Intergovernmental Tax Immunity
Intergovernmental tax immunity means that the different governments in the federal system may not tax each others’ agencies or operations directly, and puts limits on taxation of the employees or contractors of one government by another. It represents a constitutional check on the powers of both the federal government and state governments to levy taxes on each other. For instance, state governments may not tax land that the federal government owns, such as post offices and national parks. Likewise, the federal government may not enact a special tax on the incomes of state employees.
The U.S. Supreme Court first defined this concept in the seminal McCulloch v. Maryland decision in 1819. In part, this decision held that the State of Maryland could not tax the Bank of the United States. Since the U.S. Constitution made both the federal and state governments sovereign in their own proper spheres of activity, the state could not use its power of taxation to interfere with and potentially destroy the federal government’s proper exercise of its power, in this case the power to create 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. The courts considered to be exempt from state and local taxation any activity that had a federal government component, including the salaries of federal employees. Likewise, the courts considered exempt from federal taxation state and local government activity and the salaries of state and local employees. In effect, the courts forbade any tax that would have the effect of increasing the cost of doing business for another government, or impairing its ability to make contracts.
This early broad interpretation of intergovernmental tax immunity had little practical effect on the federal government, which raised most of its revenue in the nineteenth century from import duties and used internal taxation only on an emergency basis, such as during the Civil War. State governments raised most of their revenue from the property tax until the Great Depression, and so merely had to forgo taxation of federal property. Local governments rely predominately on the property tax to this day.
This began to change in the early twentieth century when the federal government and many state governments enacted income taxes and began relying increasingly on those proceeds. With the New Deal in the 1930s, the federal government also considerably increased its expenditures on domestic projects such as roads and bridges, and states felt that they should be able to tax the contractors and their employees on these projects. The courts began to narrow their interpretation of the reach of intergovernmental tax immunity to the direct activities of governments, and allowed most taxation of 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 not singled out but 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.
While the general interpretation of the scope of intergovernmental tax immunity has not changed since 1939, there continue to be difficulties in the application of this general interpretation to particular cases. In particular, the federal government may tax a wide range of activities and states may have some participation in these activities, so the courts must decide what is a discriminatory or a nondiscriminatory tax. For instance, the federal government may have a registration tax on civil aircraft, and a state may own a highway patrol helicopter. The courts would then have to decide if the state would have to pay the tax on the helicopter. Generally, the courts have tended to give the federal government broad powers to tax, if the tax is not specifically aimed at state or local governments.
A recent series of court cases have dealt with discrimination between the taxation of state and federal retirees. Several states had exempted all or part of the pension income of retired state employees, while not giving similar exemptions to retired federal employees. In a 1989 case, Davis v. Michigan Department of Treasury, the U.S. Supreme Court decided that this was discriminatory, and that since federal and state employees were similar to each other, they should be taxed similarly. However, they left it up to the states to decide whether to extend the exemptions to all retired government employees or eliminate it for the state employees.
Nicholas W. Jenny
SEE ALSO: Crossover Sanctions; Environmental Policy; Fiscal Federalism; Pass through Requirements; Unfunded Mandates; Welfare Policy