Justices brushed aside legitimate concerns in online sales tax case

The U.S. Supreme Court recently decided South Dakota v. Wayfair (138 S. Ct. 2080 (2018)). The decision will have broad consequences for online retail transactions, state and local taxation, and general e-commerce. The case also provides useful insight into the court's contemporary view of balancing the doctrine of stare decisis ("to stand by things decided") with other considerations.

The commerce clause provides that "Congress shall have Power ... To regulate Commerce with foreign Nations and among the several States." Its purpose to promote the free flow of commerce among the states, and to prevent the states from retreating into economic hegemony, which was a problem when the country was founded. Pursuant to this grant of power, Congress has the complete power to authorize or forbid the state taxation of activities interfering with interstate commerce.

The power of states to tax interstate commerce is an area of constitutional significance. The dormant commerce clause limits states from discriminating against or unduly burdening interstate commerce when Congress has not acted. The court has held that a state law that "regulates even-handedly to effectuate a legitimate local public interest" and has "only incidental" effect on interstate commerce is constitutional "unless the burden imposed on such commerce is clearly excessive in relation to putative local benefits." These principles mark the general constitutional boundaries of state taxation under the dormant commerce clause.

In the 1992 case Quill v. North Dakota, the Supreme Court held that the dormant commerce clause required that a seller have a "physical presence" in the state before it could impose tax collection obligations on that seller. An out-of-state seller without a physical presence, or who was unwilling to voluntarily cooperate, could simply ignore any entreaties by a state to collect the tax. Quill was not the typical dormant commerce case. Out-of-state businesses without a physical presence were actually advantaged, not disadvantaged, relative to in-state businesses.

The South Dakota legislature, which relies heavily on sales taxes, determined that its inability to collect sales taxes from remote online sellers was eroding its sales tax base and causing harm to its citizens through the loss of critical funding. Based on a declared emergency, it enacted an "economic presence" law requiring out-of-state sellers with a significant quantity of in-state business to collect and remit sales taxes "as if the seller had a physical presence" in South Dakota.

South Dakota asked the Supreme Court in Wayfair to decide whether an out-of-state online seller, without a physical presence, could be required to collect and remit a sales tax on online purchases made by its residents. The court overruled the Quill "physical presence" test, which it created 25 years earlier, as an "unsound and an incorrect" interpretation of the commerce clause.

The doctrine of stare decisis generally fosters the rule of law by promoting stability, certainty and predictability. Yet, it is also a discretionary doctrine that is weighed and balanced with other considerations, which in Wayfair included: (1) significant factual developments; (2) the difficulty in applying the physical presence test; and (3) the absence of a persuasive reliance interest. The court found these considerations outweighed the application of stare decisis.

The court reasoned that the present day realities of the internet and the dynamics of the national economy rendered the physical presence test technologically outdated. Physical borders aren't relevant to online shopping. The adverse impact to state revenues from online sales was also significantly greater than in 1992. State and local governments were not the only losers. Although online purchasers are advantaged when they avoid the sales tax, brick-and-mortar businesses and surrounding communities are unfairly disadvantaged by tilting the economic-playing field in favor of online sellers. Empty storefronts and closed businesses were the resulting harvest. When the law treats similarly situated purchasers differently through a judicially created "tax shelter," the underlying sense of fair and equitable treatment is offended.

The court found that the physical presence rule was neither clear nor easy to apply to online sales. As a result, the lower courts were becoming increasingly embroiled in technical and arbitrary disputes about what constitutes a physical presence. An economic incentive existed to avoid having an in-state physical presence in order to reap the tax avoidance benefit for purchasers and secure a competitive advantage. In the end, the promotion and protection of interstate commerce was being undermined.

Finally, the reliance interest argument also failed to persuade the court to follow Quill. It reasoned that an out-of-state business is in no position to predicate a constitutional right on the opportunity for tax avoidance, which internet sellers were pitching to consumers as an advantage to shopping online.

The court acted appropriately in abandoning the physical presence test. But the burden of collecting sales taxes in different states and varied amounts by online sellers poses a complex and legitimate concern, which was brushed aside by the court. In addition, the concept of "economic presence" as a benchmark may prove as difficult to apply as "physical presence." Because no physical borders exist on the internet, the treatment of international online sales also must be taken into account. The solution to these and other thorny problems lies with Congress as it has the power to provide comprehensive rules on state taxation of internet transactions under the commerce clause. In the final analysis, Congress, not the judiciary, is better suited to determine these rules.