Petition for Writ of Certiorari — Moran v. Hibbs

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C) No. Supreme Court, U.S.

OO a es a)

INTHE O31405 Mat > 3 2004

Supreme Court of the United States

SUSAN MORAN, et al..

Petitioners,

v.

J. ELLIOTT HIBBS, et al...

Respondents.

On Petition for Writ of Certiorari to the

Supreme Court of Arizona

PETITION FOR WRIT OF CERTIORARI

PAUL V. BONN MICHAEL J. KATOR *

RANDALL D. WILKINS KATOR, PARKS & WEISER, PLLC

D. MICHAEL HALL 1020 19th Street, Suite 350

BRIAN A. LUSCHER Washington, D.C. 20036

BONN & WILKINS, CHARTERED = (202) 898-4800

805 North Secord Street

Phoenix, AZ 85004

(602) 254-5557

EUGENE O. DUFFY

O’NEIL, CANNON, HOLLMAN,

DEJONG, S.C.

Suite 1400, 111 East Wisconsin Avenue

Milwaukee, Wisconsin 53202-4803

(414) 276-5000

Counsel for Petitioners

April 29, 2004 * Counsel of Record

SHE SNR UNE RPE ATE ASR IE AE MSO NAR ea

WILSON-EPES PRINTING CO., INC. — (202) 789-0096 — WASHINGTON, D.C. 20001

QUESTION PRESENTED

Whether state taxation of the mandatory retirement plan

contributions of federal civilian employees violates 4 U.S.C.

§ 111 (2000) when the mandatory retirement plan contribu-

tions of identically-situated state and local government

employees are exempt from state tax.

_

il

PARTIES TO THE PROCEEDING

The parties to the consolidated proceedings below were the

taxpayer plaintiffs, Clark J. Kerr, his wife, Billie Sue Kerr,

Susan Moran, Steve Allen and John Udall. The action was

brought as a class action on behalf of each of the taxpayer

plaintiffs and the approximately 42,000 similarly circum-

stenced federal employees in the State of Arizona. The

defendants included Mark J. Killian in his official capacity as

the Director of the Department of Revenue and the Arizona

Department of Revenue. The Department of Revenue also

appeared as a plaintiff with respect to its claim concerning the

tax year 1984. The taxpayer plaintiffs and the law firms of

Bonn, Luscher, Padden & Wilkins, Chartered, its successor in

interest, Bonn & Wilkins, Chartered, and O’Neil, Cannon &

Hollman, S.C. maintained counterclaims against the Depart-

ment of Revenue regarding attorney fees. Mr. Kerr did not

work for the federal government after 1990 and therefore, he

and his wife are not petitioners here. Petitioners Susan

Moran, Steve Allen and John Udall continued as federal

employees for years after 1990. Mark J. Killian has been

succeeded as Director of the Arizona Department of Revenue

by J. Elliott Hibbs, who is thus named as a respondent in

his official capacity as Director of the Arizona Department

of Revenue.

TABLE OF CONTENTS

Page

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STATUTORY PROVISIONS INVOLVED ................. 2

SPAT REIT GF THEE CASE. cnccscccecscsscsscsssconscnsnscnseees 3

REASONS FOR GRANTING THE WRIT .................. 7

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APPENDICES

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TABLE OF AUTHORITIES

CASES Page

Barker v. Kansas, 503 U.S. 594 (1992)........cceseeee 7, 13-14

Davis v. Michigan Dep't of Treasury, 489 US.

eee Pevknisasstiniianistbcnnsetendundiciinicnienionn 3, 7, 8, 9, 10

In re Estate of Alercon, 718 P.2d 989 (Ariz.

PUM chictvessakstenicdosciiinsibtaniecieealeueanaaditaaeanes 6

Graves v. People of State of New York, ex rel

OO Keefe, FIO US. GOO (UGS) sscsescascvsvesnsecisseress 10

Harper v. Virginia Dep't of Taxation, 509 US.

BEF I Padcsviegsinesuresscusciessinnsesadandaivinsvandabiaiecsonien 8, 13

Jefferson County v. Acker, 527 U.S. 423

Fair ti ctasscsenvasinisecinaiebsenbinenihinapestiaaieniasinineadnns 10, 12, 14

Kraft Gen. Foods, Inc. v. lowa Dep't. of

Revenue, SOS U.S. 71 CPGBZ) .ccccosorscccesssovcssenccees 14

McCulloch v. Maryland, \7 U.S. (4 Wheat.) 316

CREE hecsatsposnsnnneinesevonieannsennenenraceiioonetenedinianatvetnies 10

Memphis Bank & Trust Co. v. Garner, 459 US.

FE Eh arriside tis stieacinic tandiasneeaaoiginaadivn: 12

South Carolina v. Baker, 485 U.S. 505 (1988)...... 10

Thurston v. Judges’ Ret. Plan, 876 P.2d 545

fo | De indelivinebeadactceniiaisidlinsiiebiie 13

United States v. City of Detroit, 355 U.S. 466

FaPara eiahsiniaiisctesceniscehnanbelovuneansdcueatacammaminieeaionn 10

Yeazell v. Copins, 402 P.2d 541! (Ariz. 1965)........ 13

STATUTES

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Be Ue © VE i Ce tcctoheetisnitcruaneensinée 2

Art. K. Civ, ABD. F, ZO) GI) csvcccsvscssecessvesenes 6

Ariz. Rev. Stat. § 38-792 (2004) ..........ccccceeeeeees 4-5

Ariz. Rev. Stat. § 43-1001(2) (2004)... eee 5, 12

Ariz. Rev. Stat. § 43-1021 (2004) .....................066 5

Ariz. Rev. Stat. § 43-1022 (2004) ...........eceseeeees 5, 11

V

TABLE OF AUTHORITIES—Continued

Kan. Stat. Ann. § 79-32, 117(b)(vi) (2003)...........

Me. Rev. Stat. Ann. tit. 36, § 5122(G) (West

Pai suena da tinditienphiaaicsalanedanirmnamnadtncn dinate

Mass. Gen. Laws Ann. ch. 32 § 22(10) (2004) .....

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

Ce is scknscdnacissakeacanuemadsaadinsuniekusctivamientidan maine

Md. Code Ann., Tax-Gen. § 10-204(f) (2003)......

N.Y. Tax Law § 612(b) (26) (Consol. 2004).........

OTHER AUTHORITIES

Brief Amici Curiae of the States of Arizona and

North Carolina in support of Virginia

Department of Taxation, U.S. No. 91-794

CE, hy SE) scccteenisaiseiasniesscedevanitlbvaaenieaataiaas

CLM, FPSO I. Ba COG sicsscecesansinisiaspinncincee

http://opm.gov/feddata/geograph/table3.pdf

COIGIINE FIRE, £1. Be enacseoreaialaaaeets

Re: § 58.1-1821 Application: Indiv. Income Tax,

P.D. 94-354, 1994 Westlaw 722715 (Va. Dep’t

FER, FROM, 2S, Te vinitstinistinrnsiiinniaeniins

Page

13

1]

IN THE

Supreme Court of the Anited States

No.

SUSAN MORAN, ef al..

Petitioners.

Vv.

J. ELLIOTT HIBBS, ef al.,

Respondents.

On Petition for Writ of Certiorari to the

Supreme Court of Arizona

PETITION FOR WRIT OF CERTIORARI

Susan Moran, Steve Allen and John Udall, on behalf of

themselves and all others similarly situated, respectfully

petition this Court for a writ of certiorari to the Supreme

Court of Arizona.

OPINIONS BELOW

The opinion of the Supreme Court of Arizona is reported at

84 P.3d 446 (2004). App la—22a. The amended decision of

the Arizona Court of Appeals is reported at 65 P.3d 434

(Ariz. Ct. App. 2001). App. 23a—49a. The initial decision of

the Arizona Court of Appeals in this case is reported at 32

P.3d 408 (Ariz. Ct. App. 2001). App. S50a-69a. The

Judgment of the Arizona Superior Court on the parties’ cross

motions for summary judgment is unreported. App. 70a—73a.

For the sake of completeness, prior opinions of the Arizona

Court of Appeals, which provide additional historical back-

ground of this controversy and litigation, are reported at

5

3 P.3d 1133 (Ariz. Ct. App. 2000), App. 74a-87a; 916 P.2d

1173 (Ariz. Ct. App. 1996), App. 88a—106a; and 899 P.2d

162 (Ariz. Ct. App. 1994). App. 107a—153a.

JURISDICTION

The opinion of the Supreme Court of Arizona was entered

on February 13, 2004. This petition is, accordingly, filed

within the time allowed by law. Jurisdiction to review the

decision in this case by writ of certiorari is conferred upon

this Court by 28 U.S.C. § 1257(a) (2000).

STATUTORY PROVISIONS INVOLVED

Title 4, United States Code, section 111 provides, in

relevant part:

The United States consents to the taxation of pay or

compensation for personal service as an officer or

employee of the United States ... by a duly constituted

taxing authority having jurisdiction, if the taxation does

not discriminate against the officer or employee because

of the source of the pay or compensation.

Title 26, United States Code, section 414(h) provides, in

relevant part:

Tax treatment of-certam contributions.—

(1) In general.—Effective with respect to taxable years

beginning after December 31, 1973, for purposes of this

title, any amount contributed—

(A) to an employees’ trust described in section 401 (a),

or

(B) under a plan described in section 403(a), shall not

be treated as having been made by the employer if it is

designated as an employee contribution.

(2) Designation by units of government.—For purposes

of paragraph (1), in the case of any plan established by

the government of any State oy political subdivision

3

thereof, or by any agency or instrumentality of any of

the foregoing, where the contributions of employing

units are designated as employee contributions but

where any employing unit picks up the contributions, the

contributions so picked up shall be treated as employer

contributions.

Pertinent provisions of the relevant state statutes are set forth

at App. 157a—163a.

STATEMENT OF THE CASE

This litigation arose in the wake of this Court’s decision in

Davis v. Michigan Dep't of Treasury, 489 U.S. 80% (1989),

In Davis, this Court invalidated Michigan's taxing scheme

that discriminated in favor of local and state government

retirees and against federal retirees. /d. at 817. This case,

like Davis, involves a taxing scheme shared by over 20 states

that affects over a million federal employees. But unlike

Davis, this case involves discriminatory state taxation of the

current compensation of federal employees.

Arizona, like most governmental employers, offers con-

tributory pension plans for its employees. In order for state

and local pensions plans to be “qualifying” under the Internal

Revenue Code, they must include both employer and

mandatory employee contributions. Thus, like the federal

pension plans, Arizona’s plans include both employer and

mandatory employee contributions. Unlike the federal plans,

however, Arizona is authorized under the Internal Revenue

Code, and has opted, to pick up the payment of the em-

ployees’ mandatory contribution. For federal income tax

purposes only, the mandatory contribution “picked up” by the

state is excluded from federal adjusted gross income.

In addition to picking up employees’ mandatory con-

tributions, since as far back as 1943 Arizona has also

exempted this portion of state employees’ compensation from

State income tax. This exemption applies currently to a// state

4

and local employees in the State of Arizona.’ Arizona does

not provide a similar exemption for federal employees. Thus,

Arizona state and local employees pay no state income tax on

the portion of their compensation representing the employee

mandatory contribution to their pension plan while federal

employees pay income tax to the State of Arizona on that

identical portion of their current compensation. Under

Arizona’s tax scheme, for example, a hypothetical federal

employee who earned $100,000 and who made a seven per

cent retirement contribution would pay state income tax on

the full $100,000 salary; an identically situated state

employee would pay state income tax only on $93,000 of his

$100,000 salary.

This discriminatory treatment arises out of two inde-

pendent statutory bases. First, the exemption from income

tax for current state and local employees is contained in the

Statutory provisions of the various state retirement plans

themselves. Just as Arizona formerly provided a statutory

exemption for the pensions of state and local employees, it

currently provides in the various pension statutes exemption

from taxation for the mandatory employee contribution. See

App. 7a n.6 (“In addition to the subtractions from income

previously set forth [in the state tax code] for contributions to

state retirement plans, the statutes governing [the state

retirement plans] have long provided that member contri-

butions ‘are exempt from state, county and municipal

taxes.’’’) (citation omitted). See also Ariz. Rev. Stat. § 38-

' Between 1991 and 1999, new hires in two small retirement plans

were not provided this exemption. During this same period, well over

180,000 state and local government employees were exempt from the tax.

Until 1990, Arizona also provided an express subtraction in its income tax

code for State employees’ mandatory contributions. However, the State

confessed judgment as to those years, acknowledging that Arizona’s

discriminatory scheme violated 4 U.S.C. § 111 and the intergovernmental

tax immunity doctrine because of the express subtraction.

5

792 (2004) (“The member and employer contributions . . . are

exempt from state, county and municipal income taxes.”)

App. 160a.

The second source of the exemption for state and local

government employees is Arizona’s adoption of the federal

adjusted gross income from the Internal Revenue Code as the

Starting point for determining Arizona gross income. See

Ariz. Rev. Stat. § 43-1001(2) (2004) (“‘Arizona gross in-

come’ of a resident individual means the individual’s federal

adjusted gross income for the taxable year, computed

pursuant to the internal revenue code.”).” Under 26 U.S.C.

§ 414(h), employee retirement contributions of state and local

governments “picked up” by the employer are excluded from

federal adjusted gross income. Accordingly, in Arizona (and

many other states), that portion of state and local employees’

compensation representing their mandatory retirement con-

tribution is excluded from federal adjusted gross income, and

thereby escapes state taxation. There is no Arizona income

tax subtraction that permits federal employees to subtract

their mandatory contributions from Arizona gross income,

nor is there a provision that requires State employees to add

their mandatory contributions back in to equalize the treat-

ment of the two groups.

Thus, this case arises in this Court on the undisputed record

that Arizona taxes the current compensation of all federal

employees representing their mandatory contributions to

federal retirement systems, while exempting from taxation the

identical element of compensation of its own employees. Not

only is this discrimination uncontroverted, but so too it is

conceded that the mandatory contributions of state and local

> The Arizona legislature also provides numerous subtractions and ad-

ditions to determine Arizona gross income, including, for example,

subtractions for interest from federal obligations and Railroad Retirement

Benefits. See, e.g., Ariz. Rev. Stat. §§ 43-1021 and 43-1022 (2004).

ee a

6

government employees are substantively indistinguish-

able from the mandatory contributions of federal employees

and that 26 U.S.C. § 414(h) does not affect what is

compensation.”

After years of procedural skirmisties, in 2000 the taxpayers

were finally able to obtain a ruling on the merits of their

claim. The trial court sustained their challenge, held that

Arizona’s discriminatory taxation scheme violated 4 U.S.C.

§ 111 and the doctrine of intergovernmental tax immunity,

and ordered the State to pay refunds. App. 72a. Ultimately,

the Arizona Court of Appeals affirmed the trial court. App.

24a. Yet the Arizona Supreme Court, on the State’s juris-

dictionally untimely petition for review,’ reversed the lower

courts. Despite the overwhelming evidence and admissions

by the State to the contrary, the Supreme Court of Arizona

concluded that Arizona’s discriminatory income tax scheme

does not discriminate against federal employees because of

the source of their compensation. App. 2a. The Arizona

Supreme Court reasoned that the only impediment to federal

employees receiving the same tax treatment as State em-

ployees was Congress’s failure to “pick-up” federal employ-

ees’ mandatory contributions. The court concluded that when

and if Congress changes federal law, Arizona will then treat

federal employees equally. App. 19a.

* For example, the State conceded below that the mandatory contri-

butions are part of a state or local government employee’s compensation,

including for purposes of retirement benefits calculations, workmen’s

compensation, vacation pay, sick pay, unemployment insurance and social

security benefits. See Petitioners’ Cross-Motion for Summary Judgment.

* Arizona law provides that a party must seek review within 15 days of

the mailing of a determination on reconsideration. See Ariz. R. Civ. App.

P. 23(a) (2004). See also In re Estate of Alarcon, 718 P.2d 989 (Ariz.

1986). The State’s petition was due by March 17, 2003 but it was not

filed until March 31, 2003. The Supreme Court of Arizona denied the

taxpayers’ motion to dismiss the State’s petition without comment.

BONED LP IA a DIN wa) WE

7

Because the Arizona Supreme Court’s decision is funda-

mentally flawed, and because its decision validates a discrim-

inatory taxation scheme prevalent throughout the Untied

States, the taxpayers bring this petition for a writ of certiorari.

REASONS FOR GRANTING THE WRIT

This case presents questions of substantial public im-

portance concerning the practice of Arizona, and twenty-eight

other states, of discriminatorily taxing the mandatory retire-

ment contributions of federal employees’ current compen-

sation. In Davis v. Michigan, 489 U.S. 803, 817 (1989), this

Court held that states could not tax the annuities of retired

federal employees if they exempted the annuities of state and

local government employees from state taxation. This case is

essentially indistinguishable from Davis, with the exceptions

that here the discrimination affects the current compensation

of federal employees, not their pensions, and, because the

discriminatory practices are more pervasive among the states,

the discrimination affects more federal employees.

With its decision below, the Supreme Court of Arizona has

flouted this Court’s holdings in Davis v. Michigan, and

Barker v. Kansas, 503 U.S. 594 (1992), among others. So too,

in holding that it is Congress’s burden to cure the

discrimination by altering its compensation schemes for

federal employees, the court below has turned the doctrine of

intergovernmental tax immunity on its head. Review by this

Court is necessary to bring Arizona law into conformity with

the decisions of this Court and to end its practice of

discriminating against the United States and those with whom

it deals.

1. In Davis v. Michigan, this Court invalidated Michigan‘s

discriminatory taxation of federal retirement benefits. At the

8

time the Court decided Davis, 23 states gave preferential tax

treatment to benefits received by state and local government

retirees relative to the tax treatment received by federal

employees. Harper v. Virginia Dep't of Taxation, 509 U.S.

86, 93 (1993).

Arizona’s challenged tax, in contrast to Davis, affects the

current compensation of some forty-plus thousand federal

employees.” But, as in Davis, Arizona’s discriminatory tax

scheme is not unique. Indeed, far from it—it appears that

there are at least 28 additional states that have adopted tax

schemes similar to Arizona’s that discriminate against federal

employees by providing an exemption for the mandatory

retirement contributions of state and local government em-

ployees. App. 167a-169a. Thus, this case implicates the

interests of over a million current federal employees across

the nation.

Some states that, like Arizona, have adopted the federal

Adjusted Gross Income as the starting point for determining

state tax liability, have nonetheless corrected for this

discrimination.® Maryland, for example, specifically requires

state employees to add to their Maryland adjusted gross

income amounts “excluded from federal adjusted gross

income under [26 U.S.C.] § 414(h)(2).”. Md. Code Ann.,

Tax-Gen. § 10-204(f)(2) (2003). Virginia, in contrast, makes

no such correction—indeed, its Tax Commissioner has

specifically ruled that it need not do so. See Re: § 58.1-1821

Application: Indiv. Income Tax, P.D. 94-354, 1994 Westlaw

722715 (Va. Dep’t Tax. Nov. 23, 1994). California, which

* State-by-state federal employment statistics as of December 31,

2000 are available at http://opm.gov/feddata/geograph/table3.pdf (visited

Apr. 27, 2004).

° See, e.g., Mass. Gen. Laws Ann. ch. 62, § 2(a)(1)(1) and ch. 32

§ 22(10) (2004); N.Y. Tax Law § 612(b) (26) (Consol. 2004); Kan. Stat.

Ann. § 79-32, 117(b)(vi) (2003); Me. Rev. Stat. Ann. tit. 36, § 5122(G)

(West 2003); Md. Code Ann., Tax-Gen. § 10-204(f)(1) and (2) (2003).

Oe atts in et Le

9

has the highest number of federal employees (nearly a quarter

million), joins Virginia and Arizona in discriminatorily taxing

federal employees.

This widespread difference in treatment among the states

impacts over a million federal employees nationwide. So too,

it directly implicates the interests of the United States—as

this Court recognized in Davis, “[t]axes enacted to reduce the

State’s employment costs at the expense of the federal

treasury are the type of discriminatory legislation that the

doctrine of intergovernmental tax immunity is intended to

bar.” 489 U.S. at 815 n.4. Review by this Court is necessary

not only to resolve this issue of inconsistent application from

state to state but also to ensure that the United States is

not involuntarily subsidizing the employment costs of state

governments.

2. The court below held that Arizona's discrimination was

not based on the source of federal employees’ income; rather,

it held, the discrimination was based on Congress’s allowing

states to “pick up’-employee contributions and its decision

not to “pick up” tive contributions of federal employees. App.

18a. Thus, the court held, Congress was free to cure the

discrimination simply by changing the way in which it com-

pensates federal employees: “When and if the federal

employer makes the same choice [to pick up the employee

contribution], Arizona tax law will treat its employees’ con-

tributions in an identical fashion.” App. 19a.

This holding defies the precedent of this Court. Indeed, it

turns the doctrine of intergovernmental tax immunity on its

head—it is the states’ responsibility, not Congress’s, to

ensure that they do not discriminate against the United States

or those with whom it deals. Review by this Court is

necessary to ensure that this perversion of the law of

intergovernmental tax immunity, which has already been

adopted by at least one other state, does not gain currency.

10

As this Court has held “from the time of McCulloch v.

Maryland,”’ the intergovernmental tax immunity doctrine

“barred taxes that ‘operat[e] so as to discriminate against

the Government or those with whom it deals.’” Davis v.

Michigan, 489 U.S. at 812 (quoting United States v. City of

Detroit, 355 U.S. 466, 473 (1958)). While this doctrine has

now been codified in 4 U.S.C. § 111, the prohibition against

discriminatory state taxation has been, and continues to be, a

constitutional imperative. Moreover, in all of this Court’s

jurisprudence, the doctrine has always been characterized as

one of immunity from state taxation. As such, it is not a

matter subject to states’ control or conditions. Rather, this is

an area “over which Congress is the principal superin-

tendent.” Jefferson County v. Acker, 527 U.S. 423, 437

(1999).

Indeed,

the federal tax immunity has always been greater than

the States’ immunity. The Federal Government, for

example, possesses the power to enact statutes im-

munizing those with whom it deals from state taxation

even if intergovernmental tax immunity doctrine would

not otherwise confer an immunity. See, e.g., Graves v.

People of State of New York, ex rel O'Keefe, 306 U.S.

466, 478 (1939). The States lack any such power.

South Carolina v. Baker, 485 U.S. 505, 520 n. 1! (1988). As

a corollary to this greater immunity, the United States has

always been free to discriminate in matters of taxation against

itself and those with whom it deals. For example, the federal

government has taxed income from federal bonds while not

taxing income from state bonds, but that fact gives the States

no power to discriminate. /d. Arizona recognizes this

limitation on its taxing power by its subtraction for interest

717 US. (4 Wheat.) 316 (1819).

ee eS ee ee

en fee eae

1]

received from federal obligations. See Ariz. Rev. Stat. § 43-

1022 (2004)."

The court below suggests that Arizona will cease discrim-

inating against federal employees when Congress changes its

compensation schemes for federal employees. App. 19a. So

too, the Virginia Tax Commissioner has opined that Virginia

will stop discriminating when “Congress decides to offer” a

pension plan similar to Virginia’s. P.D. 94-354, 1994

Westlaw 722715, at 2. But it is not Congress’s burden to

structure compensation for federal employees in such a way

that it mirrors how any particular state has chosen to

compensate its employees. Rather, it is the states’ privilege

to impose an income tax on federal employees, but only to the

extent that they do so in a non-discriminatory fashion.

The decision of the court below, mirrored by Virginia,

threatens to erode the government’s immunity to the point of

meaninglessness. Congress cannot possibly structure the

compensation of feccral employees in such a way that it is

identical to that chosen by all 50 states and countless other

governmental entities. Nor, of course, should it be required

to do so as a condition of obtaining equal tax treatment for

federal employees. Review by this Court is necessary to

forestall Arizona’s attempt to impose an impermissible

burden on the United States and to ensure that it remains the

states’ burden to structure their tax schemes so that they do

not discriminate against the United States or those with whom

it deals.

* The federal government in the exercise of its sovereignty has

provided a federal tax benefit for federal income tax purposes only. See

G.C.M. 39,540 (Jul. 25, 1986) (414(h) is only relevant to federal tax

treatment and does not bind the state. .. .”). Therefore, there is no basis

for the conclusion below that Congress’s action may be deemed a ground

upon which to claim that it excuses what is plainly discriminatory.

12

3. The decision below also misinterprets this Court’s deci-

sion in Memphis Bank & Trust Co. v. Garner, 459 U.S. 392

(1983). The court below suggests that the intergovernmental

tax immunity doctrine applies only to. statutes that

discriminate on their face against a federal interest. App. 16a.

However, that is not the case. This Court has repeatedly

admonished courts that in determining whether a tax violates

the federal government’s constitutional immunity, they

“*must look through form and behind labels to substance.’”

Jefferson County v. Acker, 527 U.S. 423, 439 (1999) (citation

omitted). This Court has never constrained the tax immunity

doctrine in such a fashion, which would essentially be an

open invitation to the states to engage in clever drafting to

conceal their discrimination.

Here, the substance of Arizona’s proffered rationale fails

constitutional muster for precisely the same reason that

Tennessee’s scheme failed in Memphis Bank. 459 U.S. at

398-99. Arizona’s scheme operates to discriminate in favor

of its employees and against federal employees by including

in the tax base all income of federal employees while

excluding from the tax base an identical element of income of

state and local government employees. See id. (“The State

[discriminates] by including in the tax base income from

federal obligations while excluding income from otherwise

comparable state and local obligations. We conclude,

therefore, that the Tennessee bank tax impermissibly

discriminates against the Federal Government and those with

whom it deals.”’) (footnote omitted).’

” The decision’s suggestion (App. 16a) that Ariz. Rev. Stat. § 43-

1001(2) (2004) contains no overt discrimination is untenable. As the

record establishes, including the admissions of the State’s pension expert,

having adopted the federal derinition as its tax base, under both a literal

reading and a consideration of the tax provision’s practical operation, if a

taxpayer is not an employee of the state or one of its local subdivisions,

13

The court below simply glossed over Arizona’s inde-

pendent statutory basis for the discrimination. Under long-

standing principles of Arizona law, the statutory provisions of

the State’s retirement plans are part of an employee's

employment contract and are fully vested at the date of

employment. Thurston v. Judges’ Ret. Plan, 876 P.2d 545,

546 (Ariz. 1994); Yeazell v. Copins, 402 P.2d 541, 544 (Ariz.

1965).'” Changes that disadvantage employees can operate

only as to future employees. Yeazell, 402 P.2d at 546. Thus,

every state and local government employee who enjoyed the

exemption in 1990 has also enjoyed the exemption through-

out the period in issue. App. 157a—163a.

At bottom, the court’s failure to address the independent

second source of discrimination clearly “suggests that the

State’s articulated rationale is not in fact the basis for the

disparate treatment, but only a cloak for discrimination

against federally funded benefits.” Barker v. Kansas, 503

the employee cannot qualify for the favored treatment. Stated another

way, the favored treatment under Arizona law is based exclusively on the

source of an employee’s compensation.

'’ Arizona acknowledged this much in its amici curiae brief filed in

this Court in Harper v. Virginia Dep't. of Taxation, 509 U.S. 86 (1993).

The Arizona Solicitor General explained the fact that the exemption exists

separate and apart from the provisions of the State’s tax code:

[T]he principal North Carolina and Arizona exemptions were

contained in the states’ retirement plan statutes, not in their income

tax laws. E.g., N.C. Gen. Stat. §§ 128-31; 135-9 (1986); former

A.R.S. §§ 38-762(A) and 33-781.22(A).

* *

The tax exemptions for state and local retirees were to all appear-

ances legitimate employment benefits separate and apart from the

seemingly wholly legitimate income taxes.

Brief Amici Curiae of the States of Arizona and North Carolina in support

of Virginia Department of Taxation, U.S. No. 91-794, Sept. 8, 1992 at 22

(emphasis added).

ee ae ee

14

U.S. 594, 604-05 (1992) (citation omitted), Review by this

Court is necessary to ensure that states may not so easily

escape their constitutional obligations when taxing the United

States and those with whom it deals.

4. The court below justified Arizona’s discriminatory tax

by seeking to hide behind the Internal Revenue Code.

Specifically, the court held that “nothing in the Arizona

scheme discriminates between taxpayers based on the federal

or non-federal source of income; instead the distinction is

based on whether a particular state employer has voluntarily

opted to pick up the employee contribution” as authorized by

26 U.S.C. § 414(h)(2). App. 18a. As noted above, this

reasoning is fallacious—the only employees who can benefit

under § 414(h)(2) are state and local employees. Thus,

Arizona’s saying that the discrimination is based on whether

the employer “picks up” the contribution under § 414(h)(2) is

no more compelling than saying the discrimination is based

on whether the employer has the letter “z” in its name. In

determining whether a tax violates the federal government’s

constitutional immunity, courts “must look through form and

behind labels to substance.” Jefferson County v. Acker, 527

U.S. 423, 439 (1999) (citation omitted). This the court below

failed to do.

Moreover, as this Court held in Kraft Gen. Foods, Inc. v.

lowa Dep't of Revenue, 505 U.S. 71, 82 (1992), the “adoption

of the federal system in whole or in part, however, cannot

shield a state tax statute from [constitutional] scrutiny,” |

The court below eschewed Kraft, concluding that because it

was a Foreign Commerce Clause case it was too far afield to

be instructive in resolving these Supremacy Clause and

intergovernmental tax immunity issues. App. 17a n.13. But

'' At present count a total of 43 states have adopted the federal system

in whole or in part for purposes of either the personal or corporate income

tax. App. 164a-166a.

SO

15

nothing in either the holding or rationale of Kraft suggests

that it should be so limited.

Accordingly, review by this Court is necessary to make

clear that this important principle is not limited to the

Commerce Clause. Otherwise, the decision below will

provide a road map for States to nullify federal statutory and

constitutional protections by invoking the simple expedient

that they were merely adopting the Internal Revenue Code.

This Court has never before accepted this excuse and it

should not do so now,

CONCLUSION

For each of the above reasons, the petition should be

granted.

Respectfully submitted,

PAUL V, BONN MICHAEL J. KATOR *

RANDALL D. WILKINS KATOR, PARKS & WEISER, PLLC

D. MICHAEL HALL 1020 19th Street, Suite 350

BRIAN A, LUSCHER Washington, D.C. 20036

BONN & WILKINS, CHARTERED (202) 898-4800

805 North Second Street

Phoenix, AZ 85004

(602) 254-5557

EUGENE O, DUFFY

O’ NEIL, CANNON, HOLLMAN,

DEJONG, S.C.

Suite 1400, 111 East Wisconsin Avenue

Milwaukee, Wisconsin 53202-4803

(414) 276-5000

Counsel for Petitioners

April 29, 2004 * Counsel of Record