Analysis

One obvious motivation, and one somewhat more subtle, drove the Supreme Court on Monday to salvage the most common form of state taxing of money that investors make when they buy state or local government bonds "” "municipal bonds," in market parlance.  The Court in Kentucky Department of Revenue (06-666) upheld the differing treatment that 41 states give to bonds' interest "” exempting the return on their own issues, while imposing a tax on the income on those sold by other states.  The Court, most obviously, was determined to avoid the bold stroke of throwing out what it called "the system of financing municipal improvements throughout most of the United States."  Not so clear, but quite apparent, is that the Court is turning out to be more generous than perhaps had been thought about finding valid public purposes behind some discriminatory economic actions of state and local governments.

Those two observations emerge out of the Court’s new examination of state economic action under the so-called "dormant Commerce Clause" — an examination that, on Monday, led the Justices to issue seven opinions from widely varying perspectives. The "dormant" Clause is the one, invented by the Court, that limits state authority to add burdens to interstate economic activity by discriminating in favor of in-state business. In the face of the fervent opposition of two Justices, the remainder of the Court is not about to abandon that version of the Commerce Clause.

But version is clearly undergoing change. The majority opinion of Justice David H. Souter, in one of its more provocative sections (supported by only five of the nine members), hinted at a change that may come in the future, but did not emerge full-blown Monday. The Court, it seems, is moving away from one aspect of dormant Commerce Clause analysis "” the use of the so-called "Pike balancing test" that limits states’ authority when they do not discriminate economically, but take action that still burdens interstate commerce without really producing much local benefit (the test derived from the 1970 decision in Pike v. Bruce Church). The test was put forth as one of the challenges to Kentucky’s different way of dealing with municipal bond interest. But Souter’s opinion refused to apply that test, and the rationale for the refusal was contained in a strongly worded essay on the hazards of having the judiciary make the "very subtle exercise" of weighing costs against benefits in a complex economic setting. (Justice Antonin Scalia wants to abandon the Pike test altogether, but there does not appear to be a majority for that sharp break "“ at least not yet.)

In the course of his essay on that point, Souter also reinforced the impression that the Court validated the differential system of taxing municipal bond interest out of a genuine concern about disrupting virtually the entire system of raising money in the market to pay for public works. The challengers to Kentucky approach, the opinion said, did not simply ask the Court to "tinker with details of a tax scheme," but rather to expose the states to the uncertainties of experimentation with their traditional method of financing civic improvements. Souter called that "adventurism," threatening to undercut "the experience of nearly a century."

In fact, Souter’s opinion as a whole clearly was motivated by the twin facts that this differential taxing mode has prevailed for so long, and that all 49 other states joined in supporting Kentucky’s right (and their right) to treat their own bonds more favorably tax-wise than their sister states’. So much of Souter’s writing, on all points in dispute, grew out of the unappealing prospect "“ as he saw it "“ of compelling the states to start over in "funding the work of government."

The other motivation was the "public purpose" rationale that Souter deployed. This rationale actually began to emerge most clearly on April 30 of last year, in Chief Justice John G. Roberts Jr.’s main opinion for the Court in United Haulers v. Oneida-Herkimer Solid Waste Management Authority. Under that approach, a state (or local) government’s action that would otherwise violate the dormant Commerce Clause is constitutional if it advances a government, as opposed to a private, economic interest.

On Monday, Souter wrote: "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." Souter went on to judge the Kentucky bond scheme under that precedent, finding that raising money for civic works of government "is a quintessentially public function." It would be, the opinion added, an "unprecedented interference" to use the dormant Commerce Clause to nullify that kind of function.

It is thus apparent that, as future dormant Commerce Clause cases arise, the concept of "government function" may expand, rather than contract, further enlarging state and local government powers to take economic measures that they deem advisable for the public good as they see it. The Kentucky ruling seems sure to embolden them to craft programs so that they fit the rationale.

On a more immediate level, the opinion does raise a significant question about whether the “public purpose” rationale will be extended beyond municipal bonds so as to allow states to have different tax treatment for “industrial revenue” bonds or similar issues designed to finance private projects, rather than public works, as such.  A footnote in Souter’s opinion said the Court was not deciding that issue, since the issue had not been addressed in lower courts.  But, tellingly, perhaps, the footnote at least implied that disrupting such a differential tax system could interfere with “important projects that the states have deemed to have public purposes.”

Posted in Dept. of Revenue of Kentucky v. Davis, Uncategorized