Last week, the Supreme Court issued a ruling in Comptroller of the Treasury of Maryland v. Wynne, a case dealing with the limitations on states’ tax systems implied by the dormant Commerce Clause. On May 20, Professor Michael C. Dorf published a column here on Verdict, in which he used that case to analyze the ongoing debate about the validity of the dormant Commerce Clause as a matter of constitutional law. Professor Dorf specifically stated that he had chosen not to comment on the merits of the underlying tax issue.
In this column, I will analyze the ruling in the case, focusing in particular on the several ways in which the majority’s opinion fails to provide any reasonable rationale for its conclusion, and showing that the ultimate implications of the case are completely unclear. Other than counting as a victory for the named plaintiffs, as well as the anti-tax lobbyists that supported their case, the problem with Wynne is that we now know little more about the limitations on state taxation than we did before the decision was handed down.
The Notion of Cross-Border Tax Disadvantage (Warning: This Turns Out To Be a Red Herring)
By now, we have come to expect that 5-4 decisions from the Supreme Court will find Justice Kennedy siding with either Justices Ginsburg, Breyer, Sotomayor, and Kagan, or with Chief Justice Roberts and Justices Scalia, Thomas, and Alito. Here, however, the breakdown was truly unexpected: Justice Alito wrote the majority opinion, joined by Breyer, Kennedy, Roberts, and Sotomayor, while various dissents were filed and joined by Ginsburg, Kagan, Scalia, and Thomas.
The dissents by Justices Ginsburg and Scalia devastatingly exposed the logical incoherence of the majority’s ruling. Justice Ginsburg, in particular, provided a brilliant analysis. (This might not be surprising, because her late husband was Professor Martin Ginsburg, one of the all-time great legal tax scholars produced by this country.) It is simply astonishing to me that—in a case without any obvious political valence—her opinion did not persuade her colleagues on the other side.
The majority seems mostly to have been disturbed by an aspect of the State of Maryland’s tax system that, in the majority’s words, Maryland admits “has the same economic effect as a state tariff, the quintessential evil targeted by the dormant Commerce Clause.” Unfortunately, it turns out that the majority’s holding ultimately does not target that evil (if it is, in fact, evil at all).
Maryland’s state income tax system levies taxes on both a state-level basis and a county-level basis. The state-level tax was not at issue in the case. Each of the state’s counties can adopt a tax, assessed on the same taxable income that determines one’s state-level liability, to provide revenues for county-level services. Howard County, where the plaintiffs live, imposes a 3.2 percent tax on all taxable income of its residents.
The twist in Maryland’s system is that it does not require the counties to grant a credit for taxes paid by their residents to other states (although Maryland does provide a credit for the state-level tax computation). So, if a Maryland taxpayer earns income in another state, and that other state taxes out-of-state residents on their income earned there, then the taxpayer will pay tax both to their Maryland county and to the other state, assessed on the same income. (All of the decisions in the case refer to this as “double taxation,” a common term that is unfortunately a misleading misnomer. Here, I will refer to this more accurately as a “cross-border disadvantage.”)
Imagine that there are two Howard County residents, both of whom have $1,000,000 in taxable income in a given year. (The Wynnes’ income in the relevant year was about $2.7 million.) One resident earns all of her income from business activities in Maryland, whereas the other earns $200,000 of his $1,000,000 in New York. The “tariff” that so upsets the majority arises from the fact that the Maryland-income-only resident will pay 3.2 percent of $1,000,000 ($32,000) in taxes to Howard County and nothing to any other state, whereas the other resident will pay the same $32,000 plus whatever amount New York State levies on $200,000 of income earned in New York.
The idea, then, is that the Maryland system could be seen as discouraging people from doing business outside the state, if they are sensitive to taxes. If there is a constitutional requirement to prevent governments from imposing such cross-border disadvantages, then that would be grounds to challenge this tax system. The plaintiffs argued that Maryland should be ordered to require its counties to credit out-of-state taxes, such that if New York imposed $32,000 or more in taxes in my example above, Maryland could not collect any county-level tax on that income.
Whose Problem Is It?
The plaintiff’s proposed solution—requiring their home state to adopt a rule to prevent this cross-border disadvantage—is not, however, the only way to solve the supposed problem. In the example above, New York State could be required to waive taxes on income earned by citizens of any state that has a system like Maryland’s. (In fact, only Maryland has such a system, although that is irrelevant to the analysis.) Either way, the cross-border advantage would disappear.
What do we do when the same problem could be resolved in two different ways? At oral argument and in their briefs, the plaintiffs’ lawyers relied on generic invocations of precedent that supposedly required Maryland to give way, yet they offered (even under direct questioning from Justice Ginsburg) no principled reason why the burden could not, or should not, be placed on the non-resident state.
How would we decide which way to go in solving this cross-border disadvantage? Maryland argued that the benefits provided by the county to its residents—excellent public schools, fire service, police protection, and so on—justified the county in treating two taxpayers with similar incomes the same. The plaintiffs, on that theory, had chosen to pay taxes to a second jurisdiction, when they could have decided that they were perfectly happy making money in their home state. In any case, both million-dollar earners pay $32,000 to Howard County. What could be more even-handed?
The contrary argument is that other states are perfectly within their rights to impose taxes on activities within their borders, and if an out-of-state resident wants to take advantage of the business opportunities that are supported by that state’s services, then the outsider should still pay taxes to the other state.
This argument is a bit more difficult to sustain, however, when the income that is being earned “in the other state” is, for example, derived from financial investments. Saying that a person who never sets foot in New York, but who makes some financial investments there, is benefiting from New York’s public services, is a bit of a stretch. It is not impossible to find some connection, but at least in degree, it is likely to be quite minimal.
Happily, however, there is a longstanding doctrine (more firmly established than the contested precedents on which the plaintiffs relied, and in fact conceded as a core principle by the Wynnes’ attorneys) that states are permitted to impose taxes on all of their residents’ incomes, wherever those incomes are earned. At best, then, the plaintiffs’ case against Maryland would seem to require the Court to overrule itself and to hold that the right of states to tax their residents’ income disappears when another state taxes that income.
Moreover, even if it had happened that New York was willing to waive taxation on out-of-staters’ New York-sourced income, the plaintiffs claimed that the Maryland system was still unconstitutional, because so long as Maryland kept its existing system, some other state could someday impose a tax on a Marylander that would create a cross-border disadvantage. The mere possibility that such disadvantage could ever exist was, by that analysis, enough to make Maryland’s approach unacceptable.
In any event, at this point of the analysis, it would appear that Maryland should be required to abandon its system of imposing taxes on all of its residents’ income. In fact, however, the majority does not reach that conclusion.
The Internal Consistency Test and the Disappearance of the Majority’s Concern for “Double Taxation”
So far, so bad. Matters become even worse, however, when we get to a second relevant aspect of Maryland’s tax system. It turns out that, although Maryland only credits out-of-state income on the state-level income tax (but not on the county-level tax, which was at issue in the case), Maryland does in fact tax the Maryland-sourced income earned by out-of-staters.
One can see why the optics of this might raise the ire of the majority. Maryland seems to be trying to have it both ways, collecting taxes on outsiders while not crediting the taxes that its residents pay to other states. Beyond the optics, however, why is this a constitutional problem? Why is it not the case that Marylanders could simply say to their legislators, “We don’t mind taxing out-of-staters, but stop taxing us on out-of-state income”? And if that political argument fails, why is that not the end of it?
The majority relies on a so-called “internal consistency test,” which essentially says that a state can adopt any tax system, so long as such a system would not lead to cross-border disadvantages if every other state were to adopt the same system. The majority is correct that, although a state like New York could cure the cross-border disadvantage that is created by the interaction of the current respective state tax regimes, if New York instead adopted a system exactly like Maryland’s, there would still be cross-border disadvantages. Thus, Maryland’s system is not internally consistent.
Although Justice Scalia correctly questions the very legitimacy of the internal consistency test, the more telling point that both he and Justice Ginsburg make in their dissents is that the internal consistency test does not, in fact, solve cross-border tax disadvantages.
The Ginsburg dissent lays out the logic, showing that under the internal consistency test, Maryland could keep its current rule that all residents’ income (including income earned out of state) is taxable, so long as it stopped taxing out-of-staters’ incomes earned in Maryland. If every state were to adopt such a system there would be no cross-border disadvantages.
But this would not solve issue that motivated the plaintiffs, because the reason that they pay higher total taxes than their neighbor is not that they pay more to Maryland and Howard County, but that Maryland’s counties do not credit the taxes paid to other states. As Justice Scalia noted with his usual acidity, referencing his disdain for the artificial origins of the dormant Commerce Clause, “it is only fitting that the Imaginary Commerce Clause would lead to imaginary benefits.”
In short, the tax disadvantage of which the plaintiffs complain is not addressed by the internal consistency test. If New York decides to tax only income that is earned in New York (crediting taxes for income earned elsewhere), its system would also pass the internal consistency test. It is the interaction of that internally consistent system with Maryland’s new internally consistent system that creates the cross-border disadvantage.
The only way to actually eliminate cross-border disadvantages, then, would be to require that all states in fact adopt the same internally consistent system. And that is a level of judicial activism to which the majority does not aspire.
At the end of the day, then, we have a majority opinion that is motivated by the “quintessential evil” of state laws that create cross-border disadvantages, yet that opinion fails to justify not adopting one of two methods that would actually solve that problem (if, again, it is actually a problem at all, constitutionally or otherwise). To top it all off, the majority ultimately holds that the State of Maryland must refund money to its own residents who would have paid exactly the same total amount of money to Maryland and Howard County under an internally consistent rule—and that rule would be identical to the part of Maryland’s current system that affects these taxpayers.
Some Supreme Court opinions might be bad on the merits, but at least we know what the Court was actually thinking, and we know what is and is not allowed in the aftermath of the Court’s ruling. Here, the stated concern for interstate neutrality turns out to be empty, and the State of Maryland is left to fix its state tax system in some way that would not hypothetically be disadvantageous to cross-border trade. This is hardly the worst decision the Court has ever issued, but its internal incoherence—incoherence that was highlighted by two justices who almost never agree on anything else—is nonetheless disturbing.