# Amicus Curiae Brief — Department of Revenue of Ky. v. Davis

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Curiae Brief
- **Published:** January 1, 2008
- **Citation:** 553 U.S. 328

## Text

Supreme Coun, Us. |
9 FILED

No. 06-666 JUL 19 2007

FFI CLERK |

IN THE

Supreme Court of the United States

DEPARTMENT OF REVENUE OF THE COMMONWEALTH OF
KENTUCKY AND FINANCE AND ADMINISTRATION
CABINET OF THE COMMONWEALTH OF KENTUCKY,

Petitioners,
Vv.

GEORGE W. DAVIS AND CATHERINE V. DAVIS,
Respondents.

On Writ of Certiorari to the
Kentucky Court of Appeals

BRIEF OF THE GOVERNMENT FINANCE
OFFICERS ASSOCIATION, NATIONAL
GOVERNORS ASSOCIATION, NATIONAL
LEAGUE OF CITIES, NATIONAL CONFERENCE
OF STATE LEGISLATURES, NATIONAL
ASSOCIATION OF COUNTIES, COUNCIL OF
STATE GOVERNMENTS, U.S. CONFERENCE
OF MAYORS, INTERNATIONAL MUNICIPAL
LAWYERS ASSOCIATION, AND INTERNATIONAL
CITY/COUNTY MANAGEMENT ASSOCIATION
AS AMICI CURIAE SUPPORTING PETITIONERS

RICHARD RUDA*
Chief Counsel
STATE AND LOCAL LEGAL CENTER
444 North Capitol Street, N.W.
Suite 309
Washington, D.C. 20001
(202) 434-4850

* Counsel of Record for the
Amici Curiae

WILSON-EPES ‘RINTINGCO.,INC. - (202) 789-0096 - WASHINGTON, D C. 20002

QUESTION PRESENTED

Whether Kentucky’s income tax exemption for interest on
municipal bonds issued by the Commonwealth or its political
subdivisions violates the dormant Commerce Clause because
Kentucky does not exempt interest earned by Kentucky
taxpayers on bonds issued by other States or their political
subdivisions.

(i)

TABLE OF CONTENTS

QUESTION PRESENTED .o-eseeescsssscsssssesesesssssssssseeeeee
TABLE OF AUTHORITIES ..csssscsccssscssssssssssssssssssseeeeee

I.

Il.

STATE GOVERNMENTS HAVE REASON-
ABLY RELIED ON THE CONSTITUTION-
ALITY OF TAX EXEMPTIONS LIKE
KENTUCKY’S, AND CONGRESS IS IN
THE BEST POSITION TO ALTER THE
SE ID wnectincesenicasissnmmacsniesesianensicenencees

A.

Longstanding Historical Practice Supports
the Constitutionality of State Tax Exemp-
tions for Interest Paid on In-State Munic-

A Judicial Declaration that Kentucky’s
Tax Exemption Is Unconstitutional Would
Disrupt the States’ Substantial Reliance
i iccincinsiiniitcintinidcnsnisciniepeinaniiitaniinsigitiieins

If a Change in the State Tax Treatment of
Municipal Bond Interest Is Desirable,
Congress Is in the Best Position to Make
RD ccctcnscsenntintannctonnnistesemmnnaninsnnan

UNDER UNITED HAULERS, KENTUCKY’S
TAX EXEMPTION FOR _ INTEREST
EARNED ON_ IN-STATE MUNICIPAL
BONDS DOES NOT VIOLATE THE
DORMANT COMMERCE CLAUSE...............

(iii)

12

iV
TABLE OF CONTENTS—Continued

Page
A. A State Tax Exemption for Interest Earned
on Bonds Issued by the Taxing State and
Its Political Subdivisions Does Not Dis-
criminate Against Interstate Commerce ...... 16

B. Kentucky’s Tax Exemption Does Not Im-
pose a “Clearly Excessive” Burden on
SRRUIIND CITI oacccenssscecssenssvesenmsstianins 23

CIO A FIIIITS coveccrscsescasnssnnsoseonsveinentesesusatiitinsiiidiaieatian 27

Vv

TABLE OF AUTHORITIES
Cases Page
Atkin v. Kansas, 191 U.S. 207 (1903) .0.......c0cc0000+ 25
Barclays Bank PLC v. Franchise Tax Bd. of Cal.,
EE 7
Bode v. Barrett, 344 U.S. 583 (1953)... 22
Brown-Forman Distillers Corp. v. New York
State Liquor Auth., 476 U. S. 573 (1986).......... 19-20
C & A Carbone, Inc. v. Clarkstown, 511 U.S.
i stiaraiicertnctned tenteniedncnsnenerescoeiecees 16
Camps Newfound/Owatonna, Inc. v. Town of
Harrison, 520 U.S. 564 (1997)........ccccccceceeeeees 5
City of Philadelphia v. New Jersey, 437 U.S. 617
TA sistIiiliicnestaecestnncaaencensendnemnesenenscessszcssseecee 23
Commonwealth Edison Co. v. Montana, 453
ee 6-7, 13
Complete Auto Transit, Inc. v. Brady, 430 U.S.
ES a aE 23
Edgar v. MITE Corp., 457 U.S. 624 (1982).......... 26-27
General Motors Corp. v. Tracy, 519 U.S. 278
tetas iaedaeieseatieaentnaetneattncensencennssmmennecee 7, 23
Goldberg v. Sweet, 488 U.S. 252, 259-260
iad ara tactcrncnenenanneennnsensnececes 23
Granholm v. Heald, 544 U.S. 460 (2005)............. 19
Harper v. Virginia Dept. of Taxation, 509 U.S.
EET 9, 9-10
Itel Containers Int'l Corp. v. Huddleston, 507
aint cttrcerininentnensnemnesencssennes 23

Joseph v. Carter & Weekes Stevedoring Co., 330
U.S. 422 (1947), overruled on other grounds,
Department of Revenue of Wash. v. Associa-
tion of Wash. Stevedoring Cos., 435 U.S. 734
EE 7
Kassel v. Consolidated Freightways Corp. of
ee 26

vi
TABLE OF AUTHORITIES—Continued

Page
Marsh v. Chambers, 463 U.S. 783 (1983)............. 7
McKesson Corp. v. Division of Alcoholic
Beverages & Tobacco, 496 U.S. 18 (1990)....... 8, 10
Moorman Mfg. Co. v. Bair, 437 U.S. 267
Feel iicnaseneunstenapentetininesenniaentincnnabiaiaiasiliiinnass 5, 12-13
National Bellas Hess, Inc. v. Department of
Revenue of Ill., 386 U. S. 753 (1967) .............0. 14
Oklahoma Tax Comm. v. Jefferson Lines, Inc.,
Fe ee Ce wiiccicnetintnnienniiininintiiionsiin 23
Pike v. Bruce Church, Inc., 397 U.S. 137
Pe nstintanedncumesiencitsinniasinaninpanaseiatinmnniaitaliiia 3, 23, 26, 27
Prudential Ins. Co. v. Benjamin, 328 U.S. 408
[Ti ctiecentcncetesnnsnaiasienididedieiineadainamnenpiiniiiditaadianl 5
Quill Corp. v. North Dakota, 504 U.S. 298
pera csnesecnsemianntismicheticinininenniinientinintinnianidatiial 5, 14, 15
Raymond Motor Transp., Inc. v. Rice, 434 U.S.
ea ikssensesistcnicitiiiecihiesiitineanetbitaniiiiidieainaaiansintaiaiits 26
Reeves, Inc. v. Stake, 447 U.S. 429 (1980)............ 25
Schneidewind v. ANR Pipeline Co., 485 U.S. 293
SI cctesecennisitettentianinaibanneieninntineenniienitabemees 7
South Carolina v. Baker, 485 U.S. 505 (1988) ..... 21
Trinova Corp. v. Michigan Dept. of Treasury,
a a ee ctertenternctenmnaeniininninns 23
United Haulers Assn., Inc. v. Oneida-Herkimer
Solid Waste Mgmt. Auth., 127 S. Ct. 1786
IID crrsnsransvennnnesninenmenninesuinonnapmantnmsnianteiisiies passim
Wyoming v. Oklahoma, 502 U.S. 437 (1992)........ 7
Statutes
Ind. Code Ann. § 6—3—1-3.5.0.......cccccccsseeeeeeeeeeeees 5
Ky. Rev. Stat. Ann. §141.010(09) ..0..... ccc eeceeeees 19
Ky. Rev. Stat. Ann. §141.010(10)(c).........0.0. 19
SE te Wc CID CII carvcnscasenceinadvenmssncorimesnenints

vii
TABLE OF AUTHORITIES—Continued

Se eh AE cccncninrinitetntintiniininantcnesinenimeies 5
Pub. L. No. 108-435, 118 Stat. 2615 .................... 6
Soldiers’ and Sailors’ Civil Relief Act of 1940,

Act of Oct. 17, 1940, ch. 888, § 514, as

amended, 50 App. U.S.C. §571 2........cccceeeeeeeee
I I aainiiincccintcniinsladicccnnsinissitiintensineneenteniones
ITT icininnnetenicanatatpssiateiiaiiinineetinn
STII sitosisissrnenesstsninasentamenumnienneedninitie
BI icles escarineinaneprnitematminanisinnaienagns
STITT TTT inci daiesnatarencsenetianannnemniempiemuniinens |
TTT scccesiscnnsinsunininuienmmneiinnenenasnies
Is UTD cidincisnrareenmentescnnehinnniigunneaninenintte
8 Ee
ET ies iicinpicendninsennementnnesciteninineene
eT sscnersisnninrnrentemnnnnstnnenmmennen
es I tertarccsinrnitiernecesrnennpeninenneuennite
tS \ Ce

Other Authorities

C. Belmonte, Tax-Exempt Bonds, 1996-2002
(SOI Bulletin Summer 2005)................:cccecceeeees 18, 19
Cole et al., The Capitalization of the State Tax
Exemption Benefit in Municipal Bond Yields, 7
J. Financial & Strategic Decisions 67 (1994)... 18
D. Denison et al., Davis v. Department of
Revenue of Kentucky: A Preliminary Impact
Assessment, [FIR Working Paper No. 2007-03

T. DeSue, Ky. Ruling Would Lift Tax on Out-of-
State Bonds, Bond Buyer, Jan. 10, 2006, at 1.... &
J. Hellerstein & W. Hellerstein, State Taxation

Vili
TABLE OF AUTHORITIES—Continued

W. Hellerstein & D. Coenen, Commerce Clause
Restraints on State Business Development
Incentives, 81 Cornell L. Rev. 789 (1996) ........

T. Herman, Justices to Hear Muni-Bond Case—
Kentucky Tax Fight Over Exemptions Affects
Many States, Wall St. J., May 22, 2007, at D3..

J. Mysak, Trash-Hauler Case Muddies Water for
Municipal Market, Bloomberg, May 9, 2007....

Public Finance Network, Tax-Exempt Financing:
PR ee

J. W. Temel, The Fundamentals of Municipal
ee Se citrrctincenrnninenenne

U.S. Census Bureau, Statistical Abstract of the
INES GEDDY isinaesinntensicinenimsesmiinememens

Page

10

21
25
18
18, 21

21

INTEREST OF THE AMICI CURIAE

Amici are organizations whose members include state,
county, and municipal governments and officials throughout
the United States.' Amici have a compelling interest in all
legal issues affecting the essential workings of state and local
government finance, including the constitutionality of state
laws that exempt municipal bond interest from taxation.
They accordingly submit this brief to assist the Court in the
resolution of this case.

SUMMARY OF ARGUMENT

1. Historical and pragmatic considerations provide com-
pelling reasons to uphold Kentucky’s income tax exemption
for the interest earned on municipal bonds issued by the
Commonwealth and its political subdivisions.

First, since the advent of state personal income taxes in the
early 1900s, the States have maintained exemptions similar or
identical to Kentucky’s that favor in-state municipal bonds.
Congress has long been aware of these exemptions and
plainly has the authority to regulate the state taxation of
interstate commerce. Yet it has never seen fit to prohibit this
practice. Where Congress has left undisturbed a longstanding
and nearly universal state tax policy, its tacit approval is
entitled to substantial respect, as this Court has recognized.

Second, a decision by this Court to invalidate Kentucky’s
exemption would impose significant economic hardships on
the States. Presently, the overwhelming majority of States
exempt some or all in-state municipal bond interest from
personal income taxation while taxing the interest earned on

' The parties have filed blanket consents to the filing of amicus briefs
in this case. Pursuant to Rule 37.6, amici state that this brief was not
authored in whole or in part by counsel for any party, and that no person
or entity other than amici, their members, or their counsel made a mone-
tary contribution to the preparation or submission of this brief.

2

out-of-state municipal bonds. Prior to the decision below,
state governments had no reason to believe that these exemp-
tions might be unconstitutional, and have structured their
fiscal affairs accordingly for almost a century. Precisely be-
cause so many States and local governments have incurred
immense financial obligations based on these understandings,
a decision to invalidate Kentucky’s tax scheme would drain
state treasuries of billions of dollars, transition costs that are
manifestly unfair given the States’ longstanding and reason-
able reliance on the exemptions’ constitutionality.

Finally, the principal reason state governments would incur
these costs is that this Court’s decision might well apply
retroactively. States could be forced to refund all recently
paid taxes on out-of-state municipal bond interest, and most
would effectively be required to forego taxing the interest on
all outstanding out-of-state municipal bonds. Only Congress
could craft a purely prospective remedy that applied solely to
municipal! bonds that have not yet been issued. It therefore
makes sense for the Court to stay its hand, as it has done be-
fore in state tax decisions raising similar issues of institu-
tional competence. Even if a rule requiring the States to tax
in-state and out-of-state bonds equally could be shown to be
good policy, Congress is the branch of government best
positioned to fashion a political solution in such a complex
area with massive fiscal ramifications.

2. In United Haulers Assn., Inc. v. Oneida-Herkimer
Solid Waste Mgmt. Auth., 127 S. Ct. 1786 (2007), this Court
held that state laws that “favor the government,” that “treat
every private business, whether in-state or out-of-state,
exactly the same,” and that concern “a traditional government
activity,” “do not discriminate against interstate commerce
for purposes of the Commerce Clause.” /d, at 1790. Ken-
tucky’s personal income tax exemption for interest earned on
in-state municipal bonds meets each of these criteria. It fav-
ors the government, as the exemption applies only to interest
on bonds issued by Kentucky and its political subdivisions. It

3

provides no advantage to Kentucky businesses over their out-
of-state competitors. And it concerns a governmental activity
that dates to the colonial period and, like waste management
in United Haulers, is central to state and local governments’
ability to carry out their governmental obligations. Thus,
Kentucky’s tax exemption does not discriminate against
interstate commerce.

Because Kentucky’s tax exemption is not discriminatory, it
is constitutional if it does not impose a burden on interstate
commerce that is “clearly excessive in relation to the putative
local benefits.” Pike v. Bruce Church, Inc., 397 U.S. 137,
142 (1970). The exemption’s local benefits are substantial,
while its economic impact is not properly understood as a
“burden” on interstate commerce for purposes of the dormant
Commerce Clause, let alone one that is “clearly excessive.”
The exemption’s principal effect is to shift the geographic
distribution of the investors purchasing a given State’s
municipal bonds, such that a larger proportion of those
investors holding Kentucky municipal bonds are Kentucky
residents. But this is a natural and salutary consequence
of the distinctive relationship between a sovereign and its
citizens, not a distortion of interstate commerce.

ARGUMENT

I. STATE GOVERNMENTS HAVE REASONABLY
RELIED ON THE CONSTITUTIONALITY OF
TAX EXEMPTIONS LIKE KENTUCKY’S, AND
CONGRESS IS IN THE BEST POSITION TO
ALTER THE STATUS QUO

Since the inception of modern state income taxes during
the Progressive Era, state governments have granted pref-
erential tax exemptions for the interest earned on in-state
municipal bonds and have had no reason to question their
validity. Congress plainly has the authority under the
Commerce Clause to regulate the States’ taxation of interstate

4

commerce, yet it has never seen fit to interfere with this
practice. Although this Court is generally reluctant to draw
inferences from congressional silence, in this particular con-
text Congress’s inaction warrants significant consideration,
especially given the extensive evidence of Congress’s
awareness of the practice. Currently, 42 States provide
income tax preferences for in-state municipal bonds, and
myriad state and local governments have structured their
budgets in reliance on these exemptions’ constitutionality.
Consequently, a decision to invalidate Kentucky’s tax scheme
would force state treasuries to absorb billions of dollars in
transition costs, a large-scale financial disruption that is
manifestly unfair given the reasonableness of the States’
reliance on the validity of a ubiquitous tax policy.

The principal reason the States would incur these costs is
that this Court’s decision could apply retroactively. State
governments might be forced to refund hundreds of millions
of dollars in taxes paid on out-of-state municipal bond
interest, and most States would effectively be required to
forego taxing the interest on all outstanding out-of-state
municipal bonds. Only Congress could craft a purely
prospective remedy that applied solely to municipal bonds
that have not yet been issued. These practical considerations
Suggest that the Court should stay its hand, as it has done in
several prior state tax decisions raising similar issues of
institutional competence. For even if one concluded that
interstate commerce might benefit from the States’ equal
treatment of in-state and out-of-state municipal bonds, Con-
gress is the only institution capable of crafting an equit-
able transition to such a regime.

A. Longstanding Historical Practice Supports the
Constitutionality of State Tax Exemptions for
Interest Paid on In-State Municipal Bonds

American state and local governments have imposed
various forms of personal income taxes since the colonial

5

period. See 2 J. Hellerstein & W. Hellerstein, State Taxation
q 20.01 (2007). Wisconsin enacted the first modern personal
income tax in 1911, and several other States quickly followed
suit. See id. From their inception, these state income tax
codes have exempted the interest earned on municipal bonds
issued by the taxing State, and they have denied this benefit
to the interest earned on bonds issued by their sister States.
New York adopted such a preference in 1919, see 1919 N.Y.
Laws 1641-42, North Carolina in 1921, see 1921 N.C. Sess.
Laws 207-208, and Virginia in 1926, see 1926 Va. Acts 961.
Today, 42 States offer some form of tax preference for the
interest earned on in-state municipal bonds.” And until the
Kentucky Court of Appeals’ handed down its decision in this
case, no court in the United States, state or federal, had held
that this differential tax treatment of in-state and out-of-state
municipal bonds was unconstitutional. See 1 Hellerstein &
Hellerstein, ¥ 4.13.

As this Court has recognized on several occasions, Con-
gress “unquestionably” has the authority under the Commerce
Clause to regulate the States’ taxation of interstate commerce.
Camps Newfound/Owatonna, Inc. v. Town of Harrison, 520
U.S. 564, 572 (1997). See also Quill Corp. v. North Dakota,
504 U.S. 298, 318 (1992); Moorman Mfg. Co. v. Bair, 437
U.S. 267, 280 (1978); Prudential Ins. Co. v. Benjamin, 328
U.S. 408, 434 (1946). And Congress has invoked this
authority on numerous occasions to protect interstate com-
merce from various burdens it has deemed inconsistent with
the national interest. See, e.g., Pub. L. No. 86-272, 73 Stat.
55, codified at 15 U.S.C. §381 (prohibiting the States from
imposing income taxes on businesses that keep their contacts
within the taxing State beneath a specific threshold); Internet

? Alaska, Florida, Nevada, South Dakota, Texas, Washington, and
Wyoming impose no taxes on personal income, 2 Hellerstein & Heller-
stein { 20.01 n. 5, while Indiana does not distinguish in-state from out-of-
state municipal bonds, see Ind. Code Ann. § 6—3-—1-3.5.

6

Tax Nondiscrimination Act, Pub. L. No. 108-435, 118 Stat.
2615 (2004) (prohibiting States from imposing taxes on
internet access or “discriminatory taxes on electronic
commerce”); Pub. L. No. 104-95, 109 Stat. 979, codified at 4
U.S.C. §114 (restricting the States’ authority to tax the
retirement income of nonresidents); Soldiers’ and Sailors’
Civil Relief Act of 1940, Act of Oct. 17, 1940, ch. 888, § 514,
as amended, 50 App. U.S.C. §571 (limiting the States’ power
to tax the property and personal income of military
personnel); Railroad Revitalization and Regulatory Reform
Act of 1976 (the 4-R Act), Pub. L. No. 94-210, 90 Stat. 54,
codified at 49 U.S.C. §11501 (prohibiting States from im-
posing higher taxes on railroad property than on other
commercial or industrial property).°

States have maintained these tax preferences for their own
municipal bonds for nearly a century, and Congress has
plainly been aware of the practice. See Br. Am. Cur. North
Carolina et al. at 19-21 (collecting cases and legislative
authorities); Br. Am. Cur. National Association of State
Treasurers at 14-16 (same). Yet Congress, though it “has the

power to protect interstate commerce,” “is so far content to

* See also 15 U.S.C. §391 (prohibiting the States from imposing a tax
on “the generation or transmission of electricity which discriminates
against out-of-State manufacturers, producers, wholesalers, retailers, or
consumers of that electricity”); Pub. L. No. 94-29, 89 Stat. 97, codified at
15 U.S.C. §78bb(d) (limiting the States’ power to impose stock transfer
taxes); Employee Retirement Income Security Act (ERISA), 29 U.S.C.
§1144(a) (dictating that ERISA “shall supersede any and all State laws
insofar as they now or hereafter relate to any employee benefit plan,”
including state tax laws); 49 U.S.C. §§14502(b), 401 16(d)\(2\(A) (extend-
ing the protections of the 4-R Act to property owned by motor and air
carriers); 49 U.S.C. §§14505, 40116(b) (prohibiting the States or their po-
litical subdivisions from taxing the interstate transportation of passengers
by motor carrier or in air commerce); 49 U.S.C. §40116(c) (permitting
state or local taxes “related to a flight of a commercial aircraft or an
activity or service on the aircraft only if the aircraft takes off or lands in
the State or political subdivision as part of the flight”).

7

let the matter rest.” Commonwealth Edison Co. v. Montana,
453 U. S. 609, 637 (1981) (White, J., concurring)

To be sure, “[s]tanding alone, historical patterns cannot
justify contemporary violations of constitutional guarantees,”
Marsh v. Chambers, 463 U.S. 783, 790 (1983), and “[t}his
Court generally is reluctant to draw inferences from Con-
gress’ failure to act,” Schneidewind v. ANR Pipeline Co., 485
U.S. 293, 306 (1988). Moreover, the Court has stated that
Congress must indicate its intent with “unmistakable clarity

. . to permit state regulation that discriminates against
interstate commerce.” Barclays Bank PLC v. Franchise Tax
Bd. of Cal., 512 U.S. 298, 323 (1994). See also Wyoming v.
Oklahoma, 502 U.S. 437, 458 (1992). But, for the reasons set
out in Part II infra, Kentucky’s tax exemption does not
discriminate against interstate commerce. And the Court has
acknowledged that, when the question at hand concerns
whether the States’ tax policies impermissibly burden inter-
state commerce, Congress’s silence is important. See Gen-
eral Motors Corp. v. Tracy, 519 U. S. 278, 304-305 (1997);
Joseph v. Carter & Weekes Stevedoring Co., 330 U.S. 422
(1947), overruled on other grounds, Department of Revenue
of Wash. v. Association of Wash. Stevedoring Cos., 435 U.S.
734 (1978).

In Carter & Weekes Stevedoring, the Court held that,
because “the power lies in Congress under the [Commerce]
Clause to make any desired adjustment in the taxation area,
its acquiescence in [this Court’s] former rulings on state
taxation indicates its agreement with the adjustments of the
competing interests of commerce and necessary state reve-
nues.” 330 U.S., at 428. Of course, the Court has not
squarely addressed whether the economic burdens and bene-
fits attributable to tax exemptions like Kentucky’s are con-
sistent with the dormant Commerce Clause. In this case there
is no judicial ruling in which Congress has acquiesced;
instead, Congress has tacitly endorsed a widespread, long-

8

standing, and uninterrupted practice by the States that, until
very recently, has gone unchallenged. But this distinction
should have no constitutional significance. In our federal
system—and with respect to a matter that Congress is
expressly charged by the Constitution to superintend, see Art.
I, §8, cl. 3—Congress’s tacit approval of the States’ con-
sistent and longstanding judgments should be entitled to the
same consideration and respect as its silent approval of this
Court’s holdings.

B. A Judicial Declaration that Kentucky’s Tax
Exemption Is Unconstitutional Would Disrupt
the States’ Substantial Reliance Interests

In light of the exemptions’ deep historical roots, all but
eight States have structured their financial affairs around the
assumption that providing a tax preference for the interest
earned on in-state municipal bonds is constitutional. A
decision by this Court to invalidate Kentucky’s tax scheme
would therefore impose severe financial hardships on state
governments, transition costs that are patently unfair given
the States’ reasonable reliance on the constitutionality of
exemptions like Kentucky’s.

Perhaps these consequences would not be disquieting had
the States persisted in imposing income taxes that they had
good reason to believe were unconstitutional. Cf. McKesson
Corp. v. Division of Alcoholic Beverages & Tobacco, 496
U.S. 18, 46-50 (1990) (discussing Florida’s continued impo-
sition of a liquor tax that was blatantly protectionist and only
cosmetically different from a Hawaii liquor tax that the Court
had previously invalidated). But that is not the case here.
The States, like most other observers, were caught completely
off guard by the Kentucky Court of Appeals’ decision. See
T. DeSue, Ky. Ruling Would Lift Tax on Out-of-State Bonds,
Bond Buyer, Jan. 10, 2006, at 1 (quoting a bond industry
executive who called the decision “earth shattering”). Before

9

January 2006, state governments had little reason to believe
that these tax exemptions were constitutionally suspect, and
they acted accordingly. To force the States to shoulder these
breathtaking transition costs, despite their reasonable and
substantial reliance on extant understandings of the dormant
Commerce Clause, is wholly inequitable.

To appreciate what is at stake for the States, it is useful to
isolate the implications of this-case for two distinct (but
overlapping) groups of taxpayers. The first group is tax-
payers who have recently paid state income tax on interest
earned on out-of-state municipal bonds. The second and far
more significant group is taxpayers who presently own out-
of-state municipal bonds. With respect to the first group, a
decision to invalidate Kentucky’s tax exemption may well
require the States to disgorge hundreds of millions of dollars
in tax refunds. With respect to the second group, it would
effectively force the States to forego billions of dollars in
income tax revenue well into the future. These are dollars on
which the States’ budgets critically depend. And these are
transit »n costs that the States would be forced to shoulder
merely because they have incurred debt obligations based on
a reasonable understanding of the dormant Commerce Clause.

1. Taxpayers who have recently paid taxes on interest
earned on out-of-state municipal bonds. As a threshold
matter, there is a significant possibility that a ruling by this
Court to invalidate Kentucky’s tax exemption would apply
retroactively. Granted, this Court’s precedent has “left
unresolved the precise extent to which the presumptively
retroactive effect of this Court’s decisions may be altered in
civil cases.” See Harper v. Virginia Dept. of Taxation, 509
U.S. 86, 96 (1993). But the Court held in Harper that
“(w]hen this Court applies a rule of federal law to the parties
before it, that rule . . . must be given full retroactive effect in
all cases still open on direct review and as to all events,
regardless of whether such events predate or postdate our

10

announcement of the rule.” 509 U.S., at 97. Thus, a decision
invalidating Kentucky’s tax exemption could apply retro-
actively to all similarly situated taxpayers nationwide.

Further, the Due Process Clause could require that this
retroactive remedy “provide meaningful backward-looking
relief to rectify any unconstitutional deprivation.” McKesson,
496 U.S., at 31. Ina case like this, where the claim is that the
State’s tax scheme discriminates against interstate commerce,
such relief could take three forms, any of which would
remedy the constitutional problem: (1) the States could refund
all taxes paid on any interest earned on out-of-state municipal
bonds; (2) the States could retroactively impose a tax on any
interest earned on in-state municipal bonds; or (3) the States
could enact some combination of the two that results in the
equal tax treatment of all municipal bond interest during the
relevant time period. See id., at 40-41.

Although each of these options would be open to the States
in theory, “[i]n the real world, . . . the practical and political
difficulties of fashioning any retroactive remedy other than a
refund (as well as legal difficulties presented by federal and
State strictures regarding retroactive legislation) make solu-
tions that require back-tax collections unlikely.” W. Heller-
stein & D. Coenen, Commerce Clause Restraints on State
Business Development Incentives, 81 Cornell L. Rev. 789,
873 (1996). Thus, the States could be required to award
refunds to every taxpayer who had paid income tax on
interest earned on out-of-state municipal bonds within the
relevant limitations period, unquestionably a substantial
liability. For instance, in 2003 New York residents reported
$636.4 million of interest income from out-of-state municipal
bonds. D. Denison et al., Davis v. Department of Revenue
of Kentucky: A Preliminary Impact Assessment, IFIR Work-
ing Paper No. 2007-03 (2007), at pp. 13-14, available
at http://www. ifigr.org/publication/ifir_ working papers/IFIR-
WP-2007-03.pdf (last visited July 16, 2007). New York's

11

estimated tax revenue from this interest was $45.8 million.
Id., at 14. For Connecticut, the estimated income tax revenue
in 2004 from out-of-state municipal bond interest and the
dividends paid by municipal bond mutual funds was $70.9
million. /d Thus, the immediate tax refund liability for the
States as a whole could run well into the hundreds of millions
of dollars.

2. The tax treatment of outstanding municipal bonds.
While substantial, the States’ immediate liability for tax
refunds would pale in comparison to the fiscal consequences
related to the taxation of the interest yet to be earned on
outstanding out-of-state municipal bonds. Again, a decision
invalidating Kentucky’s tax exemption would require the
States to treat all municipal bonds equally. For the interest
earned on municipal bonds that have already been issued, the
States would have two choices in providing an adequate
remedy: (1) they could tax the interest earned on in-state
municipal bonds, or (2) they could exempt the interest earned
on out-of-state municipal bonds.

For most States, the option of taxing the interest earned on
in-state municipal bonds that investors have already pur-
chased would be impracticable, if not legally foreclosed. In-
state investors have purchased these bonds in reliance on their
favorable state (ox treatment. For most in-state investors, the
state tax exemption is a critical aspect of the transaction:
They have accepted a lower yield in exchange for the state
income tax benefit, such that they still receive a competitive
after-tax rate of return on their investment. Thus,-taxing the
interest on in-state municipal bonds that taxpayers have
already acquired would be inequitable, if not a breach of
contract. It would change the rules on the bondholders
midstream, forcing them to accept an after-tax rate of return
well below that of comparable investments.

This means that to treat in-state and out-of-state municipal
bonds equally, most States would likely be forced to abstain

12

from taxing any interest earned by their taxpayers on
outstanding out-of-state municipal bonds. The fiscal reper-
cussions of such a mandate would be astounding. As
discussed above, the revenue loss for the States for a single
year would run well into the hundreds of millions of dollars.
See Denison et al., supra, at pp. 13-14. Given that many
outstanding bonds will not mature for another thirty years,
affirmance of the judgment below would cost state govern-
ments billions of dollars in foregone tax revenue.

C. If a Change in the State Tax Treatment of
Municipal Bond Interest Is Desirable, Congress
Is in the Best Position to Make that Change

For the reasons discussed in Part II, infra, amici believe
that Kentucky’s tax exemption is constitutional. Even if
respondents were correct on the law, however, all of the
attendant transition costs could be avoided if the substantive
rule that they seek—the equal state tax treatment of in-state
and out-of-state municipal bonds—could be applied purely
prospectively. That is, these financial dislocations would
disappear if any mandate of equal tax treatment were to apply
only to municipal bonds issued in the future. For the rea-
sons discussed earlier, however, this Court generally cannot
fashion such relief. The only branch of government capable
of adopting such a rule, without simultaneously imposing
massive costs on state treasuries, is Congress.

There is a strong tradition of this Court deferring to
Congress’s superintendence of interstate commerce in cases
raising similar issues of institutional competence, particularly
when they involve matters of state and local taxation. For
example, Moorman Mfg. Co. v. Bair addressed lowa’s single-
factor formula for apportioning the income of interstate
businesses. The plaintiffs demonstrated that lowa’s method
of apportionment likely subjected a number of out-of-state
taxpayers to multiple taxation, and thus disadvantaged inter-

13

state commerce. See 437 U.S., at 276-277. But the Court
reasoned that it was ill-suited to resolve the controversy, as
doing so would have effectively required the Court to choose
a particular method of apportioning income under the guise of
interpreting the dormant Commerce Clause, which it declined
to do. /d., at 278-280. “It is clear,” the Court held, “that the
legislative power granted to Congress by the Commerce
Clause of the Constitution would amply justify the enactment
of legislation requiring all States to adhere to uniform rules
for the division of income. It is to that body, and not this
Court, that the Constitution has committed such policy
decisions.” /d., at 280.

Commonwealth Edison Co. v. Montana involved a sev-
erance tax that Montana imposed on all coal mined in the
State. Because the tax rate was extremely high, and because
its incidence fell predominantly on out-of-state electricity
consumers, the plaintiffs asserted that Montana had effec-
tively exported its tax burden to other States. See 453 U.S., at
617-618. But because a holding in favor of the taxpayers
would have forced the Court to make a range of difficult
empirical economic judgments, it upheld the State’s tax
scheme and left the ultimate resolution to Congress: “Under
our federal system, the determination is to be made by state
legislatures in the first instance and, if necessary, by Con-
gress, when particular state taxes are thought to be contrary to
federal interests.” Jd, at 628. Despite some reservations, this
Court declined to intervene. See id, at 637 (White, J.,
concurring) (“This is a very troublesome case for me, and |
join the Court's opinion with considerable doubt and with the
realization that Montana’s levy on consumers in other States
may in the long run prove to be an intolerable and unac-
ceptable burden on commerce” but “Congress has the power
to protect interstate commerce from intolerable or even unde-
sirable burdens”).

14

Perhaps the most analogous case is Quill Corp. v. North
Dakota, which addressed whether a State could require an
out-of-state vendor to collect use taxes on sales to the taxing
State’s consumers, even when the vendor had no physical
presence in the taxing State. See 504 U.S. at 301. The Court
had invalidated an identical collection obligation 25 years
earlier in National Bellas Hess, Inc. v. Department of
Revenue of ill., 386 U.S. 753 (1967), and “the Bellas Hess
rule . . . engendered substantial reliance and has become part
of the basic framework of a sizable industry.” Quill, 504
U.S., at 317. Despite some evident ambivalence, see id., at
315, 317 (conceding that the physical presence requirement
“appears artificial at its edges” and that the Court had rejected
a “similar bright-line, physical-presence requirement” in
other state tax cases), the Court reaffirmed the rule of Bellas
Hess. \t concluded that, although there were problems with
the rule, Congress was in the best position to alter the status
quo. See id., at 317-318. “[T]he underlying issue is not only
one that Congress may be better qualified to resolve, but also
one that Congress has the ultimate power to resolve. No
matter how we evaluate the burdens that use taxes impose on
interstate commerce, Congress remains free to disagree with
our conclusions.” /d_, at 318 (footnote omitted).

Moorman, Commonwealth Edison, and Quill together rep-
resent a critical strand of this Court’s dormant Commerce
Clause jurisprudence. Specifically, they show that even when
state laws arguably burden interstate commerce, the judicial
disruption of the status quo may not be the wisest course,
particularly in the field of taxation. Reasons of institutional
competence can dictate that the controversy is simply not
meet for judicial resolution.

This is such a case. Even assuming some change in state
tax treatment of bond interest were needed, Congress is the
only institution capable of devising an equitable transition to
a system in which the States’ tax the interest on in-state and
out-of-state municipal bonds equally. Cf. United Haulers,

15

127 S. Ct. at 1797 n. 7 (“Congress retains authority under the |
Commerce Clause as written to regulate interstate commerce,
whether engaged in by private or public entities.”).

In the concluding paragraph of the majority opinion in
Quill, the Court offered the following insight:

[E]ven if we were convinced that Bellas Hess was
inconsistent with our Commerce Clause jurisprudence,
this very fact might give us pause and counsel with-
holding our hand, at least for now. Congress has the
power to protect interstate commerce from intolerable or
even undesirable burdens. In this situation, it may be
that the better part of both wisdom and valor is to respect
the judgment of the other branches of the Government.

504 U.S., at 318—19 (internal quotation marks, alterations,
and citations omitted). The same is true here. Given the
enormous reliance interests at stake, Congress is the branch of
government best suited to craft a solution if one is needed.

II. UNDER UNITED HAULERS, KENTUCKY’S
TAX EXEMPTION FOR INTEREST EARNED
ON IN-STATE MUNICIPAL BONDS DOES
NOT VIOLATE THE DORMANT COMMERCE
CLAUSE

In United Haulers, this Court held that state laws granting
a preference to the government generally do not discriminate
against interstate commerce for purposes of the dormant
Commerce Clause. Specifically, “laws favoring local govern-
ment” with respect to “a customary and traditional gov-
ernment function,” but which trea “all private companies
exactly the same,” “do not discriminate against interstate
commerce.” 127 S. Ct., at 1795-1797 & n. 7 (order of
quotations altered). The tax exemption challenged here meets
all three of these criteria. It favors the government, as it only
covers interest earned on bonds issued by Kentucky and its
municipalities; it treats all private businesses exactly the

16

same; and it concerns an activity—borrowing money—that is
a traditional and core governmental function. It therefore
does not discriminate against interstate commerce. Finally,
because the economic impact of Kentucky’s tax exemption Is
not a cognizable “burden” on interstate commerce, let alone
one that is clearly excessive relative to its local benefits, the
exemption does not violate the dormant Commerce Clause.

A. A State Tax Exemption for Interest Earned on
Bonds Issued by the Taxing State and Its
Political Subdivisions Does Not Discriminate
Against Interstate Commerce

In United Haulers, a coalition of waste haulers contended
that two county “flow control” ordinances violated the dor-
mant Commerce Clause. In particular, they argued that the
ordinances discriminated against interstate commerce because
they prohibited the haulers from delivering trash to out-of-
state processing facilities at lower cost. /d, at 1792. The
Court had confronted a nearly identical ordinance thirteen
years earlier in C & A Carbone, Inc. v. Clarkstown, 511 U.S.
383 (1994), and found the regulation unconstitutional. The
“only salient difference” between the two cases was that the
favored facility in Carbone was privately owned, whereas the
favored facilities in United Haulers were owned and operated
by local government. United Haulers, 127 S. Ct., at 1790.

This sole difference was “constitutionally significant”’—
indeed, dispositive—leading the Court to conclude that the
flow control ordinances did not discriminate against interstate
commerce. /d As the Court noted, there are several
“(clompelling reasons” that justify treating laws that benefit
the government differently from those that bencfit in-state
private businesses under the dormant Commerce Clause. /d.,
at 1795.

First, unlike private businesses, “government is vested with
the responsibilty of protecting the health, safety, and welfare

17

of its citizens.” Jd. (citing Metropolitan Life Ins. Co. v.
Massachusetts, 471 U.S. 724, 756 (1985)). Laws favoring
state and local governments therefore “may be directed
toward any number of legitimate goals unrelated to pro-
tectionism.” -/d., at 1796. Second, treating public and private
entities alike for purposes of the dormant Commerce Clause
“would lead to unprecedented and unbounded interference by
the courts with state and local government.” Jd. Though the
Commerce Clause plays an important role in preventing state
and local governments from engaging in economic pro-
tectionism, it “is not a roving license for federal courts to
decide what activities are appropriate for state and local
government to undertake.” Jd. Finally, courts should be
“particularly hesitant to interfere with [government] efforts
under the guise of the Commerce Clause” when the activities
in question are “both typically and traditionally a local
government function.” /d. (internal quotation marks and
citation omitted).

The essential holding of United Haulers was succinct:
“laws that favor the government” in areas of “traditional
government activity,” but which “treat every private business,
whether in-state or out-of-state, exactly the same,” “do not
discriminate against interstate commerce for purposes of the
Commerce Clause.” /d, at 1790. The logic of that holding
dictates that Kentucky’s tax exemption is not discriminatory.

First, Kentucky’s tax exemption favors the Commonwealth
and its political subdivisions, not private business interests.
Because of the tax exemption, Kentucky taxpayers are willing
to eccept a lower pre-tax rate of return on in-state municipal
bonds. This means that Kentucky and its political sub-
divisions can issue their bonds at a considerably lower
interest rate than the market would require absent the
exemption. Thus, the beneficiaries of the tax exemption are
not Kentucky bondholders; the market largely accounts for
their favorable tax treatment by reducing their yield on the

18

tax-preferred bonds. See Cole et al., The Capitalization of the
State Tax Exemption Benefit in Municipal Bond Yields, 7 J.
Financial & Strategic Decisions 67, 68 (1994), available at
http://www.studyfinance.com/jfsd/pdffiles/v7n2/cole.pdf (last
visited July 16, 2007) (finding 100% capitalization of the
state tax exemption benefit in the yield of municipal bonds).

The beneficiaries are the Commonwealth and its political
subdivisions, which are able to borrow at a considerably
lower interest rate, reducing their costs in raising capital.
This, in turn, enables them to finance a range of public
services and public works. See J. W. Temel, The Funda-
mentals of Municipal Bonds 53-55 (Sth ed. 2001) (explaining
that lower debt-service costs enable state and local govern-
ments to finance such public works as schools, roads, bridges,
airports, public power facilities, sewers, hospitals, fire sta-
tions, affordable housing, mass transit facilities, and uni-
versities).* Of course, it is conceivable that the tax exemption

* Municipal bonds fall into two basic categories: governmental bonds
and private activity bonds. See C. Belmonte, Tax-Exempt Bonds, 1996-
2002 at 151-52 (SOI Bulletin Summer 2005), available at http://www.
irs.gov/pub/irs-soi/02govbnd.pdf (last visited July 17, 2007). Govern-
mental bonds have no statutory definition. See Public Finance Network,
Tax-Exempt Financing: A Primer 3 (rev. ed., n.d.). They are generally
issued to finance facilities that are owned, controlled, and operated by
state or local governments, such as schools, streets, and utilities. See id.,
at 2; Belmonte, supra, at 155.

Private activity bonds are defined by § 141 of the Internal Revenue
Code. See 26 U.S.C. §141. In brief, a municipal obligation will be
considered a private activity bond, “irrespective of the purpose for which
it is issued or the source of payment, if (1) more than 10 percent of the
proceeds of the issue will finance property that will be used by a
nongovernmental person in a trade or business, and (2) the payment of
debt service on more than 10 percent of the proceeds of the issue will be
(A) secured by property used in a private trade or business or payments in
respect of such property, or (B) derived from payments in respect of
property used in a private trade or business.” Temel, supra, at 25}.
Roughly three-fourths of the municipal bond market consists of govern-

19

actually costs Kentucky more in foregone tax revenue than it
delivers in reduced borrowing costs. See Cole et al., supra, at
68, 72. But the relevant point for purposes of United Haulers
is that, to the extent the exemption provides a benefit, that
benefit runs to the government.

Second, Kentucky’s tax scheme treats all private busi-
ness interests identically. The Kentucky tax code includes
all bond interest in income, with the sole exception of
the interest earned on bonds issued by the Commonwealth
or its political subdivisions. See Ky. Rev. Stat. Ann.
§§ 141.010(9), 141.010(10)(c). Every private issuer of debt
is treated the same, regardless of its location. The law grants
no advantage to Kentucky businesses—whether they are bond
issuers, bond dealers, bond brokers, or bond holders—over
their out-of-state competitors.°

Consequently, Kentucky’s tax exemption does not repre-
sent the sort of economic protectionism with which the
dormant Commerce Clause is chiefly concerned. This is not
a law that “burden[s} out-of-state producers or shippers
simply to give a competitive advantage to in-state busi-
nesses.” Granholm v. Heald, 544 U.S. 460, 472 (2005) (em-
phasis added). Nor is it a law that “give[s] local consumers

mental bonds, and one-fourth of private activity bonds. See Belmonte,
supra, at 151 (between 1996 and 2002 more than $1.5 trillion in
governmental bonds and $548 billion in private activity bonds were
issued).

> As discussed in more detail infra at 20 & 25-26, Kentucky’s
exemption also furthers the legitimate objectives of decentralizing control
over the Commonwealth’s fiscal affairs and encouraging more state
citizens to become genuine stakeholders in their community.

° Of course, the issuance of municipal bonds will produce benefits for
private contractors that perform the projects that are financed by the
bonds. But the same is true of any public spending, whether financed
through bonds, taxes, license fees, or a grant from the federal government.
This Court has never considered the existence of such benefits, in itself,
“protectionist.”

20

an advantage over consumers in other States.” Brown-
Forman Distillers Corp. v. New York State Liquor Auth., 476
U.S. 573, 580 (1986).

Instead, the exemption operates as an implicit, intrastate
transfer from the Commonwealth’s pool of general revenue to
those governmental units (including the Commonwealth
itself) that choose to raise capital through the issuance of
municipal bonds. The decision whether to issue municipal
bonds is vested by state law in various governmental units
and, through elections, their respective constituents. When
these governments issue debt, the exemption offers an
implicit subsidy by reducing the interest rate that the market
will demand. The cost of this subsidy, however, is fully
funded by Commonwealth itself: The Kentucky government
must pay for it by relinquishing personal income tax revenue.
In this sense, the tax exemption is indistinguishable in prac-
tical effect from a program under which the Commonwealth
offered no tax exemption but made direct cash payments to its
municipalities when they issued bonds, a program that would
plainly be constitutional.

The exemption is therefore best understood as a policy
choice by the Commonwealth about how to structure the
financing of its various governmental units. Through the
mechanism of the exemption, Kentucky has decided (1) to
raise less revenue through personal income taxes and more
through municipal bond issues, and (2) to decentralize the
decisionmaking process concerning how much capital to raise
and which public works to pursue. Those governmental units
with the authority to issue bonds are empowered to use state
general funds (in the form of foregone income tax revenue) to
pursue projects that they believe are beneficial to their
respective jurisdictions. Structuring state and municipal
finances in this fashion is thus a political choice. And like the
decision by Oneida and Herkimer Counties and New York
State to displace private competition in waste processing with

21

a government-run monopoly, “nothing in the Commerce
Clause vests the responsibility for that policy judgment with
the Federal Judiciary.” United Haulers, 127 S. Ct., at 1796.

Finally, the activity of borrowing money to finance the
construction of infrastructure and other necessary public
improvements is a “traditional government function.” First,
the practice has deep historical roots, predating the issuance
of corporate debt by several centuries. See Temel, supra, at
49 (noting that Italian city-states borrowed from major
merchant banking families during the Renaissance). Ameri-
can cities incurred debt as early as the seventeenth century.
See id. New York City issued the first officially recorded
municipal bond in 1812 to finance the construction of the Erie
Canal. See Shafroth, Which State Taxes Are ‘Preferred’ for
Infrastructure?, 40 State Tax Notes 237 (2006). By 1843,
U.S. cities had accumulated approximately $25 million in
outstanding debt, and the number of municipal bond issues
has grown exponentially ever since. See Temel, supra, at 49-
50. State and local governments issued $26 billion in
municipal bonds in 1975, and they issued more than ten times
that amount ($263.8 billion) in 1999. See id, at 3. Presently,
the value of outstanding U.S. municipal bonds is roughly $2.4
trillion. See T. Herman, Justices to Hear Muni-Bond Case—
Kentucky Tax Fight Over Exemptions Affects Many States,
Wall St. J., May 22, 2007, at D3.

Second, and more fundamentally, borrowing money is
indispensable to state and local governments’ capacity to
provide essential but costly governmental services. See South
Carolina v. Baker, 485 U.S. 505, 531 (1988) (O’Connor, J.,
dissenting) (“Long-term debt obligations are an essential
source of funding for state and local governments.”). There
are approximately 87,000 state and local governments in the
United States, U.S. Census Bureau, Statistical Abstract of the
United States: 2007, at p. 264 (Table 415), and only the very
largest are capable of financing any significant capital im-

22

provements exclusively from current revenue. Even for state
governments, issuing bonds is often the only practical means
to finance the construction of essential infrastructure, such as
roads, highways, sewers, and utilities. Bond issues make
these public investments possible by allowing state and
local governments to spread the relevant tax burden over
several years.

Issuing bonds is thus a temporal extension of a State’s
authority to tax, a power that is “basic to its sovereignty.”
Bode v. Barrett, 344 U.S. 583, 585 (1953). Municipal bonds
permit governments to extend the time frame of taxation over
the useful life of the capital improvement, rather than forcing
them to impose the entire tax burden at the time of the
improvement’s construction. Moreover, bonds promote fair-
ness in public finance by enabling state and local govern-
ments better to ensure that the citizens who benefit from long-
term capital improvements (those who live in the community
over the life of the assets) are those who pay for them (in
taxes that go toward servicing the debts). Absent such a
spreading of the tax burden, taxpayers required to fund the
entire cost of public works at the time of their construction
would have a strong incentive to undersupply these important
public goods. Thus, there are powerful systemic reasons that
local governments have incurred debt since colonial times,
and that they continue to rely on it heavily today.

In short, Kentucky’s tax exemption falls squarely within
the rule announced in United Haulers: It favors state and
local government, it treats all private businesses equally, and
it concerns a traditional government activity. It necessarily
follows that, for purposes of the dormant Commerce Clause,
Kentucky’s income tax exemption for interest earned on in-
state municipal bonds does not discriminate against interstate
commerce.

23

B. Kentucky’s Tax Exemption Does Not Impose a
“Clearly Excessive” Burden on _ Interstate
Commerce

Because Kentucky’s tax exemption does not discriminate
against interstate commerce, the appropriate test under the
dormant Commerce Clause is that set out in Pike v. Bruce
Church, Inc., 397 U.S. 137 (1970), for laws that are “directed
to legitimate local concerns, with effects upon interstate
commerce that are only incidental.” City of Philadelphia v.
New Jersey, 437 U.S. 617, 624 (1978).’ To pass muster,
Kentucky must only show that the burden on interstate
commerce attributable to the tax exemption is not “clearly
excessive in relation to the putative local benefits.” Pike, 397
U.S., at 142. Kentucky has made that showing here.®

” Since 1977, this Court has typically applied the 4-part test originally
articulated in Complete Auto Transit, Inc. v. Brady, 430 U. S. 274 (1977),
to determine whether a challenged state tax provision is consistent with
the dormant Commerce Clause. See, e.g., Oklahoma Tax Comm. v.
Jefferson Lines, Inc., 514 U. S. 175, 183 (1995); Itel Containers Int'l
Corp. v. Huddleston, 507 U. S. 60, 73 (1993); Trinova Corp. v. Michigan
Dept. of Treasury, 498 U. S. 358, 372 (1991); Goldberg v. Sweet, 488
U.S. 252, 259-260 (1989). Under Complete Auto, a state tax is
permissible so long as it “is applied to an activity with a substantial nexus
with the taxing State, is fairly apportioned, does not discriminate against
interstate commerce, and is fairly related to the services provided by the
State.” Complete Auto, 430 U.S., at 279. Here, Respondents’ only
Commerce Clause claim appears to be that Kentucky’s tax exemption
discriminates against interstate commerce. See J.A. 24. Thus, if the
Court concludes that the exemption is non-discriminatory, further analysis
under Pike may be unnecessary. Cf. General Motors v. Tracy, 519 U.S. at
824 n. 12 (suggesting that Pike balancing is not required if Complete
Auto’s apportionment prong is satisfied).

* Because the trial court upheld Kentucky’s tax exemption on the
ground that the Commonwealth was acting as a market participant, it did
not reach the question whether the exemption satisfied Pike’s balancing
test. See Pet. App. 18a-19a. Likewise, because the Kentucky Court of
Appeals invalidated the exemption on the ground that it discriminated

24

First, Kentucky’s tax exemption furthers several legitimate
government objectives. It reduces the interest rate that
Kentucky and its political subdivisions must pay when they
issue bonds. It devolves greater power over the Common-
wealth’s fiscal affairs—-how much money to spend, and
which projects to fund—-to local governments, which are
better positioned to respond to their respective communities’
needs. And it encourages Kentucky citizens to become
personally invested in the construction of the Common-
wealth’s infrastructure, and indeed its future—its schools,
universities, roads, utilities, hospitals, and low-income
housing.

Second, the exemption’s economic impact is not properly
understood as a “burden on interstate commerce,” let alone a
burden that is “clearly excessive in relation to its putative
benefits.” The principal economic effect of the exemption is
to alter the residential distribution of those persons holding
Kentucky municipal bonds. It creates a financial incentive
for Kentucky citizens, when they are purchasing municipal
bonds, to purchase Kentucky bonds rather than those issued
by another State. As a result, the proportion of investors
holding Kentucky municipal bonds who are Kentucky
citizens is substantially greater than it would be absent the
exemption. The same is almost certainly true, to greater and
lesser degrees, for all 42 States that offer a tax preference for
the interest zarned on in-state municipal bonds.” This ex-

against interstate commerce, it did not address the Pike balancing ques-
tion, either. See Pet. App. 4a—lla. Thus, no court has evaluated the
exemption’s local benefits or its impact on interstate commerce. For the
reasons stated infra, we believe that, as a matter of law, the exemption’s
impact on interstate commerce is not a cognizable “burden” for purposes
of the dormant Commerce Clause, and that this Court should therefore
uphold the exemption under Pike.

* The strength of this incentive turns on the taxpayer’s marginal state
income tax rate. The effect is apt to be strongest for bonds issued by
states like California, where the top marginal income tax rate is 9.3

25

plains the existence of the 400-odd state-specific mutual
funds that various investment companies now market to
investors. '°

Though this practical consequence is rather obvious, it is
not a “burden on interstate commerce.” Although the
exemption steers more Kentucky residents towards Kentucky
municipal bonds, the Commonwealth’s relationship to its
residents is qualitatively different than that between a typical
debtor and its creditors: It is the relationship between a
sovereign and its citizens. “[A]s the guardian and trustee for
its people,” Atkin v. Kansas, 191 U.S. 207, 222 (1903),
Kentucky has a strong interest in encouraging its citizens to
be more than just consumers of the State’s public services.
Like any sovereign, it naturally desires its citizens to be genu-
ine stakeholders in the Commonwealth and its municipalities

An investor’s decision to purchase a municipal bond issued
by his or her home State is also distinctive from the investor’s
perspective. After all, it is Kentucky citizens who will
directly benefit from the projects financed by Kentucky’s
municipal bonds, and it is Kentucky citizens who, through
their tax dollars, will pay off the interest on these bonds. Cf
Reeves. Inc. v. Stake, 447 U.S. 429, 442 (1980); United
Haulers, 127 S.Ct. at 1797. A citizen’s decision to invest in
his or her own State therefore implicates important, non-
financial considerations that are inapplicable to other
commitments of capital. For all of these reasons, the fact that
Kentucky taxpayers are more heavily invested in Kentucky

percent, while it less significant for bonds issued by states like
Connecticut, where the top marginal rate is 5 percent.

' According to the Investment Company Institute, at the close of 2006
there were 482 single-state municipal bond mutual funds with combined
assets totaling $155 billion. See J. Mysak, Trash-Hauler Case Muddies
Water for Municipal Market, Bloomberg, May 9, 2007, available at
http://www.bloomberg.com/apps/news?pid=2060 1039&sid=aaVU49WiU
SFs&refer=columnist mysak (last visited July 16, 2007).

26

municipal bonds—both literally and figuratively—is not a
“distortion” of interstate commerce. Instead, it is a natural
and salutary consequence of the Nation’s federal structure.

Moreover, Respondents’ arguments about the beneficial
economic effects that would flow from invalidating Ken-
tucky’s tax exemption are empirically unsupported and
logically flawed. For instance, Respondents assert that,
without theses tax exemptions, States “will compete for
investors’ dollars . . . on the merits of the projects funded by
the investment sales,” and that, “[a]s a result, the market will
provide incentives for governments to be more careful in
selecting and funding projects through bond sales.” Brief in
Opp. 11 n. 5. But that incentive already exists, and strongly
so. For purposes of assessing the States’ incentives, what
matters are the effects of changes in their creditworthiness at
the margin. Because the state tax exemption is largely
capitalized into municipal bonds’ yields, the tax exemption—
while lowering the interest rate that state and local govern-
ments must offer—does nothing to diminish the marginal
importance to them of remaining a good credit risk. Stated
differently, a change in a state or local government’s bond
rating in a State with an exemption like Kentucky’s is apt to
have the same impact on that government’s borrowing costs
as it would absent the exemption.

Finally, the economic impact attributable to Kentucky’s tax
exemption is quite unlike the harms that this Court has found
to constitute “clearly excessive” burdens on interstate com-
merce in its prior applications of Pike. It is not an
idiosyncratic state regulation that, when combined with the
laws of surrounding States, clogs the channels of interstate
commerce. Cf. Kassel v. Consolidated Freightways Corp. of
Del., 450 U.S. 662 (1981); Raymond Motor Transp., Inc. v.
Rice, 434 U.S. 429 (1978). It is not a law that operates
extraterritorially, regulating commercial transactions that oc-
cur in other States. Cf. Edgar v. MITE Corp., 457 U.S. 624

27

(1982). And it is not an explicit embargo that prohibits
private businesses from transporting certain goods across
state borders, as was the case in Pike itself. See 397 U.S. at
139.

Kentucky’s tax exemption represents a preference by a
sovereign for itself, in selling to its own citizens, over other
sovereigns. Its effects are simply not comparable to anything
this Court has previously held to be an a burden
on interstate commerce.

CONCLUSION

The judgment of the Kentucky Court of Appeals should be
reversed.

Respectfully submitted,

RICHARD RUDA*
Chief Counsel
STATE AND LOCAL LEGAL CENTER
444 North Capitol Street, N.W.
Suite 309
Washington, D.C. 20001
(202) 434-4850

July 19, 2007 * Counsel of Record for the
Amici Curiae

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0507%3A13. Public record. Not legal advice.