Pigs, Pike and the Uncertain Future of State Tax Regulation and Litigation

On the surface, the U.S. Supreme Court’s May decision to let a 2018 California animal welfare law stand was about animal cruelty and, in this case, protecting pigs. Considering a deeper policy level, however, the decision featured new interpretations of the Dormant Commerce Clause (DCC), the Pike balancing test and state ballot initiatives – all of which will have potentially substantial implications on the future of state tax litigation, policymaking and implementation.  

The Commerce Clause, found in Article I, Section 8, Clause 3 of the Federal Constitution, gives Congress the power to ... “regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes”. Designed originally to prohibit state regulation from unduly restricting or constraining interstate commerce, the Commerce Clause has kept states from enacting protectionist or discriminatory laws to uphold open and balanced interstate commerce. However, in the absence of any affirmative federal legislation regulating a particular field of policy or legislation, the Commerce Clause is “dormant, when states themselves originate legislation that can impact interstate commerce”.  

Now, after the holding in National Pork, the application of the Commerce Clause has been narrowed and limited further. The principle of “extraterritoriality” has been expanded, potentially permitting states to regulate conduct beyond their borders. This makes the future of state tax regulation and commerce even more uncertain and ambiguous.  While the gradual erosion of the Commerce Clause, coupled with the increasing expansion of extraterritoriality, is not novel per se, legal scholars and tax practitioners alike have been debating the same for years. What should concern us today is the risky and unstable regulatory and judicial landscape it is creating in the new global digital economy. Additionally, the continual growth of borderless e-commerce, marketplaces and digital taxation (not to mention the approaching controversy of digital services tax, energy and environmental, social and governance-type regulations) adds further complexity.    

The Supreme Court’s National Pork Producers Council v. Karen Ross decision has multifaceted ramifications that are too complex to thoroughly examine in a blog post. (Ross is California’s Department of Food and Agriculture Secretary.)  That said, the ruling is essential for tax leaders to take notice and understand moving forward. This decision has generated regulatory uncertainty and, eventually, it will be applied across the vast field of state regulation, including taxation. This has the potential for placing more onerous compliance obligations on merchants and online marketplaces, perhaps triggering prices to rise further. That is, until perhaps Congress addresses the imbalances and pre-empts the field effectively. 

Consequently, we should review a few of the most notable aspects of the dispute, the oral arguments and the decision: 

• New state tax laws may now have more latitude and range: The National Pork Producers Council claimed that a law – one designed to ban in-state sales of pork derived from pigs kept in small cages – passed by California voters interfered with interstate commerce by burdening out-of-state pork producers with excessive production costs related to complying with the animal welfare standards. By ruling against the challenge in a 5-4 decision, the Supreme Court signalled that it is allowing states more latitude to regulate commerce that extends beyond state borders. 
• The decision could affect future tax regulation, litigation and interstate enforcement: “The case has piqued the interest of tax professionals who see parallels between arguments presented in the dispute and those raised in tax litigation,” according to Law360 Senior Tax Correspondent Paul Williams. Notably, this is the first Supreme Court decision involving the dormant Commerce Clause since the Court’s Wayfair ruling five years ago. 
• The Court may be “rebalancing” the Pike test: The Supreme Court used its 1970 Pike vs. Bruce Church decision in the Wayfair arguments to help determine whether a state law is unconstitutional because the burden it places on interstate commerce exceeds the in-state benefits the law is designed to generate. However, the majority of justices indicated that the National Pork Producers Council failed to demonstrate that Proposition 12 created a significant burden on interstate commerce – and, therefore, that the Pike balancing test was unnecessary. In other words, the Court executed what amounts to a “half Pike” by redefining when the Pike balancing test should be applied. Suppose this interpretation of Pike had been used in litigation involving Maryland’s Digital Advertising Tax (DAT). In that case, it’s not a leap to conclude that Maryland’s troubled DAT regulation may have been upheld on its merits, not merely on procedural grounds. It may indeed even succeed in its future trajectory in the Federal Courts. 

I want to re-emphasise that this is a highly condensed summary of some of the most compelling developments in the Supreme Court’s decision. Other noteworthy consequences include the fate of the Commerce Clause (which some Justices would like to abandon), cross-border income tax disputes and enforcement and future Wayfair-related challenges to cross-border tax compliance costs and economic and legal burdens, particularly to small and mid-size online retailers. 

As I’ve stated before, the fundamental question of whether a state can “regulate” beyond its borders (extraterritoriality), thus having an economic impact in other states that can impede commerce, has a long and tangled history – and a new and more uncertain future has emerged.