Paul L. Caron

Monday, November 5, 2007

Supreme Court Hears Oral Argument Today in Davis

The Supreme Court hears oral argument today in Kentucky Department of Revenue v. Davis, No. 06-666:

The Wall Street Journal reports that most experts predict that the Court will uphold Kentucky's tax exemption for in-state municipal bonds: High Court May Look Favorably on Municipal Bond Tax Breaks, by Mark H. Anderson:

The Supreme Court, in a pivotal case for the $2.5 trillion municipal-bond market, is likely to rule states can continue special tax breaks on municipal-bond interest, legal experts said.

The court will hear oral arguments Monday on the issue in a challenge to Kentucky's tax break on municipal-bond interest. Justices may indicate whether they will overturn a state court ruling that alarmed the municipal bond market. That ruling said tax breaks that favor in-state bonds over out-of-state offerings violate constitutional interstate commerce limits.

Experts believe the Supreme Court will strike down the ruling despite conflicts the widespread practice may have with the Constitution.

"I think the court is going to reverse because it is this court," said Walter Hellerstein, a tax law professor at the University of Georgia School of Law. "They are very, very cautious about messing with settled expectations." He spoke about the case at a recent American Enterprise Institute panel.

More than 40 states exempt interest on in-state municipal bonds from income taxes, creating what is a tremendous nationwide market for bond products carved up by state boundaries. According to the Bond Buyer/Thompson Financial 2007 Yearbook, state and local government bonds are increasingly popular with $891 billion issued in 2005 and 2006 alone.

Mr. Hellerstein and other legal experts said it is clear the favorable tax treatment of municipal bonds violates at least some Supreme Court precedent on interstate commerce. But the high court last year, in the United-Haulers waste management ruling, said there are times when state and local entities have a valid reason for discriminating against out-of-state commerce.

"Kentucky's tax exemption is not protectionist," said Paul Caron, a University of Cincinnati College of Law professor, on his tax law blog. "It advances a legitimate government interest in having an adequate supply of capital to finance public works." He said the United Haulers opinion, a 6-3 split that isn't unusual in interstate commerce matters, outlines the legal reasoning for allowing the in-state interest exemption.

The states that issue tax-exempt municipal bonds and the municipal-bond market are both counting on this outcome. "The court should follow the reasoning set forth in its recent opinion in United Haulers," the Securities Industry and Financial Markets Association said in a friend-of-the-court brief.

Other press coverage:

Prior TaxProf Blog coverage:

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