TaxProf Blog

Editor: Paul L. Caron
Pepperdine University School of Law

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Thursday, October 4, 2007

Student Note Says Davis Was Right

One of our students (Julie Muething) has published an excellent note on Department of Revenue of Kentucky. v. Davis, 193 S.W.3d 557 (Ky. App. 2006), cert. granted, 127 S.Ct. 2451 (2007):  An Analysis of the Disparate Tax Treatment of Municipal Bonds, 75 U. Cin. L. Rev. 1711 (2007).  Here is the Conclusion:

The Davis decision is significant because it represents the first time a court found that the common practice of exempting from taxation interest derived from in-state bonds while simultaneously taxing interest derived from out-of-state bonds was unconstitutional. Although state laws that facially discriminate against out-of-state interests are rarely upheld, the Davis court reviewed the state's justifications for the discrimination. However, none of the proffered justifications survived the court's strict scrutiny analysis. In addition, Kentucky's taxation scheme does not fall into one of the limited exceptions under which discrimination against interstate commerce is permissible. Moreover, the Davis decision is in line with the Supreme Court's Commerce Clause jurisprudence and the basic principles underlying the dormant commerce clause. Therefore, the Davis court correctly held that Kentucky's policy of only exempting from taxation bonds issued by the Commonwealth of Kentucky or its subdivisions violates the Commerce Clause.

In 1995 when Shaper was appealed to the Supreme Court, the constitutionality of these tax plans was not a very pressing issue of constitutional law. On the contrary, the taxation of municipal bonds is now an important issue of constitutional law that is relevant to the vast majority of states. The combination of the Davis ruling and the class certification in Dunn is likely to drastically increase litigation.

Therefore, it is imperative that the Supreme Court affirm the Davis decision and provide some guidance for states in making taxation decisions. However, in light of the number of remedial issues posed by unconstitutional rulings such as Davis, Congress should pass a law minimizing the remedial problems stemming from determinations that tax schemes are unconstitutional as the Kentucky court correctly did in Davis.

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