Kentucky taxpayers George and Katherine Davis have filed suit against the State of Kentucky alleging that the state violates the Commerce Clause by allowing an exemption for interest income from Kentucky municipal bonds while taxing income from out-of-state bonds. The state has argued that the Court “has never held that a law which favors government, whether the State or local government, rather than private business enterprises violates the dormant Commerce Clause.”
Justice Breyer did what judges sometimes do and posed a hypothetical to both sides involving in-state dairy farmers who ask the state to pass a law imposing a tax on milk imported by producers from out of state. That would be unlawful, he surmised. However, if a state imposes a tax on out-of-state bonds in order to fund its school system, he queried, “what’s the difference?”
The milk hypothetical was drawn out further by Breyer with the attorney for the state finally stating, “That’s our answer, is that the Commerce Clause does not extend to activities by a State on behalf of all of its people.”
The practice of taxing out of state bonds for purposes of state income tax was started by New York in 1919. Other states quickly followed. The amount of time that had passed since those taxes were imposed did not go unnoticed. Chief Justice Roberts stated, “[T]his is an area where Congress can regulate if it wants to, and it has never shown the slightest interest in interfering with state tax exemptions for their own bonds.” An interesting point, no?
