Department of Revenue of Kentucky v. Davis

PETITIONER: Department of Revenue of Kentucky et al.
RESPONDENT: George W. Davis et ux.
LOCATION: U.S. Naval Base at Guantanamo Bay

DOCKET NO.: 06-666
DECIDED BY: Roberts Court (2006-2009)
LOWER COURT: State appellate court

CITATION: 553 US 328 (2008)
GRANTED: May 21, 2007
ARGUED: Nov 05, 2007
DECIDED: May 19, 2008

ADVOCATES:
C. Christopher Trower - on behalf of the Petitioners
G. Eric Brunstad, Jr. - on behalf of the Respondents

Facts of the case

When calculating gross income for tax purposes, the Internal Revenue Code exempts from taxation the interest earned on any state or local bond. However, Kentucky law requires that interest income earned on bonds issued by other states be taxed as part of an individual's adjusted gross income. George and Catherine Davis filed a class action complaint arguing that Kentucky's policy of taxing out-of-state bonds was in violation of the dormant Commerce Clause - the doctrine that the Commerce Clause forbids states from interfering with interstate commerce. The state trial court ruled in favor of the Kentucky Department of Revenue and declared the tax policy constitutional.

On appeal, the Davises stressed Kentucky's market discrimination against other states as a factor indicating that the policy was unconstitutional. In response, the Department of Revenue cited a similar policy that was upheld by state courts in Ohio. The Department also invoked the "market participant doctrine," which stands for the idea that only the state's actions as a regulator are subject to the dormant Commerce Clause. Actions undertaken as a market participant, such as the issuance of bonds, are not. The Kentucky Court of Appeals reversed the lower court and struck down the tax policy. The Court of Appeals held that the tax discrimination rather than the bond issuance was at issue, and the taxation was indisputably undertaken in the state's capacity as a regulator. The court concluded that the Commerce Clause was incompatible with such a discriminatory state policy.

Question

Does a state violate the dormant Commerce Clause by providing an income tax exemption for interest on bonds issued by the state, while denying the exemption to interest on bonds issued by other states?

Media for Department of Revenue of Kentucky v. Davis

Audio Transcription for Oral Argument - November 05, 2007 in Department of Revenue of Kentucky v. Davis

Audio Transcription for Opinion Announcement - May 19, 2008 in Department of Revenue of Kentucky v. Davis

David H. Souter:

This case comes to us on a writ of certiorari to the Court of Appeals of Kentucky.

The Commonwealth of Kentucky exempts from state income taxation any interest on bonds issued by the Commonwealth in its political subdivisions.

At the same time as it taxes the interest earned on bonds issued by other States.

This way, it -- it decreases the interest cost of borrowing money for its own public projects.

40 other States employ the same scheme with the first one dating back to 1919.

Respondents, George and Catherine Davis, are Kentucky residents who own and pay state income tax on interest from out-of-state municipal bonds.

They sued Kentucky, claiming that its differential tax scheme amounted to local protectionism in violation of the dormant Commerce Clause.

After the trial court granted judgment to Kentucky, the State Court of Appeals reversed and held that differential taxation was unconstitutional.

The Supreme Court of Kentucky denied the Commonwealth's motion for discretionary review and we granted certiorari.

In an opinion filed with the clerk of the Court today, we hold that Kentucky's tax scheme does not violate the Commerce Clause and we reverse and remand.

Last term, we decided a case called United Haulers Association against Oneida-Herkimer Solid Waste Management Authority.

That case decided independently of our market participation precedence that a governmental ordinance requiring trash haulers to deliver solid waste to a local processing plant owned and operated by a public authority was constitutional.

We explained that laws favoring a government function are not susceptible to standard dormant Commerce Clause scrutiny owing to their likely motivation by legitimate objectives distinct from simple economic protectionism.

We also, warned against unprecedented and unbounded interference by the courts with local and state government.

It follows from United Haulers that Kentucky must prevail here.

The issuance of debt securities to pay for public projects is a quintessentially public function with a venerable history.

Bonds help State and local governments finance projects that protect health, safety and welfare of citizens and the apprehension in United Haulers about unprecedented interference with a traditional governmental function is just as warranted here.

The Davis's would have us invalidate a century-old taxing practice that is presently employed by 41 States and affirmatively supported in this Court and by all 50.

What is more, we have previously held that a foreign state is properly treated as a private entity with respect to state issued bonds that have travelled outside its borders.

Viewed through this lens, the Kentucky tax benefits a clearly public issuer, Kentucky, while treating oral private issue as exactly the same.

It does not involve desperate treatment of substantially similar entities, the hallmark of forbidden discrimination.

Some members of the -- of the Court -- I have also looked at this case under the broader rubric of the market participation exception to the dormant Commerce Clause which applies when States participate in the market rather than acting in a wholly regulatory capacity.

Kentucky's regulation by taxation goes hand-in-hand with its market participation by selling bonds.

Like the laws upheld in prior market participant cases, Kentucky's differential tax is tied to the public object of its foray into the market which gives the scheme a civic objective different from the typical goals of unlawful discrimination.

We note that differential tax schemes facilitate the issuance of bonds by smaller municipalities that the interstate markets tend to ignore.

This helps to explain why the State is so committed to this system and it underscores how far the State's objectives probably lie from economic protectionism for any local businesses. Having found no per se unconstitutional discrimination against Interstate Commerce, we also hold that the Davis's claim is not susceptible to class benefit balancing analysis that is often proper under the case of Pike against Bruce Church.

The current record and scholarly materials show that the Judicial Branch is not institutionally suited to draw reliable conclusions of the kind that would be necessary for the Davis's to satisfy a Pike burden in this particular case.

Justice Stevens has filed a concurring opinion.

The Chief Justice and Justice Scalia have both filed opinions concurring in part.

Justice Thomas has filed an opinion concurring in the judgment.