Legal Corner: – An In-Depth Review of the Potential Impact of South Dakota v. Wayfair

By Christina Estes-Werther, League General Counsel

Last month’s Legal Corner article highlighted several cases before the U.S. Supreme Court, including South Dakota v. Wayfair. Due to the significant impact of this case on municipalities, this article will delve further into the case and examine the dormant Commerce Clause.

Dormant Commerce Clause
The Constitution of the United States declares that Congress has the power “[t]o regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes;” U.S. Const. art. I, § 8, cl. 3. This is known as the Commerce Clause and provides Congress with authority to regulate “the commercial intercourse between nations, and parts of nations, in all its branches…” Gibbons v. Ogden, 22 U.S. 1, 189–90, 6 L. Ed. 23 (1824). The dormant Commerce Clause (also known as the negative Commerce Clause) is a principle that state and local laws are unconstitutional if they place an undue burden on interstate commerce even if Congress has not acted. The dormant Commerce Clause cannot be found in the Constitution, but has been inferred by the Supreme Court based on the authority of Congress under the Commerce Clause. Therefore, the Commerce Clause, in its “dormant” state, may halt state and local laws that the Court finds impedes interstate commerce.

History of the Dormant Commerce Clause Relating To Mail-Order Catalogs
Although most of the attention has been focused on whether the Wayfair case will overturn the Quill decision, the original case affecting the taxing of interstate commerce began with Nat’l Bellas Hess, Inc. v. Dep’t of Revenue of State of Ill., 386 U.S. 753, 760, 87 S. Ct. 1389, 1393, 18 L. Ed. 2d 505 (1967), overruled by Quill Corp. v. N. Dakota By & Through Heitkamp, 504 U.S. 298, 112 S. Ct. 1904, 119 L. Ed. 2d 91 (1992).

National Bellas Hess was a mail order house that did not maintain any offices, properties, or employees in Illinois. The company mailed catalogues twice a year to Illinois customers and any ordered goods were sent to the customers by mail or common carrier. The State of Illinois imposed a tax on National Bellas Hess because under state law “retailer” included those who solicited orders within the state by means of catalogues or other advertising. The U.S. Supreme Court found that mail order transactions were exclusively interstate in character and if the state imposed this tax, other states and political subdivisions would follow, which may cause “unjustifiable local entanglements in the national economy.” Id. at 760, 1393. The Court reversed the state supreme court’s decision and held that Illinois had no power to impose the tax on an out-of-state mail order company.

In 1992, a similar case was heard by the U.S. Supreme Court in Quill Corp. v. N. Dakota By & Through Heitkamp, 504 U.S. 298, 112 S. Ct. 1904, 119 L. Ed. 2d 91 (1992). The Court faced the question of whether North Dakota’s imposition of a use tax on Quill, an out-of-state mail order house with no presence in the state, is an unconstitutional burden on interstate commerce. The state supreme court rejected Bellas Hess due to the significant changes in the economic and commercial landscape. However, the U.S. Supreme Court reiterated that the commerce clause is based on the “structural concerns about the effects of state regulation on the national economy” and the substantial nexus requirement is “a means for limiting state burdens on interstate commerce.” Id. at 313, 1913. The Court recognized the growth of the mail order industry may have been due to the exemption established in Bellas Hess, and found that the ruling in Bellas Hess relating to the commerce clause “remains good law” and the stability afforded to the industry supports the doctrine of stare decisis (decisions should be guided by established legal precedent). The Court also noted that Congress has been free to take action on this matter, but has not acted to address this issue. The Court reversed the state supreme court’s ruling and held the state’s action to impose taxes on an out-of-state company without physical presence in the state was a violation of the dormant Commerce Clause. Therefore, it has been well established for fifty years that states and localities cannot impose a tax on entities that do not have a physical presence in the state.

2018 Supreme Court Preview of South Dakota v. Wayfair
Fast-forward sixteen years after the Quill decision, and the U.S. Supreme Court is once again revisiting the same question in South Dakota v. Wayfair, Inc.: whether a state can collect sales tax on a retailer with no in-state physical presence. This time the context is no longer about mail-order catalogs, but instead the explosive growth of retail sales over the Internet.

In 2016, the South Dakota Legislature enacted a law that requires the collection of sales tax on sellers with no physical presence in the state to directly challenge the previous Supreme Court’s Commerce Clause decisions. South Dakota then filed a declaratory judgment action seeking to overturn the existing law, but the court adhered to precedent and enjoined the state from enforcing the 2016 legislation. The State appealed and the state supreme court affirmed the decision. State v. Wayfair Inc., 2017 S.D. 56, ¶ 1, 901 N.W.2d 754, 756, cert. granted sub nom. S. Dakota v. Wayfair, Inc., 138 S. Ct. 735 (2018). The U.S. Supreme Court accepted cert to review the decision, which many believe is an indication that the court will overturn Quill, especially based on some of the previous opinions by current justices on the court.

In Direct Marketing Association v. Brohl, Justice Kennedy wrote a concurring opinion stating that the “legal system should find an appropriate case for this Court to reexamine Quill” and he criticized Quill as being outdated in our current economic and technological climate and stated that “in 1992, the Internet was in its infancy. By 2008, e-commerce sales alone totaled $3.16 trillion per year in the United States.” Direct Mktg. Ass'n v. Brohl, 135 S. Ct. 1124, 1135, 191 L. Ed. 2d 97 (2015). No one can argue with his assessment that our methods of commerce have changed dramatically since the 1967 Bellas Hess case.

Additionally, some justices have also questioned the dormant Commerce Clause itself because it is not expressly supported by the U.S. Constitution. Justice Thomas has rejected the concept of dormant Commerce Clause, on which the Quill decision rests. Specifically, he stated “[t]he negative Commerce Clause has no basis in the text of the Constitution, makes little sense, and has proved virtually unworkable in application.” Camps Newfound/Owatonna, Inc. v. Town of Harrison, Me., 520 U.S. 564, 610, 117 S. Ct. 1590, 1615, 137 L. Ed. 2d 852 (1997). Further, he noted that the dormant Commerce Clause test compels the court to act more like legislators instead of judges, and the Court should limit its interpretation to the Constitution itself, and allow Congress to enact regulation that addresses interstate commerce.

And lastly, Justice Gorsuch, while serving on the Tenth Circuit, implied that the U.S. Supreme Court should be given an opportunity to overrule Quill and noted in his concurrence to Direct Marketing Association v. Brohl, that “we are obliged to follow Quill out of fidelity to our system of precedent whether or not we profess confidence in the decision itself” and has questioned Quill’s application in today’s economy. Direct Mktg. Ass'n v. Brohl, 814 F.3d 1129, 1148 (10th Cir.), cert. denied, 137 S. Ct. 591, 196 L. Ed. 2d 473 (2016), and cert. denied, 137 S. Ct. 593, 196 L. Ed. 2d 473 (2016).

Potential Impact If Quill Is Overturned
State and local governments continue to recover from the recession and if the Court overturns Quill, governments may greatly benefit from the collection of additional tax on remote retailers operating in the state. The National Conference of State Legislatures has estimated that states lost $23.3 billion in 2012 from being prohibited from collecting sales tax from online and catalog purchases. Although consumers are required by law to remit use taxes if the retail tax is not paid by the seller, this is often not the case, so the state or local government never collects the taxes due.

Additionally, sales tax will be uniformly and fairly applied based on the trade and not whether the business is located in the jurisdiction. Many commentators have noted that Quill has undermined its own goals because it steers retailers away from establishing businesses in states that charge sales tax, and those in-state retailers are at a competitive disadvantage from online retailers. However, it is possible that if the Court overturns Quill, Congress may decide to take action if there is sufficient concern that the overturning of a long-standing decision may be too disruptive or burdensome on remote sellers.

Oral argument for the case is scheduled for April 17, 2018 and a decision is expected by the end of June. Although the Court has the option of maintaining the status quo, it could have easily met that objective by denying review of the case. At the very least, the Court will provide an updated view of the dormant Commerce Clause in this new era of technological innovation. A summer Legal Corner article will cover the decision in-depth and provide an analysis of how the decision affects Arizona’s municipalities.