In-flow-ential Decision

Tax Breaks for Local Residents on municipal bonds issued by states and their political subdivisions do not run afoul of the Commerce Clause of the Constitution, according to a ruling by the U.S. Supreme Court. Notably, the outcome, which preserves a prime incentive for investors in the $2.5 trillion municipal bond market, was all but dictated by the high court's decision last year upholding the legality of flow control to publicly owned solid waste handling facilities. [United Haulers Assn., Inc. v. Oneida-Herkimer Solid Waste Management Authority, 127 S.Ct. 1786 (2007)]

Article I of the U.S. Constitution contains a provision, known as the Commerce Clause, granting Congress the power to regulate commerce “among the several states.” Under a line of decisions stretching back about 150 years, the Supreme Court has said that this affirmative statement has a negative implication: states and localities themselves may not adopt measures that discriminate against or otherwise unduly burden interstate commerce. Protectionist efforts by individual states and local jurisdictions — that is, regulatory measures designed to benefit in-state economic interests by burdening out-of-state competitors — have been overturned because of this interpretation.

The 7-2 municipal bond ruling reversed a Kentucky appeals court decision that said the state was unconstitutionally discriminating against interstate commerce by exempting the interest on its bonds from residents' taxable income while taxing the interest earned on the bonds of other states.

Delivering the majority opinion, Justice David Souter quoted from the United Haulers decision: “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,’ and laws favoring such States and their subdivisions may ‘be directed toward any number of legitimate goals unrelated to protectionism.’” And he later adds: “It should go without saying that the apprehension in United Haulers about ‘unprecedented … interference’ with a traditional government function is just as warranted here … .”

Some 40 states follow Kentucky's practice, and a high court ruling to uphold the lower court decision would have forced them to change their systems. Without the special tax breaks, states and localities would have to compensate investors with higher interest rates. They might end up taxing interest on in-state bonds or extending breaks to out-of-state ones.

Indeed, all 49 other states joined in a friend-of-the-court brief urging the justices to overturn the Kentucky court and uphold the state preference. Acknowledging that sentiment, Justice Souter inferred that “no State perceives any local advantage or disadvantage beyond the permissible ones … .” To sustain the Kentucky ruling would “throw out the system of financing municipal improvements throughout most of the United States,” he said.

Meanwhile, Chief Justice John Roberts, who wrote the court's opinion in United Haulers, chimed in with a 60-word concurring opinion simply stating that “a majority of the court shares the view” that the Kentucky case is “readily resolved” by last term's waste case.

[Department of Revenue of Kentucky, v. Davis, No. 06-666, May 19, 2008]

The legal editor welcomes comments from readers. Contact Barry Shanoff via e-mail: [email protected].

The columnist is a Rockville, Md., attorney and serves as general counsel of the Solid Waste Association of North America.