Challenged Law 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. es Out-of-State Companies at Twice the Rate of In-State Companies
South Dakota Supreme Court No. 24704Z
Amicus Curiae Brief in Support of Petition for Rehearing
Filed on April 15, 2008
Petition for Rehearing Denied on May 6, 2008
The Tax Foundation, in a friend-of-the-court brief filed with the South Dakota Supreme Court, urges that state to stop its discriminatory insurance tax system that taxes out-of-state companies at twice the rate of in-state companies. The case, Metropolitan Life Ins. Co., et al. v. Kinsman, et al., is currently before the court on a petition for rehearing.
Since explicit discrimination in rates was struck down as violating the Equal Protection Clause of the Fourteenth Amendment by the U.S. Supreme Court in 1985, South Dakota is one of 8 remaining states that seek to protect their domestic insurance companies by imposing heavier taxes on out-of-state companies that do business in the state. All companies pay a tax of 2.5% of premiums, but companies with headquarters or regional offices get their rate lowered to between 0.75% and 1.25%. Domestic companies automatically have such offices, which must be the repository of records and the site of approving or rejecting all claims for insurance, as well as the location of public relations, sales force training, and actuarial and legal functions for more than one state. For an out-of-state company, setting up such a new office would duplicate functions more efficiently handled centrally at existing offices.
Thus, while on paper all companies pay the same rate, the reality is that only domestic companies qualify for the lower rate. The result is effective discrimination against out-of-state companies, which violates the Equal Protection Clause, as the trial judge concluded. On appeal, the South Dakota Supreme Court reversed, and the plaintiffs are now seeking a rehearing.
The court earlier upheld the tax scheme as non-discriminatory because an out-of-state company can avoid the punitive tax by opening an office in the state. The Tax Foundation’s brief argues that this misses the point, because the court must consider effective discrimination in the case at hand, not whether there would still be discrimination if the facts were different. The brief also cites academic literature rejecting the idea that discriminatory behavior becomes non-discriminatory if the victim had the option of avoiding being subjected to it.
The brief also reviews the issue of retaliatory taxes, which the Court’s opinion ignored. South Dakota’s domestic insurance industry suffers because of these taxes, which are imposed by other states on companies from states that practice tax discrimination. For example, a South Dakota company doing business in Minnesota must pay Minnesota’s regular 2.0% insurance tax, plus a 0.5% retaliatory tax (representing the difference between Minnesota’s rate on out-of-state companies and South Dakota’s rate on out-of-state companies). Few South Dakota companies do business in other states as a result of these taxes, and that they are hit by them is evidence that South Dakota’s insurance tax system is discriminatory.
The case implicates states with similar discriminatory insurance tax systems. It is most relevant for states with similar statutes: Colorado, Hawaii, and Nevada, where domestic companies also automatically qualify for a lower rate but out-of-state companies have to clear additional burdens and often fail to do so. Louisiana and Mississippi condition the lower rate on investing 25% of the company’s assets in state, which few companies can do (and would be impossible to do if five states adopted such a rule). Indiana is the only remaining state which still explicitly discriminates, with out-of-state companies paying higher rates as a matter of law. New Jersey curiously discriminates the other way by enabling out-of-state companies to create in-state subsidiaries that pay lower taxes than domestic companies.
Finally, the brief argued that the tax does not survive “rational basis review,” which invalidates laws unless they “bear a rational relation to a legitimate state purpose.” The brief criticized each of the rationales offered by the state for the discriminatory tax system. First, the state cannot use discriminatory taxes to further the purpose of raising revenue, as previous South Dakota and U.S. Supreme Court rulings have held. Second, the tax does not further regulation since all insurance companies doing business in South Dakota are subject to identically stringent regulation. Finally, drawing on the Tax Foundation brief in the Kentucky v. Davis case and the principles of sound tax policy, the brief argued that states cannot promote in-state economic development by punishing out-of-state companies or economic activity with heavier taxes. The state should aim to tax all similar activity at the same general rate in order to maintain a neutral tax system.
A decision on the petition for rehearing is expected this spring.
- Tax Foundation Urges a Stop to South Dakota’s Discriminatory Insurance Taxes, April 16, 2008, by Joseph Henchman