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DEPARTMENT OF REVENUE OF KENTUCKY ET AL. v. DAVIS ET UX. | FindLaw
DEPARTMENT OF REVENUE OF KENTUCKY ET AL. v. DAVIS ET UX., (2008)
Argued: November 5, 2007 Decided: May 19, 2008
Kentucky exempts from state income taxes interest on bonds issued by it or its political subdivisions but not on bonds issued by other States and their subdivisions. After paying state income tax on out-of-state municipal bonds, respondents sued petitioners (hereinafter Kentucky) for a refund, claiming that Kentucky's differential tax impermissibly discriminated against interstate commerce. The trial court ruled for Kentucky, relying in part on a "market-participation" exception to the dormant Commerce Clause limit on state regulation. The State Court of Appeals reversed, finding that Kentucky's scheme ran afoul of the Commerce Clause. Held: The judgment is reversed, and the case is remanded. 197 S. W. 3d 557, reversed and remanded.
Justice Souter delivered the opinion of the Court, except as to Part III-B, concluding that Kentucky's differential tax scheme does not offend the Commerce Clause. Pp. 7-13, 20-28.
(a) Modern dormant Commerce Clause law is driven by concern about "economic protectionism--that is, regulatory measures designed to benefit in-state economic interests by burdening out-of-state competitors," New Energy Co. of Ind. v. Limbach, 486 U. S. 269, 273-274--but that concern is limited by federalism favoring a degree of local autonomy. Under the resulting analysis, a discriminatory law is "virtually per se invalid." Oregon Waste Systems, Inc. v. Department of Environmental Quality of Ore., 511 U. S. 93, 99. An exception covers States that go beyond regulation and themselves "participat[e] in the market" to "exercis[e] the right to favor [their] own citizens over others," Hughes v. Alexandria Scrap Corp., 426 U. S. 794, 810, reflecting a "basic distinction ... between States as market participants and States as market regulators," Reeves, Inc. v. Stake, 447 U. S. 429, 436. Last Term, in a case decided independently of the market participant exception, this Court upheld an ordinance requiring trash haulers to deliver solid waste to a public authority's processing plant, finding that it addressed what was " 'both typically and traditionally a local government function,' " and did "not discriminate against interstate commerce for purposes of the dormant Commerce Clause," United Haulers Assn., Inc. v. Oneida-Herkimer Solid Waste Management Authority, 550 U. S. ___, ___. Pp. 7-10. (b) United Haulers provides a firm basis for reversal here. The logic that a government function is not susceptible to standard dormant Commerce Clause scrutiny because it is likely motivated by legitimate objectives distinct from simple economic protectionism applies with even greater force to laws favoring a State's municipal bonds, since issuing debt securities to pay for public projects is a quintessentially public function, with a venerable history. Bond proceeds are a way to shoulder the cardinal civic responsibilities listed in United Haulers: protecting citizens' health, safety, and welfare. And United Haulers' apprehension about "unprecedented ... interference" with a traditional government function is warranted here, where respondents would have this Court invalidate a century-old taxing practice presently employed by 41 States and supported by all. In fact, emphasizing an enterprise's public character is just one step in addressing the fundamental element of dormant Commerce Clause jurisprudence that "any notion of discrimination assumes a comparison of substantially similar entities," id., at ___. Viewed through the lens of Bonaparte v. Tax Court, 104 U. S. 592, there is no forbidden discrimination because Kentucky, as a public entity, does not have to treat itself as being "substantially similar" to other bond issuers in the market. Pp. 11-13.
(c) A look at the specific markets in which the exemption's effects are felt confirms that no traditionally forbidden discrimination is underway and points to the tax policy's distinctive character. In both the interstate market as most broadly conceived--issuers and holders of all fixed-income securities--and the more specialized market--commerce solely in federally tax-exempt municipal bonds, often conducted through interstate municipal bond funds--nearly every taxing State believes its public interests are served by the same tax-and-exemption feature which is supported in this Court by every State. These facts suggest that no State perceives any local advantage or disadvantage beyond the permissible ones open to a government and to those who deal with that government when it enters the market. An equally significant perception emerges from examining the market for municipal bonds within the issuing State, a large proportion of which market is managed by one or more single-state funds. An important feature of such markets is that intrastate funds absorb securities issued by smaller or lesser known municipalities that interstate markets tend to ignore. Many single-state funds would likely disappear if the current differential tax schemes were upset, and there is no suggestion that the interstate markets would welcome the weaker municipal issues that would lose their local market homes after a Davis victory. Financing for long-term municipal improvements would thus change radically if the differential tax feature disappeared. The fact that the differential tax scheme is critical to the operation of an identifiable segment of the current municipal financial market demonstrates that the States' unanimous desire to preserve the scheme is a far cry from the private protectionism that has driven the dormant Commerce Clause's development. Pp. 20-23.
(e) The Court generally applies the rule in Pike v. Bruce Church, Inc., 397 U. S. 137, 142, that even nondiscriminatory burdens on commerce may be struck down on a showing that they clearly outweigh the benefits of a state or local practice. But the current record and scholarly material show that the Judicial Branch is not institutionally suited to draw reliable conclusions of the kind that would be necessary for the Davises to satisfy a Pike burden in this particular case. Pp. 23-27.
Souter, J., announced the judgment of the Court and delivered the opinion of the Court, except as to Part III-B. Stevens and Breyer, JJ., joined that opinion in full; Roberts, C. J., and Ginsburg, J., joined all but Part III-B; and Scalia, J., joined all but Parts III-B and IV. Stevens, J., filed a concurring opinion. Roberts, C. J., and Scalia, J., filed opinions concurring in part. Thomas, J., filed an opinion concurring in the judgment. Kennedy, J., filed a dissenting opinion, in which Alito, J., joined. Alito, J., filed a dissenting opinion.
DEPARTMENT OF REVENUE OF KENTUCKY, et al.,PETITIONERS v. GEORGE W. DAVIS et ux.
Justice Souter delivered the opinion of the Court, except as to Part III-B.**
For the better part of two centuries States and their political subdivisions have issued bonds for public purposes, and for nearly half that time some States have exempted interest on their own bonds from their state income taxes, which are imposed on bond interest from other States. The question here is whether Kentucky's version of this differential tax scheme offends the Commerce Clause. We hold that it does not.
Like most other States, the Commonwealth of Kentucky taxes its residents' income. See Ky. Rev. Stat. Ann. §141.020(1) (West 2006). The tax is assessed on "net income," see ibid., calculated by reference to "gross income" as defined by the Internal Revenue Code, see §§141.010(9)-(11) (West Supp. 2007),1 which excludes "interest on any State or local bond" ("municipal bond," for short2), 26 U. S. C. §103(a). Kentucky piggybacks on this exclusion, but only up to a point: it adds "interest income derived from obligations of sister states and political subdivisions thereof" back into the taxable net. Ky. Rev. Stat. Ann. §141.010(10)(c). Interest on bonds issued by Kentucky and its political subdivisions is thus entirely exempt,3 whereas interest on municipal bonds of other States and their subdivisions is taxable. (Interest on bonds issued by private entities is taxed by Kentucky regardless of the private issuer's home.)
The ostensible reason for this regime is the attractiveness of tax-exempt bonds at "lower rates of interest ... than that paid on taxable ... bonds of comparable risk." M. Graetz & D. Schenk, Federal Income Taxation 215 (5th ed. 2005) (hereinafter Graetz & Schenk). Under the Internal Revenue Code, for example, see 26 U. S. C. §103, "if the market rate of interest is 10 percent on a comparable corporate bond, a municipality could pay only 6.5 percent on its debt and a purchaser in a 35 percent marginal tax bracket would be indifferent between the municipal and the corporate bond, since the after-tax interest rate on the corporate bond is 6.5 percent," Graetz & Schenk 215.4 The differential tax scheme in Kentucky works the same way; the Commonwealth's tax benefit to residents who buy its bonds makes lower interest rates acceptable,5 while limiting the exception to Kentucky bonds raises in-state demand for them without also subsidizing other issuers.
The significance of the scheme is immense. Between 1996 and 2002, Kentucky and its subdivisions issued $7.7 billion in long-term bonds to pay for spending on transportation, public safety, education, utilities, and environmental protection, among other things. IRS, Statistics of Income Bulletin, C. Belmonte, Tax-Exempt Bonds, 1996-2002, pp. 169-170, http://www.irs.gov/pub/irs-soi/02gov bnd.pdf (as visited Jan. 23, 2008, and available in Clerk of Court's case file). Across the Nation during the same period, States issued over $750 billion in long-term bonds, with nearly a third of the money going to education, followed by transportation (13%) and utilities (11%). See ibid. Municipal bonds currently finance roughly two-thirds of capital expenditures by state and local governments. L. Thomas, Money, Banking and Financial Markets 55 (2006).
Funding the work of government this way follows a tradition going back as far as the 17th century. See C. Johnson & M. Rubin, The Municipal Bond Market: Structure and Changes, in Handbook of Public Finance 483, 485 (F. Thompson & M. Green eds. 1998) ("[In] 1690 ... Massachusetts issued bills of credit to pay soldiers who had participated in an unsuccessful raid on the City of Quebec"). Municipal bonds first appeared in the United States in the early 19th century: "New York City began to float [debt] securities in about 1812," A. Hillhouse, Municipal Bonds: A Century of Experience 31 (1936) (hereinafter Hillhouse), and by 1822 Boston "had a bonded debt of $100,000," id., at 32. The municipal bond market had swelled by the mid-1840s, when the aggregate debt of American cities exceeded $27 million, and the total debt of the States was nearly 10 times that amount. See ibid. Bonds funded some of the great public works of the day, including New York City's first water system, see id., at 31, and the Erie Canal, see R. Amdursky & C. Gillette, Municipal Debt Finance Law §1.2.1, p. 15 (1992) (hereinafter Amdursky & Gillette). At the turn of the 20th century, the total state and municipal debt was closing in on $2 billion, see Hillhouse 35, and by the turn of the millennium, over "$1.5 trillion in municipal bonds were outstanding," J. Temel, The Fundamentals of Municipal Bonds, p. ix (5th ed. 2001).
Differential tax schemes like Kentucky's have a long pedigree, too. State income taxation became widespread in the early 20th century, see A. Comstock, State Taxation of Personal Incomes 11 (1921) (reprinted 2005) (hereinafter Comstock), and along with the new tax regimes came exemptions and deductions, see id., at 171-184, to induce all sorts of economic behavior, including lending to state and local governments at favorable rates of untaxed interest. New York enacted the first of these statutes in 1919, see 1919 N. Y. Laws pp. 1641-1642, the same year it imposed an income tax, see Comstock 104,6 and other States followed, see, e.g., 1921 N. C. Sess. Laws p. 208; 1923 N. H. Laws p. 78; 1926 Va. Acts ch. 576, pp. 960-961, with Kentucky joining the pack in 1936, see 1936 Ky. Acts p. 71. Today, 41 States have laws like the one before us.7
Petitioners (for brevity, Kentucky or the Commonwealth) collect the Kentucky income tax. Respondents George and Catherine Davis are Kentucky residents who paid state income tax on interest from out-of-state municipal bonds, and then sued the tax collectors in state court on a refund claim that Kentucky's differential taxation of municipal bond income impermissibly discriminates against interstate commerce in violation of the Commerce Clause of the National Constitution. The trial court granted judgment to the Commonwealth, relying in part on our cases recognizing the "market-participant" exception to the dormant Commerce Clause limit on state regulation. See App. to Pet. for Cert. A18-A19 (citing Reeves, Inc. v. Stake, 447 U. S. 429 (1980), and Hughes v. Alexandria Scrap Corp., 426 U. S. 794 (1976)).
The Court of Appeals of Kentucky reversed. See 197 S. W. 3d 557 (2006). In a brief discussion, it rejected the reasoning of an Ohio case upholding a similar tax scheme challenged under the Commerce Clause, see id., at 563 (discussing Shaper v. Tracy, 97 Ohio App. 3d 750, 647 N. E. 2d 550 (1994)), and distinguished our market participant cases, see 197 S. W. 3d, at 564, as well as a decision from the 19th century the Commonwealth relied on, see id., at 563-564 (discussing Bonaparte v. Tax Court, 104 U. S. 592 (1882)). The Court of Appeals thought it had "no choice but to find that Kentucky's system of taxing only extraterritorial bonds runs afoul of the Commerce Clause," 197 S. W. 3d, at 564, and the Supreme Court of Kentucky denied the Commonwealth's motion for discretionary review, see App. to Pet. for Cert. A14.
The Commerce Clause empowers Congress "[t]o regulate Commerce ... among the several States," Art. I, §8, cl. 3, and although its terms do not expressly restrain "the several States" in any way, we have sensed a negative implication in the provision since the early days, see, e.g., Cooley v. Board of Wardens of Port of Philadelphia ex rel. Soc. for Relief of Distressed Pilots, 12 How. 299, 318-319 (1852); cf. Gibbons v. Ogden, 9 Wheat. 1, 209 (1824) (Marshall, C. J.) (dictum). The modern law of what has come to be called the dormant Commerce Clause is driven by concern about "economic protectionism--that is, regulatory measures designed to benefit in-state economic interests by burdening out-of-state competitors." New Energy Co. of Ind. v. Limbach, 486 U. S. 269, 273-274 (1988). The point is to "effectuat[e] the Framers' purpose to 'prevent a State from retreating into [the] economic isolation,' " Fulton Corp. v. Faulkner, 516 U. S. 325, 330 (1996) (quoting Oklahoma Tax Comm'n v. Jefferson Lines, Inc., 514 U. S. 175, 180 (1995); brackets omitted), "that had plagued relations among the Colonies and later among the States under the Articles of Confederation," Hughes v. Oklahoma, 441 U. S. 322, 325-326 (1979).
The law has had to respect a cross purpose as well, for the Framers' distrust of economic Balkanization was limited by their federalism favoring a degree of local autonomy. Compare The Federalist Nos. 7 (A. Hamilton), 11 (A. Hamilton), and 42 (J. Madison), with The Federalist No. 51 (J. Madison); see also Garcia v. San Antonio Metropolitan Transit Authority, 469 U. S. 528, 546 (1985) ("The essence of our federal system is that within the realm of authority left open to them under the Constitution, the States must be equally free to engage in any activity that their citizens choose for the common weal").
Under the resulting protocol for dormant Commerce Clause analysis, we ask whether a challenged law discriminates against interstate commerce. See Oregon Waste Systems, Inc. v. Department of Environmental Quality of Ore., 511 U. S. 93, 99 (1994). A discriminatory law is "virtually per se invalid," ibid.; see also Philadelphia v. New Jersey, 437 U. S. 617, 624 (1978), and will survive only if it "advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives," Oregon Waste Systems, supra, at 101 (internal quotation marks omitted); see also Maine v. Taylor, 477 U. S. 131, 138 (1986). Absent discrimination for the forbidden purpose, however, the law "will be upheld unless the burden imposed on [interstate] commerce is clearly excessive in relation to the putative local benefits." Pike v. Bruce Church, Inc., 397 U. S. 137, 142 (1970). State laws frequently survive this Pike scrutiny, see, e.g., United Haulers Assn., Inc. v. Oneida-Herkimer Solid Waste Management Authority, 550 U. S. ___, ___-___ (2007) (slip op., at 14-15) (plurality opinion); Northwest Central Pipeline Corp. v. State Corporation Comm'n of Kan., 489 U. S. 493, 525-526 (1989); Minnesota v. Clover Leaf Creamery Co., 449 U. S. 456, 472-474 (1981), though not always, as in Pike itself, 397 U. S., at 146.
Some cases run a different course, however, and an exception covers States that go beyond regulation and themselves "participat[e] in the market" so as to "exercis[e] the right to favor [their] own citizens over others." Alexandria Scrap, 426 U. S., at 810. This "market-participant" exception reflects a "basic distinction . . . between States as market participants and States as market regulators," Reeves, 447 U. S., at 436, "[t]here [being] no indication of a constitutional plan to limit the ability of the States themselves to operate freely in the free market," id., at 437. See also White v. Massachusetts Council of Constr. Employers, Inc., 460 U. S. 204, 208 (1983) ("[W]hen a state or local government enters the market as a participant it is not subject to the restraints of the Commerce Clause"). Thus, in Alexandria Scrap, we found that a state law authorizing state payments to processors of automobile hulks validly burdened out-of-state processors with more onerous documentation requirements than their in-state counterparts. Likewise, Reeves accepted South Dakota's policy of giving in-state customers first dibs on cement produced by a state-owned plant, and White held that a Boston executive order requiring half the workers on city-financed construction projects to be city residents passed muster.
Our most recent look at the reach of the dormant Commerce Clause came just last Term, in a case decided independently of the market participation precedents. United Haulers, supra, upheld a "flow control" ordinance requiring trash haulers to deliver solid waste to a processing plant owned and operated by a public authority in New York State. We found "[c]ompelling reasons" for "treating [the ordinance] differently from laws favoring particular private businesses over their competitors." Id., at ___ (slip op., at 10). State and local governments that provide public goods and services on their own, unlike private businesses, are "vested with the responsibility of protecting the health, safety, and welfare of [their] citizens," ibid., and laws favoring such States and their subdivisions may "be directed toward any number of legitimate goals unrelated to protectionism," id., at ___ (slip op., at 11). That was true in United Haulers, where the ordinance addressed waste disposal, "both typically and traditionally a local government function." Id., at ___ (slip op., at 12) (quoting United Haulers Assn., Inc. v. Oneida-Herkimer Solid Waste Management Authority, 261 F. 3d 245, 264 (CA2 2001) (Calabresi, J., concurring); internal quotation marks omitted). And if more had been needed to show that New York's object was consequently different from forbidden protectionism, we pointed out that "the most palpable harm imposed by the ordinances--more expensive trash removal--[was] likely to fall upon the very people who voted for the laws," rather than out-of-state interests. United Haulers, 550 U. S., at ___ (slip op., at 13). Being concerned that a "contrary approach . . . would lead to unprecedented and unbounded interference by the courts with state and local government," id., at ___ (slip op., at 11), we held that the ordinance did "not discriminate against interstate commerce for purposes of the dormant Commerce Clause," id., at ___ (slip op., at 10).8
It follows a fortiori from United Haulers that Kentucky must prevail. In United Haulers, we explained that a government function is not susceptible to standard dormant Commerce Clause scrutiny owing to its likely motivation by legitimate objectives distinct from the simple economic protectionism the Clause abhors. See id., at ___ (slip op., at 11) ("Laws favoring local government ... may be directed toward any number of legitimate goals unrelated to protectionism"); see also id., at ___ (slip op., at 12) (noting that "[w]e should be particularly hesitant to interfere ... under the guise of the Commerce Clause" where a local government engages in a traditional government function).9 This logic applies with even greater force to laws favoring a State's municipal bonds, given that the issuance of debt securities to pay for public projects is a quintessentially public function, with the venerable history we have already sketched, see supra, at 4-5. By issuing bonds, state and local governments "sprea[d] the costs of public projects over time," Amdursky & Gillette §1.1.3, at 11, much as one might buy a house with a loan subject to monthly payments. Bonds place the cost of a project on the citizens who benefit from it over the years, see ibid., and they allow for public work beyond what current revenues could support, see id., §1.2, at 12-13. Bond proceeds are thus the way to shoulder the cardinal civic responsibilities listed in United Haulers: protecting the health,10 safety,11 and welfare12 of citizens. It should go without saying that the apprehension in United Haulers about "unprecedented . . . interference" with a traditional government function is just as warranted here, where the Davises would have us invalidate a century-old taxing practice, see supra, at 5, presently employed by 41 States, see n. 7, supra, and affirmatively supported by all of them, see Brief for 49 States as Amici Curiae.
In fact, this emphasis on the public character of the enterprise supported by the tax preference is just a step in addressing a fundamental element of dormant Commerce Clause jurisprudence, the principle that "any notion of discrimination assumes a comparison of substantially similar entities." United Haulers, 550 U. S., at ___ (slip op., at 10) (internal quotation marks omitted) (quoting General Motors Corp. v. Tracy, 519 U. S. 278, 298 (1997)). In Bonaparte v. Tax Court, 104 U. S. 592 (1882), a case involving the Full Faith and Credit Clause, we held that a foreign State is properly treated as a private entity with respect to state-issued bonds that have traveled outside its borders. See id., at 595 (beyond its borders, a debtor State "is compelled to go into the market as a borrower, subject to the same disabilities in this particular as individuals," and has none "of the attributes of sovereignty as to the debt it owes"). Viewed through this lens, the Kentucky tax scheme parallels the ordinance upheld in United Haulers: it "benefit[s] a clearly public [issuer, that is, Kentucky], while treating all private [issuers] exactly the same." 550 U. S., at ___ (slip op., at 10). There is no forbidden discrimination because Kentucky, as a public entity, does not have to treat itself as being "substantially similar" to the other bond issuers in the market.13
Thus, United Haulers provides a firm basis for reversal. Just like the ordinances upheld there, Kentucky's tax exemption favors a traditional government function without any differential treatment favoring local entities over substantially similar out-of-state interests. This type of law does "not 'discriminate against interstate commerce' for purposes of the dormant Commerce Clause." Id., at ___ (slip op., at 13).
This case, like United Haulers, may also be seen under the broader rubric of the market participation doctrine, although the Davises say that market participant cases are inapposite here. In their view, we may not characterize state action under the Kentucky statutes as market activity for public purposes, because this would ignore a fact absent in United Haulers but central here: this is a case about differential taxation, and a difference that amounts to a heavier tax burden on interstate activity is forbidden, see, e.g., Camps Newfound/Owatonna, Inc. v. Town of Harrison, 520 U. S. 564 (1997) (invalidating statute exempting charities from real estate and personal property taxes unless conducted or operated principally for the benefit of out-of-state residents); Fulton Corp., 516 U. S. 325 (striking down tax on corporate stock held by state residents, where rate of tax was inversely proportional to the corporation's exposure to the State's income tax); Bacchus Imports, Ltd. v. Dias, 468 U. S. 263 (1984) (holding excise tax on sale of liquor at wholesale unconstitutional because it exempted some locally produced alcoholic beverages).
The Davises make a fair point to the extent that they argue that Kentucky acts in two roles at once, issuing bonds and setting taxes, and if looked at as a taxing authority it seems to invite dormant Commerce Clause scrutiny of its regulatory activity, see Walling v. Michigan, 116 U. S. 446, 455 (1886) ("A discriminating tax imposed by a State operating to the disadvantage of the products of other States when introduced into the first mentioned State, is, in effect, a regulation in restraint of commerce among the States, and as such is a usurpation of the power conferred by the