Department of Revenue of Kentucky v. Davis,
No. 06-666 (previously discussed in the
May 21, 2007 Docket Report). The Supreme Court today
upheld a Kentucky law that exempts from state taxes interest
earned from bonds issued by the state of Kentucky and its
political subdivisions, but that denies the same exemption for
interest earned from bonds issued by other states and their
subdivisions. Since more than forty other states, including New
York and California, have similar laws, the $2 trillion
municipal bond market would surely have "change[d] radically"
(Slip op. 22) if the court had held Kentucky's "differential tax
feature" to be unconstitutional.
the Supreme Court's so-called "dormant Commerce Clause"
jurisprudence, the Commerce Clause prohibits states from
discriminating against interstate commerce. Among other things,
a state cannot "tax a transaction or incident more heavily when
it crosses state lines than when it occurs entirely within the
State." Armco Inc. v. Hardesty, 467 U.S. 638, 642 (1984).
Residents of Kentucky who paid Kentucky state income tax on
interest earned from holding bonds issued by states other than
Kentucky challenged Kentucky's statutory limitation on the tax
exemption in state court, claiming that it violated the Commerce
Clause. The Court of Appeal of Kentucky invalidated the law,
noting that "it obviously affords more favorable taxation
treatment to in-state bonds than it does to extraterritorially
majority opinion by Justice Souter, the Supreme Court reversed.
The Court noted that "the issuance of debt securities to pay for
public projects is a quintessentially public function, with [a]
venerable history." Slip op. 12. As such, the Court explained,
its decision was governed by United Haulers Association, Inc.
v. Oneida-Herkimer Solid Waste Management Authority, 127 S.
Ct. 1786 (2006), which held that traditional government
functions are "not susceptible to [the] standard dormant
Commerce Clause scrutiny" applied to laws favoring in-state
private businesses because traditional government functions are
more likely to be motivated "by legitimate objectives distinct
from the simple economic protectionism the Clause abhors." Slip
op. 11. The Court went on to hold that because "a foreign State
is properly treated as a private entity with respect to
state-issued bonds that have traveled outside its borders,"
id. at 13, Kentucky's law--like the ordinance in United
Haulers--treated all private issuers identically. Moreover,
"Kentucky, as a public entity, does not have to treat itself as
being 'substantially similar' to the other bond issuers in the
market." Id. Because the Kentucky bonds are properly
treated as the only bonds furthering governmental functions, the
tax preference could not constitute the discrimination among
substantially similar entities that is forbidden by the dormant
Commerce Clause. Finally, the Court refused to remand the case
for a balancing of the burdens on commerce against the local
benefits of the tax scheme under Pike v. Bruce Church, Inc.,
397 U.S. 137, 142 (1970), on the ground that judges should not
"expose the States to the uncertainties of . . . economic
experimentation" that the balancing test would allow under these
circumstances. Slip op. 27.
separate Justices issued opinions in this case, which deeply
divided the Court. In a portion of his opinion joined by only
two other justices--Justices Stevens and Breyer--Justice Souter
suggested that Kentucky's tax preference was exempt from the
dormant Commerce Clause on the ground that Kentucky was
primarily acting as a participant in the bond market. Justice
Stevens issued a concurrence noting that, even in the absence of
the United Haulers precedent, he would uphold the statute
because Kentucky was not participating in a private trade or
business. Justice Scalia wrote a partial concurrence reiterating
his view that the dormant Commerce Clause should be applied only
where stare decisis leaves no room for any other result,
while Justice Thomas concurred in the judgment on the ground
that the Court should reject its prior dormant Commerce Clause
jurisprudence altogether. Justice Kennedy, joined by Justice
Alito, dissented, agreeing with the state court that the tax
preference was "an explicit discrimination against out-of-state
issuances for admitted protectionist purposes."