By Adam Thimmesch
As I’ve previously blogged, the Supreme Court granted certiorari in South Dakota v. Wayfair last month. The question presented in the cert petition was whether the Court should overrule the physical-presence rule of Quill. For most folks, the resolution of the case will be felt most directly in whether their favorite online stores start to collect use tax on their purchases. (If your favorite vendor is Amazon, fear not, you’re already paying…at least on some of your purchases.) For states, it could mean an infusion of tax revenue at a time when many are struggling with budget issues…or maybe they will use the funds to pay for President Trump’s infrastructure plan.
The primary issue in Wayfair is whether the Court should abandon its long-standing physical-presence rule. That rule dates back to the Court’s early regulation of states and how they taxed the itinerant drummers and mail-order companies of the 1800s and early 1900s. The Court originally imposed that jurisdictional limitation under both the Due Process and dormant Commerce Clauses, but it abandoned the former with its 1967 decision in National Bellas Hess v. Illinois. (Lawyers reading this post should remember something about personal jurisdiction and the Court’s move away from a physical-presences test for purposes of that concept during this same time frame.)
The Quill Court was not similarly inclined to abandon the physical-presence “nexus” requirement that it had imposed under the dormant Commerce Clause, and it stands today. Since Quill, academics have lambasted that rule from a number of angles and have called for the Court or Congress to free states of its restriction. Congress has not acted, but the Court has the opportunity do so in Wayfair.
One big question that the legal literature has not explored is what the Court would do if it were to overrule Quill and get rid of the physical-presence requirement. Would it provide a different jurisdictional rule or would it abandon the nexus requirement all together? In a forthcoming essay, I explain why the latter is the best choice for the Court. A brief preview of the arguments are contained in the next few paragraphs.
Would eliminating the nexus requirement be drastic? Perhaps, but it is the best option for the Court. To start, the nexus requirement serves a purpose that is incredibly difficult to pursue through judicial means. As a dormant Commerce Clause matter, the nexus requirement functions to protect interstate commerce by protecting vendors from the assured cumulative tax costs that come from engaging in interstate commerce. That is, unless and until a vendor has some connection with a state that makes those burdens okay. And there’s the rub.
Determining when a vendor has “done enough” within a state to justify the cumulative regulatory burdens that come with engaging in interstate commerce is fundamentally a legislative task. It requires a balancing of a variety of political and economic factors. In non-tax cases, the Court has adopted this approach explicitly and requires something colloquially referred to as “Pike balancing.” Balancing is a useful “soft” approach to judicial review, but it is terribly difficult to do in practice. So difficult, in fact, that the Supreme Court hasn’t actually struck down a state statute using Pike balancing since the 1980s. The current Court seems particularly unwilling to do so.
In the essay, I discuss the history of the Court’s treatment of tax and non-tax regulations under the dormant Commerce Clause and identify why balancing would be incredibly difficult in Wayfair. Not only are states’ interests different than one another on this issue, but so are the costs of tax compliance for firms. The marginal cost of complying with another state’s tax laws depends on a number of factors, including where a vendor currently engages in commerce, where it is expanding, whether it uses software, and how long it has been engaged in commerce in a particular state.
The impact of those costs on firms (and thus perhaps on interstate commerce) also differs from firm to firm and over time. Firms have different profit margins and costs of capital. Some are at stages where they expect losses, and some can more easily pass costs on to their consumers.
The issues go much deeper than this, but even this limited look shows how difficult it would be to create a new national nexus test by balancing the state interest against vendors’ costs of compliance. Eliminating the nexus requirement would allow the Court to avoid these difficulties. Incidentally, it would also better align how the Court reviews direct and indirect taxes and tax and non-tax regulations under the dormant Commerce Clause. There is a lot to be said for this approach.
It would not be without cost though. Smaller online vendors who would absolutely be faced with compliance costs that could impede their ability to expand their operations. (Those costs might not necessarily be additional costs because they might substitute for vendors’ costs of complying with states’ use tax notification and reporting laws. That is a factor that should be recognized, but I digress.) I am sensitive to this issue, but I am also aware that many of those vendors avoid the traditional costs of doing business because they use the internet to cheaply exploit remote markets. It seems odd to me that we must protect firms from tax costs because they otherwise have very low costs of operation. In any event, we have Congress to deal with these types of issues.
The issues involved in Wayfair are complicated, and I do not want to get into them too deeply in this blog post, but the essay identifies many benefits that would stem from the Court abandoning the nexus requirement in Wayfair. It is not a perfect option, but it is the one that best comports with the Court’s general approach to adjudication under the dormant Commerce Clause and the one that best sets the stage for Congress to act if it so desires. If you are interested in more analysis, give the essay a read and let me know your thoughts.