INTERGOVERNMENTAL TAX IMMUNITIES

To what extent should the federal government be able to collect taxes from the states? To what extent should the states be able to collect taxes from the federal government? The Supreme Court has struggled with these questions for over 170 years.

In 1819, in mcculloch v. maryland, the Court held that a state tax on the operations of a bank created by the United States was in violation of the supremacy clause of the Constitution. Speaking for the Court, Chief Justice john marshall asserted that "the power to tax is the power to destroy" and stated "that the states have no power, by taxation or otherwise, to retard, impede, burden, or in any manner control the operations of the constitutional laws enacted by Congress to carry into the execution the powers vested in the general government." This same logic was used in weston v. city council of charleston (1829) to hold that a city tax imposed on stocks and bonds generally could not be applied to bonds issued by the federal government and in Dobbins v. Commissioners of Erie County (1842) to hold that states could not tax the salaries of federal employees.

In collector v. day (1871) the Court took a major step and held the federal income tax could not be applied to the salaries of state officials. It said the immunity was reciprocal and that the exemption from taxation of the federal government by the states and the states by the federal government "rests upon necessary implication, and is upheld by the great law of self-preservation."

For over half a century the Court applied the intergovernmental immunity doctrine to permit large numbers of private taxpayers to escape federal and state taxes on the ground that the tax burden would be passed on to the federal or state governments. For example, in Indian Motorcycle Co. v. United States (1931) the Court held invalid a tax imposed by the United States on the sale of a motorcycle to a city for use in its police force. The Court said that the state and federal governments were equally exempt from taxes by the other. "This principle is implied from the independence of the national and state governments within their respective spheres and from the provisions of the Constitution which look to the maintenance of the dual system." The only exception to this broad doctrine recognized by the Court was that the federal government could impose taxes on state enterprises which departed from usual government functions and engaged in businesses of a private nature, such as running a railroad or selling mineral water.

In the late 1930s, the Court began a process of dismantling the tax immunity doctrine. In graves v. new york ex rel. o ' keefe (1939), the Court upheld the imposition of a state income tax on the salary of a federal official, saying, "So much of the burden of a non-discriminatory general tax upon the incomes of employees of a government, state or national, as may be passed on economically to that government through the effect of the tax on the price level of labor or materials, is but the normal incident of the organization within the same territory of two governments, each possessing the taxing power." And, in Alabama v. King & Boozer (1941) the Court upheld a state sales tax imposed on a government contractor, even though the financial burden of the tax was entirely passed on to the federal government through a cost-plus contract.

Over the past half-century the Court has reduced the tax immunity doctrine to a very narrow scope. Private parties doing business with the federal government or leasing government property, even for completing a government contract, may be subjected to state taxation. In United States v. New Mexico (1982) the Court upheld the right of a state to tax fixed fees paid by the United States to private contractors in return for managing government installations, saying that "tax immunity is appropriate in only one circumstance: when the levy falls on the United States itself, or on an agency or instrumentality so closely connected to the Government that the two cannot realistically be viewed as separate entities." The only limit on the states is that they cannot impose taxes that discriminate against the United States. Thus, in Davis v. Michigan Department of Treasury (1989), a state was not permitted to tax the pensions received by federal retirees when it exempted state employees from the same tax.

The immunity of the states is even narrower. The Court assumes that the states themselves or their property cannot be directly subjected to federal taxation, but even here there is an exception permitting the application of nondiscriminatory federal taxes directly to some kinds of state enterprises. Recently, in South Carolina v. Baker (1988), the Court said the intergovernmental tax immunity doctrine had been "thoroughly repudiated" and held that the federal government could impose its income tax on the income received from state and local bonds. The federal tax was limited in this case to income from bonds issued in bearer form, but the Court said it could apply to all such bonds if Congress so provided.

Under the supremacy clause the federal government has one additional power: it can expand or retract its immunity from state taxation, permitting states to tax what the Court otherwise would forbid or denying the states the right to tax what the Court would otherwise permit.

The intergovernmental tax immunity doctrine now has so little vitality that it should not interfere with any reasonable, nondiscriminatory taxation by either state or federal governments. Yet attempts to use it persist. In 1989 the Supreme Court had cases in which it held that a state could tax an oil company on profits from producing oil on an Indian reservation; that a state could tax bankruptcy liquidation sales by a bankruptcy trustee; and that a tax on pensions of federal retirees was invalid when it exempted state employees from the same tax.

Edward L. Barrett
(1992)