by
The United States Supreme Court’s recent decision to vacate the Cuno judgment on standing grounds resolves the immediate constitutional threat to state tax incentives to promote local economic
growth. DaimlerChrysler Corp.v.Cuno, 126 S. Ct. 1854 (2006).[fn1] However, the decision does nothing to resolve the doctrinal conflict that spawned the litigation, and the plaintiffs have
vowed to renew their challenge through the Ohio courts where they maintain the broader standing requirements will set the
stage for another appeal to the Court. See Karen Setze, Supreme Court: Plaintiffs in OhioIncentive Case Lack Standing,State Tax Notes, May 16, 2006, at 573. Moreover, other litigants have similar tax challenges in the state courts in Minnesota
and Wisconsin where the standing rules may prove more accommodating. See, e.g., Olson v. Minnesota,No. 62-C8-05-2727 (Minn. Dist. Ct., filed Mar. 17, 2005); Northwest Airlines, Inc.v.Wis. Dep’t of Revenue, No. 02CV3533 (Wis. Cir. Ct. Dec. 8, 2003), appeal pending, No. 2004AP319 (Wis. Ct. App.).[fn2] Meanwhile, proponents of the "Economic Development Act of 2005" [fn3] continue to push for congressional legislation to ward off future challenges of the type advanced in Cuno.
As the parties regroup and consider their next moves, we take the opportunity to reflect upon the current state of Dormant
Commerce Clause jurisprudence and the future role the courts, Congress, and others might play in developing a more coherent
and predictable approach to identifying and evaluating discriminatory state taxes.
In doing so, we proceed as follows: First, we describe in very broad terms the structure of the Commerce Clause and the United
States Supreme Court’s historical (pre-Complete Auto Transit) approach to taxation of interstate and foreign commerce. Thereafter, we describe the analytical framework the Court currently
appears to use in evaluating claims of discriminatory taxation. Our goal here is not so much to describe the taxes that are
or are not discriminatory. Rather, we are simply trying to identify the "rules," or at least the guidelines, the Court applies
in evaluating whether state taxes are discriminatory under the Commerce Clause. Because the state courts are on the front
line of these developing principles, this section of the article also offers an opportunity to provide a brief roundup of
some of the more important, recent state court decisions considering discrimination under the Dormant Commerce Clause.
Next, we revisit the basic question presented in Cuno. That issue, considered in connection with the Court’s other recent Dormant Commerce Clause case, American Trucking Ass’nsv.Michigan Public Service Commission, 545 U.S. 429 (2005), illustrates the difficulties the Court has had in developing a fully consistent and workable analytical
framework for its Dormant Commerce Clause jurisprudence. With respect to Cuno, court decisions striking down taxes that favor local commerce appear to be in profound tension with other decisions where
the Court recognizes that states should be free to compete for and attract interstate business. In the American Trucking Ass’ns decision, the Court set aside one of its most consistent guiding principles for evaluating discriminatory taxes, the internal
consistency test, in approving a state flat tax that plainly failed the requirements of that test, and grounded that action
on formalistic distinctions that are reminiscent of the Court’s pre-Complete Auto Transit jurisprudence.
That discussion leads to an examination and evaluation of the proposed congressional fix, i.e., the Economic Development Act of 2005. This legislation would identify those taxes which, in the future, will be viewed as
permissible state economic incentives and those taxes which, in the future, will be viewed as discriminatory. Because we are
skeptical that such a system is likely to prove workable in the long run, we pose the question whether other approaches might
better serve the purposes of the Dormant Commerce Clause, and outline an alternative system drawn from the model currently
used by the European Union ("EU").
Finally, we offer a brief preview of a few of the more important state tax issues that are likely to call for Court attention
in the future. In this regard, we describe briefly a case currently pending before the Court on a Petition for Certiorari
involving a new brand of discrimination implemented through a "shifting tax base." In addition, we touch upon the Commerce
Clause questions presented by state "addback statutes," [fn4] as well as the continuing question whether states should be permitted to apportion income based upon a single sales factor.
Before embarking upon this full agenda, we wish to offer a couple of caveats. First, our purpose here is not to offer an in-depth
review of the Court’s Commerce Clause decisions. Professor Hellerstein and his late father have fully occupied that field.
[fn5] We are grateful to have that resource in trying to sort out the broad themes we dwell upon in this article. Second, although
we suggest a possible realignment of the Supreme Court’s role in deciding Commerce Clause cases, until that role is supplanted,
if ever, by congressional legislation, the Court’s participation in the field of state taxation remains vital. While the Court
may have had difficulty in developing a fully workable analysis for evaluating discriminatory state taxes, taxpayers continue
to require the Court’s attention as a counterweight to the inevitable pressures upon states (and their localities) to favor
local commerce and export the burdens of taxation to outsiders. In short, the Court has been the guardian of our free-trade
interstate system, and we need its continuing vigilance unless or until a more workable system is developed.
Overview of the Commerce Clause[fn6]
Notably, the text of the Commerce Clause is short and to the point: [fn7]
The Congress shall have the Power . . . [t]o regulate Commerce with foreign Nations, and among the several States, and with
the Indian Tribes.
Logically, this assignment of authority has two distinct elements. First, Congress has the power to limit state taxing authority.
Public Law 86-272, 86th Cong. (1959) ("P.L. 86-272"), is a familiar illustration. By this statute, Congress has forbidden
states from imposing a tax on the income of sellers of tangible personal property so long as these sellers restrict their
conduct within the state to certain prescribed activities generally limited to soliciting sales. Absent this statute, states
plainly would have constitutional authority to impose an income tax upon taxpayers who conduct such activities (beyond some de minimis amount).
Second, Congress has the power to expand state authority to tax. To those who like to fish or hunt, Schutzv.Thorne, 415 F.3d 1128 (10th Cir. 2005), cert. denied, 126 S. Ct. 1340 (2006), provides a familiar illustration of that power. In that case, a nonresident challenged a statute that charged
higher fees for out-of-state hunters than for in-state hunters. In dismissing the Commerce Clause challenge, the United States
Court of Appeals for the Tenth Circuit noted that congressional legislation recently had been enacted to authorize such disparate
fees and concluded the plaintiff’s action was simply "moot" under the circumstances. Another, more prosaic example of this
power may be found in the current congressional attempts to expand state authority to collect taxes on remote (non-physically
present) sellers for states that are members of the simplified sales tax project. See Sales Tax Fairness and Simplification Act, S. 2152, 109th Cong. (2005), and Streamlined Sales Tax Simplification Act, S. 2153, 109th Cong. (2005).
In addition to this express delegation of authority to Congress, since at least 1873, the Supreme Court has also read the
Commerce Clause to authorize the Court to strike down taxes that unduly burden interstate or foreign commerce, even in the
absence of congressional legislation. See Case of State Freight Taxv.Pennsylvania,82 U.S. 232 (15 Wall.) (1873). The Court found this so-called "Dormant Commerce Clause" authority by implication from the Constitution’s
exclusive delegation to Congress of the right to regulate interstate commerce. Because taxation is an exercise of state legislative
authority indistinguishable in substance from state regulation and arguably simply a form of regulation, taxation that unduly
burdens interstate commerce thereby impinges upon congressional authority to regulate interstate commerce and, in the Court’s
view, is inconsistent with the Commerce Clause. The Court’s assumption of this authority has, as a practical matter, meant
that the Court is the primary guardian of free trade among the states.
Evolution of the Court’s Decisional Framework
In what might be called the "pre-modern" era, i.e.,prior to 1977, the Court’s Dormant Commerce Clause jurisprudence was largely shaped by the principle that interstate commerce
should operate free from any state tax impositions that could be viewed as regulation. As such, the Court’s decisions provided
a dismaying patchwork of formalistic distinctions as to what constituted "local" versus "interstate" commerce and when a tax should be viewed as "direct" (impermissible) versus "indirect" (permissible). See, e.g., McGoldrickv.Berwind-White Coal Mining Co.,309 U.S. 33 (1940) (upholding tax on an interstate sale of coal into taxing state because delivery constituted a "local activity"
rather than interstate commerce).
In 1977, the Court abandoned what remained of this analytical model when it ruled that interstate commerce may be made to
bear its fair share of a state’s tax burden so long as the tax met four criteria: i.e.,the tax must (1) be applied to an activity with respect to which the state has substantial nexus; (2) be fairly apportioned
to reflect the instate activities or values; (3) not discriminate against interstate commerce; and (4) be fairly related to
services provided by the state. Complete Auto Transit, Inc.v.Brady, 430 U.S. 274 (1977). [fn8]
Experience demonstrates that among the four factors articulated in Complete Auto Transit, the prohibition against discriminatory taxes plays the most important role in the Court’s efforts to ensure free trade among
the various states. Moreover, the Court itself has observed that the requirement of fair apportionment in many cases may be
viewed simply as a subset of the discrimination prong because an apportionment system that inappropriately sources income
or values invites multiple taxation as other states, with more legitimate claims over the income or values, impose their taxes
as well. See Armco Inc.v.Hardesty,467 U.S. 638 (1984). [fn9] Thus, the Court’s discrimination decisions far outnumber its decisions resting upon one or more of the other prongs of Complete Auto Transit. [fn10]
The Court’s Framework for Identifying a Discriminatory Tax
The Court’s basic principle for determining whether state action (and, therefore, a state tax) discriminates against interstate
commerce is broad and flexible. In Granholmv.Heald,544 U.S. 460, 472 (2005) (citation omitted), the Court articulated the principle as follows:
Time and again this Court has held that, in all but the narrowest circumstances, state laws violate the Commerce Clause if
they mandate "differential treatment of in-state and out-of-state economic interests that benefits the former and burdens
the latter."
As such, tax discrimination is forbidden equally if it is effected through a higher tax rate imposed upon interstate commerce
(Associated Industries of Missouriv.Lohman,511 U.S. 641 (1994)); through the denial of a tax exemption to out-of-state interests (Camps Newfound/Owatonna, Inc.v.Town of Harrison,520 U.S. 564 (1997)); or through a tax base that is higher for interstate commerce than for local commerce (Halliburton Oil Well Cementing Co.v.Reily,373 U.S. 64 (1963)).
In general, the Court’s modern decisions focus upon the conceptual possibility of an undue burden rather than upon factual
evidence of actual harm to the commerce. In that regard, a challenge to a state tax need not establish that interstate commerce
was actually impeded or that income was actually subject to double taxation to be successful. See Armco Inc.v.Hardesty, 467 U.S. 638 (1984). Nor must a taxpayer prove that the discrimination was motivated by an intention to favor local commerce
over interstate commerce. See, e.g., Halliburton Oil Well Cementing Co.,373 U.S. at 72 (striking down a discriminatory tax base that admittedly "may have been an accident of statutory drafting").
[fn11]
The Court has also made clear that where discrimination exists there is no de minimis exception:
Under our cases, unless one of several narrow bases of justification is shown, actual discrimination, wherever it is found,
is impermissible, and the magnitude and scope of the discrimination have no bearing on the determinative question whether
discrimination has occurred.
Associated Indus., 511 U.S. at 649-50 (citation omitted).
Broadly speaking, the Court’s protection extends to the commerce itself, rather than to the individual taxpayers. See Gen. Motors Corp.v.Tracy,519 U.S. 278 (1997). Because the purpose of the protection is to ensure that interstate commerce is not placed at a competitive
disadvantage, logically, the disfavored interstate commerce must be in competition with the favored local commerce for unconstitutional
discrimination to exist.
Discrimination against interstate commerce is not immunized simply because its burden is somehow tied to a "local event."
Boston Stock Exch.v.State Tax Comm’n,429 U.S. 318, 332 n.12 (1977) ("Because of the discrimination inherent in [the taxing statute], we also reject the . . .
argument that the tax should be sustained because it is imposed on a local event at the end of interstate commerce."). Indeed,
the Court has made it clear that the stage of commerce bearing the discriminatory burden is simply immaterial. W. Lynn Creamery, Inc.v.Healy, 512 U.S. 186, 202 (1994) ("For over 150 years, our cases have rightly concluded that the imposition of a differential burden
on any part of the stream of commerce – from wholesaler to retailer to consumer – is invalid, because a burden placed at any
point will result in a disadvantage to the out-of-state producer."). Nor is it of material significance that some forms of
local commerce also suffer the discrimination borne by interstate commerce. For example, the Kansas Supreme Court recently
struck down a tax that assessed both interstate and intercounty pipelines at a higher assessed value and rate than intracounty
pipelines. In re Appeals of CIG Field Servs. Co., 112 P.3d 138 (Kan. 2005). The Kansas court concluded that the discrimination suffered by certain forms of intrastate commerce,
i.e.,intercounty pipelines, when compared to intracounty pipelines, was simply beside the point when considering whether interstate
commerce had been disadvantaged.
Discrimination against interstate commerce will not be countenanced simply because a state is attempting to coordinate its
taxes to avoid imposing tax on the same income twice. See Farmer Bros. Co.v.Franchise Tax Bd., 108 Cal. App. 4th 976 (2003) (striking down California’s dividends-received deduction that was limited to the payer’s California
income), cert. denied, 540 U.S. 1178 (2004); D.D.I., Inc.v.North Dakota, 657 N.W.2d 228 (N.D. 2003) (striking down a North Dakota deduction that mirrored the dividends-received deduction at issue
in Farmer Bros.). In effect, these cases hold that while a policy against multiple taxation may be rational, where the policy is not extended
to taxes of other states, it constitutes discrimination that skews economic decisions in favor of local investments. See also Fulton Corp.v.Faulkner, 516 U.S. 325 (1996) (striking down a tax on intangible property, such as stock, that was inversely related to the investor’s
presence in the state).
As a corollary, the mere fact that interstate commerce may be subject to multiple taxes does not establish a discriminatory
tax regime. The point is illustrated by the recent decision of the Ohio Supreme Court in Diehl,Inc.v.Ohio Department of Agriculture, 806 N.E.2d 533 (Ohio 2004). In that case, the plaintiff, a manufacturer of evaporated milk, challenged the imposition of
an inspection fee based upon the amount of its milk purchases. Because its out-of-state suppliers were subject to another
fee that funded the same service in their state, the manufacturer complained that out-of-state product was subject to multiple
fees, thereby increasing its price, while Ohio milk was subject to only one inspection fee. Nonetheless, the court rejected
arguments that the fee should be viewed as discriminating against interstate commerce. While the conflict between the differing
systems for collecting inspection fees resulted in a disadvantage to producers operating in states that collected the fees
prior to the manufacturing process, such a conflict does not constitute discrimination under the Commerce Clause because the
two fees were imposed upon different events, i.e.,producing milk versus manufacturing a milk product.
A Flawed Apportionment System May Create Discrimination
Since its decision in Container Corp. of Americav.Franchise Tax Board,463 U.S. 159 (1983), the Court has employed two distinct inquiries to determine whether an apportionment system satisfies
the Commerce Clause, i.e., the internal and external consistency tests. Under the internal consistency test, a tax is considered a violation of the
Commerce Clause if the tax would result in the income being taxed more than once, assuming the tested tax were enacted in
its identical form by other states. In contrast, the external consistency test looks not to multiple taxation but rather to
whether the state’s system for locating income or values actually reflects a reasonable sense of how the income or value is
generated. [fn12]
Internal Consistency
Over the last twenty years, the internal consistency test has become something of a workhorse, particularly in the state courts,
for determining whether a tax should be struck down as a violation of the Commerce Clause. For example, in American Trucking Ass’nsv.New Jersey,852 A.2d 142 (N.J. 2004), the New Jersey Supreme Court struck down an (unapportioned) flat fee collected from transporters
of hazardous waste because, if that fee were replicated by other states, interstate carriers would be subjected to multiple
fees while instate carriers would pay but one fee. See also Am. Trucking Ass’nsv.Scheiner, 483 U.S. 266 (1987). [fn13] In Home Interiors & Gifts, Inc.v.Strayhorn, 175 S.W.3d 856 (Tex. App. 2005), petition for review filed, No. 05-0939 (Jan. 6, 2006),a Texas Court of Appeal relied upon internal consistency to strike down the State’s earned surplus
throwback provision of the franchise tax because the throwback of the receipts was keyed to whether the taxpayer’s operation
in another state would enjoy the protection of P.L. 86-272. Because P.L. 86-272 would not protect the taxpayer from the State’s
alternative franchise tax base, i.e., the net worth tax, were the Texas franchise tax to be replicated in other states, an interstate taxpayer would be exposed
to a double franchise tax (one imposed upon earned surplus and the other upon net worth). As a consequence, the court found
the provision violated the Commerce Clause.
And, in Fluor Enterprises Inc.v.Department of Treasury, 697 N.W.2d 539 (Mich. Ct. App. 2005), appeal granted, 711 N.W.2d 74 (Mich. 2006), the Michigan Appellate Court relied upon the internal consistency test to prohibit Michigan
from attributing to the State receipts from out-of-state services on Michigan construction projects because the State also
attributed to Michigan receipts from in-state services on out-of-state projects.
Because the internal consistency test looks to whether the state’s tax regime, if replicated, would result in multiple taxation
of interstate commerce, an effective credit mechanism (whereby the tested state reduces its taxes by the amount of tax previously
imposed by another state on the same commerce) is considered a complete defense to a claim that a tax violates internal consistency.
See Goldbergv.Sweet, 488 U.S. 252 (1989). A recent decision of the Minnesota Supreme Court illustrates that this defense also applies where the
State grants a credit for taxes subsequently paid to another state that taxes the same commerce (i.e., downstream from the initial taxes). See Mayo Collaborative Servs.v.Comm’r of Revenue,698 N.W.2d 408 (Minn. 2005), cert. denied, 126 S. Ct. 1334 (2006). This case involved the constitutionality of an exemption from the MinnesotaCare tax on the gross
revenues of a health-care provider (the in-state wholesale provider) for revenue received from another health-care provider
who was also subject to the MinnesotaCare tax (the in-state retail provider). In rejecting a challenge that the tax violated
the internal consistency test, the court relied on, among other things, the State’s representation that the tax provided for
a refund of the tax paid by the in-state wholesaler when the out-of-state retailer paid a similar tax on the gross receipts
to another state and bore the burden of the Minnesota tax because the tax was passed through. Thus, while the in-state wholesaler’s
sales to local medical service providers were exempt because those local providers paid the tax on their sales to the ultimate
patient, the credit mechanism apparently provided for a similar end result in the interstate context.
External Consistency
In contrast to the internal consistency test, the external consistency test looks to whether the income or values taxed by
a state are fairly related to activities within the state. In theory, this test is concerned with whether the tax is excessive
in light of the taxpayer’s actual operations in the state. [fn14] In recent years, this test has been employed primarily to attack tax regimes that lack any apportionment mechanism, and
the litigation has centered upon whether an apportionment mechanism is required at all for that type of tax. See Okla. Tax Comm’rv.Jefferson Lines, Inc.,514 U.S. 175 (1995) (holding that a traditional sales tax need not be apportioned even when applied to the gross proceeds
of an interstate service, but that gross receipts or gross income taxes do require apportionment).
Recently, at least three state courts have relied upon the external consistency test as authority for striking down local
gross receipts taxes. See City of Modestov.Nat’l Med., Inc., 128 Cal. App. 4th 518 (2005) (affirming a lower court decision striking down an unapportioned business license tax on gross
receipts and rejecting the City’s attempt to create an apportionment mechanism retroactively); Northwood Constr. Co.v.Twp. of Upper Moreland, 856 A.2d 789 (Pa. 2004) (striking down an unapportioned local Pennsylvania gross receipts tax and holding that a credit
for taxes paid in other jurisdictions does not satisfy the external consistency test), cert. denied, 544 U.S. 962 (2005); S. Pac. Transp. Co.v.Arizona, 44 P.3d 1006 (Ariz. Ct. App. 2002) (striking down an unapportioned state gross receipts tax on railroad operations conducted
between two states).
Defenses to Discriminatory Tax Claims
As a general matter, in order to justify a discriminatory tax, the state must demonstrate that the scheme "‘advances a legitimate
local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.’" Camps Newfound/Owatonna, Inc.,520 U.S. at 581 (citation omitted). In reality, defending a tax that admittedly discriminates against interstate commerce
is an almost impossible task since the Court has indicated such defenses will be subject to a strict scrutiny standard. Moreover,
there is almost always a nondiscriminatory alternative to a discriminatory tax, namely, a nondiscriminatory tax. Thus, alleviating
administrative burdens, while a legitimate local purpose, provides no defense to discrimination against interstate commerce
at least where those administrative burdens could be resolved by extending the favorable treatment to interstate commerce.
See Halliburton Oil Well Cementing Co.,373 U.S. 64; Ex parte Hoover, Inc.,No. 1040969, 2006 Ala. LEXIS 82 (Ala. Apr. 28, 2006) (striking down a sales tax exemption for sales to the Alabama government
but not to governments of other states, based upon a finding that any administrative burden of collecting tax from what would
be the recipient of those same tax revenues could be equally resolved by extending the exemption to other states that purchase
goods within Alabama).
To date, the only workable defense to a discriminatory tax is technically not a defense at all, but rather a framework for
establishing that the tax ultimately is not discriminatory when other taxes imposed by the state are considered. This framework,
known as the compensatory tax defense, involves three distinct elements. First, the state must identify the intrastate tax
burden for which it is attempting to compensate. Second, the tax on interstate commerce must be shown to approximate – but
not exceed – the amount of the tax on intrastate commerce. Finally, the events on which interstate and intrastate taxes are
imposed must be "substantially equivalent"; that is, they must be sufficiently similar in substance to serve as mutually exclusive
"proxies" for each other. See Fulton Corp.,516 U.S. 325.
The Court has expressed considerable skepticism concerning the compensatory tax defense and, to date, the Court has accepted
the defense in only one context: use taxes on products purchased out of state when in-state purchases are subject to the state’s
sales tax. See Or. Waste Sys., Inc.v.Dep’t of Envtl. Quality of Or.,511 U.S. 93 (1994). However, at least in theory, the defense should be available in other contexts, and one state court recently
relied upon the defense to uphold a tax that on its face appeared to be discriminatory. See Tenn. Gas Pipelinev.Urbach,750 N.E.2d 52 (N.Y. 2001)(upholding a tax imposed on consumers of natural gas sold in interstate commerce because the tax
compensated for two other New York taxes that were imposed upon in-state sellers of natural gas but that were passed through
to consumers under the State Public Utility Commission tariff).
As noted, to invoke the defense, the state must identify a burden on in-state commerce for which the apparent discriminatory
tax on interstate commerce is purporting to compensate. Because the defense focuses upon a particular state’s tax system,
the question arises as to whether taxes imposed by other jurisdictions may be considered in determining whether the discriminatory
tax merely levels the playing field. A related question is whether the state’s tax system may be used to affect a benefit
provided by another jurisdiction. At least where the benefit is afforded by the federal government, the answer to the latter
question appears to be no. See Hutchinson Tech., Inc.v.Comm’r of Revenue,698 N.W.2d 1 (Minn. 2005) (concluding, based upon Kraft General Foods, Inc.v.Iowa Department of Revenue & Finance, 505 U.S. 71, 76 (1992), that benefits provided to the disfavored foreign commerce by the federal government could not be
relied upon as compensating taxes that leveled the playing field when considering favorable state tax benefits that were extended
only to local commerce). And while there appears to be no authority concerning whether another state’s tax may be used to
justify discrimination, given the Court’s apparent hostility to the compensatory tax defense, it seems unlikely that the Court
would permit such a multi-state formulation. [fn15]
Re-evaluating the Dormant Commerce Clause
As should be evident from the foregoing discussion, when considered in broad strokes, the decisional framework followed by
the Court in its Dormant Commerce Clause jurisprudence has internal logic and generally appears to make sense. Moreover, judging
by the results, the Court’s efforts in this field have worked. In general, commerce between the states appears to flow without
noticeable impediments. And, for the most part, when discriminatory taxes have arisen, either the Court or the state courts
have eventually addressed the issues using this decisional framework, and in most (but not all) cases have gotten it right
(in our opinion).
That the Court’s efforts ultimately have proven workable, however, is not an answer to the broader question whether there
may be a better way to approach these problems. The Court, itself, has frequently acknowledged its struggle to fulfill its
responsibilities in this area. Indeed, the Court has long referred to its Dormant Commerce Clause jurisprudence as a "quagmire."
See, e.g., Northwestern States Portland Cement Co.v.Minnesota, 358 U.S. 450, 458 (1959). And Justices Scalia and Thomas have made clear that they favor scaling back the Court’s Dormant
Commerce Clause responsibilities to inquiries relating solely to facial discrimination. See, e.g.,Camps Newfound/Owatonna, Inc.,520 U.S. at 610 (Thomas, J., joined by Rehnquist, C.J., and Scalia, J., dissenting) ("The negative Commerce Clause has no
basis in the text of the Constitution, makes little sense, and has proved virtually unworkable in application."). [fn16]
At its heart, the Court’s struggle appears to arise from the common law process whereby the Court is required to decide actual
cases based upon particular facts as a means for establishing broad principles that necessarily are applied to a myriad of
unforeseen circumstances arising in different facts. The first consequence of this limitation is that the Court is frequently
called upon to reconcile to its prior decisions new cases arising with different fact patterns presented by an ever-changing
economy. The second consequence is that the Court simply may not have the resources, particularly the economic data and analysis,
to draw a distinction between taxes that are actually antithetical to our free market and taxes that provide incentives which
ultimately will improve the health of the economy at little or no cost to free trade between the states.
Cuno and American Trucking Ass’ns
Two cases from the Court’s recent docket illustrate the Court’s continuing struggle with these limitations. The first, of
course, is DaimlerChrysler Corp.v.Cuno, 126 S. Ct. 1854 (2006). In that case, the Court was called upon to consider a decision of the United States Court of Appeals
for the Sixth Circuit that had struck down Ohio investment tax credits granted to DaimlerChrysler for "‘purchas[ing] new manufacturing
machinery and equipment during the qualifying period, provided that the new manufacturing machinery and equipment are installed
in [Ohio].’" Cunov.DaimlerChrysler, Inc., 386 F.3d 738, 741 (6th Cir. 2004) (citation omitted). In invalidating the tax credit, the Sixth Circuit relied upon United
States Supreme Court decisions striking down taxes that discriminated against interstate commerce by coercing taxpayers to
locate business operations or conduct transactions within the taxing state. [fn17] In this regard, the court rejected any distinction between taxes that penalize out-of-state activity and those that provide
a tax incentive (lower taxes) for operating within the state. The court noted that "‘virtually every discriminatory statute
allocates benefits and burdens unequally; each can be viewed as conferring a benefit on one party and a detriment on the other,
in either an absolute or relative sense.’" Id. at 745 (quoting Bacchus Imports, Ltd. v. Dias,468 U.S. 263, 273 (1984)). The court also found that the Supreme Court had at least hinted at a distinction between direct
subsidies and tax credits because the latter implicate the state’s power to regulate interstate commerce, which must be even-handed.
Finally, the court rejected a challenge to a 10-year personal property tax exemption that was also granted to DaimlerChrysler
as an incentive to locate the facility in the state. Here the court found that the exemption did not impose any requirement
not directly connected to the use of the exempted property. For example, the statute did not impose specific monetary requirements,
require the creation of new jobs, or encourage a beneficiary to engage in an additional form of commerce independent of the
newly acquired property.
Putting aside the question of whether the court’s distinction between the property tax exemption and the income tax credit
makes any economic sense, the central dilemma presented by the case was how, and perhaps whether, a tax incentive freely and
openly offered by a state to a willing taxpayer for locating operations in the state can be distinguished on a principled
basis from a broadly applicable tax benefit or detriment that may be viewed as effectively forcing a re-location of operations
to within the state. The dilemma may be illustrated by considering two hypothetical tax provisions. In the first hypothetical,
suppose, as a means of attracting local business, California offered a deduction against income based upon the amount of investment
made in California manufacturing facilities. In the second hypothetical, suppose California instead offered an alternative
deduction designed to promote capital investment in companies that built and operated such facilities: i.e.,the state offered a dividends received deduction ("DRD") for investment in the stock of companies that built and operated
such manufacturing facilities, and the DRD was limited to dividends paid from the investee’s California income.
The first hypothetical, of course, closely resembles the tax benefit at issue in Cuno, albeit in Cuno, the benefit was in the form of a tax credit, rather than a tax deduction. Hypothetical two is essentially the deduction
struck down by both the California Court of Appeal and the North Dakota Supreme Court as a violation of the Dormant Commerce
Clause. See Farmer Bros. Co.v.Franchise Tax Bd., 108 Cal. App. 4th 976 (2003),cert. denied, 540 U.S. 1178 (2004); D.D.I., Inc.v.North Dakota, 657 N.W.2d 228 (N.D. 2003). While there are certainly factual differences between these two hypotheticals, as a matter of
economics it is difficult to see why one would be permissible and the other would not. [fn18]
The second case illustrating the Court’s continuing struggle with its Dormant Commerce Clause doctrine is its most recent
decision in this area, i.e., American Trucking Ass’nsv.Michigan Public Service Commission, 545 U.S. 429 (2005). In that case, the Court upheld a flat fee ($100) imposed on intrastate trucking activities that was
also applicable to carriers that "top off" with local loads in making deliveries. To its credit, the Court acknowledged that
the flat fee could not be reconciled with the mathematics of internal consistency. Plainly, interstate carriers that make
such deliveries in more than one state will pay multiple fees, while an intrastate operation would pay but a single fee. Indeed,
the Court seemed to have resolved this basic issue in its earlier decision, American Trucking Ass’nsv.Scheiner, 483 U.S. 266 (1987), where it struck down a Pennsylvania flat tax imposed upon interstate carriers. To avoid that implication, however, the Court
reasoned that the Michigan fee applied only to local commerce and that carriers should expect to pay fees for conducting intrastate
commerce in each of the states.
By basing its approval of the flat fee in American Trucking Ass’ns on the theory that the fee in that case simply involved local as opposed to interstate commerce, the Court appears to be
retreating from the Complete Auto Transit analytical construct for evaluating taxes, into a prior, largely discredited approach in which formalistic distinctions drive
the results. Plainly, from the carrier’s point of view, the carriage at issue was simply two stops on a route that probably
crossed a number of state boundaries. Economically, it is difficult to see why, for example, a delivery between New York City
and Philadelphia should be treated differently from a delivery between New York City and Buffalo. Moreover, even if the carrier
was operating entirely within one state, the goods being delivered were almost certainly en route from another state or country,
and thus the interstate commerce ultimately would bear the burden of the fee.
Ultimately, the Court’s difficulty with American Trucking Ass’ns arises from the same source as the dilemma of separating acceptable tax incentives from unacceptable discriminatory taxes:
essentially the Court lacks the economic tools and perhaps the record to determine whether these impositions are damaging
to the free flow of interstate commerce. For example, one might well conclude that flat fees which are modest in amount are
acceptable even if, in theory, approval might result in multiple impositions for interstate carriers. It simply may be that
the benefits of state regulation of local roadways outweigh the administrative difficulties of trying to apportion such modest
fees based on, say, the miles traveled within the state compared to total miles. Unfortunately, the Court is simply not equipped
to complete such an analysis and, thus, its decisions tend to rest upon factors that often are less than fully satisfying.
Congress to the Rescue?
In the wake of the outcry that followed the Sixth Circuit’s decision in Cuno striking down the Ohio investment tax credit, the business community and the states joined forces to sponsor legislation to
circumscribe the Court’s Dormant Commerce Clause doctrine and provide broad congressional authorization of business incentives.
See Economic Development Act of 2005, S. 1066, H.R. 2471, 109th Cong. (2005). [fn19] To limit that authorization to "beneficial" tax incentives while retaining protection against "harmful" discriminatory tax
provisions, the legislation essentially carves out of the authorization certain impositions that resemble impositions the
Court has previously branded as discriminatory.
In structure, the bill proceeds as follows: First, the bill broadly authorizes "tax incentives" by providing that a state
may "provide to any person for economic development purposes tax incentives that otherwise would be the cause or source of
discrimination against interstate commerce under the Commerce Clause." Economic Development Act of 2005, S. 1066, H.R. 2471,
§ 2, 109th Cong. (2005). The term "tax incentive" is thereafter defined as "any provision that reduces a state tax burden
or provides a tax benefit as a result of any activity by a person that is enumerated or recognized by a state tax jurisdiction
as a qualified activity for economic development purposes." Economic Development Act of 2005, S. 1066, H.R. 2471, § 4(a)(9),
109th Cong. (2005). Finally, the legislation provides in sweeping terms that economic development purposes encompass "all legally permitted activities
for attracting, retaining, or expanding business activity, jobs, or investment in a state." Economic Development Act of 2005,
S. 1066, H.R. 2471, § 4(a)(2), 109th Cong. (2005). [fn20]
Thereafter the proposed legislation sets forth a list of tax provisions that are to be carved out of this authority. These
provisions appear to be designed to leave undisturbed most of the Dormant Commerce Clause framework discussed above, by fashioning
the carve-outs to track state tax provisions that the Court has struck down in the past under its Commerce Clause doctrine.
[fn21] In summary, under the carve-outs, a tax incentive will not be authorized if the tax benefit:
- Is dependent upon the state or country of incorporation, commercial domicile, or residence of an individual;
- Requires the recipient to acquire or use property or to provide services to property produced in the state;
- Is reduced or eliminated as a result of an increase in out-of-state activity by the recipient of the tax incentive;
- Is reduced or eliminated as a result of an increase in out-of-state activity by a person other than the recipient or as a
result of such other person not having taxable presence in the state;
- Results in loss of a compensating tax system because the tax on interstate commerce exceeds the tax on intrastate commerce;
- Requires other taxing jurisdictions to offer reciprocal benefits; or
- Requires the offset against another tax on local activities.
Is There a Better Solution than the Economic Development Act of 2005?
The Court’s dismissal of Cuno on standing grounds provides an opportunity, perhaps, to ask more fundamental questions about how discriminatory taxes should
be identified and analyzed than would otherwise be possible in the heat of litigation, with millions of dollars at stake.
Ultimately this question involves the possibility of redefining the role of both the Court and the Congress, and even the
Executive Branch, in resolving these issues.
In regard to the Economic Development Act of 2005, there is both the practical question of whether Congress is likely to act,
now that the heat is off, and the more fundamental question whether we want Congress to act on this legislation. In particular,
at least from our perspective, the question is whether the approach embodied in the legislation will prove workable in protecting
interstate commerce from future forms of state discrimination. Certainly, history suggests that the pressures upon states
and their localities (consciously or unconsciously) to create taxes that export the burden to out-of-state entities and that
lighten the load upon their neighbors are likely to continue. Again, if history is any indication, these pressures will continue
to produce new, unexpected discriminatory levies that may or may not resemble impositions previously tested by the Court.
Indeed, one might well wonder whether it is even possible for Congress to delineate in a statute specific instances in which
providing an advantage to local commerce should or should not be permitted, given the changing nature of the economy.
That is not to suggest that continuing the current system, whereby the courts are the principal arbiters of these disputes,
is necessarily the best resolution. As suggested above, the common law process whereby broad economic policy is established
by litigation, at best, places courts in a difficult position. For the most part, cases arise in the context of factual patterns
that often involve transactions which are decades old. The records in those cases typically are reduced to the bare minimum
and are designed to allow the courts to test the tax based upon categorical, often abstract rules: e.g.,will this tax result in multiple tax burdens if replicated by other states? Or, does this tax require some form of apportionment
mechanism, or can we assume that all of the income or value the state seeks to tax is located within a single jurisdiction?
And so on. Moreover, because courts have limited resources and time, the framework governing judicial decisions virtually
precludes economic analysis or even evidence concerning what other state taxes might actually have been imposed upon the same
commerce. As a consequence, the courts have, at best, a limited perspective for evaluating whether interstate commerce is
actually disadvantaged. And yet, in spite of these limitations, the courts are expected to deliver decisions that advisers
and others will reduce to bright-line principles governing fact patterns that may not even have been existent at the time
the taxation question arose. Under the circumstances, it is hardly surprising that some of the Justices would apparently like
to beat a fast retreat from continuing responsibility for policing this area.
Is There Any Alternative?
With heartfelt modesty, we would like to suggest that it may be possible to envision a system that might offer some improvement
both to the status quo and to the legislative approach currently being considered in the Economic Development Act of 2005.
While the specifics of any such system are beyond the scope of this article, in its broadest sense, the system might involve
the following. First, in lieu of the list of specific transactions that are embodied in the carve-outs from the authority
for tax incentives, we believe that Congress should enact legislation that articulates broad principles that are to inform
decisions as to whether a state tax should be viewed as contrary to our free market, e.g., that state taxes must not restrict, or impose unreasonable burdens on, the free flow of goods across state borders. Second,
Congress should establish some administrative agency or special court (e.g., similar to the U.S. Tax Court but with explicit jurisdiction over these disputes) that is to be charged with reviewing state
tax impositions that may have some discriminatory effect upon interstate or foreign commerce. That agency or court should
have access to economists to assist it in making decisions as to what taxes actually hinder free trade and under what circumstances.
It should also have authority to review state taxes before they are actually adopted. By design, the agency or court could
narrowly draw the scope of the decision so as to affect only the imposition at issue, much like the advance pricing agreements
negotiated by the Internal Revenue Service with individual taxpayers.
Such a system, of course, brings the danger that we will simply be creating another level of expensive administrative or court
review that is unlikely to improve upon the problems identified above. We acknowledge this risk but believe it important to
recognize that the current system may sometimes do more harm than good in adopting what, admittedly, must be a wholly inflexible
approach to discriminatory taxes. For example, there might be specific circumstances in which a state should be permitted
to enact what appears to be a discriminatory tax in order to stimulate growth in a long-depressed region that lags behind
the rest of the national economy or in an area that has been hit by natural disaster. To take a specific example, in the aftermath
of Katrina, perhaps Louisiana should be permitted to enact tax statutes that, for a period of years, stimulate local growth
to speed recovery, even if those taxes may discriminate against interstate commerce. On the other hand, a state that is simply
attempting to strengthen an industry with an already strong market might be prohibited from enacting that same statute. See, e.g., Boston Stock Exch.v.State Tax Comm’n, 429 U.S. 318 (1977) (striking down a New York tax intended to protect the New York Stock Exchange).
Those who would dismiss our proposed system as Pollyannaish might examine the system used by the EU before rushing to judgment
on the proposal. In general, the EU system roughly follows this model for evaluating taxes that are considered inimical to
the EU’s movement towards a single market. As broad principles, the Treaty Establishing the European Community articulates
five fundamental freedoms (the "Five Freedoms") that are to inform any evaluation of taxes or other impositions by the Member
States:
- Free movement of goods;
- Freedom of establishment;
- Free movement of capital;
- Free movement of persons; and
- Free movement of services.
See generally Treaty Establishing the European Community, Dec. 24, 2002, 2002 O.J. (C 325) 33 (the "EC Treaty").
The protection of the Five Freedoms generally is entrusted to a dual system: In one path, a state wishing to adopt a tax that
might be viewed as infringing upon the principles of the EC Treaty may (and under certain circumstances must) submit the tax
for approval to the European Commission. See, e.g.,EC Treaty art. 87, 88, 94, 211; Council Directive 98/34, art. 2, 1998 O.J. (L 204) 37, 40 (EC). In another path, an aggrieved
taxpayer may test the tax directly in its home country and eventually present the question to the European Court of Justice,
which is charged with ultimately resolving such questions. See, e.g., EC Treaty art. 230, 232.
By making this suggestion, we do not intend to imply that we have fully resolved, even in our own minds, that the United States
should follow the same model employed by the EU. We are suggesting that, at this juncture, it makes sense to broaden our lens
and consider alternatives to both the current system in America, where the Court is largely left to its own devices to resolve
these questions, and the specific delineation approach adopted in the Economic Development Act of 2005.
Future Challenges Likely to Reach the Court
In closing, we want to offer a brief preview of a few of the more important state tax issues that are likely to call for Court
attention in the future.
McLane Western, Inc. v. Department of Revenue
As we write, McLane Western, Inc., has filed with the Court a Petition for Certiorari that involves a new brand of state tax
discrimination implemented through a "shifting tax base." McLane Western, Inc.v.Dep’t of Revenue,126 P.3d 211 (Colo. Ct. App. 2005), cert. denied, No. 05SC439 (Colo. Jan. 9, 2006), petition for cert. filed (U.S. Apr. 7, 2006) (No. 05-1294). [fn22] The Colorado tax at issue in that case is imposed once, but only once, upon the chain of the products’ distribution and
is based on the price of the product paid by the first distributor with a taxable presence in the state. As a consequence,
product that is manufactured and distributed entirely within the state is taxed on a lower tax base than product whose upstream
distribution is conducted out-of-state. Simply, the later in the distribution chain the product is taxed, the higher the price,
and therefore the higher the tax borne by the product. By way of contrast, a traditional sales tax is always imposed at the
same stage of distribution (the retail distribution), and the tax is the same regardless of the location (in-state or out-of-state) of the upstream distributors.
In the lower court proceedings, the Colorado Court of Appeals explicitly acknowledged that the tax may place out-of-state
product at a competitive disadvantage because the higher tax will be added to the price of the product. Nonetheless, the court
refused to strike down the tax because, in the court’s view, the higher burden on interstate goods is the result of a "shifting
tax base," not a more favorable tax rate or exemption for local commerce.
The Addback Statutes
In our view, the recently-enacted addback statutes also are likely to present Commerce Clause questions worthy of the Court’s
attention. [fn23] In general, those statutes disallow a deduction for certain payments (e.g., royalties or interest) made to affiliates. However, typically, the disallowance is overridden (the deduction is allowed)
when the recipient of the payment is located in the addback state or the recipient is taxable on the income at a rate the
addback state considers to be acceptably high. See,e.g., Md. Code Ann., Tax Gen. § 10-306.1(c)(3)(ii); N.J. Stat. § 54:10A-4(k)(2)(I). Embedded within the details of these exceptions to the addback statutes are a variety of specific Commerce Clause issues. For example, Maryland’s initial addback statute appears
to discriminate against foreign commerce in effectively extending the exemption only to interstate and not foreign transactions.
See Md. Code Ann., Tax Gen. § 10-306.1(c). But, to our minds, the overriding issue is whether a state may avoid the obvious charge
that its addback statute facially discriminates against interstate commerce by conditioning a tax benefit (the deduction of
the royalty or interest payment) on the presence of the recipient in the addback state (i.e., upon the payment being made in intrastate commerce). While the state may point to the fact that the deduction is also permitted
where the recipient pays sufficient tax in another state, it is not at all clear that such a defense would be effective under
the current Commerce Clause framework. In particular, as discussed above, it is not clear that a state may use its tax system
merely to level the playing field to counter some tax benefit provided by another jurisdiction. See,e.g.,Hutchinson Tech., Inc.v.Comm’r of Revenue, 698 N.W.2d 1 (Minn. 2005) (concluding, based upon Kraft General Foods, Inc.v.Iowa Department of Revenue & Finance, 505 U.S. 71, 76 (1992), that benefits provided to the disfavored foreign commerce by the federal government could not be
relied upon as compensating taxes that leveled the playing field when considering favorable tax benefits that were extended
by the state only to local commerce). A variation on the question is whether a state may effectively punish taxpayers (through
the denial of a deduction) for making payments to businesses located in another state that has a lower tax rate. See Austinv.New Hampshire, 420 U.S. 656 (1975) (discriminatory tax imposed on income of residents of other states that provide credit for New Hampshire
tax not cured by fact that other states could repeal their credit).
The Single Sales Factor Apportionment System
Finally, there is the issue of the single (or enhanced) sales factor apportionment statute. In Moorman Manufacturing Co.v.Bair, 437 U.S. 267 (1978), of course, the Court rejected a challenge to Iowa’s adoption of a single factor apportionment formula,
on the basis of a record that offered no evidence that the formula actually resulted in extraterritorial taxation in violation
of the Due Process Clause. Moreover, the Court was unconvinced that the risk of multiple taxation (produced by the interplay
of that system with other systems such as an equally weighted three-factor formula) should be blamed upon Iowa. In particular,
the Court was unwilling to endorse any particular system for determining the income earned within the state.
The recent proliferation of state apportionment systems that rely in whole or in large part on the sales factor, along with
widely publicized evidence that such systems are often patently designed to benefit in-state activity at the expense of out-of-state
activity, suggests it may be time to revisit this issue. Quite simply, the purpose of these apportionment systems is to encourage
local industry and to export the tax burden to those businesses which are not present within the state (or have a relatively
small presence) but which sell in the state’s market. While the Court generally does not require a showing that a statute
was intended to produce discrimination, when the record contains explicit evidence to that effect, the Court may consider
such evidence, particularly if faced with other evidence that the effect of the formula is to reduce the tax burden on profits
actually earned from local industry, at the cost of out-of-state operations.
Conclusion
It may well be said that the Court, more than any other institution, has been responsible for the free flow of commerce between
the states. At the moment, the Commerce Clause jurisprudence developed by the Court is virtually the only protection interstate
business has against discriminatory impositions. Admittedly, the Court’s current doctrine has unresolved internal tensions
such as those framed in the Cuno litigation and those that were exposed in American Trucking Ass’nsv.MichiganPublic Service Commission. The very process the Court uses to decide cases is problematic and probably makes such conflicts inevitable. Nonetheless,
we need the Court to stay on duty until Congress develops a better system.
To improve the system, we believe the dialogue ought to encompass broader alternatives than the approach taken by the Economic
Development Act of 2005, which attempts to delineate by statute what constitutes a discriminatory tax. In support of that
observation, we note that it is not at all clear how the controversies identified in the preceding sections would be resolved
under the statute. For example, the controversies presented by addback statutes would not appear to fit neatly within the
carve-outs of impositions that will continue to be viewed as discriminatory taxes. As a consequence, under the legislation,
the addback statutes would apparently be immune (or at least could be immunized by branding them as an incentive) from challenge
as a discriminatory levy.
Our proposal for an alternative system for evaluating discriminatory taxes, modeled roughly on the system used by the EU,
is offered simply as an attempt to begin a broader dialogue. We, ourselves, are not yet convinced that such a system would
necessarily be an improvement over the current system. But, if the purpose of the Commerce Clause is to enhance the national
economic health through a single market system, we do believe that the current system of litigating such cases before the
Court might not provide the best approach and that we should consider an alternative system that broadens the analysis and
the decisional tools beyond the abstract conceptual framework currently in use. Given the demands already placed on the Court,
it is not realistic to expect the Court, itself, to shoulder the full burden of such analysis. If the current decisional framework
is to be improved upon, Congress must provide the direction, and ultimately the resources, to implement a new system.
Footnotes
1 The Court’s order reads as follows: "All the theories plaintiffs have offered to support their standing to challenge the franchise
tax credit are unavailing. Because plaintiffs have no standing to challenge that credit, the lower courts erred by considering
their claims against it on the merits. The judgment of the Sixth Circuit is therefore vacated in part, and the cases are remanded
for dismissal of plaintiffs challenge to the franchise tax credit." Id. at 1868. The Court subsequently dismissed the Petition for Certiorari filed by the plaintiffs which sought to overturn the
lower court’s approval of the property tax exemption, discussed below. 2006 U.S. LEXIS 3964 (May 22, 2006).
2 Similar cases filed in North Carolina and Nebraska have now been dismissed. See, e.g., DeCamp v. Nebraska, No. CI041981 (Neb. Dist. Ct. Mar. 7, 2005); Blinson v. North Carolina, No. 05-CVS-8378 (N.C. Super. Ct. May 10, 2006). In Blinson,the North Carolina court concluded that plaintiffs lacked standing but that, in any event, the incentives in question did
not violate the Commerce Clause.
3 Economic Development Act of 2005, S. 1066, H.R. 2471, 109th Cong. (2005).
4 See, e.g.,Ala. Code § 40-18-35(b); Ark. Code § 26-51-423(g)(1); Conn. Gen. Stat. § 12-218c; 2003 Conn. Pub. Acts § 78 (Spec. Sess.);
Md. Code Ann. Tax Gen. § 10-306.1.
5 Jerome R. Hellerstein & Walter Hellerstein, State Taxation (3d ed. 2001 & Supp. 2005).
6 For a more detailed treatment of the authority provided by the Commerce Clause, see Walter Hellerstein, Symposium: DaimlerChryslerv.Cunoand the Constitutionality of State Tax Incentives for Economic Development: Cuno and Congress: An Analysis of Proposed Federal Legislation Authorizing State Economic Development Incentives, 4 Geo. J.L. & Pub. Pol’y 73 (2006).
7 U.S. Const., art. I, § 8, cl. 3.
8 In Japan Line, Ltd.v.County of Los Angeles,441 U.S. 434, 451 (1979) (citation omitted), the Court ruled that taxation of foreign commerce may call for additional inquiries,
namely whether the tax creates "a substantial risk of international multiple taxation" when considered against international
norms and/or whether the tax "prevents the Federal Government from ‘speaking with one voice when regulating commercial relations
with foreign governments.’" The impact of this decision, however, apparently has been limited to the facts of that case by
subsequent decisions. See, e.g., Container Corp. of Am.v.Franchise Tax Bd.,463 U.S. 159 (1983) (state apportionment of income of an international unitary business permitte
