Department of Revenue of Kentucky v. Davis
170 L. Ed. 2d 685, 2008 U.S. LEXIS 4312, 128 S.Ct. 1801 (2008)
Rule of Law:
A state tax scheme that exempts interest income from its own municipal bonds while taxing interest income from other states' bonds does not violate the dormant Commerce Clause, as issuing debt for public projects is a traditional government function, and the tax preference supports the state's participation in the bond market.
Facts:
- The Commonwealth of Kentucky imposes a state income tax on its residents.
- Kentucky's tax laws exempt interest income earned on bonds issued by Kentucky and its political subdivisions.
- The same tax laws require residents to pay taxes on interest income earned from bonds issued by other states and their subdivisions.
- George and Catherine Davis are residents of Kentucky.
- The Davises owned out-of-state municipal bonds and earned interest income from them.
- The Davises paid Kentucky state income tax on the interest earned from their out-of-state bonds.
Procedural Posture:
- George and Catherine Davis sued Kentucky tax officials in a Kentucky state trial court, seeking a refund for taxes paid on out-of-state bond interest.
- The trial court granted judgment to the Commonwealth of Kentucky.
- The Davises, as appellants, appealed to the Court of Appeals of Kentucky.
- The Court of Appeals of Kentucky reversed, holding that the tax scheme violated the Commerce Clause.
- The Commonwealth of Kentucky's motion for discretionary review was denied by the Supreme Court of Kentucky.
- The Commonwealth of Kentucky, as petitioner, successfully petitioned the U.S. Supreme Court for a writ of certiorari.
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Issue:
Does a state's differential tax scheme, which exempts interest earned on its own public bonds from state income tax while taxing interest earned on public bonds from other states, violate the dormant Commerce Clause?
Opinions:
Majority - Justice Souter
No. Kentucky's differential tax scheme does not violate the dormant Commerce Clause. Issuing bonds to finance public projects is a traditional and quintessential government function, and laws that favor a government in carrying out such functions are not subject to the same strict dormant Commerce Clause scrutiny as laws favoring local private businesses. Drawing from United Haulers Assn., Inc. v. Oneida-Herkimer Solid Waste Management Authority, such laws are motivated by legitimate public objectives, not simple economic protectionism. The principle of discrimination assumes a comparison of 'substantially similar entities,' and Kentucky, as a public issuer financing public works, is not substantially similar to other private and public bond issuers. Therefore, there is no forbidden discrimination. Additionally (in a plurality portion of the opinion), the tax scheme is a form of market participation; Kentucky enters the debt market to sell bonds, and the tax exemption is an inseparable tool of competition in that market, not merely a regulation of it.
Concurring - Justice Stevens
Yes, Kentucky's law is constitutional, but for reasons distinct from the majority's reliance on United Haulers. Unlike cases where a state participates in a commercial market for goods and services, here Kentucky is not operating a commercial enterprise but is merely borrowing funds to finance public improvements. A state's reliance on municipal bonds to fund public projects, and its decision to make interest on those bonds tax-exempt to its own citizens—who are the beneficiaries of the projects and the source of repayment—is not the sort of 'burden' on interstate commerce implicated by the dormant Commerce Clause.
Concurring - Chief Justice Roberts
Yes, the law is constitutional. The case is fully resolved by the reasoning in United Haulers that laws favoring government performance of traditional functions are permissible. There is no need to reach the alternative market-participant analysis presented in Part III-B of the majority opinion.
Concurring - Justice Scalia
Yes, the law is constitutional. The negative Commerce Clause is a 'judicial invention' that should not be expanded. Invalidating a state's discrimination in favor of its own subdivisions performing a traditional governmental function would be an unwarranted expansion of this doctrine. Furthermore, the Pike balancing test, which weighs burdens against benefits, should be abandoned altogether as it requires a quintessential legislative judgment that courts are ill-equipped to make.
Concurring - Justice Thomas
Yes, the law is constitutional because the dormant Commerce Clause jurisprudence should be entirely discarded as it has no basis in the Constitution. The power to regulate interstate commerce and prevent state burdens rests with Congress. Since Congress has not acted to preempt the longstanding and widespread practice of differential state bond taxation, the judiciary has no authority to invalidate Kentucky's law.
Dissenting - Justice Kennedy
Yes, Kentucky's tax scheme violates the dormant Commerce Clause. The law is an explicit act of economic protectionism designed to disadvantage out-of-state bonds and erect local barriers to trade, which the Commerce Clause was intended to prevent. The majority's 'traditional government function' argument is a mere restatement of the 'police power' concept, which is a tautology that cannot excuse constitutional violations. The challenged law is one of discriminatory taxation, not bond issuance, and directly harms the national market by favoring local interests. United Haulers is inapplicable because that case involved a government monopoly that treated all private haulers equally, whereas here Kentucky competes in an open market and uses its tax power to give itself an unfair advantage.
Dissenting - Justice Alito
Yes, the law is unconstitutional. Assuming the Court's established dormant Commerce Clause precedents should be followed, Justice Kennedy's dissent is correct in its entirety.
Analysis:
This decision solidifies the distinction between permissible government self-preference and impermissible protectionism of private local industry under the dormant Commerce Clause. It carves out a significant safe harbor for states to favor their own bonds, providing legal certainty for a nearly-universal practice in the multi-trillion dollar municipal bond market. The ruling expands the logic of United Haulers, confirming that when a state or its subdivisions perform a 'traditional governmental function,' they are not subject to the same anti-discrimination rules as when they regulate private commerce. By treating the tax exemption as an element of market participation, the Court also blurs the traditional line between a state acting as a regulator and as a market participant, potentially giving states more latitude to structure financial incentives that benefit public entities.
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