2013 was a year of many changes to the U.S. tax code, and some of the most significant changes were targeted at raising taxes on high-income Americans. The fiscal cliff tax deal created a new 39.6 percent income tax...
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U.S. Supreme Court Considers Constitutionality of Kentucky Taxing Only Other States' Bonds
The transcripts of this morning's oral arguments are here:
Forbes Magazine also did a story today on our brief in the Davis case, noting that we are almost alone in supporting Mr. and Mrs. Davis, as opposed to the state governments, municipal leaders, and bond industry organizations supporting Kentucky's discriminatory tax system. David vs. Goliath!
The Davis case involves a Kentucky couple who are challenging that state's practice of taxing interest earned on non-Kentucky bonds, but also excluding from taxation any interest earned on Kentucky bonds. The Tax Foundation's brief recites a string of past cases in which the Supreme Court has struck down laws that discriminate against out-of-state activity by taxing it while leaving identical activity in-state untaxed. Such laws violate the Commerce Clause, which was designed by the Framers to guarantee a national market unhindered by protectionist state obstructions.
Back in April, the Supreme Court handed down a decision called United Haulers. There, the Court found no Commerce Clause violation when a state requires waste haulers to use a state-owned facility. As we note on page 14 of our Davis brief, that case involved a state-run monopoly-there was no discrimination because competition was prohibited by law-so a finding that the Commerce Clause did not apply is correct. The state barred all competition, public or private, in-state or out-of-state, so the treatment was even-handed.
Some commentators, and some justices, wonder if the decision should be read more broadly than that. Kentucky's counsel, C. Christopher Trower, argued this morning that United Haulers stands for the view that a state favoring itself (such as by foregoing tax revenue in the form of excluding bonds from taxation) is constitutional. Justices David Souter and Stephen Breyer seemed receptive to this argument, suggesting that governments should be able to discriminate in favor of in-state activity when performing "traditional government functions" such as "producing electricity" or operating "libraries, schools, [and] streets."
Chief Justice Roberts posed a hypothetical where Kentucky passed a law forbidding sales of used cars except by Kentucky car dealers, but the dealers would be required to pay a tax, and the proceeds would go to fund public hospitals and schools. Trower responded that such a tax would not be constitutional, because what matters is who is discriminating, not where the proceeds go.
G. Eric Brunstad, Jr., arguing for the Davises, said that the lack of monopoly in this case distinguished United Haulers, a view received warmly by the three justices who dissented in that case-Justices Samuel Alito, John Paul Stevens, and Anthony Kennedy. Kennedy went so far as to say that "there's no doubt that this is explicit discrimination," and echoed the Tax Foundation's right to travel argument by noting that because a Kentucky resident moving out of state (and presumably moving jobs out of state) loses the exemption, Kentucky's law discourages interstate activity.
Unfortunately, Brunstad argued that taxes should receive greater constitutional scrutiny than subsidies, because (as he put it) "taxes tear down, while subsidies build up." Our brief rejected such a distinction on pages 26-29, warning that such a view could license discriminatory state actions and ignores economic reality. Brunstad received heavy questioning for this view, although it is understandable why he took the position. The state is attempting to characterize their taxation of out-of-state investment as a subsidy to in-state investment, and past Supreme Court cases have scrutinized taxes more than subsidies.
As we state in our brief, we believe the proper question is punishment-is the state punishing out-of-state activity with taxes while leaving identical in-state activity untaxed. Kentucky's law is economically both a subsidy and a tax-a subsidy to in-staters who receive preferential tax treatment, and a penalty on out-of-staters who must pay more tax.
All in all, the oral argument in Davis was mixed. It's folly to read too much into justices' questions, as they often play devil's advocate or use counsel to argue with their fellow justices. Ultimately, it may come down to whether those in the United Haulers majority think that case was a fundamental reworking of Commerce Clause jurisprudence, as Kentucky believes, or if it really isn't relevant at all, as our brief argues. While many of the current Court correctly express concerns with upsetting expectations too much, and some are reluctant to restrain state sovereignty in all but the clearest cases of discrimination, I think the case will be a close one.
Justice Alito put it aptly when he asked Kentucky's counsel: "It seems to me you're making a lot of arguments that, if accepted, would -- maybe this isn't true of all of your arguments, but certainly many of them would demonstrate that the Commerce Clause jurisprudence is utterly incoherent. If taxation is the same thing as a subsidy, if congressional inaction is the same thing as approval, if Kentucky bonds are not really in the same market as out-of-State bonds, what would be left of Commerce, of dormant Commerce Clause jurisprudence if those arguments were accepted?"
A decision is expected sometime in the spring.
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