Lottery Case Heard in North Carolina Supreme Court

September 8, 2008

Ever since it was first debated in the legislature, North Carolina’s lottery has been plagued by scandal, crime, accusations of underhanded machinations in the legislature, and a slew of other problems. But none of this compares to the lawsuit, argued this morning in the North Carolina Supreme Court.

Six of the Court’s justices (one recused himself from the case) heard arguments from the state and from the North Carolina Institute for Constitutional Law (NCICL), a non-profit legal foundation. The NCICL had brought the lawsuit, arguing that the lottery’s passage violated the state’s constitutional requirement that tax legislation be passed in both the House and Senate on three separate days.

One of the things the judges are taking into consideration is an amicus curiae brief submitted by the Tax Foundation, arguing that lottery profits are tax revenue. A tax is a charge imposed by the government at least in part to raise revenue, paid by broad swath of the public, and used for a general government function. Because 35% of the revenue generated by North Carolina’s lottery is used for education spending, and this is in excess of what is needed to administer and operate the lottery, it is an implicit tax.

Observers agreed that the justices seemed engaged and informed as the argument proceeded, leaving the ultimate outcome in doubt. Former Justice Robert Orr presented the case for the NCICL, noting that the question before the Court is whether the 35% portion is a tax. Responding to a question from Justice Robin E. Hudson, Orr agreed that that the fact that the lottery raises revenue does not by itself resolve the question. Orr argued that for the state to win, it would have to (1) disregard the fact that the 35% portion going to the North Carolina general fund is a separate component from the funds used to operate the lottery and pay prizes, (2) rely solely on a question of “voluntariness,” which is dangerous since such a rule would turn virtually any tax into a non-tax, and (3) treat the 35% as profit, and have the state in the profit-making business.

Justice Hudson again asked for further clarification on the voluntariness issue. The state has argued that because purchasing a lottery ticket is the result of a voluntary decision, and because taxes involve coercive power by the state, the lottery must therefore not be a tax. Orr (and the Tax Foundation’s brief) agree that purchasing lottery tickets is voluntary, but so are many other purchases subject to mandatory taxes, such as the purchases of liquor, cigarettes, and gasoline. Even general sales taxes and income taxes are the result of voluntary decisions; the only tax that does not stem from a voluntary action is a head tax imposed on each person.

As I noted in our brief, “Government officials defending taxes like the voluntariness test, because any tax other than a head tax could be characterized as voluntary, since taxes on cigarettes, liquor, gasoline, and even income, payroll, property, and sales are the result of voluntary decisions.” This is why courts from around the country, including those in North Carolina, instead analyze the use of the revenue as the key issue.

Justice Edward T. Brady had read the Tax Foundation’s brief in the case, as he referred to it several times. He asked Orr to explain the test from the San Juan Cellular case, written by now-Justice Stephen Breyer of the U.S. Supreme Court and treated as the definitive test for analyzing whether a given charge is a tax. The state has attempted to argue that the case is irrelevant since the lottery does not “impose” any charge.

After the attorney for the state began her argument, Justice Brady again referred to the Tax Foundation brief, asking the state to explain why the Court should reject the San Juan Cellular test when so many other courts have adopted it (including a federal court in North Carolina). The state’s attorney responded that this case involves not a charge being imposed, but rather profits earned from a vendor-vendee relationship with benefits to the purchaser. This response is troubling because most taxes produce some benefit to the taxpayer, even if generalized and attenuated. But creative state officials could recast these implicit and explicit payments used for government spending as “profits” obtained from “voluntary contributions,” undermining state taxpayer protections.

The state’s attorney also dismissed contrary cases, saying that the definition of “tax” used for the purposes of the North Carolina Constitution is not necessarily the same as the definition of “tax” used in other contexts. This is also dangerous-taxes should not mean something different in North Carolina than it means everywhere else.

Justice Paul Newby was concerned about another argument raised in the case-whether the Lottery pledges the faith of the state for repayment. The lower court had rejected this claim, stating it was “inconceivable” that the Lottery could ever default on its obligations. The Tax Foundation’s brief produced numerous examples of state-operated lotteries failing to cover their obligations, and as Justice Newby noted, the general public has the impression that the state operates the lottery and stands behind its obligations. Justice Brady also noted the morning’s headline about Fannie Mae and Freddie Mac, ostensibly independent entities whose obligations nevertheless fell upon the state when they became in danger of default. The attorney for the state answered that the possibility seemed too remote since the Lottery issued no bonds, but acknowledged that nothing limits the liability of the Lottery’s obligations from reaching the state.

Jack Holtzman of the North Carolina Justice Center wrapped up the argument for the appellants. Unlike utility charges or road tolls, the Lottery’s sole purpose was to raise revenue for the general fund, not to operate a service. The people of North Carolina, in enacting the North Carolina Constitution, attempted to ensure transparency in requiring elected officials to have multiple roll call votes on revenue bills. Allowing the lottery to escape these requirements gives an incentive to label revenue as non-tax and prevent accountability. Because the ultimate use of the 35% charge imposed on every lottery ticket is for general government spending beyond the benefits of the service provided to purchasers, and because the undisputed purpose of the Lottery is to raise revenue, it is in part a tax.

A decision is expected anytime between now and this winter.

More on the Heatherly case, including past blog posts and a copy of the Tax Foundation’s brief, here.

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