Thoughts on Why the U.S. Supreme Court Doesn’t Stop State Tax Overreaching

September 3, 2008

Robin C. Capehart of West Liberty State College and Raymond Keener III of Marshall University have a well-written piece in today’s Tax Notes examining the Supreme Court’s handling of the nexus issue. States have always had the power to tax income earned and goods and services sold, as well as property located within, their borders. Ability to tax outside those borders has been limited only to individuals and businesses physically present in the jurisdiction. The Supreme Court, in two major cases, curtailed these efforts by ruling that states can only force a seller to collect taxes if the seller has property or employees located within the state.

States, sometimes because they have poor business tax climates, or just because it is politically advantageous to shift tax burdens to out-of-staters, are increasingly reaching out beyond their borders to tax income and even transactions that occur in other states. Such states have argued that while businesses conducting these activities are not physically present in the jurisdiction, they are economically present (that is, they have customers in the state). This economic nexus argument is problematic because it allows citizens to have a larger government than they are willing to pay for, making up the difference by taxing citizens in other states. The race to loot out-of-staters quickly hurts the national economy because we’re all out-of-staters to 49 states. It can also lead to multiple taxation as some transactions (over the Internet, for instance) can be “economically” present in more than one state. There are also serious compliance issues associated with keeping updated and in good standing with over 8,000 sales taxes and 40 income taxes.

In 2005, a case challenged West Virginia’s imposition of an income tax on the earnings of an out-of-state credit card company that had no property or employees in the state. The West Virginia courts ruled for the state, and the U.S. Supreme Court declined to hear the case (at least four justices must want to hear a case, and they ultimately hear less than 100 of the 7,000+ appeals each year). They may have done so for any number of reasons. Capehart and Keener argue that the decision not to take the case reflects the existing judicial philosophies represented on the Court:

[E]ach philosophical side possesses a different motive for permitting the parade of expansionist state court cases to stand. Apparently, the liberal constructionists on the Court are content to allow the state courts to aggressively extract tax revenue from out-of-state corporations while textualists on the Court stand by their belief that it is the duty of Congress to step in and make political decisions regarding the regulation of commerce among the states.

In short, the Court’s “liberals” are unwilling to interfere with what they view as the proper role for states, and the Court’s “conservatives” are unwilling to interfere with what they view as the proper role for Congress. I think it’s an apt characterization; I would just add that two justices may think differently on this issue. Justices Anthony Kennedy and Samuel Alito, in their dissent in the Kentucky v. Davis case, suggest that they aren’t willing to give states a free ride to discriminate at will.

Related Articles