Intergovernmental Tax Immunity
Intergovernmental tax immunity is a legal principle that ensures the sovereignty of the federal and state governments. This principle represents a constitutional check on the powers of both the federal and state governments to levy taxes on each other. For example, state governments may not tax land that the federal government owns, such as post offices and national parks. On the other hand, the federal government may not enact a special tax on the incomes of state employees.
The U.S. Supreme Court first established the principle of intergovernmental immunity in the seminal McCulloch v. Maryland decision in 1819. In part, this decision held that the State of Maryland could not tax the second Bank of the United States. Since the U.S. Constitution made both the federal and state governments sovereign in their own spheres of activity, the state could not use its power of taxation to interfere with the federal government’s ability to exercise its powers, in this case the power to create and operate a bank.
Throughout the remainder of the nineteenth and the early part of the twentieth centuries, the courts used a very broad definition of the concept of intergovernmental tax immunity. Any activity that had a federal government component, including the salaries of federal employees, was exempt from state and local taxes. Likewise, the courts considered state and local government activities and the salaries of state and local employees exempt from federal taxes. In effect, the courts forbade any tax that would hinder the ability of another government to conduct its sovereign duties.
The early interpretation of intergovernmental tax immunity had little practical effect on the federal government, which raised most of its revenue from import duties in the nineteenth century and used internal taxation only in emergencies, e.g. the Civil War. State governments raised most of their revenue from property taxes until the Great Depression. Thus, states merely had to forgo taxation of federal property. Local governments still rely predominately on property taxes as the main source of revenue to meet budgetary obligations.
The dynamic began to change in the early twentieth century when the federal government and many state governments enacted income taxation through the Revenue Act of 1913, immediately following the passage of the 16th Amendment to the U.S. Constitution. With the New Deal in the 1930s, the federal government also considerably increased its expenditures on domestic projects such as roads and bridges. The courts began to narrow their interpretation of the reach of intergovernmental tax immunity to the direct activities of governments and allowed taxation of most government contractors. In 1938, the Supreme Court held that the federal government could tax the incomes of state employees, so long as those taxes were nondiscriminatory, that is, that state workers were taxed like other workers.
The federal government enacted the Public Salary Tax Act in 1939, which, in addition to confirming the right of the federal government to tax state employees, allowed the states to tax federal employees in a nondiscriminatory fashion. Thereafter, courts have held that intergovernmental tax immunity barred only taxes that were placed directly on one government by another, or that discriminated against a government or its employees or contractors.
There is no similar constitutional protection in the relationship between state and local governments, since local governments are not independently sovereign from the states. Local governments share the protection that states have from federal taxes, but the courts have not granted them similar protection from state actions. However, states have generally forgone taxing local governments and exempted their activities from local taxation.
Konul Amrahova Riegel & Nicholas W. Jenny
Last updated: January 2018