Abstract: The U.S. Supreme Court’s landmark 1992 decision in Quill Corporation v. North Dakota protects out-of-state businesses in the Internet era from overreaching by revenue-hungry states. The Court’s decision prevents a state from forcing an out-of-state business to serve as the state’s sales tax collector if the business has no physical presence in the state and simply takes sales orders by Internet, catalog, or telephone. Congress has under consideration legislation (S. 1832) to overturn the Quill Corporation decision. To support a strong national economy and encourage fiscal responsibility among the states, Congress should reject the legislation.
Congress has under consideration legislation (S. 1832 of the 112th Congress) to allow states to require out-of-state businesses that have no connection to the state, other than taking orders over the Internet, by mail, or by telephone from in-state customers and sending the ordered goods by common carrier or U.S. mail, to become sales tax collection agents for the states. Enactment of such legislation would increase the amount of tax dollars millions of Americans pay, encourage states to increase the size and scope of their governments, favor some states over others in granting federal authority, and discourage free-market competition in interstate commerce. Accordingly, Congress should not enact the legislation.
The legislation overrules the U.S. Supreme Court’s decision in Quill Corporation v. North Dakota. The Quill decision protects out-of-state businesses that have no facilities or personnel in a state, but that receive orders by Internet, mail order catalog, or telephone from in-state customers (called “remote sales”), from the state’s desire to force the out-of-state businesses to serve as tax collectors.
Many state governments have budgetary and political interests in maximizing the revenues they obtain from out-of-state businesses through sales and use taxes. Many-state businesses have an economic interest in increasing the costs of doing business for their out-of-state competitors to gain a marketplace advantage.
Thus, it is unsurprising that state governments and their national associations, and brick-and-mortar in-state retailers and their trade associations, have endorsed enactment of federal legislation to override the Quill decision and allow state governments to require out-of-state businesses to collect and remit state sales and use taxes on remote sales. Associations representing companies that conduct or facilitate remote selling that is protected under the Quill decision from state compulsion to collect and remit sales taxes oppose the legislation.
In enacting S. 1832, Congress would use its power under the Commerce Clause to regulate interstate commerce, and perhaps its power under the Compact Clause to consent to compacts or agreements among the states, to override the Quill decision and allow state governments to increase revenues by requiring out-of-state sellers to collect state sales or use taxes on remote sales. Congress should reject S. 1832 so that it does not discourage spending restraint in the states and free enterprise in the economy.
Quill Decision Protected Out-of-State Sellers from Undue State Burdens on Interstate Commerce
In 1992, the U.S. Supreme Court faced the Quill case involving a North Dakota statute that imposed a tax on property purchased for storage, use, or consumption in North Dakota and required retailers to collect the tax from consumers and remit the revenue to North Dakota. North Dakota regulations implementing the statute made clear that retailers covered by the statute included those who engaged in “regular or systematic solicitation of a consumer market in this state.”
Quill Corporation (“Quill”) was an office supply business incorporated in Delaware, with offices and warehouses in Illinois, California, and Georgia but with no employees, sales representatives, or significant property in North Dakota. Quill solicited sales from North Dakota residents by mail order catalog, advertisements and flyers, and telephone calls. Quill sent the purchased products to customers in North Dakota by U.S. mail or common carrier. Quill had about 3,000 customers in North Dakota and about $1 million in annual sales to them. Quill did not collect and remit the North Dakota use tax on its sales to North Dakota residents. North Dakota sued Quill in state courts for the taxes not remitted, and the case ultimately reached the U.S. Supreme Court.
Quill maintained that the Due Process Clause of the Fourteenth Amendment to the U.S. Constitution (“nor shall any State deprive any person of…property, without due process of law”) and the Commerce Clause (“The Congress shall have Power…To regulate Commerce…among the several States”) barred North Dakota from imposing the use tax on property purchased from Quill for storage, use, or consumption in North Dakota and from requiring Quill to collect the use tax from customers and remit the collections to North Dakota.
In its decision, the U.S. Supreme Court determined that “there is no question that Quill has purposefully directed its activities at North Dakota residents, that the magnitude of those contacts is more than sufficient for due process purposes, and that the use tax is related to the benefits Quill receives from access to the State” and agreed with the “conclusion that the Due Process Clause does not bar enforcement of that State’s use tax against Quill.” However, the Court held that the Commerce Clause barred North Dakota from enforcing the state’s use tax against Quill.
In discussing the impact of the Commerce Clause with respect to state taxes, the Court noted that “we will sustain a tax against a Commerce Clause challenge so long as the ‘tax  is applied to an activity with a substantial nexus with the taxing State,  is fairly apportioned,  does not discriminate against interstate commerce, and  is fairly related to the services provided by the State.’” The Court noted with respect to the first requirement that “the Commerce Clause and its nexus requirement are informed not so much by concerns about fairness for the individual defendant as by structural concerns about the effects of state regulation on the national economy.”
The Supreme Court adopted in Quill a bright-line rule that the “negative” or “dormant” aspect of the Commerce Clause, which protects against imposition by a state of unreasonable burdens on interstate commerce even in the absence of congressional exercise of power under the Commerce Clause, does not allow North Dakota to require collection and remittance of the state use tax revenue by a corporation whose only connection with customers in the state is by common carrier or U.S. mail. The Court noted, however, that Congress remains free, by an affirmative exercise of its power under the Commerce Clause, to change that rule.
State supreme courts have generally construed the Quill decision narrowly and state taxing power broadly, but states remain bound by the Commerce Clause holding in Quill that a state cannot require collection and remittance of a sales or use tax on remote sales by an out-of-state seller who has no connection to the state other than by common carrier or U.S. mail. Thus, the holding in Quill continues to protect an out-of-state company that has no facilities, personnel, or other connection to a state, other than a common carrier or the U.S. mail, from a requirement to collect and remit the state’s sales or use tax on remote sales. Congress, however, has the authority under the Commerce Clause to take away that protection from the out-of-state businesses, as S. 1832 would do.
Overriding Quill Would Cause American Businesses and Individuals to Pay Much More to States in Taxes
Enactment of S. 1832 will increase the amount of tax dollars Americans pay to state governments. Although proponents claim that the legislation causes no “tax increase” because state laws imposing sales and use taxes are already on the statute books and S. 1832 does not itself change those state statutes, there is no denying that businesses and individuals will pay more in taxes out of their pockets as a result of enactment of S. 1832. Indeed, that increase in what remote sellers will collect from businesses and individuals and remit to the state in tax revenues is precisely why many state governments want Congress to enact S. 1832.
The National Conference of State Legislatures (NCSL) has noted with respect to S. 1832 that “[t]here will be some who claim that this is a new tax” and that “[t]his legislation will not require any state to levy a sales tax on any product or means of buying a product.” Both claims miss the point. As a direct result of enactment of S. 1832, which allows states to require out-of-state remote sellers to collect state sales and use taxes that the Quill case currently prevents states from requiring, businesses and individuals will pay much more money to states in sales taxes. Indeed, the NCSL states that, “[a]t a time when states continue to face severe budget gaps—states closed shortfalls totaling $72 billion leading into the FY 2012 budget process—it is essential states be allowed to collect the revenue generated by uncollected sales taxes,” noting further that “[i]n 2012, states will collectively lose an estimated $23.3 billion in uncollected sales taxes from out-of-state sales, with more than $11.3 billion alone from electronic commerce transactions….”
The NCSL could not have made clearer that its objective in asking Congress to enact S. 1832 is to change federal law to authorize states to force remote-selling businesses and individuals to pay more money as sales and use taxes to the states, which want more revenue.
Overriding Quill Would Give States an Incentive to Increase Revenues Instead of Cutting the Size, Scope, and Cost of State Governments
Although many state governments have faced difficulty with their budgets, especially in a weak economy, slow improvement of state finances has begun. As a general proposition, states should focus on cutting their spending rather than seeking more money in taxes as the means to balance their budgets. Especially in a weak economy, state governments should generally pursue pro-growth, job-creating tax policies rather than taking more money out of the private economy in sales tax collection.
Whether the NCSL-cited estimate of $11.3 billion in additional money that would be paid to states in sales taxes on electronic remote sales is precise or not, it is clear that businesses and individuals will pay more money to states in such taxes as a result of enactment of S. 1832. The federal government should not enact legislation such as S. 1832, whose principal purpose is to allow states to reach out of the state and take in yet more tax money from businesses and individuals.
Enactment of S. 1832 Would Favor Some States over Others
The proposed federal legislation fails to respect the traditional roles of the states as equal sovereign actors in the federal system and instead has Congress, using its power under the Commerce Clause, favoring some states over others. The federal legislation has the effect of dividing the states into three classes and gives different federally granted, tax-related authority to the three classes, with some states receiving more than others.
The first class consists of a minority of states, currently numbering 21, that have joined as full members of the multi-state Streamlined Sales and Use Tax Agreement (SSUTA or Agreement), administered by an organization called the Streamlined Sales Tax Governing Board, Inc. The laudable stated purpose of the SSUTA is “to simplify and modernize sales and use tax administration in the member states in order to substantially reduce the burden of tax compliance.” Article VI of the SSUTA, however, goes beyond the stated tax-simplification purpose of the agreement and encourages enactment of federal legislation to overrule Quill and authorize states to collect sales or use taxes on “remote sales.”
The SSUTA defines “Remote sales” as “sales into a state in which the seller would not legally be required to collect sales or use tax, but for the ability of that state to require such ‘remote seller’ to collect sales or use tax under federal authority,” the latter referring to the federal legislation under the Commerce Clause to overrule the Quill decision that the SSUTA member states seek. The first class of states gets federal authority to collect its sales or use tax on remote sales under subsection 3(a) of S. 1832, which provides that “Each Member State under the Streamlined Sales and Use Tax Agreement is authorized to require all sellers not qualifying for a small seller exception to collect and remit sales and use taxes with respect to remote sales sourced to that Member State pursuant to the provisions of the Streamlined Sales and Use Tax Agreement.”
The second class of states consists of states that are not full members of the SSUTA but that adopt state laws that impose SSUTA-like “minimum simplification requirements.” Subsection 3(b) of S. 1832 provides that “[a] State that is not a Member State under the Streamlined Sales and Use Tax Agreement is authorized to require all sellers not qualifying for the small seller exception to collect and remit sales and use taxes with respect to remote sales sourced to that State, but only if the State adopts and implements minimum simplification requirements.” Under subsection 3(b), the “minimum simplification requirements” are:
- A “single State-level agency to administer all sales and use tax laws”;
- A “single audit for all State and local taxing jurisdictions within that State”;
- A “single sales and use tax return”;
- A “uniform sales and use tax base among the State and the local taxing jurisdictions within the State”;
- A requirement that “remote sellers…collect sales and use taxes pursuant to the applicable destination rate, which is the sum of the applicable State rate and any applicable rate for the local jurisdiction into which the sale is made”; and
- Various requirements concerning software, certification of service providers remote sellers can use to remit the taxes collected, relief from liability for mistakes not caused by the remote sellers, and 30-day notice of local tax rate changes.
The “minimum simplification requirements” parallel to some extent SSUTA requirements.
The third class of states under the proposed federal legislation are those that neither wish to join the SSUTA nor wish to adopt the SSUTA-like minimum simplification requirements. Examples of states likely to fall into the third class are Delaware, Montana, New Hampshire, and Oregon, which do not levy general sales taxes. If S. 1832 were enacted, other states could collect sales taxes on remote sales by remote sellers located in those four states even though those four states do not impose general sales taxes on anyone, either in-state or out-of-state. As a result, any remote-seller businesses in Delaware, Montana, New Hampshire, and Oregon, whose state legislatures have made conscious decisions not to impose a general state sales tax, would nevertheless have to collect and remit such sales taxes to other states.
Under S. 1832, the first class of states and the second class of states get federal authority, the Quill decision notwithstanding, to require remote sellers—that is, out-of-state businesses that obtain sales in a state by Internet, mail order, or telephone without having any facilities or personnel in the state—to collect and remit the state’s sales or use tax on remote sales. The first class of states—that is, the SSUTA full members—get greater flexibility, however, than the second class of states. States in the first class can, acting in concert through the SSUTA governing board, establish their own alternative small seller exceptions, but the second class of states must follow the small seller exception specified in the federal legislation. Also, states in the first class can, again acting in concert through the SSUTA governing board, change their rules with respect to “sourcing” remote sales (that is, deciding where to treat the sale as having occurred, such as at the point of a product’s origin or at its destination, and therefore what state will tax the sale), whereas the other states must follow the sourcing rules set forth is S. 1832.
The third class of states remains covered by the Quill decision unless they enact the “minimum simplification requirements” to enter the second class of states or decide to become full members of the SSUTA to enter the first class of states. Clearly, enactment of S. 1832 would pressure the current majority of states that have stayed out of the SSUTA to join the minority of states that are members of the SSUTA.
Enactment of S. 1832 to override Quill, authorize state governments to require out-of-state remote sellers to collect sales taxes, and allow SSUTA full member states to have the power to change their sourcing rules from time to time, creates the potential for multiple taxation of the remote sellers in some circumstances, with the same sales transactions taxed by the state of the customer who used the Internet to place the order and the state in which the remote seller is located. Current law prohibits such multiple taxation, but that prohibition expires on November 1, 2014.
Enactment of S. 1832 Would Discourage Free-Market Competition
The National Conference of State Legislatures has said with respect to state sales taxes that “[a]llowing some remote sellers to avoid collecting this tax is unfair to the main street merchants that make up the lifeblood of our local communities.” The SSUTA member states complain that “[a]t a time when Main Street retailers face enormous competitive challenges it is appropriate for Congress to end this unfair treatment.” The Federation of Tax Administrators believes “the current system disadvantages ‘bricks and mortar’ stores to the advantage of out-of-state businesses and this Act will help improve business activities in our states and the employment these in-state businesses generate.”
These organizations are remarkably transparent about their purpose: They seek enactment of S. 1832 so that states can prefer in-state businesses over out-of-state businesses in the kind of anti-competitive economic discrimination the U.S. Constitution was in part adopted to prevent. As the U.S. Supreme Court has stated, “[p]reservation of local industry by protecting it from the rigors of interstate competition is the hallmark of the economic protectionism that the Commerce Clause prohibits.”
The Constitution of the United States has set the legal baseline—the level playing field—around which the American free-market economy has built itself. The Constitution, as reflected in the Quill decision, is the source of the present arrangement regarding collection of state sales and use taxes by remote sellers. Ever since the Supreme Court decided Quill in 1992, American businesses have made millions of business decisions in the competitive marketplace based in part on settled expectations regarding state taxation affecting their sales transactions. The states and businesses advocating S. 1832 seek to change the current, constitutionally prescribed playing field. They seek to use governmental power to intervene in the economy to help in-state, store-based businesses by imposing a new tax-collection burden on out-of-state competitors who sell over the Internet, through mail order catalogs, or by telephone. Free-market principles generally discourage such government intervention in the economy to pick winners and losers based on legislative policy preferences.
The Constitution has not set up a system that is “unfair” to “Main Street” or “brick and mortar” retailers. The issue is not “taxable” in-state businesses selling from stores competing with “untaxable” out-of-state businesses selling through the Internet. Both types of businesses are taxable through some form of tax in some state (or in many states).
Every sale of goods, whether to a business consumer or an individual consumer, has an order (“I’ll take it”), payment (“Cash, check, debit, or credit?”), and a delivery (“Here you go; have a nice day”). If a consumer chooses to go to a store to buy a product, the ordering and delivery typically occur in the seller’s physical facility (the store) in a state. If the consumer chooses to go online to buy the product, the ordering occurs online without the involvement of a physical facility of the seller (i.e., the order does not occur in a store), but the sale and delivery require that the seller (directly or through agents) have a physical facility (for example, a warehouse) in some state from which the seller sends goods via common carrier or U.S. mail to the consumer who ordered them online.
Thus, every sale of goods involves at least one physical facility located in one state or another, which provides a basis for taxation by that state. No one has become completely “untaxable.”
A consumer’s preference between two methods of purchase, such as buying in a store or buying over the Internet, on a given occasion may involve consumer thoughts about price, quality, commercial loyalty, geographical convenience, temporal convenience, perceived pleasantness of the sales method chosen, other reasons, or not much thought at all. A consumer’s choice between buying in a store or buying online does not necessarily mean a conscious choice between an in-state and an out-of-state seller, as consumers rarely know the state in which an Internet operation is located. The consumer’s choice between buying in a store or buying online does not necessarily even mean a choice between two different sellers. Many companies sell both from stores and through the Internet. Consumers should be free to choose how and where they will buy goods they seek without interference from a state trying to steer that purchase to a local store.
In the long run, the national economy as a whole benefits from allowing consumers to choose freely what they wish to buy, of whatever quality they wish, at whatever prices they choose to pay, and from whatever seller they wish, whether in the same state as the consumer or not. Intervention by the federal government and the states in the consumers’ choices by enactment and implementation of S. 1832 would increase the revenues of states, but hobbling out-of-state businesses that sell through the Internet or mail order catalogs does not help the national economy.
Congress should not override the Supreme Court’s decision in Quill Corporation v. North Dakota that the Commerce Clause prohibits a state from requiring out-of-state sellers over the Internet, by catalog, or by telephone that have no connection to a state other than a common carrier or the U.S. mail to collect and remit the state’s sales and use taxes. Enactment of S. 1832 would simply encourage state governments to take more money from taxpayers and spend it instead of getting the size, scope, and cost of state governments under control.
The independent decisions of millions of consumers in the free marketplace should decide the appropriate allocation of sales between the store-based model of selling and the non-store-based model of selling, such as Internet sales, and between sellers who are local and sellers who are elsewhere in America. To support a stronger national economy, Congress should reject economic protectionism for local businesses, reject state government bloat, and reject S. 1832.
—David S. Addington is Vice President for Domestic and Economic Policy at The Heritage Foundation.