Constitution Day: 228 Years of Restraining State Tax Overreaching
September 17, 2015
Today is Constitution Day, the 228th anniversary of Constitutional Convention delegates signing the draft document. It might be unsurprising that taxes played a big part in that day happening.
The U.S. Constitution exists in large part because states were disrupting the national economy by using trade barriers and discriminatory taxes against each other. Absent some constraints, states have an incentive to shift tax burdens from physically present individuals and businesses to those who are beyond their borders.
Justice Johnson, concurring in Gibbons v. Ogden (1824), wrote that “states’ power over commerce,] guided by inexperience and jealousy, began to show itself in iniquitous laws and impolitic measures . . ., destructive to the harmony of the states, and fatal to their commercial interests abroad. This was the immediate cause, that led to the forming of a convention.” Gouverneur Morris argued at the Constitutional Convention that “local concerns ought not to impede the general interest. There is great weight in the argument, that the exporting States will tax the produce of their uncommercial neighbors.”
Congress thus has the power to restrain states from interfering with interstate commerce, particularly with their taxing power. As Justice Story explained, “[T]here is wisdom and policy in restraining the states themselves from the exercise of [taxation] injuriously to the interests of each other. A petty warfare of regulation is thus prevented, which would rouse resentments, and create dissensions, to the ruin of the harmony and amity of the states.” More recently, Professor Daniel Shaviro has noted that “[p]erceived tax exportation is a valuable political tool for state legislators, permitting them to claim that they provide government services for free.”
The Commerce Clause prohibits states from imposing a tax on activity out-of-state while leaving identical activity in-state untaxed, a relatively uncontroversial element of the Commerce Clause distinct from the more controversial aspect of the Commerce Clause involving the scope of Congress’s power to regulate private activity. The Import-Export Clause prohibits states from penalizing activity that crosses state lines, particularly imports. The Tonnage Clause prohibits state charges on shipping freight. The Privileges and Immunities Clause of Article IV and the Privileges or Immunities Clause of the Fourteenth Amendment protects the right of citizens to cross state lines in pursuit of an honest living.
So strong was the concern over state misuse of their power, that the rule for a century and a half was that states could not tax interstate commerce at all. This eroded in the 1950s and 1960s as it was recognized that interstate commerce do enjoy benefits in states where they were present, so it is not unfair to have them support those services with taxes. The complete ban on state taxation of interstate commerce was abandoned in 1977, replaced by a recognition that resident businesses engaged in interstate commerce should pay for the fair share of the state services they consume. See Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) (holding that states may tax interstate commerce if the tax meets a four part test:
- nexus, a sufficient connection between the state and the taxpayer;
- fair apportionment, the state cannot tax beyond its fair share of the taxpayer’s income;
- nondiscrimination, the state must not burden out-of-state taxpayers while exempting in-state taxpayers;
- fairly related, the tax must be fairly related to services provided to the taxpayer.
That’s still the test used today, and every courts consider constitutional challenges to state taxes that affect interstate commerce. Just this year, the U.S. Supreme Court struck down a Maryland tax law because it “has the effect of double-taxing income residents earn in other states.” The Constitution plays an important role, because groups like the Tax Foundation are ever vigilant against states sseeking to use their tax code to benefit in-state people and businesses while punishing out-of-state people and businesses. In Federalist No. 42, James Madison wrote what may well be the mantra of those who seek simple, neutral, pro-growth tax codes: “[T]he mild voice of reason, pleading the cause of an enlarged and permanent interest, is but too often drowned before public bodies as well as individuals, by the clamours of impatient avidity for immediate and immoderate gain.” The provisions he and others wrote into the Constitution help restrain that tendency.
Happy Constitution Day!