South Carolina v. Baker
485 U.S. 505 (1988)
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Rule of Law:
A nondiscriminatory federal tax on the interest earned on state-issued bonds does not violate the doctrine of intergovernmental tax immunity. The Tenth Amendment's limits on Congress's authority to regulate state activities are structural and are protected through the national political process, not through judicially defined spheres of unregulable state activity.
Facts:
- Historically, governments and corporations issued long-term bonds in two forms: registered (ownership recorded on a central list) and bearer (ownership based on physical possession).
- Congress became concerned about the growing magnitude of tax evasion, as bearer bonds left no paper trail and facilitated the concealment of income.
- Internal Revenue Service studies indicated that unreported income had grown from an estimated range of $31.1-$32.2 billion in 1973 to $93.3-$97 billion in 1981.
- In 1982, Congress enacted the Tax Equity and Fiscal Responsibility Act (TEFRA) to improve tax compliance.
- Section 310 of TEFRA removed the federal income tax exemption for interest earned on publicly offered long-term state bonds unless those bonds were issued in registered form.
- The law also required federal bonds to be issued in registered form and imposed tax penalties on private corporations that issued long-term bonds in bearer form.
- The State of South Carolina objected to the registration requirement, arguing it infringed on its constitutional rights.
Procedural Posture:
- The State of South Carolina invoked the U.S. Supreme Court's original jurisdiction, filing a complaint against the Secretary of the Treasury.
- The Supreme Court granted South Carolina leave to file its complaint.
- The National Governors' Association was granted leave to intervene as a plaintiff.
- The Court appointed a Special Master to conduct hearings, gather evidence, and make findings of fact and law.
- The Special Master issued a report recommending that the Court find the statute constitutional and enter judgment for the defendant.
- South Carolina and the National Governors' Association filed exceptions to the Special Master's report, bringing the matter before the full Court for a decision.
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Issue:
Does Section 310(b)(1) of the Tax Equity and Fiscal Responsibility Act, which removes the federal tax exemption for interest earned on unregistered state and local bonds, violate the Tenth Amendment or the constitutional doctrine of intergovernmental tax immunity?
Opinions:
Majority - Justice Brennan
No. Section 310(b)(1) does not violate the Tenth Amendment or the doctrine of intergovernmental tax immunity. With respect to the Tenth Amendment, the limits on congressional authority are structural; states find their protection through the national political process, not judicially defined zones of immunity. South Carolina was not deprived of its right to participate in the political process, nor was it singled out, so the Tenth Amendment is not implicated. The law does not 'commandeer' state legislative processes; it is a generally applicable regulation, and the requirement that states take administrative or legislative action to comply is a commonplace consequence of federal regulation. Regarding intergovernmental tax immunity, the Court explicitly overrules Pollock v. Farmers’ Loan & Trust Co. The modern doctrine holds that a nondiscriminatory tax on private parties who contract with the government is constitutional, even if the financial burden is passed on to the government. A tax on the income of bondholders is not a direct tax on the state, and the tax here is nondiscriminatory as it is part of a comprehensive scheme affecting federal, state, and corporate bonds.
Dissenting - Justice O'Connor
Yes. The Court's decision to overrule Pollock v. Farmers' Loan & Trust Co. abandons nearly a century of precedent and threatens state autonomy. The ability of states to finance essential government functions like education and road construction will be severely hindered if the cost of their borrowing rises by an estimated 28-35% due to federal taxation of bond interest. Previous cases limiting intergovernmental tax immunity only did so after finding no substantial effect on government operations, a finding that cannot be made here. The majority's formalistic test—focusing only on whether a tax is direct or discriminatory—fails to account for the devastating practical effects on state sovereignty. Federal taxation of state activities is an inherent threat to state sovereignty, and the Court has shirked its responsibility to protect the states from federal overreach.
Concurring - Justice Stevens
Yes, the law is constitutional. The outcome of this case was clear even before the Court's decision in Garcia v. San Antonio Metropolitan Transit Authority. However, this opinion does not express any view on the wisdom of Congress taxing the interest on state or local bonds.
Concurring - Justice Scalia
Yes, the law is constitutional. I concur in the judgment but not in the majority's description of Garcia. I do not read Garcia to mean that the 'national political process' is the States' only constitutional protection against federal overreach. The constitutional structure itself imposes affirmative limits on federal action, but those limits are not crossed in this case.
Concurring - Chief Justice Rehnquist
Yes, the law is constitutional. I concur in the judgment but believe the Court's Tenth Amendment analysis is unnecessarily broad. The Special Master found that the registration requirement had a de minimis impact on the States' ability to borrow money. This finding alone should have been sufficient to resolve the Tenth Amendment claim, without the need to delve into theories about defects in the national political process. I agree with the majority’s decision to overrule Pollock.
Analysis:
This landmark decision explicitly overrules Pollock v. Farmers’ Loan & Trust Co. (1895), a foundational case of the intergovernmental tax immunity doctrine. By doing so, the Court eliminated the constitutional immunity for interest earned on state and local bonds, bringing it in line with modern jurisprudence that permits nondiscriminatory federal taxes that indirectly burden state governments. The ruling solidifies the post-Garcia v. San Antonio Metropolitan Transit Authority view of the Tenth Amendment, emphasizing that states' primary protection from federal overreach lies in the political process, not in judicially enforced immunities for 'traditional' or 'integral' government functions. The decision grants Congress significant authority to subject state-related activities to general, nondiscriminatory taxation.
