The U.S. Supreme Court has long interpreted the dormant commerce clause1 to prohibit states from imposing an obligation to collect and remit sales and use taxes2 on vendors that lack a physical presence in the state.3 The Court affirmed this rule in Quill Corp. v. North Dakota,4 in which it found that the costs to interstate entities of complying with multiple state and local tax collection and remission systems “might unduly burden interstate commerce”5 and therefore justified a “bright-line rule” against such state tax requirements.6 However, in the twenty-six years that have elapsed since Quill, the growth of e-commerce has diverted significant business from brick-and-mortar stores to their virtual competitors,7 reducing the sales tax revenue available to states.8 As a consequence, thirty-two states have resisted the Quill rule via legislation, regulation, and litigation.9 Recently, in State v. Wayfair Inc.,10 the South Dakota Supreme Court held that a state law requiring some internet retailers with no physical presence in the state to collect and remit sales taxes at rates equivalent to in-state vendors contravened Quill.11 Wayfair illustrates the flaws that make the Quill rule impractical in the era of e-commerce. But when the Supreme Court revisits the doctrine this Term, the Court’s limited institutional capacity to design an alternative to Quill indicates that it should provide only a conservative revision. The Court should leave the task of crafting a nuanced solution to the increasingly complex problem of physical-presence nexus to Congress.
In 2016, the South Dakota Legislature passed Senate Bill 10612 (S.B. 106), a law extending the obligation to collect and remit sales taxes to sellers of “tangible personal property” without any physical presence in the state.13 S.B. 106 expanded this duty only to remote sellers that either earned “gross revenue” of more than $100,000 per calendar year from sales to South Dakota residents or businesses, or completed over two hundred “separate transactions” in the state in the same period.14 The text of S.B. 106 made clear that the Legislature specifically designed it to challenge the Quill doctrine.15 The bill directly referenced Justice Kennedy’s concurring opinion in Direct Marketing Ass’n v. Brohl,16 the last occasion on which the Supreme Court discussed the rule. Justice Kennedy questioned the enduring validity of Quill, observing that a retailer “doing extensive business within a State” may well have a sufficient nexus “to justify imposing some minor tax-collection duty”; he called for a test case in which the Court might reconsider the rule.17 To meet this call to action, S.B. 106 allowed the state to bring a declaratory judgment action against retailers thought to meet the law’s criteria for collection and remission in its courts of appeals to facilitate a speedy review.18
Soon after S.B. 106 was signed into law, retailers believed to meet its criteria received written notices from the South Dakota Department of Revenue informing them of the deadline to register for state sales tax licenses.19 Wayfair Inc., Overstock.com, Inc., and Newegg Inc. received notices but did not register for sales tax licenses.20 Pursuant to S.B. 106, the State filed a declaratory judgment action against the retailers in South Dakota’s Sixth Judicial Circuit Court.21 The sellers filed a motion for summary judgment, admitting that they each met S.B. 106’s economic-nexus threshold but raising the affirmative defense of S.B. 106’s unconstitutionality under Quill.22 The State agreed both with the sellers’ presentation of the material facts and that Quill bound the lower court to grant the motion for summary judgment — but nonetheless pursued the case in the hope that Quill would be overruled.23 In a brief order, Judge Barnett of the Sixth Judicial Circuit of South Dakota found himself “duty bound” to follow Quill as U.S. Supreme Court precedent and granted the retailers’ motion for summary judgment.24 He enjoined the State from enforcing S.B. 106 against remote sellers.25
The South Dakota Supreme Court affirmed. Writing for a unanimous court, Justice Severson26 concluded that S.B. 106 “could not impose a valid obligation on [the retailers] to collect and remit sales tax to [the] State because,” although they met the remission criteria of the law, “none of them had a physical presence in the state.”27 He recounted the history of the Quill doctrine, beginning with the 1967 U.S. Supreme Court decision in National Bellas Hess, Inc. v. Department of Revenue28 that prohibited the state of Illinois from imposing an obligation to collect and remit use tax on a seller whose “only contacts with [the] state were by mail or common carrier.”29 The Bellas Hess Court reasoned that the Commerce Clause grants Congress “exclusive authority”30 to regulate interstate commerce with the purpose of “ensur[ing] a national economy free from . . . unjustifiable local entanglements.”31 Obligating interstate retailers to comply with myriad reporting and remission requirements would unduly burden interstate commerce; the dormant commerce clause therefore committed taxation of such entities to Congress alone.32 Justice Severson recalled the Supreme Court’s affirmation in Quill of Bellas Hess’s bright-line rule against imposing state and local sales taxes on interstate retailers without physical presence.33 He emphasized that the Quill Court recognized the discontinuities between the Bellas Hess rule and later dormant commerce clause cases concerning other taxes.34 Despite these shifts, Quill followed Bellas Hess because it “encourage[d] settled expectations and . . . foster[ed] investment by businesses and individuals.”35
Justice Severson acknowledged obstacles raised by the Quill doctrine in the contemporary context. He first situated the origins of both S.B. 106 and the State’s contention that the litigation was intended to generate a Quill test case in the language of Justice Kennedy’s concurrence in Direct Marketing.36 He also noted that Justice Kennedy in fact “recognized many of the State’s arguments supporting reconsideration” of the bright-line rule.37 Justice Severson further bolstered the legal pedigree of the State’s anti-Quill stance, tracing its key elements back to the dissenting opinions in Bellas Hess and Quill.38 He hinted at the potential for future doctrinal evolution, observing that then-Judge Gorsuch had expressed similar qualms before joining the Supreme Court.39
However, Justice Severson remained “mindful of the Supreme Court’s directive to follow its precedent when it ‘has direct application in a case.’”40 The court, cognizant of its position in the judicial hierarchy and unable to identify any distinction between the collection obligation at issue in Quill and that created by S.B. 106, followed the “controlling precedent on the issue of Commerce Clause limitations on interstate collection of sales and use taxes.”41 S.B. 106, a law clearly impermissible under Quill, could not be constitutional. The South Dakota Supreme Court consequently held that the circuit court “correctly applied the law” by granting the retailers’ motion for summary judgment.42 The U.S. Supreme Court granted certiorari.43
The court’s injunction against S.B. 106, by deferring to clearly controlling Supreme Court precedent, necessarily could not account for the pragmatic difficulties of using physical-presence nexus to assess the extent of seller contact in light of the technological and economic transformations of recent decades. But the formalistic approach to nexus enshrined in the Quill rule cuts against economic reality: post-Wayfair, an in-state retailer that completes a single transaction in South Dakota has sufficient nexus to be subject to the collection and remission obligation, while an out-of-state retailer that completes two hundred or more transactions does not. Wayfair clearly demonstrates the Quill rule’s doctrinal and policy shortcomings, but the question of institutional capacity surrounding any refashioning of the bright-line physical-presence doctrine suggests that the Supreme Court should take an incremental approach to revising it. As it revisits Quill this Term, the Court should align the nexus rule for remote-sales taxation with the more flexible economic-nexus standard already used in related contexts.
In the internet economy, physical presence alone is both over- and underinclusive as a legal standard. It is overinclusive of business entities with very limited physical contact within the state and underinclusive of businesses whose models do not happen to require brick-and-mortar presence. Wayfair shows that even internet retailers completing hundreds of transactions generating thousands of dollars in revenue and therefore availing themselves of state infrastructure and amenities are beyond the reach of physical-presence nexus,44 but an out-of-state entity’s decision to employ even a handful of in-state individuals legitimizes local tax obligations.45 Quill, a rule that is blind to this disparity, is a doctrinal outlier: the Supreme Court has developed more responsive frameworks when considering other forms of taxation, such as business and occupation taxes for out-of-state entities.46 In this analogous context, the test for nexus is a flexible balancing model that examines “whether the activities performed in [the] state on behalf of the taxpayer are significantly associated with the taxpayer’s ability to establish and maintain a market in [the] state for the sales.”47 Nexus is bolstered if some meaningful physical presence is established,48 but slight physical presence alone is neither necessary nor sufficient.49 The Court grounds nexus in some economic activity of the entity, such as the cultivation of “market share” and “goodwill”50 or “the realization and continuance of valuable contractual relations.”51
Besides creating problems of over- and underinclusion, the Quill rule has growing consequences for states: in 2018, states’ inability to tax retailers without physical presence will result in $34 billion in lost state tax revenue, a number projected to reach $52 billion annually by 2022, compared to an estimated loss of up to $3 billion per year when Quill was decided.52 These projections may fall short of capturing the total revenue that would be lost to the Quill rule, as e-commerce is growing at a rate of “23% year-over-year,” a pace expected to accelerate as the digital retail landscape continues to evolve.53 By 2022, online sales will represent 17% of all U.S. retail sales, compared to 12.7% in 2017.54 Yet the Quill rule, because it denies states the ability to impose collection responsibilities on remote sellers, approximates a constitutional requirement for states to provide an advantage to these entities. It virtually ensures that purchases made online appear to be tax-free, incentivizing consumers to prefer e-commerce.55 A number of states attempt to mitigate their losses by imposing equivalent use taxes that consumers must pay to the state if the retailer does not remit sales taxes.56 But use tax compliance rates are low,57 and Bellas Hess, a case about a state use tax, forecloses the possibility of states placing collection and remission obligations on out-of-state vendors.58 Consequently, many online transactions are tax-free in effect as well as appearance.
In addition to its fiscal impact, physical-presence nexus also undermines the traditional goals of dormant commerce clause limits: to curb protectionist impulses,59 promote the creation of a single common market,60 and encourage economic integration.61 The Quill rule works against these objectives by encouraging interstate companies to concentrate in as few states as possible to avoid incurring additional obligations to collect sales taxes.62 This practical consideration undercuts Quill on doctrinal grounds: the Quill Court adopted the Bellas Hess Court’s justification of the bright-line rule that, in answering the question of when a state can burden interstate commerce, physical presence stands as a proxy for the balance of compliance burdens from tax obligations against benefits received from state protection and services.63 Bellas Hess and Quill concluded that the proper balance weighed in favor of reducing retailers’ burden in light of the minimal sales conducted by remote sellers.64 This determination of the balancing merits loses force in “an economy that no longer connects vendors and consumers via physical contact.”65 Though Bellas Hess and Quill assume that remote sellers do not enjoy the benefits of state services, in fact, like their brick-and-mortar counterparts, remote sellers use state and local law enforcement, transportation infrastructure, and other amenities.66
The Supreme Court should bring its sales and use tax doctrine into alignment with its business and occupation tax model,67 but go no further. The business and occupation tax cases’ blended physical- and economic-nexus test would offer the benefits of predictability and settlement that advocates of the Quill rule fear will be lost in a new regime.68 Today, when the relevant questions involve e-commerce, the reliance interests on which the Quill Court based its decision do not raise the same concerns. E-commerce is now so embedded in the national economy that the obligation to collect and remit is unlikely to threaten the vitality of the industry.69
Wayfair provides an opportunity for the Supreme Court to reconsider a formalistic, bright-line rule that is increasingly in tension with economic reality and bring it in line with related areas of precedent. If the Court loosens the strictures of physical-presence nexus by moving toward the economic-nexus standard, experimentation by the states will produce myriad models of assessing nexus to inform future deliberation.70 Should eventual developments in the economic and technological landscapes prove the economic-nexus approach unworkable, Congress can and should enact a more comprehensive national policy for state taxation of remote sellers.71 This was the solution urged by the Quill Court, which chose to maintain the settled Bellas Hess rule in part because the problem of remote-sales taxation is one “that Congress may be better qualified” and “has the ultimate power” to settle.72 Congress has already attempted to pass legislation modifying or overturning the Quill rule.73 Though it is possible that Congress will continue to fail to pass post-Quill legislation,74 the collection and remission obligations that internet and mail-order retailers would most likely face should the Court modify or abrogate the existing standard might incentivize them to support federal legislation creating national standards in order to ease their compliance burdens, marking a shift in the political landscape to this point.75 The Court should abrogate the Quill rule in favor of economic nexus for remote sellers, avoiding risky innovation with the knowledge that Congress remains free, as it has been since 1992, to establish a sound national policy for remote-sales taxation.