The dormant Commerce Clause requires the invalidation of much state Internet regulation and acts as a roadblock to state regulation... COMMERCE CLAUSE IN CYBERSPACE

By Renee L. Giachino,
General Counsel, Center for Individual Freedom

This paper will address potential dormant Commerce Clause restrictions on state attempts to regulate e-commerce and other activities over the Internet. In a world without borders, the Internet facilitates an explosion of online retail opportunities, as more commerce is moving onto the Internet. Despite the borderless nature of the Internet, hundreds of laws concerning the Internet and e-commerce have been passed over the last few years. This patchwork of state, national and international laws and regulations threaten continued growth of e-commerce. Many of these statutes on their face discriminate against out-of-state commerce and place a burdensome "chilling effect" on interstate and international e-commerce. The problems facing e-commerce suggest the extreme need for a cautious approach to state and national regulation of commercial Internet activity.

1. BACKGROUND

The Commerce Clause contained within the U.S. Constitution states: "The Congress shall have Power . . . To regulate commerce . . . among the several States . . .." (U.S. Const., Art. 1, sec. 8, cl. 3). It is well settled that the Supreme Court’s Commerce Clause jurisprudence gives the Federal government the ability to regulate commerce. Likewise, it is well established that the negative implications of federal power result in the application of the so-called "dormant Commerce Clause" to block states from regulating or taxing in a way that would materially burden or discriminate against interstate commerce. Where legislation has the effect of favoring in-state economic interests over out-of-state interests, it has been held to discriminate against interstate commerce and is an illegitimate exercise of state power in violation of the dormant Commerce Clause.

Over the years, the United States Supreme Court has developed a series of complex tests to determine whether a state regulation that affects interstate commerce violates the dormant Commerce Clause. If a state statute directly discriminates against interstate commerce, it is subject to the strictest scrutiny for any purported legitimate local purpose and in the absence thereof a court will invalidate it without further inquiry.

When the statute or regulation is non-discriminatory on its face and affects interstate commerce only indirectly, then, generally, the state law or regulation must meet each of following criteria in order to be upheld: (i) it must pursue a legitimate state end; (ii) it must be rationally related to that legitimate end; and (iii) the burden imposed by the state on interstate commerce, and any discrimination against interstate commerce, must be outweighed by the state’s interest in enforcing the statute or regulation. Once the first two tests have been met, the court will apply a balancing test, skewed toward a finding of constitutionality, to see if the state’s interest is legitimate and the benefits it derives clearly exceed the burden on interstate commerce. "Where the statute regulates even-handedly to effectuate a legitimate local public interest, and its effects on interstate commerce are only incidental, it will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits." Pike v. Bruce Church, Inc., 397 U.S. 137, 142 (1970). The weighing of the local benefit of the law against the negative impact on interstate commerce has become known as the "Pike Balancing Test."

2. STATES’ ATTEMPTS TO PROTECT PRIVATE COMMERCE

Many cases have involved state regulations which, either intentionally or unintentionally, place barriers upon the importing of goods into a state. For example, many states forbid the direct shipment of wine and other alcoholic beverages from out of state to in-state consumers. Numerous suits have been filed throughout the United States challenging alcohol direct shipment laws and advertising restrictions. It is common understanding that the 21st Amendment to the U.S. Constitution grants the states the power to regulate sales of alcoholic beverages. See Bacchus Imports, Ltd. V. Dias, 468 U.S. 263 (1984) (United States Supreme Court discusses at length the interplay of the Commerce Clause and the 21st Amendment in striking down legislation in Hawaii that imposed a sales tax on liquor at wholesale but exempted from the tax certain locally-produced alcoholic beverages).

Although the 21st Amendment affords states unique protection to regulate sales of alcoholic beverages, some courts recently have made required analysis of state liquor regulation in light of other federal and constitutional protections. Thus, in 44 Liquormart, Inc. Rhode Island, the United States Supreme Court held that Rhode Island’s ban on price advertising for liquor violated the First Amendment’s free speech protection, a protection that is not qualified by the 21st Amendment. (517 U.S. 484 (1996)). More recently, cases have been filed in several states challenging state statutes that prohibit direct shipment of alcoholic beverages in violation of the Commerce Clause and other constitutional mandates. See, e.g., Swedenburg v. Kelly, 2000 U.S. Dist. Lexis 12758 (S.D.N.Y. 2000) (defendants’ motion to dismiss plaintiffs’ complaint denied because court found, among other things, that plaintiffs’ allegation that the New York law banning alcoholic beverage advertising (including over the Internet) and direct-shipment violates the dormant Commerce Clause sufficiently states a cause of action); Kendall-Jackson Winery, Ltd. V. Branson, 82 F. Supp.2d 844 (N.D.Ill. 2000) (Illinois Fair Dealing Act held violative of the dormant Commerce Clause because it places burdens on out-of-state suppliers but exempts local suppliers).1


1 For an in-depth analysis of the impact of state regulation on the importation of alcoholic beverages, see Susan Lorde Martin, Article, "Wine Wars-Direct Shipment of Wine: The Twenty-First Amendment, The Commerce Clause, and Consumers’ Rights, 38 Am. Bus. L.J. 1 (Fall 2000).


Attempts to modernize existing statutes to deal with the expanding growth of e-commerce and the Internet prove unworkable and unconstitutional. For example, the physical presence requirement to tax remote sales, established in the 1967 case of National Bellas Hess, Inc. v. Dept. of Rev. of Illinois, 386 U.S. 753 (1967), and reaffirmed in the 1992 case of Quill Corp. v. North Dakota, 504 U.S. 298 (1992), will be impossible to apply in the borderless Internet context.

Additionally, proposed legislation to apply old laws to new technology run afoul of constitutional principles because they discriminate against sales through a particular instrumentality of commerce, namely, the Internet. States are coming alarmingly close to violating the dormant Commerce Clause in order to protect in-state interests and obtain tax money. For example, many states in recent years have sought to resurrect the federal Jenkins Act in order to obtain access to information from out-of-state cigarette dealers regarding Internet purchases made by in-state residents in order to collect excise taxes. In addition to extreme privacy concerns that exist whenever private vendor records must be turned over to the government, such attempts are an illegitimate exercise of state power that is excessively intrusive for the presumed goal.

Numerous suits have been filed throughout the United States challenging state statutes limiting Internet activity as violative of the Commerce Clause. In 1997, a Federal District Court Judge cited the Commerce Clause to void New York’s law attempting to protect minors on the Internet, stating that "[t]he unique nature of the Internet highlights the likelihood that a single actor might be subject to haphazard, uncoordinated, and even outright inconsistent regulation by states that the actor never intended to reach and possibly was unaware were being accessed. Typically, states’ jurisdictional limits are related to geography; geography, however, is virtually meaningless construct on the Internet." (American Library Ass’n v. Pataki, 969 F. Supp. 160, 168-69 (S.D.N.Y. 1997)). The court further recognized that "the Internet is one of those areas of commerce that must be marked off as a national preserve to protect users from inconsistent legislation that, taken to its most extreme, could paralzye developments of the Internet altogether." Id. at 169.

3. CONGRESS’ SUPPORT FOR LIMITING STATE ACTION IN E-COMMERCE

Congress, in recognizing the Internet’s susceptibility to multiple and discriminatory taxes and the need to protect the development of this new medium, adopted the Internet Tax Freedom Act (ITFA) in October of 1998, which imposes a three-year moratorium on the collection of online sales and use taxes. ITFA prevents local and state governments from imposing taxes that subject merchants and consumers of online commerce to taxation in multiple states and localities, and protects against the imposition of any new taxes. In addition, it prohibits taxation of goods and services sold exclusively on the Internet. Also, ITFA averts local and state governments from taxing Internet access (the monthly service charge paid by consumers to their Internet access providers), unless such a tax was "generally imposed and actually enforced" prior to October 1, 1998.

The moratorium outlined in the Internet Tax Freedom Act is set to expire in October 2001. As that deadline approaches, there are numerous efforts in the 107th Congress that address the issue of taxing the Internet. While there appears to be widespread, bipartisan support for making permanent, or at least extending, the moratorium on Internet access taxes, such a consensus may not exist on how to deal with the issue of sales tax collection. The current congressional efforts with the greatest amount of momentum seek to encourage a large number of states to achieve consensus on a simplified, uniform tax plan, before Congress grants those states authority to require online retailers to collect taxes on goods and services delivered in-state. The facilitation of such simplification and uniformity, which is derived from Congress’ constitutional authority to regulate interstate commerce, seeks to address obvious concerns regarding the conflicts between the thousands of local and state taxing jurisdictions in the United States.

4. SUPREME COURT’S CURRENT HOSTILITY

The Supreme Court has long recognized that certain types of commerce, like rail and highway traffic, are uniquely suited to national, as opposed to state, regulation. See, e.g., Wabash, St. L. & P.R. Co. v. Illinois, 118 U.S. 557 (1886). More recently, the Supreme Court recognized that "[t]he Internet is ‘a unique and wholly new medium of worldwide human communication’ . . . located in no particular geographical location but available to anyone, anywhere in the world . . .." (Reno v. ACLU, 521 U.S. 844, 850-51 (1997) (citation omitted). Much like the highway and railway system in the United States and worldwide, the borderless nature of the Internet makes it difficult to say that activities conducted in cyberspace constitute intrastate or national transactions.

Although the Supreme Court has recently shown considerable hostility toward expanding the reach of federal regulation under the Commerce Clause doctrine, the recent cases are not conclusive of the Court’s position with respect to the application of the dormant Commerce Clause to commercial Internet activity. The Supreme Court’s current opinions that support strengthening of states’ rights and support state sovereignty resulted from challenges to Congress’ power to regulate an activity under its Commerce Clause jurisdiction that arguably did not arise out of or in connection with a commercial transaction or substantially affect interstate commerce. In United States v. Lopez, 514 U.S. 549 (1995), for example, the Court struck down a law prohibiting gun possession near schools as outside of Congress’ Commerce Clause authority because possessing a gun in a local school zone "has nothing to do with ‘commerce’ or any sort of economic enterprise . . .." Likewise, in United States v. Morrison, 529 U.S. 598 (2000), the Court struck down a provision of the Violence Against Women Act as outside of Congress’ commerce power because gender-motivated crimes of violence were not considered an economic activity and did not involve interstate commerce.

Although the Court has been hostile to expanding the application of the Commerce Clause to current attempts to regulate activity that does not substantially affect interstate commerce, it is unclear how the current Court will apply the dormant Commerce Clause jurisprudence to commercial Internet regulation.

5. CONCLUSION

Through the growth of the Internet, expansion of e-commerce results in greater consumer options through interstate and foreign trade. Overrregulation of the Internet will be fatal to its continued growth. As evidenced by the recent court rulings in France, Germany and Italy banning content from their borders, attempts to regulate the Internet can cause national and international conflict and criticism. Individual attempts by states and countries to place burdensome restrictions on the free flow of trade over the Internet should be avoided in favor of unfettered growth of the many borderless opportunities and advantages that e-commerce provides.

The dormant Commerce Clause doctrine stands for the proposition that, since regulation of interstate commerce is a power affirmatively granted to the Federal government, the states have no right to regulate it in a way that unduly burdens interstate commerce. The dormant Commerce Clause requires the invalidation of much state Internet regulation and acts as a roadblock to state regulation by restricting states and localities from impeding the free flow of goods across state lines.

2001
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