefs in Barclays/Colgate andAssociated Industries, p32.

MTC Supports Legislation to Amend “4-R” Act, p 24.State Jurisdiction to Compel Documents and Witnesses

After Quill, by Alice J. Davis, p1.

October 1994Commission to Issue New Compilation of Uniformity

Recommendations, p32.How Much is Too Little? Defining De Minimis Substan-

tial Nexus, by Alice J. Davis, p1.Issues in the Pennsylvania Corporate Income Tax, by

Eileen H. McNulty, p3.MTC Releases Final Proposed Apportionment Formula

for Financial Institutions, by Dan R. Bucks, p 1.Statement of Information Concerning Practices of

Multistate Tax Commission and Signatory StatesUnder Public Law 86-272, p23.

January 1997Advancing Uniformity: Income Apportionment for

Financial Institutions and Interpretation of PublicLaw 86-272, by Michael Mazerov, p13

Federal Tax Restructuring: Perils and Possibilities for theStates, by Dan R. Bucks, p1.

The Multistate Tax Commission’s Alternative DisputeResolution Program: History and Overview, p1.

Multistate Tax Commission Amends ApportionmentRegulation Covering Radio and Television Broadcast-ing, p3.

Multistate Tax Commission Public Participation Policy,p16.

September 2000Bringing the Sales Tax Into the Digital Age, by Professor

Charles E. McClure, Hoover Institute at StanfordUniversity, p27.

Computer Assisted Audit Services, by Harold Jennings, p22.


Current Uniformity Projects of the Multistate TaxCommission, p32.

Explanation of the Recently Enacted* Mobile Telecom-munications Sourcing Act, by Paull Mines, p15.

Farewell to Chairman Southcombe, p 4.Furniture Dealer’s Use of Personalized Delivery Service

Creates Representational Nexus, by Sheldon H.Laskin, p5.

Recent Trends in State Corporate Income Taxes, byElliott Dubin, p7.

Resolving State Tax Liabilities: Multistate VoluntaryDisclosures, by H. Beau Baez, p24.

What Is State Tax Uniformity?, by Dan R. Bucks, p3.

April 2001Letter to Senate Commerce Committee, by Elizabeth

Harchenko, p8.Nexus Update, by Beau Baez, p45.Recent Trends in State Finances, by Elliott Dubin, p34.Review and Summary of Recently Enacted E-Sign Law,

by René Y. Blocker, p39.Sampling Techniques to Improve Sales and Use tax

Auditing, by Harold Jennings, p36.Simplications of Sales and Use Tax and Taxation of

Remote Commerce, by Elizabeth Harchenko, p4.State Fiscal Issues and Risks at the State of a New

Century, by Donald J. Boyd, p15.

October 2001Business Activity Taxes: Explanation and Potential

Implications of Current Legislation, p6.Commission Adopts Three Uniformity Recommenda-

tions, p19.Conducting Corporate Income Tax Audits, by Les

Koenig, p17.The Conflict Between the Cessation-of -Business

Concept and the Functional Test in California and inOther UDITPA States, by Andrea H. Chang, p8.

Federal Legislative Update: Congress Pursues Sales andUse and Business Activity Tax Measures, by EllenMarshall, p4.

States’ Adoption of Transactional and Functional Tests,p16.

Testimony of June Summers Haas, Commissioner ofRevenue, Michigan Department of Revenue, On theIssue of H.B. 2526 Internet Tax Fairness Act of 2001,p1.

Two More States Become MTC Sovereignty Members,p20.


For further details and schedule updates, please visit our website atwww.mtc.gov/MEETINGS/training.htm.

Multistate Tax CommissionTraining Courses–2002

Nexus SchoolsApril 16-17, 2002 Seattle, WAMay 14-15, 2002 Rapid City, SDSeptember 18-19, 2002 Columbus, OHDecember 2-3, 2002 Austin, TX

Deregulation SeminarsMarch 21-22, 2002 Tuscon, AZ

Contact: Ken [email protected]

Sampling TrainingApril 8-12, 2002 Oklahoma City, OK(Non-statistical sampling)

Contact: Antonio [email protected]

Contact: Harold [email protected]

January 2002 Multistate Tax Commission 33

Calendar of Events

January 17-18, 2002 Winter Executive CommitteeU.S. Grant Hotel, San Diego, CaliforniaFeaturing: Federalism at Risk

March 18-22, 2002 Winter Program Committee MeetingsDoubletree Hotel at Reid Park, Tucson, Arizona

April 24-26, 2002 Spring Executive Committee MeetingThe Brown Palace Hotel, Denver, Colorado

July 28-August 2, 2002 35th Annual Meeting & Committee MeetingsMonona Terrace Convention Center &Hilton Madison Monana Terrace, Madison, Wisconsin

Please contact Teresa Nelson, Production Editor, at 202-624-8699 to request a more detailedCalendar of Events that includes hotel and meeting registration information and tentative com-mittee meeting schedules.

Multistate Tax Commission444 North Capitol Street, NW, Suite 425Washington, DC 20001Tel: 202-624-8699 Fax: 202-624-8819www.mtc.gov

PresortedU.S. Postage

PAIDWashington, DCPermit No. 1994

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