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Supreme Court Hears Challenge to Arbitrary Tax Refund Policy

6 min readBy: Joseph Bishop-Henchman

Yesterday, the U.S. Supreme Court heard oral arguments in Armour v. City of Indianapolis, a challenge to a government decision to refund a canceled taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. to some taxpayers and not others. We at the Tax Foundation had submitted briefs urging the Court to take the case and rule in favor of the taxpayers, and we were on hand for the oral argument and a roundtable panel afterwards.

The facts of the case:

  • Taxpayers in Indianapolis were assessed a sewer charge of $9,278 either (1) in full, up front or (2) by installment over 10, 20, or 30 years. One year later, the City changed the tax structure going forward and forgave the outstanding payments of taxpayers paying by installment. Taxpayers who paid in full requested a pro rata refund of their up front payment, but the City refused.
  • The trial court and Indiana Court of Appeals ruled that the City’s refusal to refund the up-front taxpayers, while forgiving the obligations of the installment taxpayers, violated the Equal Protection Clause. The Indiana Supreme Court, in a 3-2 decision, reversed, ruling that the City’s refund policy is valid because it could reduce administrative burdens and help the poor.

Our arguments:

  • Our brief argues that the City’s refund policy is arbitrary and unconstitutional, and that courts must evaluate whether claimed justifications have any rational connection to the stated policy, particularly where there is a strong perception of unfairness and arbitrary action.
  • If allowed to stand, the Indiana decision will undermine business certainty, tax compliance, and respect for the law.
  • For many citizens, paying taxes is one of the few ways that they interact with the government. Tax policy widely perceived as unusual and unfair threatens to foster a general disenchantment with the government, creating tensions between the law and citizens. By reiterating basic standards of equal refund treatment of a canceled tax, this Court will reduce the prevalence of a rising problem of arbitrary taxation practices.

In their briefs, the government argued that they wanted to make a clean break from the old tax system, and necessarily had to draw an arbitrary line about future obligations. They argue that their chosen method of forgiving only future obligations was a rational one and thus constitutional.

Reflections from the oral argument

Much to the surprise of nearly all observers, the case seems to be falling along the Supreme Court’s reported ideological lines: the conservative justices support the taxpayers while the liberal justices support the government. More specifically, the conservative justices expressed outrage at the City’s refund policy and its lack of rationality, and the liberal justices expressed strong concern about second-guessing a government decision to limit who gets refunds from a canceled tax.

Justice Sonia Sotomayor, an Obama appointee, asked specifically about amnesty programs, where governments can subjectively reduce or dismiss obligations by one person as part of a larger statutory framework. Immigration and traffic tickets were referenced. Chief Justice Roberts responded that amnesties involve forgiving people who have done something wrong, whereas the taxpayers here did nothing wrong.

Justice Stephen Breyer, a Clinton appointee, repeatedly framed hypotheticals about how far a refund policy must go. He discussed taxpayers who might be owed refunds from similar canceled taxes, as well as people who paid this canceled tax years ago. Justice Ruth Bader Ginsburg, a Clinton appointee, asked a question along this line, wondering how many potential plaintiffs might seek refunds.

Justice Elana Kagan, an Obama appointee, asked where the line should be drawn between a “gross disparity” that violates the Equal Protection Clause, and permissible government action. Counsel that in this case, some taxpayers were forgiven 30 times what other identically-situated taxpayers were, and that 10:1 and 30:1 is a clear case. In the post-argument roundtable discussion, one commenter noted that the higher the ratio is, the more the government must demonstrate that its policy is not irrational.

Justice Antonin Scalia, a Reagan appointee, criticized the idea that administrative inconvenience or lack of money create exceptions to the Equal Protection Clause, turning unconstitutional policies into constitutional ones.

Justice Samuel Alito, a G.W. Bush appointee, asked repeatedly for the City’s reasoning for its refund policy, and criticized each proffered rationale as illogical.

Justice Anthony Kennedy, a Reagan appointee, asked whether the City’s promise that all costs would be apportioned equally might potentially mean a violation of the Constitution’s Contracts Clause, or be an enforceable promise under contract law. He also echoed the Tax Foundation’s warning in our brief by suggesting that the government’s action of harming taxpayers who paid in full leaves people with the understanding that they “shouldn’t trust the government.”

Chief Justice John Roberts, a G.W. Bush appointee, suggested that the City had changed from a policy of treating all people equally (after 30 years of installment payments, everyone would have paid roughly equal tax burdens) to a policy of treating people unequally. The change presents the problem, he stated.

Counsel for the City (Paul Clement, a respected litigator who will be representing the challengers in this month’s health care cases oral argument) was caught twice by Roberts: once for incorrectly asserting that one would “search in vain” for a statutory promise by the City to share costs equally (Roberts found the language quickly and challenged Clement with it), and a second time for claiming that the City was not motivated by the tax’s political unpopularity for undertaking its unusual refund policy (Roberts cited page 1 of Clement’s brief, where he referenced the political unpopularity of the tax).

The justices also discussed what a proper remedy might be: whether the courts are proper to order “leveling up” (ordering continuation of the tax), “leveling down” (ordering additional refunds), or leaving it to local authorities to decide.

One interesting hypothetical posed by Armour‘s counsel was if the U.S. abandoned the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. as of March 1, 2012, and replaced it with a national sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. . If, he argued, the government said that all those who filed early (before March 1) would not get refunds, this would be a clear constitutional violation. Counsel also emphasized that the different taxpayers in this case are indistinguishable on any rational basis. He closed by stating that “too bad, so sad” is not a rational basis for government policy.

Justice Clarence Thomas, a G.H.W. Bush appointee, characteristically remained silent during the oral argument. However, he did flip through the four amicus briefs supporting the taxpayers: those filed by the Tax Foundation, the National Taxpayers Union, the Institute for Justice, and the National Association of Home Builders. Thomas has been critical of the seeming irreconcilability of two key precedents: Allegheny Pittsburgh (which struck down a property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. assessment scheme that led to unequal results) and Nordlinger v. Hahn (which upheld California’s Proposition 13 property tax assessment scheme, which led to unequal results). The Court said in the two cases that Pennsylvania has a public policy of tax equality, while California’s voters adopted a public policy of capped assessment increases for existing homeowners. Thomas has criticized this result, arguing that the cases should come out the same way (in favor of the government’s policy).

At the post-argument roundtable, the consensus among the presenters (including yours truly) is that the taxpayers will prevail. It remains to be seen how broad the rule might be, however, I noted that at present governments often treat “rational basis” review as giving them the power to do whatever they want. If the Supreme Court enunciates some minimum requirements for equal protection treatment of taxpayers, that will be a welcomed improvement in the law.

A decision is expected in the spring or early summer.

More on Armour, including our brief, here.