Court Considers Whether Lottery Is a Fee or a Tax

May 24, 2007

As we noted here yesterday, a three-judge panel of the North Carolina Court of Appeals in Raleigh heard oral arguments Tuesday in the Heatherly v. State case. The plaintiffs argue that North Carolina’s rushed passage of a state lottery violated provisions in the state constitution that guarantee deliberation and public awareness for tax increases.

Since it’s undisputed that 35 percent of lottery revenues are deposited in the state’s general fund, the court focused on the key question: is that 35 percent a tax or a fee? State attorney Norma Harrell sided with the trial court and argued voluntariness—that no one is forced to buy a lottery ticket, so it’s like a vendor-vendee relationship. In response, Judge Robert Hunter (R) noted that no one is forced to buy liquor either, but the excise tax on liquor is still a tax. His question is identical to a point we made in our amicus brief: just because a purchase is voluntary, that doesn’t make the payment of tax voluntary.

Judge Ann Marie Calabria (R) directly asked the state how the court should distinguish taxes from fees. In our brief, we urged the court to use the so-called San Juan Cellular test developed by now-Justice Stephen Breyer, which looks at whether the assessment is expended for general public purposes. Attorney Harrell, by contrast, seemed to have little to offer: “I don’t think this court can refine one bright line test. You have to look at individual circumstances.” If Harrell is right, and there is no definition of “tax,” taxpayer protection provisions in many states could be simply ignored through creative labeling.

Former Justice Robert Orr, representing the plaintiffs, argued that a tax is where the state raises money for the general fund for general purposes, no matter how the legislature labeled it. Fees, on the other hand, are narrow assessments for a particular purpose, approximating the cost of providing a service. Because the purpose of the lottery was to raise money, not regulate gambling, and because the revenue earned is more than incidental, it cannot be a fee akin to municipal utility charges or road tolls.

Judge James Wynn, Jr. (D), seemingly worried about disruption and “chaos,” asked whether the court could save the lottery by redirecting the 35 percent. Orr suggested that the court could invalidate the tax but stay enforcement to give the legislature time to act. But he agreed with Judge Hunter’s comment that the court probably would not have the power to establish a non-revenue lottery when that was the primary legislative purpose.

Our brief noted the trend of labeling tax increases as “fee increases.” If it were up to legislatures, few things would be called “taxes,” and loose definitions help deprive taxpayer protection provisions of any meaning. A hypothetical posed by Judge Wynn illustrates this: if the state were to seize all gasoline stations and send the “profits” to the general fund, instead of levying the same amount in excise taxes, that shouldn’t make a difference since the money is the same. Labeling the 35% a tax will also improve transparency and help citizens better understand the cost of government.

A decision is expected sometime in late summer or early fall.


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