THE COMMERCE CLAUSE AND STATE TAXATION OF INACTIVITY

Author: Ryan Kenny, Associate Member, University of Cincinnati Law Review

In 2012, the United States Supreme Court heard National Federation of Independent Business et al. v. Sebelius, the landmark decision regarding the Affordable Care Act.[1] One of the primary issues in the case was the individual mandate requiring individuals to purchase health insurance, or face a fine.[2] While the Court upheld the fine as a legitimate exercise of Congress’s power to tax[3], the Court held that Congress could not mandate commercial activity, as this was outside the scope of the powers granted under the Commerce Clause of the United States Constitution[4]. The Court held that Congress could not compel “individuals to become active in commerce by purchasing a product, on the ground that their failure to do so affects interstate commerce.”[5]

This raises the issue of states’ ability to tax inactivity in a similar manner as the federal government.[6] One possible interpretation from Sebelius is that under the principles of federalism, there are no Commerce Clause limitations on the states in their power to tax inactivity, since the Commerce Clause does not grant Congress the power to regulate inactivity. Another interpretation is that even though the Commerce Clause may not permit Congress to compel commercial activity, state taxes that have the same objective may nevertheless have to satisfy the test of the Dormant Commerce Clause as outlined in case law. In order to prevent the type of protectionist policies for which the Commerce Clause was enacted, the Dormant Commerce Clause must have effect on states’ ability to tax inactivity.

I. The Current Dormant Commerce Clause Framework.

The current test for the Dormant Commerce Clause analysis was explicated in Complete Auto Transit, Inc. v. Brady.[7] The Court’s opinion, written by Justice Blackmun, outlined a four-pronged analysis for determining whether a state’s tax regulation ran afoul of the Dormant Commerce Clause. To pass constitutional muster, the state must show (1) a substantial nexus between the tax and the activity being taxed, (2) that the tax is fairly apportioned, (3) the tax does not discriminate against interstate commerce, and (4) the tax is fairly related to some benefit provided by the state.[8] While the Court’s Dormant Commerce Clause analysis has been the subject of a significant number of inquiries over the years, these elements still provide the guidelines for any state tax regulation analysis. However, in most cases, the Court is charged with analyzing a tax levied against some affirmative taxpayer action; an explicit engagement with commerce.[9] The question remains how the Complete Auto analysis of Dormant Commerce Clause would apply to taxation of inactivity.

II. The Framework Behind the Argument that State Authority to Tax Inactivity is Unrestricted by the Federal Commerce Clause.

The idea behind federalism in the United States is that “local jurisdictions and political subdivisions possess exclusive or concurrent constitutional authority distinct from the national government. States have plenary rather than enumerated powers.”[10] The Constitution granted the federal government listed, limited powers, beyond which the federal government could not extend its power. The states have everything that is left: those powers not granted to the federal government are reserved to the state. This principle was codified in the Constitution in the Tenth Amendment, “[t]he powers not delegated to the United States by the Constitution, nor prohibited by it to the states, are reserved to the states respectively, or to the people.”[11] Any powers not granted to the national government, and not taken from the states, is therefore left with the states.

In several situations, even where Congress has not exercised its authority under the Commerce Clause, the Court has struck down state statutes that run afoul of the Commerce Clause.[12] This is what is known as the Dormant Commerce Clause; a constitutional limitation on the states’ regulatory power. The Dormant Commerce Clause is one of the central tenets in judicial review of state tax regulations. The judiciary has invoked the Dormant Commerce Clause where a state’s tax “regulation either discriminates against out-of-state interests or unduly burdens the free flow of commerce among the states.”[13] For example, the Court struck down a property tax regime in Maine which levied a tax against charitable institutions who provided services primarily for out-of-state residents as discriminatory, and therefore a violation of the Dormant Commerce Clause.[14]

The argument may proceed as follows: principles of federalism that grant states police power under the Tenth Amendment, necessitate that where federal commerce powers under the Commerce Clause do not extend, the Dormant Commerce Clause cannot be applied. Therefore, it could be understood that because the Court states in Sebelius that Congress cannot compel individuals to partake in commerce as outside the scope of the Commerce Clause. If a state government attempted to compel activity in commerce via a tax regime, there would be no Dormant Commerce Clause limitations. Such a tax would be in the realm of powers not granted to the national government, and therefore reserved to the states. This argument is incorrect, and the Dormant Commerce Clause would still be applicable to state tax regulations that function in a way that would not be permitted at the federal level of taxation or regulation.

III. The Dormant Commerce Clause Is the Correct Framework for Analyzing State Taxes Which Would Be Levied Against Inactivity.

Mark Hall proposed an approach regarding the Dormant Commerce Clause and regulation of inactivity in a symposium on the American health care system, one year before the Court’s decision in Sebelius.[15] Hall takes the approach that defining commerce to some affirmative engagement in commercial activity is too narrow of a scope when considering the purpose and goals of the Commerce Clause in the Constitution.[16] Hall suggest that the power to “regulate”, as granted in the Commerce Clause, allows the national government to not only lay guidelines and parameters for commerce, but to also completely prohibit certain forms of commerce.[17] Furthermore, Hall continues to say that “[t]he [commerce] clause does not say that action must precede federal intervention, only that federal power may be used to regulate something that can be called commerce.”[18] Thus, Hall comes to the conclusion because “regulation includes mandating as well as prohibiting behavior related to products, it follows logically that ‘regulating commerce’ can include mandating a purchase.”[19]

The problem with this reasoning is that it equates regulations that prohibit certain commerce with regulations that mandate an engagement in commerce. Quoting Chief Justice Marshall’s opinion in Gibbons v. Ogden, Hall states that “‘the power to regulate . . . may be exercised to its utmost extent, and acknowledges no limitations, other than are prescribed in the constitution.’”[20] To mandate means to command action.[21] To prohibit is to prevent or forbid certain action.[22] Hall fails to acknowledge this critical distinction; one that did not go unnoticed by the Court in its decision in Sebelius.[23] It would seem that mandating commercial activity is beyond the boundaries of the “utmost extent” of Congress’s regulatory power under the Commerce Clause.

However, the Dormant Commerce Clause still has a role to play in the regulation of state taxation which levies taxes on inactivity, much as the Affordable Care Act’s mandate was held a constitutional exercise of federal taxation powers.[24] In Garcia v. San Antonio Metropolitan Transit Authority, the Court held that the protection for the states from Congress’s exercise of Commerce Clause authority “is one of process rather than one of result.”[25] The Court concluded that the states receive protection from overexertion of the Commerce Clause by having an active and direct role in the representative bodies of Congress.[26] Thus, the Court rejected its previous holding in National League of Cities v. Usery, that established the framework of analyzing powers traditionally left to the states and those granted to the national government for understanding the states’ protection from the Commerce Clause powers.[27] Quoting James Madison’s address to the First Congress: “‘Interference with the power of the States was no constitutional criterion of the power of Congress. If the power was not given, Congress could not exercise it; if given, they might exercise it, although it should interfere with the laws, or even the Constitution of the States.’”[28]

While Sebelius may have determined that regulating inactivity was beyond the scope of the Commerce Clause, it was by no means a repudiation of the Commerce Clause powers granted to Congress. In the spirit of James Madison, because the Constitution grants the Commerce Clause powers to Congress, the states cannot interfere with those powers, including the Dormant Commerce Clause. Thus, it is easily conceivable of a state tax regime on inactivity that could violate the Dormant Commerce Clause, although it is not a specific power granted to Congress, but could nonetheless interfere with interstate commerce, and thus violate the Dormant Commerce Clause.

Going back to the analysis from Complete Auto, it would seem discriminatory, and thus a violation of the third prong, if a state were to tax out-of-state trucking companies for not having vehicle insurance, but not apply the same rule to in-state trucking companies. It would still fail the substantial nexus prong if the state attempted to levy an inactivity tax against a taxpayer who did not meet the requirements to establish a substantial nexus with the state.

Even though Sebelius determined that Congress could not compel commercial activity with a health care mandate, this does not mean that states are unfettered levying taxes on inactivity on the grounds that doing so is beyond the reach of the Dormant Commerce Clause. There is no reason to assume that the four-pronged analysis developed in Complete Auto would be applied in a substantially different way on state taxation of inactivity rather than state taxation on affirmative engagement in commerce. States could still use taxes on inactivity in discriminatory manner to provide competitive advantages for in-state taxpayers at the expense of out-of-state taxpayers, and it would be a windfall of state tax power to assume otherwise.

[1] National Federation of Independent Business et al., v. Sebelius, 132 U.S. 2566 (2012).

[2] Id.

[3] Id. at *2596.

[4] Id. at *2587.

[5] Id.

[6] For this analysis, “inactivity” means refraining from engaging in commerce.

[7] Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).

[8] Id. at *279.

[9] The solicitation of sales (Tyler Pipe Industries, Inc. v. Washington State Dept. of Revenue, 483 U.S. 232 (1987)), a tax on property which is used by the taxpayer in the engagement of interstate commerce (Norfolk and Western Railway Co. v. Missouri State Tax Comm., 390 U.S. 317 (1968)), severance taxes on the removal of natural resources (Commonwealth Edison Co. v. Montana, 453 U.S. 609 (1981)), or a tax exemption for charitable organizations who primarily benefitted in-state residents (Camps Newfound/Owatonna, Inc. v. Town of Harrison, 520 U.S. 564 (1997)).

[10] David Frohnmayer, A New Look at Federalism: The Dual Theory and Implications of ‘Dual Sovereignty’, 12 Envtl. L. 903, 905 (1982).

[11] U.S. Const. amend. X.

[12] Martin H. Redish and Shane V. Nugent, The Dormant Commerce Clause and the Constitutional Balance of Federalism, 1987 Duke L. J. 569, 570 (Sept. 1987).

[13] Id.

[14] Camps Newfound/Owatonna, Inc. v. Town of Harrison, 520 U.S. 564 at *575 (May 19, 1997).

[15] Mark A. Hall, Commerce Clause Challenges to Health Care Reform, 159 U. Penn. L. R. 1825 (June, 2011).

[16] Id. at 1833.

[17] Id.

[18] Id. at 1834.

[19] Id.

[20] Id.

[21] Mandate, Merriam-Webster Dictionary (https://www.merriam-webster.com/dictionary/mandate).

[22] Prohibit, Merriam-Webster Dictionary (https://www.merriam-webster.com/dictionary/prohibit).

[23] Sebelius, 132 U.S. 2566 at *2587; “Allowing Congress to justify federal regulation by pointing to the effect of inaction on commerce would bring countless decisions an individual could potentially make with the scope of federal regulation, and—under the Government’s theory—empower Congress to make those decisions for him.”

[24] Id. at 2595.

[25] Garcia v. San Antonio Metropolitan Transit Authority, 469 U.S. 528, 554 (1985).

[26] Garcia, 469 U.S. 528, 551.

[27] Garcia, 469 U.S. 528, 546-547.; rejecting the “integral v. traditional” approach.

[28] Garcia, 469 U.S. 528, 549 (quoting James Madison’s Address to the First Congress, 2 Annals of Cong. 1897 (1791)).

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