Supreme Court can overturn Quill because it applied the wrong rule

OCTOBER 2017 TERM

The issue in South Dakota v. Wayfair is whether the U.S. Supreme Court should overturn a rule that it established in 1967 and reaffirmed in 1992 to the effect that a state can only force a remote vendor to collect use tax if that vendor has a physical presence within the state. See Nat'l Bellas Hess, Inc. v. Dep't of Revenue of Ill., 386 U.S. 753 (1967); Quill Corp. v. North Dakota, 504 U.S. 298 (1992) [opinion attached below]. "Use tax" is the tax that consumers owe when they purchase an item from an out-of-state vendor that would have been subject to sales tax had it been purchased from an in-state vendor.

It has been known since the 1930s when the states first established sales taxes that: (1) there needs to be a backup tax for purchases from out-of-state vendors (the use tax) and (2) that that both the sales and use tax must be collected by the vendors because consumers could not and would not remit a transaction based tax. These hoary truths have been confirmed by the states' experience with the use tax in the age of the internet.

Thanks to the physical-presence rule reaffirmed in Quill, many remote vendors, including very large ones, scrupulously organized their operations so as to avoid physical presence in most states. Individual consumers, in turn, failed to remit the use tax and thus states have lost, and continue to lose, billions of dollars and local business operate at a serious competitive disadvantage. As Justice Byron White put it in his dissent in Quill, the physical-presence rule creates an "interstate tax shelter" in the name of a doctrine supposed to create an "even playing field."

It should be acknowledged that the rule of Quill is a response to a real challenge. There are thousands of sales tax jurisdictions in this country, and, despite substantial similarities in their sales tax laws and large advances in the compliance technology, complying with the obligation to collect and remit use taxes can be potentially substantial. This is most likely the case for a small seller that happens to sell in many states; for such a seller the compliance burden might be significant.

But the Quill rule is both an over- and under-inclusive way to address such concerns. The rule is over-inclusive because the rule protects large businesses that could easily afford the compliance burden. The rule is under-inclusive because it does not protect a small seller who happens to have a small physical presence in multiple states.

The Supreme Court did not need to agree to reconsider the Quill rule, though one justice, Anthony Kennedy, had urged the states to bring the issue to the court in a concurring opinion he wrote in 2015. Direct Mktg. Ass'n v. Brohl, 135 S. Ct. 1124, 1135 (2015). The comfortable consensus has therefore been that the Quill rule is about to be overturned. Yet, at oral argument, the justices asked so many critical questions of the attorney for South Dakota that this consensus is no longer so comfortable.

I will not hazard to guess what the court will do, but I think the court should overturn the Quill rule notwithstanding the cogent concerns raised by the justices.

The concerns expressed by the court were largely practical. How is a court to assess the amount of damage that the Quill rule is doing? What would a better rule be and, even if the court could craft one, isn't this a job for Congress? The Quill rule is based on an interpretation of the dormant commerce clause, which is a judicial gloss on the commerce clause of the U.S. Constitution, and so Congress could -- and has attempted to -- overturn the Quill holding. Does the failure of Congress to act mean that it approves of the rule?

Fortunately, there is a straightforward path to resolving this case without the Supreme Court having to act as a super-legislature. The dog that didn't bark at oral argument was whether Quill was rightly decided as a matter of law. It was not. Consider basic dormant commerce clause doctrine from Con Law I. In our constitutional system, states have plenary power unless restricted by the federal Constitution or preempted by Congress using one of its enumerated powers. As a constitutional matter, states are free to regulate commerce so long as they do not do so in a manner that is discriminatory or unduly burdens interstate commerce -- the Pike balancing test. Pike v. Bruce Church, Inc., 397 U.S. 137 (1970). The requirement to collect the use tax is not discriminatory and so such requirements should be subject to Pike balancing. We don't limit a state's ability to regulate a consumer product to cases where a business has a physical presence in a state. Even in 1967, the physical-presence rule was an anachronism; it is even more so now.

So the Supreme Court need not overturn Quill because of a policy analysis or even craft a new rule. Rather, it can overturn Quill because it applied the wrong rule, and the right rule already affords small remote vendors significant protection. Note that it is not clear that small vendors would need the protection of Pike. Are states really going to celebrate their victory in Quill by expending scarce enforcement resources chasing small sellers? In any event, if states did so act, there is excellent reason to believe that Congress would intervene to protect small sellers. Even while Congress has been unable to reach consensus on overturning Quill, Congress has acted numerous times to protect narrow economic interests from state taxing power or regulation. See Brian Galle, "The Politics of Federalism: Self-Interest or Safeguards? Evidence from Congressional Control of State Taxation," Aug. 20, 2011. Why has there been this difference in result? For one, if Congress overturns Quill, then some will argue (inaccurately) that this amounts to a tax increase. In contrast, when Congress shields a particular group from state taxes, then this is unambiguously providing a tax cut -- and one that costs the federal government nothing!

This brings us to the question of the role of Congress: How can the court properly act on even a well-supported surmise that Congress is more likely to pass comprehensive legislation if Quill is overturned? Again, returning to first constitutional principles provides a clear path. Our constitution was designed to make it hard for the federal government to act, and thus the default rule is crucial (and congressional inaction is meaningless). The party that has to convince the federal government to pass a law starts off in a deep hole. Because of this structure, the proper default as to the taxing and police powers of the states must be that they retain these powers. The Quill rule, incorrect in itself, thus reverses the proper constitutional order at great cost to the states. For the past 50 years, the states have had to convince Congress to correct a mistaken decision that has eviscerated a vital part of their sovereign powers.

In sum, there is no tension in this case between the best legal analysis and the best policy analysis. The court does not need to decide just how many billions in losses justify overturning Quill; the court should find that the Quill rule was always wrong as a matter of law. Applying the correct law to this case will not trigger the parade of horribles conjured by supporters of the Quill rule. States are not likely to act to over-burden remote sellers. If they do, the courts can apply Pike balancing. And, beyond that protection, with the constitutional default restored, Congress would be likely to act to protect small businesses from over-reaching states.