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

nS

Supreme Court, US.

1 JUL 19 2007

on No. 06-666 OFFICE OF THE CLERK |

In the

Supreme Court of the United States

DEPARTMENT OF REVENUE OF KENTUCKY, ETAL.,

Petitioners,

Ve

GEORGE W. DAVIS and CATHERINE V. DAVIS,

Respondents.

On Writ of Certiorari to the Court of Appeals of Kentucky

BRIEF FOR THE STATES OF NORTH CAROLINA,

ALABAMA, ALASKA, ARIZONA, ARKANSAS,

CALIFORNIA, COLORADO, CONNECTICUT,

DELAWARE, FLORIDA, GEORGIA, HAWAII, IDAHO,

ILLINOIS, INDIANA, IOWA, KANSAS, LOUISIANA,

MAINE, MARYLAND, MASSACHUSETTS, MICHIGAN,

MINNESOTA, MISSISSIPPI, MISSOURI, MONTANA,

NEBRASKA, NEVADA, NEW HAMPSHIRE,

NEW JERSEY, NEW MEXICO, NEW YORK,

NORTH DAKOTA, OHIO, OKLAHOMA, OREGON,

PENNSYLVANIA, RHODE ISLAND, SOUTH CAROLINA,

SOUTH DAKOTA, TENNESSEE, TEXAS, UTAH,

VERMONT, VIRGINIA, WASHINGTON, WEST VIRGINIA,

WISCONSIN AND WYOMING

AS AMICI CURIAE IN SUPPORT OF PETITIONERS

ROY COOPER North Carolina Department

Attorney General of Justice

State of North Carolina Post Office Box 629

Christopher G. Browning, Jr.* Raleigh, N.C. 27602

Kay Linn Miller Hobart Telephone: (919) 716-6900

Gregory P. Roney

July 19, 2007 *Counsel of Record

(Additional Counsel Listed On Inside Cover)

TROY KING

Attorney General

State of Alabama

State House

11 S. Union Street

Montgomery, AL 36130

(334) 242-7300

TALIS J. COLBERG

Attorney General

State of Alaska

Post Office Box 110300

Diamond Courthouse

Juneau, AK 9981 |]

(907) 465-3600

TERRY GODDARD

Attorney General

State of Arizona

1275 West Washington

Phoenix, AZ 85007

(602) 542-4266

DUSTIN McDANIEL

Attorney General

State of Arkansas

200 Tower Building

323 Center Street

Little Rock, AR 72201

(800) 482-8982

T_T

EDMUND G. BROWN, JR.

Attorney General

State of California

1300 I Street, Suite 1740

Sacramento, CA 95814

(916) 445-9555

JOHN W. SUTHERS

Attorney General

State of Colorado

1525 Sherman Street

Seventh Floor

Denver, Colorado 80203

(303) 866-3052

RICHARD BLUMENTHAL

Attorney General

State of Connecticut

55 Elm Street

Hartford, CT 06141

(860) 808-5318

JOSEPH R. BIDEN, III

Attorney General

State of Delaware

Carvel State Office Building

820 N. French Street

Wilmington, DE 19801

(302) 577-8338

BILL McCOLLUM

Attorney General

State of Florida

The Capitol, PL 01

Tallahassee, FL 32399

(850) 414-3300

THURBERT E. BAKER ©

Attorney General

State of Georgia

40 Capitol Square, SW

Atlanta, GA 30334

(404) 656-3300

MARK J. BENNETT

Attomey General

State of Hawaii

425 Queen Street

Honolulu, HI 96813

(808) 586-1500

LAWRENCE WASDEN

Attomey General

State of Idaho

Statehouse

Boise, ID 83720

(208) 334-2400

LISA MADIGAN

Attorney General

State of Illinois

James R. Thompson Center

100 W. Randolph Street

Chicago, IL 60601

(312) 814-3000

STEVE CARTER

Attorney General

State of Indiana

Indiana Government Center

South, 5" Floor

402 West Washington Street

Indianapolis, IN 46204

(317) 232-6201

TOM MILLER

Attorney General

State of Iowa

Hoover State Office Bldg.

1305 E. Walnut

Des Moines, IA 50319

(515) 281-5164

PAUL MORRISON

Attorney General

State of Kansas

120 S.W. 10" Ave., 2nd FI.

Topeka, KS 66612

(785) 296-2215

CHARLES C. FOTI, JR.

Attorney General

State of Louisiana

Post Office Box 94005

Baton Rouge, LA 70804

(225) 326-6000

G. STEVEN ROWE

Attorney General

State of Maine

State House Station 6

Augusta, ME 04333

(207) 626-8800

DOUGLAS F. GANSLER

Attomey General

State of Maryland

200 Saint Paul Place

Baltimore, MD 21202

(410) 576-6300

MARTHA COAKLEY

Attorney General

State of Massachusetts

One Ashburton Place

Boston, MA 02108

(617) 727-2200

MICHAEL A. COX

Attorney General

State of Michigan

P.O. Box 30212

Lansing, MI 48909

(517) 373-1110

LORI SWANSON

Attorney General

State of Minnesota

102 State Capitol

75 Rev. Dr. Martin Luther

King, Jr. Boulevard

St. Paul, MN 55155

(651) 296-3353

JIM HOOD

Attorney General

State of Mississippi

Department of Justice

Post Office Box 220

Jackson, MS 37205

(601) 359-3680

JEREMIAH W. (JAY) NIXON

Attorney General

State of Missoun

Supreme Court Building

207 W. High Street

Jefferson City, MO 65101

(573) 751-3321

MIKE McGRATH

Attorney General

State of Montana

Justice Building

Post Office Box 201401

Helena, MT 59620

(406) 444-2026

JON BRUNING

Attorney General

State of Nebraska

State Capitol

Post Office Box 98920

Lincoln, NE 68509

(402) 471-2682

CATHERINE CORTEZ MASTO

Attorney General

State of Nevada

100 N. Carson Street

Carson City, NV 89701

(775) 684-1112

KELLY A. AYOTTE

Attorney General

State of New Hampshire

33 Capitol Street

Concord, NH 03301

(603) 271-1202

ANNE MILGRAM

Attorney General

State of New Jersey

R.J. Hughes Justice Complex

245 Market Street

Post Office Box 080

Trenton, NJ 08625

(609) 292-8740

GARY KING

Attorney General

State of New Mexico

Post Office Drawer 1508

Sante Fe, NM 87504

(505) 827-6000

ANDREW M. CUOMO

Attorney General

State of New York

Department of Law

The Capitol, 2nd Floor

Albany, NY 12224

(518) 474-7330

WAYNE STENEHJEM

Attorney General

State of North Dakota

State Capitol

~»>) E. Boulevard Avenue

Demark, ND 58505

(701) 328-2210

MARC DANN PATRICK LYNCH

Attorney General Attorney General

State of Ohio State of Rhode Island

30 E. Broad Street, 17th Floor 150 S. Main Street

Columbus, OH 43215 Providence, RI 02903

(614) 466-8980 (401) 274-4400

W.A. DREW EDMONDSON HENRY McMASTER

Attorney General Attomey General

State of Oklahoma State of South Carolina

313 N.E. 21st Street Rembert C. Dennis Office

Oklahoma City, OK 73105 Building

(405) 521-3921 Post Office Box 11549

Columbia, SC 29211-1549

(803) 734-3970

HARDY MYERS LAWRENCE E. LONG

Attorney Genera! Attorney General

State of Oregon State of South Dakota

1162 Court St. N.E. 1302 E. Hwy. 14, Suite 1

Salem, Oregon 97301 Pierre, SD 57501-8501

(503) 378-4732 (605) 773-3215

THOMAS J. CORBETT, JR. ROBERT E. COOPER, JR.

Attorney General Attorney General

State of Pennsylvania State of Tennessee

16th Floor, Strawberry Square 500 Charlotte Avenue

Harnsburg, PA 17120 Nashville, TN 37243

(717) 787-3391 (615) 741-5860

GREG ABBOTT

Attorney General

State of Texas

Capitol Station

Post Office Box 12548

Austin, TX 78711

(512) 463-2100

MARK L. SHURTLEFF

Attorney General

State of Utah

Utah State Capitol Complex

East Office Bidg., Suite 320

Salt Lake City, UT 84114

(801) 538-9600

WILLIAM H. SORRELL

Attorney General

State of Vermont

109 State Street

Montpelier, VT 05609

(802) 828-3173

BOB McDONNELL

Attorney General

State of Virginia

900 E. Main Street

Richmond, VA 23219

(804) 786-2071

ROBERT M. McKENNA

Attorney General

State of Washington

1125 Washington Street

Post Office Box 40100

Olympia, WA 98504

(360) 753-6200

DARRELL V. McGRAW, JR.

Attorney General

State of West Virginia

State Capitol, Room 26-E

Charleston, WV 25305

(304) §58-2021

J. B. VAN HOLLEN

Attorney General

State of Wisconsin

State Capitol, Suite 114E

Post Office Box 7857

Madison, WI] 53707

(608) 266-1221

PATRICK J. CRANK

Attorney General

State of Wyoming

123 Capitol Building

Cheyenne, WY 82002

(307) 777-7841

TABLE OF CONTENTS

TAREE GP AUPE RIEEED oc ccc cccccccccccccccees inl

INTERESTS OF AMICI CURIAE ...........----555. ]

SUMMARY OF ARGUMENT .............---4-e05- 2

ARGUMENT ........ kL wundeneees Ghecanensostesees +

I. A STATE LAW PROVIDING INCOME TAX

EXEMPTIONS FOR INTEREST EARNED ON

BONDS ISSUED BY THE STATE AND ITS

POLITICAL SUBDIVISIONS, BUT NOT

INTEREST EARNED ON BONDS ISSUED BY

OTHER STATES AND THEIR POLITICAL

SUBDIVISIONS, DOES NOT DISCRIMINATE

AGAINST INTERSTATE COMMERCE. ....... 5

A. This Practice Is Longstanding and

TEED. Ge cb evcvevesadetcvedececess 6

B. The Widespread Practice by States of

Exempting Their Own Bonds, While

Taxing the Bonds of Sister States, Is

Directed Toward Legitimate Goals

Unrelated to Protectionism. ............... 8

C. The States’ Treatment of Interest Earned

on State and Local Bonds Is Not

Discriminatory Within the Meaning of the

Dormant Commerce Clause............... 12

1. AS A SELLER OF BONDS, KENTUCKY

STANDS AS A MARKET PARTICIPANT. .... 14

1]

lll. THE RULE ADOPTED BY THE LOWER

COURT WOULD HAVE DEVASTATING

EFFECTS ON THE STATES’ FISC AND THE

BOND MARKET, AND REFLECTS A

DECISION BETTER LEFT TO CONGRESS. .. 16

SURED, 6 enc w on cwscobascdeccicvevcnsaccos til

iil

TABLE OF AUTHORITIES

FEDERAL CASES

Bonaparte v. Tax Court, 104 U.S. 592 (1881)...... 6, 7,13

| Boston Stock Exch. v. State Tax Comm'n,

ED 6 bcs dewieveesecceenees 11, 22

Fulton Corp. v. Faulkner, 516 U.S. 325 (1996) ..... 16, 18

Gen. Motors Corp. v. Tracy,

pit & se 0), ee 12, 13, 14, 19, 20

Gibbons v. Ogden, 22 U.S. 1 (1824) ...........00005. 22

Nat’l Private Truck Council v. Okla. Tax Comm'n,

515 U.S. 582 (1995) ...... SP ae 4

Nat'l Bank v. County of Yankton,

Fe ED CEE Se enscodkonvecedesogsovecss 22

New Energy Co. v. Limbach, 486 U.S. 269 (1988) ... 15, 16

Northwest Airlines, Inc. v. Minnesota,

nn ost keccduidededdateaees 19, 20

Quill Corp. v. North Dakota, 504 U.S. 298 (1992) ...... 20

Reeves, Inc. v. Stake, 447 U.S. 429 (1980) ... 11, 14, 15, 22

Trinova Corp. v. Michigan Dep't of Treasury,

PE ond pa nceeseuanead onsiuees 11

iV

United Haulers Ass'n v. Oneida-Herkimer Solid Waste

Memt. Auth., 127 S. Ct. 1786 (2007) ......... 3,5, 12

White v. Mass. Council of Constr. Emplovees,

“Ga SEE 8d hse toe evetscscuekasa ~o ie

Wilson v. McNamee, 102 U.S. 572 (1880) ............. 20

Wisconsin v. J.C. Penney Co., 311 U.S. 435 (1940) ...... 4

STATE CASES

Coley v. State, 631 §.E.2d 121 (N.C. 2006)............ 19

County of Cabarrus v. Tolson,

610 S.E.2d 443 (N.C. Ct. App. 2005) ............. 19

Dunn v. State, 635 $.E.2d 604 (N.C. Ct. App. 2006),

disc. review granted, 361 N.C. 351 (2007)......... 17

Goldston v. North Carolina,

Se ee a ED 0c obedeexitsecdesncds 19

Laura v. Droll, 187 N.W. 876 (Neb. 1922) ............. 9

Smith v. State, 507 §.E.2d 28 (N.C. 1998) ............. 18

FEDERAL MATERIAL

IRs fd cccdGedeedeceveesveenes seeds 22

Pub. L. 86-272, 73 Stat. 555 (1959) ...........002eeee 20

S. Rep. No. 91-552 (1969),

reprinted in 1969 U.S.C.C.A.N. 2027 ............ 21

H.R. Rep. No. 88-1480 (1964) .. 0.0.0... eee eee eee 21

H.R. Rep. No. 89-952 (1965) .........ccccccccvceees 21

H.R. Rep. No. 91-413 (1969),

reprinted in 1969 U.S.C.C.A.N. 1645 .........45. 21

STATE MATERIAL

Alabama

Ala. Code § 40-18-14(3)(f) (2003) ..........-0558. 7

Arizona

Ariz. Rev. Stat. Ann. § 43-1021(3) (Supp. 2006)..... 7

Arkansas

Ark. Code Ann. § 26.51-404(b)(5) (1997) .......... 7

I MEE oi dcocteneseeus veneeneseeoes 6

California

Cal. Gov’t Code § 99016 (Deering 2007).......... 17

Cal. Rev. & Tax. Code § 17133 (West 2004) ........ 7

Colorado

Colo. Rev. Stat. § 39-22-104(3)(b) (2006) .......... 7

vi

Connecticut

Conn. Gen. Stat. Ann. § 12-701(a)(20)(A)(i),(B)(vil)

POPES, CED incesc cu cvccscsewsenwnns's 7

Delaware

Del. Code Ann. tit. 30, § 1106(a)(1) (1997) ......... 7

pi RE eer ere res 6

Georgia

Ga. Code Ann. § 32-10-49 (2007) ............... 17

Ga. Code Ann. § 48-7-27(b)({1 (A) (2005) .......... 7

Hawaii

A om Ee SE) error 7

See. TAU. BAAR. B SFeL DE Teeee coc ccc cc vensscvces 7

Haw. Rev. Stat. § 235-7(a)(5), (a)(6), (b)(2) (1993)... 7

PSO] Plmwelt Sees. LAWS 1 ow wc cece ee cccsceess 6, 21

Idaho

Idaho Code § 63-3022M(1) (2007) ................ 7

Idaho Code § 63-3022M(3)(b) (2007) ............. 7

Indiana

Ind. Code Ann. § 6-3-1-3.5

CRGEPCUIND TU, PD ow cccecescececens 7,8

Kansas

Kan. Stat. Ann. § 79-32,117(b)(i) (Supp. 2006) ...... 7

Kentucky

he § oy, Perro error ree TT Tere eT 17

Ky. Rev. Stat. Ann. § 58.580 (West Supp. 2006) .... 17

Ky. Rev. Stat. Ann. § 141.010(10)(c)

(West Supp. 2006) ............. aS) ane 7

PL EO was eked wan seta vinvs eee saeeees 6

Vii

Louisiana

La. Rev. Stat. Ann. § 47:48 (2001) ................ 7

La. Rev. Stat. Ann. § 47:293(6)(a), (b)

i cen ee ehwiehas oes ese eee oa we 7

Maine

Me. Rev. Stat. Ann. tit. 36, § 5122(1)(A)

ES Perr ree 7

Maryland

Md. Code Ann., Tax-Gen. § 10-204(b)

PPTL TTT TTT TTT 7

Md. Code Ann., Tax-Gen. § 10-305(d)

(LexisNexis Supp. 2006) ......cccccccccccees 7

Massachusetts

Mass. Gen. Laws Ann. ch. 62, § 2(a)(1)(A)

EE Soo cke dese eenekéeusecoas 7

i inn nate unekecehneen sue 6

Michigan

Mich. Comp. Laws § 2V6.30(1)(a)

PP TT TTT ee Te 7

Minnesota

Minn. Stat. Ann. § 290.01(19a)(1)(1) (West 1999) .... 7

Mississippi

Miss. Code Ann. § 27-7-15(4)(d) (Supp. 2006) ...... 7

Missouri

Mo. Ann. Stat. § 143.121(2)(b) (West Supp. 2007) ... 7

Vill

Montana

Mont. Code Ann. § 15-30-111(1)(a)(i) (2005)

Mont. Code Ann. § 15-30-111(2)(a)(i) (2005)

Nebraska

Neb. Rev. Stat. § 77-2716(1)(a), (c) (Supp. 2006)

New Hampshire

N.H. Rev. Stat. Ann. § 77:4(I) (Supp. 2006)

PON PS MEE OE occ bho cu vane cevnnecesesevus

New Jersey

N.J. Stat. Ann § 54A:6-14 (West 2002)

New Mexico

N.M. Stat. § 7-2-2(B)(3), (V) (2005) .......00... 7,8

New York

N.Y. Pub. Auth. Law § 372 (McKinney 2004) ......

N.Y. Tax Law § 612(b)(1)

7,8

(McKinney Supp. 2006)

SO eo EE EE ou oooh kode acne uv evawecns

North Carolina

N.C. Gen. Stat. § 105-134.6(c)(1) (2007)

SO eis MO INT gg ince u vedmceccwnns

North Dakota

N.D. Cent. Code § 57-38-01.2(1)(g) (2005)

eS 8. ee e2Beseersevseeseneses een & OOo 6 Oo 6

Ohio

747.01(A\(1)

7

Ohio Const. art. VII

Ohio Rev. Code Ann. § 5

(LexisNexis Supp. 20

ix

Oklahoma

Okla. Stat. Ann. tit. 68, § 2358 (A)(1)

PPE TD vc cccccncceccccesuceees 7,8

Okla. Stat. Ann. tit. 68, § 2358.5A (A)

EE cteccdmcrinweaseknanes 7,8

Oregon

Or. Rev. Stat. § 316.680(2)(a) (2005) ............ 7,8

Pennsylvania

72 Pa. Stat. Ann. § 7302 (West Supp. 2007) ...... 7,8

72 Pa. Stat. Ann. § 7303(a)(6)

EL ic nade his shaun ewe evade 7,8

72 Pa. Stat. Ann. § 9901 (West Supp. 2007) ...... 7,8

Rhode Island

R.I. Gen. Laws § 44-30-12(a), (b)(1) (Supp. 2006) . 7, 8

South Carolina

S.C. Code Ann. § 12-6-1120(1)

(20ee G BURR. FOGG) ww ccc ccccccccccccs 7,8

ER RS an ee ee 6

Tennessee

Tenn. Code Ann. § 67-2-104(e)(1) (Supp. 2006) ... 7, 8

Vermont

Vt. Stat. Ann. tit. 32, § 5811(18)(A)(i)d)

(Supp. 2006) ...... CCAR EHRAOD RA Wewe eset 7,8

Virginia

Va. Code Ann. § 15.2-5361 (2007) .............. 17

Va. Code Ann. § 58.1-322(B){1) (Supp. 2007) .... 7,8

Ne a 6

West Virginia

W. Va. Code § 11-21-12(b)(1)

(LexisNexis Supp. 2007) ........... Lee ee 7,8

SECONDARY SOURCES

Robert S. Amdursky & Clayton P. Gillette,

Municipal Debt Finance Law: Theory

Soe BR err 9

Scott K. Attaway, Note, The Case for Constitutional

Discrimination in Taxation of Out-of-State

Municipal Bonds, 76 B.U. L. Rev. 737 (1996) ....... 8

Dwight Denison, Merl Hackbart & Michael Moody,

Davis v. Department of Revenue: A Preliminary

Impact Assessment |} (Inst. for Federalism &

Intergovernmental Relations Working Papers

Sens, Paper No. 2007-03, 2006) .............. 2,19

The Federalist No. 81 (Alexander Hamilton)

(Arlington House 1965) .................005: l,@e

Michael J. Graetz & Deborah H. Schenk, Federal Income

Taxation: Principles and Policies (Sth ed. 2005) ....9

Christopher Kirkpatrick, Eas/ev Declares Fiscal

Emergency, Durham Herald Sun,

St SE eG ae ayaa ake a eee de wes 48 oh 8 18

Robert Lamb & Stephen P. Rappaport, Municipal Bonds:

The Comprehensive Review of Tax Exempt

Securities and Public Finance (1980) ............ 10

x1

Timothy P. Noonan & David Martin, U.S. Supreme

Court's Decision to Hear Municipal Bond

Case Raises Constitutional, Procedural

Questions, 44 State Tax Notes 969 (2007) ..... La

Edward Yorio, Equity, Efficiency and the Tax Reform

Act of 1986, 55 Fordham L. Rev. 395 (1987) ....... 10

Edward Zelinsky, For Realization: Income T. axation, |

Sectoral Accretionism, and the Virtue of Attainable

Values, 19 Cardozo L. Rev. 861 (1997) ........... 10

]

INTERESTS OF AMICI CURIAE

For nearly a century, States have exempted interest on

their own bonds from income taxation while taxing interest

income on the bonds of sister States. The overwhelming

majority of States have a taxation system comparable to

~” “Kentucky’s. A decision by this Court proscribing this

longstanding practice would injure the States in several distinct

and important ways.

The States’ sovereign interest in controlling their finances

and debt service was recognized as far back as The Federalist

No. 81, where Alexander Hamilton wrote that the Constitution

did not “divest[{]” the States “of the privilege of paying their

own debts in their own way.” The Federalist No. 81, at 488

(Alexander Hamilton) (Arlington House 1965). When the

Commerce Clause is wrongly construed so as to unduly

interfere with the ability of elected state officials to perform

traditional state functions, the sovereignty of ail States is

adversely affected.

If the decision of the Kentucky Court of Appeals is

affirmed, the 38 States that exempt their own bonds from state

income taxation, while taxing the bonds of sister States, will

face staggering potential liability. The amount at issue for

even a single tax year will significantly impact state budgets.

New York estimates that it will face claims of $200 million for

past tax years and will lose annual revenue of approximately

$70 million should the decision below be affirmed. The

liability will be even greater in those States where challenges

were filed several years ago. In North Carolina, for example,

a class of taxpayers is seeking the refund of all income taxes

paid on out-of-state bonds since 2001.

Finally, all States have a substantial interest in this appeal

given its potential impact on the overall bond market. An

affirmance of the Kentucky Court of Appeals would put the

“bond market into an unprecedented upheaval.” Timothy P.

2

Noonan & David Martin, U.S. Supreme Court's Decision to

Hear Municipal Bond Case Raises Constitutional, Procedural

Questions, 44 State Tax Notes 969 (2007). The bond market

historically has reacted negatively to change, espectally

dramatic change. Any instability in the market stands to

devalue substantially bonds held by the residents of all 50

States. Additionally, some States could see increases in their

costs of borrowing. See Dwight Denison, Merl Hackbart &

Michael Moody, Davis v. Department of Revenue: A

Preliminary Impact Assessment 11 (inst. for Federalism &

Intergovernmental Relations Working Papers Series,

Paper No. 2007-03, 2006), available at

http://www.ifigr.org/publication/index.html (follow “No. 2007-

03” hyperlink) (stating that elimination of state tax exemption

“could have a dramatic impact upon municipal bond yields”).

For this reason, all of the Amici States (regardless of their

taxation system) have a strong interest in ensuring that the

decision below ts reversed.

SUMMARY OF ARGUMENT

The practice by States of exempting their own bonds from

taxation, while taxing the interest on bonds of other States, is

longstanding, widespread and well-known by Congress. This

practice serves legitimate and important state interests. States

exempt interest on their own bonds from income taxation

because it allows them to lower their financing costs, improve

their credit ratings and build more schools, hospitals, libraries

and roads. Bond purchasers are willing to accept a lower

interest rate for a tax-exempt bond than for a comparable

taxable bond because they are motivated by the net return on

investment (i.¢., the income stream produced by the bond less

taxes imposed on this income). (

Tax exemption of municipal bonds is not without its costs.

When a State exempts a bond from taxation, 1t forgoes a stream

3

of tax revenue that it would otherwise be entitled to receive

over the life of the bond. States do not give up this income

stream lightly. Rather, they generally forgo this income stream

only when they know that what they are getting in return (more

favorable interest rates) will benefit the State. Kentucky, like

_ virtually every other State, exempts only its own bonds from

taxation. This ensures that the tax revenue Kentucky is

forgoing benefits the building of schools, hospitals, roads and -

other infrastructure in the State ~ the same use those taxes

would have served had they been collected over the life of the

bond. Kentucky’s taxation system therefore serves legitimate

state interests, unrelated to protectionism.

Kentucky’s practice of exempting only Kentucky bonds

from state income taxation helps state and local governments

fulfill their essential functions; it does not favor private

industry. Because this taxation system does not give in-state

private industry a competitive advantage over out-of-state

interests, it withstands scrutiny under United Haulers Ass'n v.

Oneida-Herkimer Solid Waste Mgmt. Auth., 127 S. Ct. 1786,

1790 (2007).

Importantly, Kentucky is not similarly situated to other

entities selling bonds in Kentucky. First, no other bond issuer

is in the business of providing public works within the State of

Kentucky. Second, only Kentucky can forgo collecting income

tax upon its bonds and, by doing so, ensure that the tax revenue

that Kentucky is forgoing will still serve to facilitate the

building of schools, hospitals and roads in Kentucky.

Kentucky is therefore unique among other entities selling

bonds within Kentucky. The Kentucky Court of Appeals

therefore erred in concluding that the Kentucky taxation system

violates the dormant Commerce Clause.

The lower court also erred in concluding that Kentucky 1s

not a market participant. When States act as market

participants, their actions ave free from dormant Commerce

Clause analysis. Here, Kentucky is merely agreeing to forgo

4

collecting a tax in order to obtain more favorable terms for a

product that Kentucky itself is selling in the marketplace.

Kentucky therefore is a market participant.

If the decision of the Kentucky Court of Appeals is upheld,

the impact on States and bondholders will be devastating.

Given Congress’ implicit approval of this longstanding,

widespread and well-known taxation practice, any change

should be made by Congress, not the courts.

ARGUMENT

This Court has “long recognized that principles of

federalism and comity generally counsel that courts should

adopt a hands-off approach with respect to state tax

administration.” Nat'l Private Truck Council v. Okla. Tax

Comm'n, 515 U.S. 582, 586 (1995); see also Wisconsin v. J.C.

Penney Co., 311 U.S. 435, 444 (1940) (recognizing that States

should be free to pursue their own fiscal and taxing policies).

Those principles apply with particular force in this case. For

nearly a century, States have exempted from taxation the

interest earned on their own bonds, while taxing interest

income from the bonds of other States. This practice has been

acknowledged and countenanced by Congress and this Court.

To suddenly strike it down in the name of the dormant

Commerce Clause would be a stark departure from tradition,

one with potentially devastating consequences for the States.

This Court’s Commerce Clause jurisprudence requires no such

result.

To the contrary, state laws that favor local government

serve legitimate, non-protectionist interests and are therefore

consistent with the Commerce Clause, under both the ant-

discrimination and market participant lines of cases. This

Court has also recognized that congressional acquiescence in

longstanding state practices militates in favor of sustaining

such practices. Kentucky's tax system should be upheld.

5

I. A STATE LAW PROVIDING INCOME TAX

EXEMPTIONS FOR INTEREST EARNED ON

BONDS ISSUED BY THE STATE AND ITS

POLITICAL SUBDIVISIONS, BUT NOT INTEREST

EARNED ON BONDS ISSUED BY OTHER STATES

AND THEIR POLITICAL SUBDIVISIONS, DOES

' NOT DISCRIMINATE AGAINST INTERSTATE

COMMERCE.

In United Haulers Ass'n v. Oneida-Herkimer Solid Waste

Mgmt. Auth., 127 S. Ct. 1786, 1795-96 (2007), this Court

rejected the charge that a “law[] favoring local government”

was facially discriminatory within the meaning of the dormant

Commerce Clause and therefore invalid. The Court recognized

that the “government is vested with the responsibility of

protecting the health, safety, and welfare of its citizens,” and

that “[t]hese important responsibilities set state and local

government apart from typical private business.” Jd. at 1795.

The Commerce Clause was not intended to, and has never been

understood to, stand in the way of the States directly engaging

in those activities — be they processing garbage, running

prisons, financing capital improvements or constructing roads.

Laws favoring local government are consistent with the

Commerce Clause because local government is not “similarly

situated” to potential competitors and because “[IJaws favoring

local government . . . may be directed toward any number of

legitimate goals unrelated to protectionism.” Jd. at 1796.

Courts “should be particularly hesitant to interfere with [a

government’s] efforts under the guise of the Commerce

Clause” where the government is engaged in what “is both

typically and traditionally a local government function.” /d.

(citation and quotation marks omitted).

All of these considerations apply with full force in this

case and support upholding Kentucky’s tax system. When

States sell bonds to pay for hospitals, roads, prisons and other

6

important capital projects — and exempt the interest on those

bonds from state income taxes to lower the bonds’ effective

cost to the State — they are engaging in a traditional

government activity that serves core sovereign functions. Out-

of-state governmental bond issuers are not similarly situated to

the taxing State and its political subdivisions, and legitimate

interests are served by the States’ common practice of

exempting the interest earned on their own bonds from

taxation, but not extending that exemption to bonds issued by

other States.

A. This Practice Is Longstanding and Widespread.

The practice by States of exempting their own bonds trom

taxation, while taxing the bonds of sister States, dates back to

the beginning of state income tax statutes. See, e.g., 1919 N.Y.

Laws 1641-42; 1921 N.C. Sess. Laws 208; 1921 Mass. Acts

616; 1923 N.H. Laws 78; 1926 Va. Acts 961; 1927 S.C. Acts

7; 1929 Ark. Acts 585; 36 Del. Laws 37 (1929); 1936 Ky. Acts

70; see also 1901 Hawaii Sess. Laws 31-32 (territorial practice

that continued following statehood).

This longstanding practice is grounded in this Court’s

decision in Bonaparte v. Tax Court, 104 U.S. 592 (1881). In

Bonaparte, this Court held that New York, by exempting its

own bonds from taxation, could not compel Maryland to

refrain from taxing those bonds when acquired by a Maryland

resident. In rendering its decision, this Court declared:

[1]f a State could protect its securities from taxation

everywhere, it might succeed in borrowing money at

reduced interest; but, inasmuch as it cannot secure

such exemption outside its own jurisdiction, it is

compelled to go into the market as a borrower, subject

to the same disabilities in this particular as

j

individuals... . [T]he States are left free to extend

the comity which is sought, or not, as they please.

Id. at 595. With this Court’s imprimatur, and the longstanding

acquiescence of Congress, state legislatures have enacted and

enforced taxation systems for a hundred years with the belief

that whether a State exempts the bonds of » «ster State is an

issue of comity that may be “extend{ed], or not, as [States]

please.” Jd.

This historical practice by States of only exempting their

own bonds from taxation continues today. Virtually all States

that have a state income tax exempt their own bonds, but tax

the bonds of sister States.’ As reflected by this nearly universal

' Ala. Code § 40-18-14(3)(f) (2003); Ariz. Rev. Stat. Ann.

§ 43-1021(3) (Supp. 2006); Ark. Code Ann. § 26.51-404(b)(5)

(1997); Cal. Rev. & Tax. Code § 17133 (West 2004); Colo. Rev.

Stat. § 39-22-104(3)(b) (2006); Conn. Gen. Stat. Ann.

§ 12-701(a)(20)(A)(i), (B)(vii) (West Supp. 2007); Del. Code Ann.

tit. 30, § 1106(a)(1) (1997); Ga. Code Ann. § 48-7-27(b)(1)(A)

(2005); Haw. Rev. Stat. §§ 39-11, 47-13, 235-7(a)(5), (a)(6), (b)(2)

(1993); Idaho Code Ann. § 63-3022M(1), -3022M(3)(b) (2007);

Kan. Stat. Ann. § 79-32,117(b)(i) (Supp. 2006); Ky. Rev. Stat. Ann.

§ 141.010(10)(c) (West Supp. 2006); La. Rev. Stat. Ann. §§ 47:48

(2001), 47:293(6)(a), (b) (Supp. 2007); Me. Rev. Stat. Ann. tit. 36,

§ 5122(1)(A) (Supp. 2006); Md. Code Ann., Tax-Gen. §§ 10-204(b),

10-305(d) (LexisNexis Supp. 2006); Mass. Gen. Laws Ann. ch. 62,

§ 2(a)(1)A) (West Supp. 2007); Mich. Comp. Laws Ann.

§ 206.30(1)(a) (West Supp. 2007); Minn. Stat. Ann.

§ 290.01(19a)(1)(i) (West 1999); Miss. Code Ann. § 27-7-15(4)(d)

(Supp. 2006); Mo. Ann. Stat. § 143.121(2)(b) (West Supp. 2007);

Mont. Code Ann. § 15-30-111(1)(a)(i), (2)(a)(i) (2005); Neb. Rev.

Stat. § 77-2716(1)(a), (c) (Supp. 2006); N.H. Rev. Stat. Ann.

§ 77:4(1) (Supp. 2006); N.J. Stat. Ann. § 54A:6-14 (West 2002);

8

practice and by the submission of this amici brief on behalf of

49 States in support of Kentucky, “the entities which

supposedly suffer by discriminatory taxation of municipal bond

income — the states themselves — have never challenged the

practice[, and] have almost uniformly adopted this method of

subsidizing local public works bonds.” Scott K. Attaway,

Note, The Case for Constitutional Discrimination in Taxation

of Out-of-State Municipal Bonds, 76 B.U. L. Rev. 737, 767

(1996).

B. The Widespread Practice by States of Exempting

Their Own Bonds, While Taxing the Bonds of

Sister States, Is Directed Toward Legitimate Goals

Unrelated to Protectionism.

1. To understand why States do not extend the tax

exemption to bonds issued by other States, it is helpful to

understand why States grant the exemption to their own bonds.

N.M. Stat. § 7-2-2(B)(3), (V) (2005); N.Y. Tax Law § 612(b)(1)

(McKinney Supp. 2006); N.C. Gen. Stat. § 105-134.6(c)(1) (2007);

N.D. Cent. Code § 57-38-01.2(1)(g) (2005); Ohio Rev. Code Ann.

§ 5747.01(A)(1) (LexisNexis Supp. 2007); Okla. Stat. Ann. tit. 68,

§§ 2358 (A){1), 2358.5A(A) (West Supp. 2007); Or. Rev. Stat.

§ 316.680(2)(a) (2005); 72 Pa. Stat. Ann. §§ 7302, 7303(a)(6),

9901 (West Supp. 2007); R.I Gen. Laws § 44-30-12(a), (b)(1)

(Supp. 2006); S.C. Code Ann. § 12-6-1120(1) (2000 & Supp. 2006);

Tenn. Code Ann. § 67-2-104(e)(1) (Supp. 2006); Vt. Stat. Ann. tt.

32, § S811¢18)A)G)UD (Supp. 2006); Va. Code Ann.

§ 58.1-322(B)(1) (Supp. 2007); W. Va. Code Ann.

§ 11-21-12(b)(1 (LexisNexis Supp. 2007); bur see Ind. Code Ann.

§ 6-3-1-3.5 (LexisNexis Supp. 2006) (extending the exemption to

interest earned on bonds issued by governmental entities outside

Indiana).

9

As an initial matter, bond issuances are essential for States to

provide needed services to their residents. Not only do they

allow States to undertake necessary capital improvements

without having to impose exorbitant taxes, they also allow

States to spread the cost of the project over its life. Robert S.

Amdursky & Clayton P. Gillette, Municipal Debt Finance

Law: Theory and Practice § 1.1.3, at 10-11 (1992). Thus,

bond issuances ensure that the cost of the State’s capital

improvements will be distributed fairly among taxpayers over

the life of those improvements.

The tax exemption of bonds allows state and local

governments to pay lower interest rates compared with rates

paid on taxable corporate bonds of equal risk and maturity. See

Michael J. Graetz & Deborah H. Schenk, Federal Income

Taxation: Principles and Policies 215-16 (5th ed. 2005). A

rational bond purchaser takes into account the total cost of the

bond (i.e., the original purchase price less the taxes that will

have to be paid on it). Laura v. Droll, 187 N.W. 876, 878

(Neb. 1922) (“It is self-evident that an investor is concerned

mainly with the net returns upon his investment, and if the state

or its municipalities issues a security drawing a certain rate of

interest, and at the same time taxes the owner of the security a

given rate, his net return is the difference between the amount

of taxes paid thereon and the amount of interest received.”).

If a bond is exempt from taxation, the potential purchaser

will be willing to pay more for the bond (or accept a lower

interest rate). Thus, when a State, such as Kentucky, sells a

bond in the marketplace, it can either: (1) tax the income from

that bond over time or (2) exempt the bond from taxation and

thereby obtain a more favorable interest rate. Instead of

collecting taxes on its bonds over the terms of the bonds and

then remitting these tax payments to the specific projects being

financed, Kentucky has effectively reinvested these taxes back

10

into the projects at the outset by obtaining more favorable

interest rates when the bonds are issued.’

The tax exemption not only allows States to obtain more

favorable financing terms, it also gives States the option of

borrowing greater sums without jeopardizing their credit

ratings. A State’s credit rating directly affects the State’s

borrowing costs. If a State is unable to maintain an acceptable

credit rating, its borrowing costs will become prohibitively

high. See Robert Lamb & Stephen P. Rappaport, Municipal

Bonds: The Comprehensive Review of Tax Exempt Securities

and Public Finance 52 (1980). By exempting its own bonds

from taxation, a State can lower its borrowing cost and,

consequently, borrow a greater amount without jeopardizing its

credit rating.

All told, the tax exemption of bonds is an indispensable

tool in ensuring the States’ fiscal needs. States have chosen to

exempt their own bonds from taxation because it allows them

to lower their borrowing costs and to increase the amount of

money available to build schools, hospitals and roads.

> Thus, with each debt-service payment, Kentucky is collecting

an implicit tax on Kentucky bonds in lieu of the explicit tax that

Kentucky collects on the bonds of other States. See Edward

Zelinsky, For Realization: Income Taxation, Sectoral Accretionism,

and the Virtue of Attainable Values, 19 Cardozo L. Rev. 861, 912

(1997) (stating that “the owners of municipal bonds .. . pay an

implicit tax in the form of higher purchase prices and lower rates of

return”); Edward Yorio, Equity, Efficiency and the Tax Reform Act

of 1986, 55 Fordham L. Rev. 395, 398 (1987) (“It is generally

acknowledged that the rate of return on [tax-exempt] bonds is lower

than the rate of return on comparable, fully-taxable investments of

equivalent risk. To the extent of the difference between those rates

of return, the investor is in effect paying an ‘implicit tax.*”).

== = v ——— ee =? CO A Ale ae le Ae “ie la ill. _—enllla

1]

2. Kentucky, like almost every other State in the Union,

has concluded that the tax exemption for interest income

should not be extended to its sister States’ bonds. There are

sound and sensible reasons for this decision. When Kentucky

exempts its bonds from taxation, it is sacrificing future tax

revenues from those bonds so that more money can be invested

in Kentucky schools now. If Kentucky were to exempt the

bonds of other States from taxation, it would be giving up state

income taxes without any corresponding benefit to the

construction of public works in Kentucky. Thus, granting a

tax exemption to bonds issued by Kentucky and its

subdivisions furthers the State’s legitimate interests. Granting

a tax exemption for out-of-state bonds does not. Kentucky

should not be forced to forgo state tax revenues to fund the

construction of schools in other States. See Reeves, Inc. v.

Stake, 447 U.S. 429, 442 (1980) (concluding that dormant

Commerce Clause does not preclude a State from “restricting

to state residents the enjoyment of state educational

institutions, energy generated by a state-run plant, police and

fire protection, and agricultural improvement and business

development programs”). Although Kentucky has a core

sovereign interest in the exercise of its borrowing, spending

and taxing powers, Kentucky has no stake in the price of other

States’ bonds and in the trade-off that other States make

between collecting funds sooner rather than later.

This Court has stressed that the Commerce Clause does

not “prevent the States from structuring their tax systems to

encourage the growth and development of intrastate commerce

and industry.” Boston Stock Exch. v. State Tax Comm'n, 429

U.S. 318, 336 (1977). In fact, it is “a laudatory goal in the

design of a tax system to promote investment that will provide

jobs and prosperity to the citizens of the taxing State.” Trinova

Corp. v. Michigan Dep’t of Treasury, 498 U.S. 358, 385

(1991). Kentucky — and the other 37 States with similar tax

systems — are merely seeking to effectuate those objectives.

12

C. The States’ Treatment of Interest Earned on State

and Local Bonds Is Not Discriminatory Within the

Meaning of the Dormant Commerce Clause.

In United Haulers, the Court recognized that “it does not

make sense to regard laws favoring local government and laws

favoring local private industry with equal skepticism.” 127 S.

Ct. at 1795. This is because “laws favoring local government”

typically further legitimate, non-protectionist interests and

because local government is not “similarly situated” to

potential competitors. /d. States furnish public services to

their citizens; no other entity competes with a State to

undertake that traditional obligation. All this holds true with

respect to States’ treatment of interest earned on government

bonds.

Kentucky’s taxation system helps state and local

governments fulfill their essential functions; it does not favor

private industry. The system does not give any private industry

based in Kentucky a competitive advantage over private

industries located out-of-state. The statutes at issue achieve a

single and simple purpose — the State is allowed to give up

future tax revenue to obtain better financing terms on the bonds

itissues. These bonds then help finance capital improvements

necessary to the well-being of the State’s residents. Because

Kentucky’s taxation system “treat[s] in-state pnvate business

interests exactly the same as out-of-state ones,” it does not

violate the dormant Commerce Clause. /d. at 1797.

Moreover, the dormant Commerce Clause is focused on

the differential treatment of entities that are substantially

similar. “‘[AJny notion of discrimination assumes comparison

of substantially similar entities.’” Jd. at 1795 (quoting Gen.

Motors Corp. v. Tracy, 519 U.S. 278, 298 (1997)). Because

Kentucky is not substantially similar to other bond issuers,

Kentucky’s practice is not discriminatory.

13

No other State is in the business of providing public works

within the State of Kentucky. Additionally, Kentucky is the

only State that can agree to forgo the payment of taxes that

would otherwise be due to the Kentucky Treasury and thereby

obtain better financing terms for infrastructure to be built in

Kentucky. Kentucky stands in the unique position of being

both the seller and the tax collector with respect to its bonds.

No other State stands in this same position with respect to

Kentucky state taxes. Consequently, Kentucky is not similarly

situated for Commerce Clause purposes with other issuers

selling their bonds in Kentucky.

This is precisely the lesson of Bonaparte. The Court

recognized that because a State bond issuer “cannot secure

such an exemption outside of its own jurisdiction, it is

compelled to go into the market as a borrower, subject to the

same disabilities in this particular as individuals.” 104 U.S. at

595. When another State seeks to sell bonds to Kentucky

residents, it does not do so as a sovereign governing those

residents. It does so as an economic actor trying to convince

Kentucky residents that investing in its bonds would be wiser

than investing in, say, IBM stock. The relationship between

Kentucky and its residents — in general and specifically with

respect to the sale and tax treatment of its bonds — is far

different. Kentucky stands in the unique position of being the

seller, tax collector and spender with respect to its bonds.

General Motors cements the point. In that case, the Court

was faced with a challenge to Ohio’s taxation system on

natural gas sold within the State. Although Ohio imposed a

sales and use tax on natural gas, Ohio excepted regulated

public utilities from this tax. Thi: Court held that Ohio’s

taxation system did not violate the dormant Commerce Clause

because regulated public utilities were not similarly situated to

other sellers of natural gas. Because regulated public utilities

were required to provide gas bundled with other services —

such as serving all members of the public without

14

discrimination, “providing a firm backup supply of gas,” and

assuring continued service to low-paying customers — the

products that they solid differed from the products sold by

independent gas marketers. Gen. Motors Corp., 519 U.S. at

297, 303-04. The Court emphasized that these services

provided by the utilities “serve[] important interests in health

and safety” and that “health and safety considerations [may] be

weighed in the process of deciding the threshold question

whether the conditions entailing application of the dormant

Commerce Clause are present.” Jd. at 306, 307.

So too, here, the entity that is receiving favorable tax

treatment is an entity whose mission is furthering the public

interest of people in the taxing State. Indeed, it is the one

entity that, under our constitutional structure, is charged solely

with serving the interests of the citizens of Kentucky. The

favorable tax treatment of Kentucky bonds helps in achieving

those public interests — just as in General Motors. This would

not be the case with respect to other private and public bond

issuers. For purposes of the Commerce Clause, Kentucky is

not similarly situated to other issuers of bonds.

The manner in which Kentucky has chosen to finance state

and local government is consistent with an “essential and

patently unobjectionable purpose of state government — to

serve the citizens of the State.” Reeves, 447 U.S. at 442. The

State does not discriminate against interstate commerce when

it chooses not to finance other state governments at the same

time.

Hi. AS A SELLER OF BONDS, KENTUCKY STANDS

AS A MARKET PARTICIPANT.

The dormant Commerce Clause does not “limit the ability

of the States themselves to operate freely in the free market.”

Reeves, 447 U.S. at 437. Rather, when States act as “market

participants,” as consumers or vendors, their actions are

15

exempt from Commerce Clause analysis. Jd. at 439. It is only

when the States act as regulators that Commerce Clause

analysis is triggered.

The critical issue in distinguishing between the State as a

regulator and as a market participant is whether the provision

in question affects private trade and not the State’s own trade.

As this Court concluded in White v. Mass. Council of Constr.

Employees, 460 U.S. 204, 218 (1983), whether a State is

viewed as a market participant “should turn primarily on

whether a particular state action more closely resembles an

attempt to impede trade among private parties, or an attempt,

analogous to the accustomed right of merchants in the private

sector, to govern the State’s own economic conduct and to

determine the parties with whom it will deal.”

A State’s issuance of bonds and the tax treatment it

accords those bonds is a classic example of a State acting in its

role of market participant. When a State sells a bond, it is

entering into a contractual agreement to repay a loan over time.

The State’s covenant with the bond purchaser that it will not

tax the “swe!, in turn, is an essential aspect of that contractual

agreein:’ Jecause it directly establishes the net return the

bondholder will obtain on his investment. Accordingly,

Kentucky’s agreement to forgo the collection of state income

tax cannot be separated from its status as a seller seeking to

obtain the best possible terms for its product in the

marketplace. The Kentucky Court of Appeals’ decision

attempting to separate Kentucky’s role as a bond seller from its

role in setting the tax status for those bonds should be rejected.

Respondents mistakenly contend that this Court’s decision

in New Energy Co. v. Limbach, 486 U.S. 269 (1988), dictates

that Kentucky should not be treated as a market participant.

See Br. in Opp. 11-13. New Energy, however, is not on point.

In New Energy, Ohio provided favorable tax treatment for

purchases of ethanol only if the ethanol was produced in Ohio

or in a State that granted similar tax advantages to ethanol

16

produced in Ohio. As such, Ohio was not acting as a seller or

purchaser itself but was instead attempting to provide

economic benefit to particular private entities. Here, unlike in

New Energy, Kentucky’s tax treatment of its bonds is an

integral part of its sale of its own product. The market

participant doctrine thus clearly applies.

Ill. THE RULE ADOPTED BY THE LOWER COURT

WOULD HAVE DEVASTATING EFFECTS ON THE

STATES’ FISC AND THE BOND MARKET, AND

REFLECTS A DECISION BETTER LEFT TO

CONGRESS.

If the decision of the Kentucky Court of Appeals is upheld,

the impact upon the States’ fisc will be devastating. Moreover,

such a holding will likely destabilize the bond market. Any

change to this longstanding taxation practice is better left to

Congress, which has thus far countenanced the practice.

1. If a State’s tax system is found to be discriminatory in

violation of the dormant Commerce Clause, the State has three

options to remedy the violation: (1) refund the additional taxes

paid by the taxpayers who suffered an undue burden, (2)

retroactively impose higher taxes on those who benefitted by

the discrimination or (3) some combination of both. Fulton

Corp. v. Faulkner, 516 U.S. 325, 346-47 (1996). Although a

State could, in theory, correct past discrimination by retro-

actively imposing a higher tax on the holders of tax-exempt

bonds who benefitted by the discrimination, that option is not

realistic for most States. First, States would face significant

constitutional and political hurdles if they were to attempt to

increase retroactively taxes for tax years that are already

17

closed.’ Second, numerous States have state constitutional

provisions that preclude their legislature from taxing their own

State’s bonds.‘ Third, many States have statutory provisions

that create a covenant between the bondholder and the State in

which the State agrees, for the life of the bond, not to tax

interest arising from the bond.°

Should the decision below be affirmed, most States would

therefore be faced with refunding any taxes deemed to be

discriminatory. For some States, that liability will go back for

seven or more years. New York, which generally allows tax

refund claims to be submitted for three years following the

filing of the return, estimates that the refund claims it faces

total $200 million. Thus, States are looking at collective

liability in the billions of dollars should this longstanding state

practice be declared unconstitutional.

In addition to being subject to claims totaling billions,

States will lose a substantial revenue stream on a going forward

basis. State and municipal bonds are frequently issued for

> North Carolina, for example, cannot realistically impose a

retroactive tax on all taxpayers who held tax-exempt North Carolina

bonds during calendar year 2001 (the first tax year at issue in a

pending class action filed against the State).

* See, e.g., Ky. Const. § 171; Ohio Const. art. VIII, §§ 2k(D)(4),

2\(E), 2m(D), 2n(E), 20(G), 2p(E) (interest on state bonds “shall at

all times be free from taxation within the state”).

* See, e.g., Cal. Gov’t Code § 99016 (Deering 2007); Ga. Code

Ann. § 32-10-49 (2007); Ky. Rev. Stat. Ann. § 58.580 (West Supp.

2006); N.Y. Pub. Auth. Law § 372 (McKinney 2004); Va. Code

Ann. § 15.2-5361 (2007).

* See, e.g., Dunn v. State, 635 S.E.2d 604 (N.C. Ct. App. 2006)

(class action seeking refund for tax years 2001 and forward), disc.

review granted, 361 N.C. 351 (2007).

18

terms of up to 40 years, depending upon the nature of the

project being financed. If a State is contractually obligated to

treat previously-issued bonds as tax-exempt, that State may be

locked into exempting all bonds (both bonds previously issued

by the State and the bonds of its sister States) for the next 40

years. Thus, the existence of outstanding bond issuances may

well limit the ability of States to tax prospectively all bonds the

same. The only choice for many States may be to exempt all

bonds for decades to come. States and local governments will

then be forced to raise other taxes substantially to replace this

lost revenue.

North Carolina’s experience following Fulton illustrates

the budgetary crises that States will face should the decision

below be affirmed. In Fulton, this Court concluded that North

Carolina’s intangibles tax violated the dormant Commerce

Clause. 516 U.S. at 346-47. The Fulton decision involved a

single taxpayer who had challenged the tax. Shortly after the

Fulton decision, however, a class action was filed by a

different litigant on behalf of all taxpayers who had paid the

intangibles tax to the State. See Smith v. State, 507 S.E.2d 28

(N.C. 1998). In that action, the North Carolina Supreme Court

held that all intangible taxes collected by the State of North

Carolina from 1991 through 1994 had to be repaid by the State.

North Carolina ultimately paid $586 million in settlement of

the class action. The combined effect of repaying this sum and

losing a significant revenue stream contributed to a state

budgetary crisis that required the Governor to declare a state of

fiscal emergency. Chnstopher Kirkpatrick, Easley Declares

Fiscal Emergency, Durham Herald Sun, Feb. 9, 2001, at Al.

Over a decade after the Fulton decision, the State of North

i9

Carolina remains in litigation over the emergency measures

that were taken to keep the doors of State government open.’

2. If the decision of the Kentucky Court of Appeals is

upheld, the bond market will also be substantially impacted.

See Noonan, supra, at 969 (noting upheaval that will occur in

bond market). Bondholders face a risk of substantial

devaluation of their bonds, particularly bonds issued by States

with high state income taxes.’ Individuals who hold such

bonds may see the market value of their assets decline. See

Denison, supra, at 10. Moreover, such losses will cause many

investors to be less inclined to make future purchases of

municipal bonds.

3. Respondents are asking this Court to dramatically alter

how the States have taxed bonds for the past hundred years.

Such a change is best left in Congress’ hands. “The

Constitution gives that branch of government [Congress] the

power to regulate commerce among the states, and until it acts

. . . we should enter the field with extreme caution.” Gen.

Motors, 519 U.S. at 310 (quoting Northwest Airlines, Inc. v.

” See Goldston v. North Carolina, 637 S.E.2d 876 (N.C. 2006)

(challenge to Governor’s emergency appropriation from State

Highway Trust Fund); see a/so Coley v. State, 631 S.E.2d 121 (N.C.

2006) (challenging mid-year increase of state income taxes); County

of Cabarrus v. Tolson, 610 S.E.2d 443 (N.C. Ct. App. 2005)

(challenging Governor’s emergency appropriation of funds originally

earmarked for loca] government).

* Although many States will not have the option of retroactively

taxing bonds that were originally issued as “tax-exempt” by the

State, the remedy that is ultimately implemented in each State must

be determined, as an initial matter, by state legislatures and state

courts. Until the specific remedy becomes settled for each State, the

uncertainty as to whether States may tax all bonds will significantly

depress the value of “tax-exempt” bonds.

20

Minnesota, 322 U.S. 292, 302 (1944) (Black, J., concurnng));

see also Quill Corp. v. North Dakota, 504 U.S. 298, 318 (1992)

(concluding that burden on interstate commerce is “not only [a

determination] that Congress may be better qualified to

resolve, but also one that Congress has the ultimate power to

resolve”).

This is especially true where Congress has long been

aware of a common state taxing practice and has taken no

action to forbid it. As this Court observed more than 125 years

ago, “[t]he long continued silence of Congress, with its plenary

power, in the presence of . . . [state legislation] is itself an

implied ratification and adoption, and is equivalent in its

consequences to an express declaration to that effect.” Wilson

v. McNamee, 102 U.S. 572, 575 (1880); see also Gen. Motors

Corp., 519 U.S. at 305 (concluding that Congress’ failure to

alter a longstanding state practice indicates that Congress

believes the practice to be “within the realm of what the States

may reasonably promote and preserve”). That 1s exactly the

situation here. Although Congress has carefully studied the

States’ longstanding practice with respect to the exemption of

interest earned on government bonds, it has chosen not to alter

or ban it.

For example, in 1959, Congress directed both the

Committee on the Judiciary of the House of Representatives

and the Committee on Finance of the Senate to make a full and

complete study of “all matters pertaining to the taxation by the

States of income . . . from the conduct of business activities

which are... a part of interstate commerce.” Pub. L. 86-272,

§ 20), 75 Stat. 555, 556 (1959). The resulting reports of the

Spec'a! Subcommittee on State Taxation of Interstate

Commerce were presented to Congress in 1964 and 1965. The

Subcommittee sought to identify “the conflicts between the tax

policies of the States and the national policy of assuring the

free flow of commerce.” Special Subcommittee on State

Taxation of Interstate Commerce, Committee on the Judiciary,

21

House of Representatives, State Taxation of Interstate

Commerce, H.R. Rep. No. 88-1480, at iii (1964).

In its report, the Subcommittee detailed the practice by

States of exempting their own bonds from taxation, while

taxing the bonds of other States. H.R. Rep. No. 88-1480, pt. 2,

at 258-59 (1964). The report expressly listed the States that

engaged in this practice and those that did not. Jd. at 259, H.R.

Rep. No. 88-1480 app. L at A371-A433 (1964). The report,

however, did not identify the taxation of bonds as an area of

conflict between State and national policy. The study therefore

made no recommendation of change in this area. Rather, the

study made the general recommendation that States “should be

as free as possible to pursue their own tax policies even though

they are at variance with the Federal policy.” H.R. Rep. No.

89-952, pt. 6, at 1159 (1965). Congress made no effort to

change taxation of state and local bonds after receiving the

Subcommittee’s report.

On numerous other occasions, Congress has been made

aware that most States exempt their own bonds from state

taxation while taxing the bonds of other States. See, e.g., H.R.

Rep. No. 91-413 (1969), reprinted in 1969 U.S.C.C.A.N. 1645,

1825 (“State and local governments generally do not directly

tax interest on Federal bonds, but they tax the interest income

on bonds issued by other States.””); S. Rep. No. 91-552 (1969),

reprinted in 1969 U.S.C.C.A.N. 2027, 2253 (noting state

practice of taxing bonds of other States). Thus, Congress is

well aware of, and has carefully studied, this practice. Its

failure to act strongly supports the practice’s validity under the

Commerce Ciause.’

* Another indication of Congress’ at least implicit approval of the

practice is its actions with respect to Hawaii. In 1901, the United

States territory of Hawaii began exempting its own bonds from

taxation while taxing the bonds of the States and other territories.

xe ek *

The decision of the Kentucky Court of Appeals interferes

with a fundamental aspect of state sovereignty — the ability of

States to determine the most appropriate means of raising

revenue in order to provide for the common good. Principles

of state sovereignty counsel that this Court should exercise

restraint in restricting the manner in which Kentucky

undertakes to sell its bonds. See Reeves, Inc. v. Stake, 447 U.S.

429, 438 (1980). Federal solicitude for the States’ power to

manage their debts goes back to the founding of the Republic.

See, e.g., the Federalist No. 81 (Alexander Hamilton)

(Arlington House 1965); accord Boston Stock Exch. v. State

Tax Comm'n, 429 U.S. 318, 328 (1977) (“The Commerce

Clause does not... eclipse the reserved ‘power of the States to

tax for the support of their own governments.’”) (quoting

Gibbons v. Ogden, 22 U.S. 1, 199 (1824)). Kentucky’s

legislature should be permitted to determine whether it makes

good economic sense for the State to forgo payment of taxes on

Kentucky bonds in order to obtain more money now (and better

1901 Hawaii Sess. Laws 31-32. Although Congress had clear

authority to override this practice, it did not do so. See U.S. Const.

art. IV, § 3, cl. 2; Nat'l Bank v. County of Yankton, 101 U.S. 129,

133 (1880). In fact, during the 59 years that Hawaii was a territory

of the United States, the tax exempt bonds that Hawaii issued were

expressly approved by Congress and the President of the United

States. See, e.g., 31 Stat. 161 (1900) (Hawaii Organic Act) (bond

issuances to be approved by the President); 66 Stat. 133 (1952)

(Congressional approval! of Hawaii bond issuance). Moreover, when

Hawaii was ultimately admitted into the Union, Congress recognized

that Hawaii's territorial laws (which at the time included tax

exemption for Hawaii bonds but not other States) “shall continue in

force.” 73 Stat. 4, 11 (1959).

23

financing terms) to build schools, hospitals and roads. The

dormant Commerce Clause does not require that this choice be

taken out of the hands of Kentucky’s elected officials.

CONCLUSION

The judgment of the Kentucky Court of Appeals should be

reversed.

Respectfully submitted,

ROY COOPER

Attomey General of North Carolina

Christopher G. Browning, Jr.*

Solicitor General of North Carolina

Kay Linn Miller Hobart

Special Deputy Attorney General

Gregory P. Raney

Assistant Attorney General

Counsel for Amici Curiae

July 19, 2007 *Counsel of Record