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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Tuesday, November 6, 2007

Analysis of Oral Argument in Kentucky Department of Revenue v. Davis

Following up on this morning's coverage, Tax Profs Gregory Germain (Syracuse) and Bradley Joondeph (Santa Clara) offer below the fold detailed analyses of yesterday's oral argument in Kentucky Department of Revenue v. Davis, No. 06-666.  Both predict a resounding victory for Kentucky, with a substantial majority of the Court rejecting the lower court's conclusion that a tax exemption for interest on in-state bonds, but not on out-of-state bonds, violated the commerce clause:

Gregory Germain (Syracuse):

The Supreme Court heard oral argument yesterday in Davis v. Kentucky, in which a Kentucky intermediate Court held unconstitutional under the dormant commerce clause an income tax exemption for interest earned on Kentucky municipal bonds.

The hearing focused heavily on the Supreme Court’s recent decision in United Haulers, upholding an ordinance requiring all garbage generated in the municipality to be processed at an expensive municipally-owned facility. The Court in United Haulers distinguished the Supreme Court’s earlier decision in Carbone, which struck down a functionally identical flow control ordinance favoring a facility that was nominally owned by a private contractor. The private/government distinction between Carbone and United Haulers was front and center in the debate over the validity of Kentucky’s tax exemption, because such facial discrimination would surely be illegal under the Court’s precedent if it favored private businesses in Kentucky rather than the governmental municipalities themselves.

Based on their comments in other cases, Justices Thomas and Scalia can be relied upon to support Kentucky. Justice Thomas has repeatedly taken the position that there is no dormant commerce clause in the Constitution, and that discrimination cases should be analyzed solely under a new reading of the import/export clause. Justice Scalia has also expressed strong misgivings about the Court’s prior dormant commerce clause jurisprudence, but has indicated that he will respect but not expand the Court’s prior rulings. Thomas made no comments at the hearing, and Scalia made only one quip about the dormant commerce clause being a legal fiction.

Justice Alito’s views are less known. He dissented in United Haulers to the expansion of the exemption for governmental entities. Before United Haulers, the Court had only recognized one commerce clause exemption for governmental activities – that the government could chose with whom it wished to deal when acting as a market participant. The flow control ordinance in United Haulers went beyond market participation by permitting the government to mandate that residents deal exclusively with the government. Justice Alito disagreed with the United Haulers’ majority’s expansion of the governmental immunity exception. This disagreement does not directly apply to the municipal bond case, which fits more closely into the old market participant exception (the government is not requiring anyone to buy its bonds, nor is it precluding anyone from buying out-of-state bonds). Therefore, Alito’s views on the municipal bond case were unknown coming into the hearing.

Justice Alito’s questions at the hearing focused on whether the private/government distinction in United Haulers is workable. He began the questioning by asking whether Kentucky’s use of private activity or conduit bonds, which grant a tax exemption to bonds issues by quasi-private entities for public uses, would run afoul of the private/government distinction between Carbone and United Haulers. Indeed, later in the argument Justice Alito accused Kentucky’s lawyer of “demonstrate[ing] that the Commerce Clause jurisprudence is utterly incoherent.” While Justice Alito did not telegraph in his questioning his ultimate views on the bond case, he certainly demonstrated a great deal of hostility toward the Court’s private/government distinction in Carbone/United Haulers, which does not bode well for Kentucky.

Justice Souter, on the other hand, seems firmly in Kentucky’s camp. Justice Souter dissented in Carbone on the grounds that the private contractor who was nominally the owner of the facility was doing the government’s bidding, and joined with the majority in United Haulers in permitting a flow control ordinance benefiting a governmental entity. Justice Souter attempted with his questioning to expand the governmental immunity exception further by focusing on whether the discrimination directly benefited the state’s citizens, and seemed to support Kentucky even with respect to private activity bonds directly benefiting private entities who are doing governmental work.

Justice Ginsburg, who switched sites to be in the majority in both Carbone and United Haulers, thwarted Justice Souter’s attempt to expand the private/government distinction between Carbone and United Haulers. During the private activity bond debate, Justice Ginsburg asked whether private activity bonds had been considered by the courts below, and stated that private activity bonds should not be in issue in the case. Kentucky’s lawyer promptly agreed, both because the issue had not been raised below and because the plaintiffs lacked standing to raise the private activity bond question because they had not alleged that they owned out-of-state private activity bonds. By attempting to limit the discussion in accordance with the nominal private/government distinction between Carbone and United Haulers, Justice Ginsburg appears also to be in Kentucky’s camp.

Justice Roberts, who wrote the majority decision in United Haulers, seems firmly in Kentucky’s camp. He asked whether this is not a case like General Motors v. Tracy in which the Court, in a close case, should maintain the status quo in the absence of congressional action. He joked several times about the dormant commerce clause not being in the constitution. He questioned the standing of Kentucky taxpayers to raise the commerce clause objections of bond issuers from other states (who had all supported Kentucky’s position). He questioned the plaintiff’s claim of economic harm, questioned whether the market should be defined nationally or only as those “who issue bonds for public works in Kentucky,” and questioned whether the discrimination caused balkanization when there are no statistics showing that Kentucky’s bonds are circulated widely. In all, Justice Roberts showed strong support for Kentucky’s position.

Justice Breyer, who had joined the United Haulers majority, admitted that he finds “the case quite difficult.” His questions were mostly hypotheticals testing the limits of the private/government distinction. What is a traditional governmental function? How about discrimination in favor of a state-owned dairy farm? Do we look at the use of the proceeds of the tax or the nature of the entity imposing the tax? Justice Breyer played his cards close to the vest, but he may have tipped his hand in one comment. He asked whether any states that do not like the status quo might have a perfectly good remedy in asking Congress to prohibit the discrimination. This comment suggests to me that Justice Breyer is unlikely to rock the $1.8 trillion municipal bond boat.

Justice Stevens, who dissented in United Haulers, asked only a few questions. He seemed impressed by the fact that all of the other states – who are the only direct victims of the alleged constitutional violation – have asked the Court not to intervene. Justice Stevens also questioned the Court’s prior distinction between a direct subsidy, which is constitutional, and an equivalent tax subsidy, which is not. Justice Stevens had previously supported the market participation exception, and his dissent in United Haulers may have been addressed only to the expansion of that exception to required dealing cases.

Justice Kennedy is the only one who clearly supported the taxpayers. Justice Kennnedy wrote Carbone and dissented in United Haulers. Throughout the argument, Justice Kennedy tossed the taxpayer’s lawyer softballs, finally asking the taxpayer’s lawyer whether Kentucky’s attempt to secure favoritism for its bonds from Kentucky residents was “consistent with the vision of the framers for our national market under the commerce clause.” Justice Kennedy is clearly in the taxpayer’s camp.

By my count, there are five justices in Kentucky’s camp: Thomas, Scalia, Souter, Ginsburg and Roberts. There are three judges who are on the fence: Stevens, Breyer and Alito. Stevens and Breyer appear to be favoring Kentucky, and Alito appears to be favoring the taxpayers. Only one justice, Kennedy, appears to be firmly in the taxpayers’ camp. Of course, with the external debate complete the internal debate begins. I remain confident that the Court is not going to disrupt the municipal bond markets and state governmental finance. It remains to be seen whether they can come up with a new dormant commerce clause doctrine that can be broadly accepted by the group, or whether we will end up with another divided decision.

Bradley Joondeph (Santa Clara):

For the sake of full disclosure, I should note that I worked on the amicus brief for the Government Finance Officers et al. in support of Kentucky.

Here is where the justices appeared to me, in order of friendliness to the taxpayers, the Davises:\

KENNEDY: Clearly ready to invalidate tax preferences for in-state bonds. He was the author in Carbone, dissented in United Haulers, and generally has been an ardent supporter of striking down state laws on dormant Commerce Clause grounds throughout his career (most famously in Granholm v. Heald). His biggest contribution at argument was to feed arguments to the Davises* lawyer, Eric Brumstad.

ALITO: Strong lean to the Davises. All of his questions were directed at Kentucky*s attorney, Chris Trower. He expressed some skepticism that United Haulers was on point, given that state and local governments could use muni bonds to finance private activities. He also mused that many of Kentucky*s arguments would render the dormant Commerce Clause *incoherent.*

STEVENS: Hard to say. Throughout his career he has generally voted against the states in dormant Commerce Clause cases (but with them in preemption cases). Yesterday, he seemed quite ambivalent, and asked some tough questions of Brumstad. He specifically mentioned that, although the other states were supposedly the victims of the alleged discrimination, all 49 of them supported Kentucky. And he also stated that muni bonds are not completely fungible, given that residents will want to support their own state*s public works.

BREYER: Again, up in the air. He openly called the case *quite difficult,* and he asked tough questions of both sides. He needs to decide whether, in his words, muni bonds are more like milk or garbage. He is a pragmatist at heart, though, and I think that will lead him to side with the Kentucky.

GINSBURG: Leaning to Kentucky, especially if the Court crafts an opinion that sets aside the question whether these tax preferences are constitutional as applied to private activity bonds. She did not ask many questions, but they were all pretty sympathetic to the Commonwealth. In particular, she discussed the ability of the states to solve any problem by getting legislation from Congress (or Congress*s blessing of a state compact).

SOUTER: Leaning to Kentucky, and more strongly than Ginsburg. He wrote the dissent in Carbone and joined the majority in United Haulers. He spent a great deal of time at argument hammering Brumstad on the idea that the state had done more than just tax*it had also entered the market, and a tax exemption related directly to this market entry was no different in substance from a subsidy. To him, it seemed quite important that Kentucky was not acting *purely as a regulator.*

ROBERTS: Strong lean to Kentucky. He started out with some fairly challenging questions for Kentucky*s attorney, Chris Trower, but then became much more animated in his questioning of Brumstad. He dominated the argument for a good 5 minutes, challenging most aspects of the Davises* theory. He seemed to indicate that he thought United Haulers was on all fours. And he almost hinted that, like his old boss (Chief Justice Rehnquist), he does not really believe in the dormant Commerce Clause. This would be consistent with his apparent ideological commitment to reducing the role of the federal judiciary.

SCALIA: Almost certainly with Kentucky. He thinks the dormant Commerce Clause is illegitimate, but he has stated his willingness to invalidate state laws that are unlawful under existing Court precedent. Given the uncertainty here, Scalia likely believes that stare decisis does not require striking down these preferences. He was uncharacteristically quiet at argument, only chiming in late to joke about the dormant Commerce Clause*s non-existence in the text.

THOMAS: Will vote for Kentucky, as he, like Scalia, does not believe the dormant Commerce Clause exists. Unlike Scalia, he would not even enforce it as a matter of stare decisis. As usual, he was silent at argument.

PREDICTION: Predicting results in Supreme Court cases based on oral argument is a fool*s errand, yet I*ll give it stab anyway. Here is how I see it: Kentucky wins 7-2, with Souter or Roberts writing the majority opinion. Scalia and Thomas concur separately, expressing their disbelief in the dormant Commerce Clause generally. Perhaps Ginsburg also writes separately to note that this case does not involve private activity bonds. Stevens concurs in the judgment, emphasizing Congress*s ability to change the rule if it wants to. Kennedy writes a strident dissent, emphasizing how the Balkanization of muni bond market flouts the original intent behind the Commerce Clause, and he is joined by Alito.

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