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Intergovernmental Tax Immunity: An Origin Story (Oct. 31, 2016)

Can state and local governments tax property owned by the federal government? How about property used by private parties who contract with the federal government?

Those question matter, especially for western states. Many of those states arose from the public domain and thus comprise a lot of federally owned property. In Nevada, for example, the federal government owns about 85% of the state—an astonishingly high percentage.

The issue whether federal property is immune from state and local taxation speaks to the doctrine of implied intergovernmental tax immunity. The doctrine began with Chief Justice John Marshall’s unfortunate immortal phrase in McCulloch v. Maryland: “[T]he power to tax involves the power to destroy.”[1] In McCulloch, the Chief announced the doctrine against this backdrop:

In 1816, the United States reestablished the National Bank, which became the Second Bank of the United States. In 1818, Maryland enacted a tax on only banks not chartered or authorized by the state. The transparent aim was to impose a tax on only one bank, the National Bank. The Chief, writing for the Court, invalidated the Maryland tax as unconstitutional on the ground the Supremacy Clause prevented the state from imposing a tax on the National Bank’s operations.[2]

The Supremacy Clause provides, in relevant part, that federal law “shall be the supreme Law of the Land[,] . . . any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.”[3] Although the Clause does not expressly provide that federal property is immune from state and local taxation, the Chief held that the Clause implies it because citizens of one state should not be permitted, by law, to tax and thus control an institution belonging to all U.S. citizens.[4] Therefore, McCulloch stands only for the proposition that a state may not transparently discriminate against the federal government in the state’s tax policy.

In other words, the Supreme Court in McCulloch struck down the Maryland tax because it took aim at the only bank in the state not represented by local interests. In dicta, the Court even said that McCulloch does not hold that a state could not tax the real property of the federal government, provided the property were taxed like all other real property in the state.[5] What is more, the unfortunate immortal phrase—“the power to tax involves the power to destroy”—is dictum. But the Court later treated this dictum as a constitutional mandate and, by ignoring the plain text of the Supremacy Clause and the full context of McCulloch, used it to strike down state and local taxes if the economic incidence of the tax fell, even slightly, on the United States.[6]

That is, despite McCulloch’s narrow holding, the Court erroneously cited it for the proposition that the United States, and those with whom it deals, are immune from state and local taxation if a tax falls in any way on the United States, regardless of any discriminatory impact. It took the Court over a century to put the tax-immunity doctrine straight. For this reason, the Court has called the doctrine a “much litigated and often confused field,”[7] which “has been marked from the beginning by inconsistent decisions and excessively delicate distinctions.”[8]

In 1937, the Court reversed course and went on to hold that a tax runs afoul of the Supremacy Clause—and the doctrine of intergovernmental tax immunity implied by it—only if: (1) the legal incidence of the tax falls on the United States, its property, or its instrumentalities; or (2) the tax discriminates against the federal government. For a federal contractor to qualify as a tax-immune instrumentality of the United States under the first condition, the contractor must be “so closely connected to the government that the two cannot realistically be viewed as separate entities.”[9] That is, the contractor must “stand in the [Federal] Government’s shoes.”[10] That’s a tall order.

Since 1937, the line between the immune and the taxable has wavered at times. But the above two conditions appear now settled, including that the economic incidence (i.e., the economic cost) of the tax may fall on the United States, though the legal incidence (i.e., the legal responsibility for the tax) may not. And it matters to those states, like Nevada, where so much hangs in the balance.

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[1] 17 U.S. (4 Wheat.) 316, 431 (1819); see Alex Kozinski & J.D. Williams, That Unfortunate Immortal Phrase, 1987 Utah L. Rev. 977 (noting that the phrase, among others, has proven much easier to say than to apply).

[2] Id. at 435.

[3] U.S. Const. art. VI, cl. 2.

[4] McCulloch, 17 U.S. (4 Wheat.) at 427.

[5] Id. at 436 (declining to “deprive the States of any resources which they originally possessed” and stating that the opinion “does not extend to . . . a tax imposed on the interest which the citizens of Maryland may hold in [the Bank], in common with other property of the same description throughout the State”); see also United States v. New Mexico, 455 U.S. 720, 731 (1982) (noting McCulloch’s limiting dicta).

[6] Weston v. City Council of Charleston, 27 U.S. (2 Pet.) 449 (1829); Dobbins v. Comm’rs of Erie County, 41 U.S. (16 Pet.) 435 (1842) (invalidating South Carolina tax on interest income from federal bonds); Gillespie v. Oklahoma, 257 U.S. 501 (1922) (invalidating Oklahoma tax on income derived from property leased from the United States), overruled by Helvering v. Mountain Producers Corp., 303 U.S. 376 (1938); Miller v. City of Milwaukee, 272 U.S. 713 (1927) (invalidating Wisconsin statute that indirectly taxed interest earned on federal bonds); Panhandle Oil Co. v. Mississippi ex rel. Knox, 277 U.S. 218 (1928) (invalidating Mississippi sales tax that reached sales from contractor to the United States), overruled by Alabama v. King & Boozer, 314 U.S. 1 (1941).

[7] United States v. City of Detroit, 355 U.S. 466, 473 (1958).

[8] United States v. New Mexico, 455 U.S. 720, 730 (1982).

[9] Id. at 735.

[10] Id. at 736 (internal quotation marks omitted).

I have made this blog available for educational purposes only, not to provide specific legal advice. By using this blog, you understand that there is no attorney–client relationship between you and me. This blog should not be used as a substitute for independent legal advice from a licensed professional attorney in your state.