Colorado Court Strikes Down Effort to Collect Illegal Tax

October 8, 2008

Sometimes a state violates a taxpayer protection rule or constitutional requirement when enacting or raising a tax. Unfortunately, sometimes justice moves slowly and it takes a few years for the law to be invalidated, while in the meantime the tax revenues have been flowing in.

When the courts finally order the tax to stop being collected, the question then becomes what to do with the revenue already raised? In the NVTA case, for instance, Virginia decided to identify who paid taxes and give the money back to them. In San Diego County, California, a 1991 case invalidated a $320 million half-percent sales tax increase, and it was decided that lowering the sales tax by a half-percent for a couple years evened things out.

Sometimes legislators aren’t willing to admit that they have to start from square one. For example, a 1980 case in South Dakota invalidated a 1969 sales tax increase, and in response the legislature passed a law raising the sales tax back where it was, retroactive to 1969. This way, the state could keep its illegally collected proceeds, with the state courts later upheld in a maddening decision (Van Emmerik v. Janklow, 304 N.W.2d 700 (S.D. 1981).

A similar situation arose in Colorado. In 2003, the city of Lone Tree raised the use tax without submitting the increase to popular vote, as required by the state constitution. Only in 2006 did the city finally submit the increase to popular vote, where it was approved. Taxpayers who paid the tax between 2003 and 2006 alleged it was illegally collected and demanded refunds, and the city refused. Last week, in HCA-Healthone, LLC v. City of Lone Tree, No. 07CA1446, October 2, 2008, ¶200-837, the Colorado Court of Appeals rejected the city’s argument and ordered the refunds.

Good for them. An illegal tax is illegal whether it was collected or not. Retroactive tax increases undermine stability in the law, unsettle expectations, and encourage illegal tax increases. They should be avoided.

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A 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.

A 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.