Note: this is the second of three blog posts on the Wayfair case. (Our last post will appear tomorrow.)

In our previous post, we patiently restated the facts and identified the main legal and theoretical issues in South Dakota v. Wayfair, Inc., the online sales tax case decided by SCOTUS on 21 June 2018. Today, we will present a Coasean (or is it Coasian?) critique of the majority opinion in this case. To appreciate our analysis, however, we need to back up and say a few words about the late economist Ronald H. Coase, the source of our “Coasean critique.”

In his classic paper on “The problem of social cost” (the most cited paper both in economics and in law, by the way), Professor Coase made one of the most intriguing and counter-intuitive observations that I have ever encountered in any academic essay I have ever read. (See Ronald H. Coase, “The Problem of Social Cost,” The Journal of Law & Economics, Vol. 3 (1960), pp. 1-40, available here.) His paper was about the problem of harmful effects, such as cattle trespass, and he claimed that this problem was always a collective one. (Or in Coase’s classic formulation (1960, p. 2): “We are dealing with a problem of a reciprocal nature.”) That is, whenever we witness a negative “externality” like cattle trespass (the fancy word in economics for “harm”), that harm is usually the result of decisions made by both parties, the rancher (the owner of the straying cattle) and his neighbor (the owner of the damaged crops). Simply put, both the wrongdoer (the rancher) and the victim (the farmer) are to blame, since either of them could have avoided the trespass problem in the first place by erecting a fence! The real question, then, is not who is to blame for the damaged crops (both parties are); the question is, who should pay to erect the fence! So, what does Coase or cattle trespass have to do with sales taxes? Let me explain:

The rationale of the majority’s decision in Wayfair is openly based on fairness and justice grounds, claiming that the physical presence rule creates an “unfair and unjust” tax loophole. (See South Dakota v. Wayfair, Inc., majority opinion, slip op. at p. 16.) According to the majority opinion (ibid.), “[The physical presence rule] is unfair and unjust to those competitors, both local and out of State, who must remit the tax; to the consumers who pay the tax; and to the States that seek fair enforcement of the sales tax, a tax many States for many years have consid­ered an indispensable source for raising revenue.” Moreover, the majority goes on to say (p. 22) that “there is nothing unfair about re­quiring companies that avail themselves of the States’ benefits to bear an equal share of the burden of tax collec­tion.” In other words, the physical presence rule harms two different groups of people. It harms tax collectors in remote places like South Dakota, since this rule makes it more difficult for them to collect sales taxes from out-of-state sellers with no physical presence in their State. And it also harms business firms who do happen to have a physical presence in South Dakota, since they must collect and remit sales takes on their in-State sales, while their competitors (the ones with no physical presence in South Dakota) do not.

Now, let’s bring Coase back into this fairness picture. We do not dispute that the physical presence rule is unfair, since it creates serious harms and economic distortions, but at the same time, getting rid of the physical presence rule is also unfair and will likewise produce serious harms and distortions. In short, by overturning its pro-physical-presence precedents, the court’s decision will harm consumers as well as out-of-state sellers, or in the words of Chief Justice Roberts’ dissenting opinion (p. 5): “ … the marketplace itself could be affected by abandoning the physical-presence rule. The [majority’s] focus on unfairness and injustice does not appear to embrace consideration of that current public policy concern.” Do you see where we are going with this line of Coasean reasoning? The problem is not whether x rule or y loophole is unfair; the problem is figuring out which rule is less unfair!

But there is an additional (and even more important) consideration in play in the Wayfair case: stare decisis. In other words, since the Supreme Court had already established the bright-line physical presence rule in previous cases, there is an additional harm we must take into consideration, the macro or system-wide harms to judicial stability and to the doctrine of stare decisis, a point we will elaborate on in our next post …