The Volokh Conspiracy

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Supreme Court Takes Up Internet Sales Tax Conundrum

Why I hope the Court leaves its "physical presence" rule for sales tax collection intact, or How I Learned to Love the Dormant Commerce Clause.


Last week, the Court granted cert in South Dakota v. Wayfair, a case that challenges the current legal status quo regarding online retailers' obligations to collect state sales tax. It is, I think, one of those unusual cases that is both fascinating, and rather profound, from a constitutional law standpoint, and simultaneously of truly prodigious practical, economic significance.

Here's the basic lay of the land. Early in the Internet Era (1992), the Supreme Court held, in Quill v. North Dakota, that a State may not require out-of-state sellers of goods or services to collect that State's sales/use tax*, unless the out-of-state seller has some "physical presence" in the State—a retail outlet, warehouse, office, or the like. So when an individual from, say, Illinois purchases goods from a seller located in Missouri—via an order placed over the telephone, or on the Net—Illinois may not require the seller to collect (and remit to Illinois) the sales tax that Illinois imposes on in-state transactions.

*Note that Illinois may—and actually does—impose a tax on Illinois taxpayers (e.g., on the purchaser, in my example) when those taxpayers make a purchase from an out-of-state seller. This tax is known as a "use tax"—based on the notion that it is not taxing the out-of-state "sale" but the buyer's "use" of the goods within Illinois—but it is generally set at a rate equal to the "sales tax" rate for in-state sales, and it functions as a sales tax equivalent.

Nothing in Quill interferes with the state's ability to impose those use taxes on its taxpayers, and most States continue to do so. But it does prohibit States from doing, in the context of "use tax" collection, what it does for "sales tax" collection, viz., requiring the sellers to collect the tax that is owed by the buyer and to remit the proceeds to Illinois—unless the seller maintains some "physical presence" in Illinois.

Quill is why most online retailers will, at checkout, say something like "Sales tax will be aded for sales to PA, NY, and IN"—places where, presumably, the seller does have a physical presence—"but not elsewhere."

The Quill Court rested its finding that taxing out-of-state sales is unconstitutional on the so-called "negative" or "dormant" Commerce Clause.

Now, the dormant Commerce Clause is one of those legal doctrines that most lawyers, I bet, still recall from Con Law I—and not at all fondly, finding it either entirely contrary to common sense and/or downright incomprehensible. For me, though, it was love at first sight (h/t to my Con Law I prof, Louis Michael Seidman, who gave us a really superlative introduction to the doctrine's many delights), and, love being blind, I've always managed to overlook and forgive the doctine's many flaws.

It's a truly stunning act of judicial creativity, crafted over several centuries of work. Here's the gist of it. In the Commerce Clause (Article I sec. 8), the Constitution gives Congress the power to "regulate Commerce … among the several States." The Court has, beginning in the early 19th century, found in this affirmative grant a power a corresponding negative, a prohibition on the exercise State power. Congress' power, in effect, is converted into an exclusive power to "regulate interstate commerce," and States may not exercise that power or interfere with Congress' excercise of it by "imposing excessive burdens on interstate commerce without congressional approval."

The Court has identified two primary categories of State actions that unconstitutionally burden interstate economic activity. First, States may not impose regulations that discriminate against out-of-State entities for the benefit of in-state entities—always a temptation for State law-makers. And second, they may not impose regulations that, while non-discriminatory, "unduly burden" interstate commerce by "subjecting it to haphazard, uncoordinated, and possibly inconsistent regulation" by States, a "welter of inconsistent and burdensome taxation and regulatory requirements" in areas of commerce that "by their nature demand cohesive national treatment."

It was this latter problem—the potential welter of burdensome taxes and regulations—that, in the Quill Court's view, doomed North Dakota's (and, by extension, any other State's) efforts to impose its tax across State lines:

North Dakota's use tax illustrates well how a state tax might unduly burden interstate commerce. North Dakota law imposes a collection duty on every vendor who advertises in the State three times in a single year. Thus, … a publisher who included a subscription card in three issues of its magazine, a vendor whose radio advertisements were heard in North Dakota on three occasions, and a corporation whose telephone sales force made three calls into the State, all would be subject to the collection duty. What is more significant, similar obligations might be imposed by the Nation's 6,000-plus taxing jurisdictions… [The] many variations in rates of tax, in allowable exemptions, and in administrative and record-keeping requirements could entangle a mail-order house in a virtual welter of complicated obligations.

Many people have complained about the Quill rule, vociferously, over the years, and the South Dakota statute now at issue in the Wayfair case—which provides that "sellers of tangible personal property in South Dakota without a physical presence in the state … shall remit sales tax according to the same procedures as sellers with a physical presence"—was clearly designed to give the Court an opportunity to reconsider and overrule it, which opportunity the Court, in its cert grant, has now apparently seized.

Complaints about the Quill certainly have considerable force. Quill allows an online retailer, operating out of her garage in State X, to sell goods to buyers in all other States without charging any sales or use tax, which puts local brick-and-mortar stores in X, who have to charge X's tax to all buyers, at a serious competitive disadvantage. This, many people persuasively contend, is both economically inefficient and has helped to destroy (or at least weaken substantially) those traditional brick-and-mortar retail outlets, with dire consequences for both the health of local retailing and for the state of America's cities and towns. A number of serious heavyweights have weighed in on the question via amicus briefs supporting South Dakota in the Wayfair case—from the National Federation of Retail Businesses to the American Booksellers Association to the American Farm Bureau to the National Governors' Association to the Attorneys General of 34 States.

But I think Quill got it right. The risk of strangling Internet commerce in a morass of complex and inconsistent obligations—6,000 plus taxing jurisdictions! – makes this precisely the sort of question that demands "cohesive national treatment" of the kind that only Congress can provide.

Of all the amicus briefs (available at Scotusblog), I found one submitted by Chris Cox, the former Republican Representative in Congress from California (and co-author, with then-Rep Ron Wyden (D-OR), of the "Internet Tax Freedom Act" of 1998) to be the most persuasive of all. He put the central issue this way:

A woman opens a small business out of her apartment in Idaho, selling iPhone cases principally over the internet … via her own web storefront. Her customers are mostly in the United States and Canada. In a typical week she fills orders primarily to New York, Florida, Texas, Illinois, Colorado, and California, with gross annual sales of $273,000. She rarely sells to customers in South Dakota—maybe four iPhone cases in an entire week. …

Because she lives and works in Idaho, she is registered with the Idaho State Tax Commission, the Idaho Department of Labor, and the Idaho Industrial Commission. She has paid the Idaho State Tax Commission for a seller's permit, and regularly files Idaho sales tax returns. Compliance with Idaho's rules requires her, like other businesses in Idaho, to be familiar with the State's varying tax rates and definitions of what is taxable, its audit and recordkeeping requirements, and its filing requirements (in her case, the requirement to file monthly sales tax reports).

South Dakota's law, however, does not merely require her to collect South Dakota's sales tax; it subjects her to the full range of South Dakota's tax and regulatory jurisdiction, including the panoply of South Dakota's licensing, recordkeeping, and registration requirements, and would, among other things, make her subject to periodic audit by the South Dakota Department of Revenue—which, in many States, requires an in-person appearance before the Revenue Board.

And of course if the Court discards the Quill rule and upholds South Dakota's law, we can expect other jurisdictions to follow suit.

South Dakota approvingly reports that "many other States have enacted provisions materially identical to South Dakota's," meaning that if this Court upholds the contested law in this case, even the smallest Internet sellers will quickly be subject to nationwide compliance burdens and the competing rules, filing requirements and audit demands of [thousands of] taxing jurisdictions.

This is precisely the sort of regulatory morass the dormant Commerce Clause was designed to prevent. It is yet another illustration of the central problem we face in applying legal rules to Internet communication. As Cox puts it, "the Internet's decentralized, packet-switched architecture," through which every individual website is "immediately and uninterruptedly exposed to billions of Internet users in every U.S. jurisdiction and around the planet," makes Internet commerce "uniquely vulnerable to tax and regulatory burdens in thousands of jurisdictions." Internet content is available to everyone, everywhere, simultaneously; that, however, cannot mean that it is thereby subject to the obligations imposed by all legal regimes, everywhere, simultaneously, because such a scheme is unworkable and incoherent.

Notice, too, that while South Dakota and its supporters argue that the Quill rule discriminates in favor of online retailers at the expense of local brick-and-mortar stores, abrogating the rule will have substantial discriminatory consequences in the opposite direction.

Consider again that Idaho seller of iphone cases. The moment she opens up her Internet storefront, she is subjecting herself to this burden of complying not only with Idaho's regulatory and tax authorities, but with the regulatory and tax authorities in whatever jurisdictions her electrons may enter, i.e., all of them. But her brick-and-mortar counterpart, who sells iphone cases over the counter in Idaho to customers in-store, has no such burden; even if he sells to Floridians or Californians passing through Idaho, his store only has to comply with Idaho's regulatory and tax apparatus. In Cox's words, "forcing one small business, with one location, to bear this burden is discriminatory when a large in-state retailer has no such burden."

There is a solution to this problem—and it is a fairly simple one at that. The dormant Commerce Clause disables States from acting because Congress has the responsibilty for solving problems like this. If the current status quo unfairly discriminates against brick-and-mortar retailers, a federal statute could require all retailers—online and off—to take X% of all sales and to remit that to a fund, administered by the federal government, from which payments will be made to the States based on their particular rates and the location of the transaction. Figuring out what X should be—presumably, some kind of weighted average of all current State sales taxes—and how the payment allocation formula will operate, are not trivial questions. But they're hardly intractable. It would operate, as far as consumers are concerned, as a national sales tax, though it would in reality be just a collection mechanism for State taxes.

It would require, yes, a functional Congress, and that's not what we seem to have these days. But it—or something like it, administered and authorized at the national level by our national institutions—is clearly the right answer to the problem, and if Congress weren't so, um, pre-occupied with other issues there might be a path forward to actually addressing this problem in a sensible and coherent manner. No, I'm not holding my breath—just hoping that the Court doesn't unleash the taxing hounds to go out and tear up the Net.