Lead Opinion
delivered the opinion of the Court.
Section 310(b)(1) of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, 96 Stat. 596, 26 U. S. C. § 103(j)(1), removes the federal income tax exemption for interest earned on publicly offered long-term bonds issued by state and local governments unless those bonds are
I
Historically, bonds have been issued as either registered bonds or bearer bonds. These two types of bonds differ in the mechanisms used for transferring ownership and making payments. Ownership of a registered bond is recorded on a central list, and a transfer of record ownership requires entering the change on that list.
In 1982, Congress enacted TEFRA, which contains a variety of provisions, including § 310, designed to reduce the federal deficit by promoting compliance with the tax laws. Congress had become concerned about the growing magnitude of tax evasion; Internal Revenue Service (IRS) studies indicated that unreported income had grown from an estimated range of $31.1 billion to $32.2 billion in 1973 to a range of $93.3 billion to $97 billion in 1981. Compliance Gap: Hearing before the Subcommittee on Oversight of the Internal
“The committee believes that a fair and efficient system of information reporting and withholding cannot be achieved with respect to interest-bearing obligations as long as a significant volume of long-term bearer instruments is issued. A system of book-entry registration will preserve the liquidity of obligations while requiring the creation of ownership records that can produce useful information reports with respect to both the payment of interest and the sale of obligations prior to maturity through brokers. Furthermore, registration will reduce the ability of noncompliant taxpayers to conceal income and property from the reach of the income, estate, and gift taxes. Finally, the registration requirement may reduce the volume of readily negotiable substitutes for cash available to persons engaged in illegal activities.” S. Rep. No. 97-494, Vol. 1, p. 242 (1982).
Section 310 was designed to meet these concerns by providing powerful incentives to issue bonds in registered form.
South Carolina invoked the original jurisdiction of this Court, contending that § 310(b)(1) is constitutionally invalid under the Tenth Amendment and the doctrine of intergovernmental tax immunity. We granted South Carolina leave to file the instant complaint against the Secretary of the Treasury of the United States, South Carolina v. Regan,
I — I hH
We address the claim that § 310(b)(1) violates the Tenth Amendment first.
The Tenth Amendment limits on Congress’ authority to regulate state activities are set out in Garcia v. San Antonio Metropolitan Transit Authority,
Although Garcia left open the possibility that some extraordinary defects in the national political process might render congressional regulation of state activities invalid under the Tenth Amendment, the Court in Garcia had no occasion to identify or define the defects that might lead to such invalidation. See id., at 556. Nor do we attempt any definitive articulation here. It suffices to observe that South
B
The NGA argues that § 310 is invalid because it commandeers the state legislative and administrative process by coercing States into enacting legislation authorizing bond registration and into administering the registration scheme. They cite FERC v. Mississippi,
Because, by hypothesis, § 310 effectively prohibits issuing unregistered bonds, it presents the very situation FERC distinguished from a commandeering of state regulatory machinery: the extent to which the Tenth Amendment “shields the States from generally applicable federal regulations.”
H — 4 I — I 1 — 1
South Carolina contends that even if a statute banning state bearer bonds entirely would be constitutional, § 310 unconstitutionally violates the doctrine of intergovernmental tax immunity because it imposes a tax on the interest earned on a state bond. We agree with South Carolina that § 310 is
The Secretary and the Master, however, suggest that we should uphold the constitutionality of § 310 without explicitly overruling Pollock because § 310 does not abolish the tax exemption for state bond interest entirely but rather taxes the interest on state bonds only if the bonds are not issued in the form Congress requires. In our view, however, this suggestion implicitly rests on a rather mischievous proposition of law. If, for example, Congress imposed a tax that applied exclusively to South Carolina and levied the tax directly on the South Carolina treasury, we would be obligated to adjudicate the constitutionality of that tax even if Congress allowed South Carolina to escape the tax by restructuring its state government in a way Congress found more to its liking. The United States cannot convert an unconstitutional tax into a constitutional one simply by making the tax conditional. Whether Congress could have imposed the condition by direct regulation is irrelevant; Congress cannot employ unconstitutional means to reach a constitutional end. Under Pollock, a tax on the interest income derived from any state bond was considered a direct tax on the State and thus unconstitutional.
This general rule was based on the rationale that any tax on income a party received under a contract with the government was a tax on the contract and thus a tax “on” the government because it burdened the government’s power to enter into the contract. The Court in Pollock borrowed its reasoning directly from the decision in Weston exempting federal bond interest from state taxation:
“‘The right to tax the contract to any extent, when made, must operate upon the power to borrow before it is exercised, and have a sensible influence on the contract. The extent of this influence depends on the will of a distinct government. To any extent, however inconsiderable, it is a burthen on the operations of government. . . . The tax on government stock is thought by this court to be a tax on the contract, a tax on the [government’s] power to borrow money . . . and consequently to be repugnant to the Constitution.’” Pollock, supra, at 586, quoting Weston, supra, at 467, 468.
Thus, although a tax was collected from an independent private party, the tax was considered to be “on” the government because the tax burden might be passed on to it through the contract. This reasoning was used to define the basic scope of both federal and state tax immunities with respect to all types of government contracts.
The rationale underlying Pollock and the general immunity for government contract income has been thoroughly repudiated by modern intergovernmental immunity case law. In Graves v. New York ex rel. O’Keefe,
“So much of the burden of a non-discriminatory general tax upon the incomes of employees of a government, state or national, as may be passed on economically to that government, through the effect of the tax on the price level of labor or materials, is but the normal incident of the organization within the same territory of two governments, each possessing the taxing power. The burden, so far as it can be said to exist or to affect the government in any indirect or incidental way, is one which the Constitution presupposes . . . .” Id., at 487.
See also James v. Dravo Contracting Co.,
“The Government, rightly we think, disclaims any contention that the Constitution, unaided by Congressional legislation, prohibits a tax exacted from the contractors merely because it is passed on economically, by the terms of the contract or otherwise, as part of the construction cost to the Government. So far as such a nondiscriminatory state tax upon the contractor enters into the cost of the materials to the Government, that is but a normal incident of the organization within the same territory of two independent taxing sovereignties. The asserted right of the one to be free of taxation by the other does not spell immunity from paying the added costs, attributable to the taxation of those who furnish supplies to the Government and who have been granted no tax immunity. So far as a different view has prevailed, we think it no longer tenable.” Id., at 8-9 (citations omitted).
King & Boozer thus completely foreclosed any claim that the nondiscriminatory imposition of costs on private entities that pass them on to States or the Federal Government unconstitutionally burdens state or federal functions. Subsequent cases have consistently reaffirmed the principle that a nondiscriminatory tax collected from private parties contracting with another government is constitutional even though part or all of the financial burden falls on the other government. See Washington v. United States,
With the rationale for conferring a tax immunity on parties dealing with another government rejected, the government
In sum, then, under current intergovernmental tax immunity doctrine the States can never tax the United States directly but can tax any private parties with whom it does business, even though the financial burden falls on the United States, as long as the tax does not discriminate against the United States or those with whom it deals. See Washington, supra, at 540; County of Fresno, supra, at 460-463; City of Detroit, supra, at 473; Oklahoma Tax Comm’n, supra, at 359-364. A tax is considered to be directly on the Federal Government only “when the levy falls on the United States itself, or on an agency or instrumentality so closely connected to the Government that the two cannot realistically be viewed as separate entities.” New Mexico, supra, at 735. The rule with respect to state tax immunity is essentially the same, see, e. g., Graves, supra, at 485; Mountain Producers Corp., supra, at 386-387, except that at least some nondiscriminatory federal taxes can be collected directly from the States even though a parallel state tax could not be collected directly from the Federal Government.
TEFRA § 310 thus clearly imposes no direct tax on the States. The tax is imposed on and collected from bondholders, not States, and any increased administrative costs incurred by States in implementing the registration system are not “taxes” within the meaning of the tax immunity doctrine. See generally United States v. Mississippi Tax Comm’n,
IV
Because the federal imposition of a bond registration requirement on States does not violate the Tenth Amendment and because a nondiscriminatory federal tax on the interest earned on state bonds does not violate the intergovernmental tax immunity doctrine, we uphold the constitutionality of § 310(b)(1),
It is so ordered.
Notes
For simplicity, we will refer to state and local governments collectively as “States” and will refer to publicly offered long-term bonds as “bonds.”
The record owner of a registered bond may sometimes differ, however, from the beneficial owner, and sellers can transfer beneficial ownership of most types of registered bonds without entering a change on the central list.
Section 310 also provides various special exceptions to the registration requirements and incentives provided under subsections (a) and (b) for long-term publicly offered bonds issued by private corporations and Federal and State Governments, but those exceptions are not relevant here.
The Special Master’s recommendation to grant the NGA’s motion for leave to intervene is hereby adopted.
We use “the Tenth Amendment” to encompass any implied constitutional limitation on Congress’ authority to regulate state activities, whether grounded in the Tenth Amendment itself or in principles of federalism derived generally from the Constitution.
Given our holding infra, at 524-525, that a federal tax on the interest paid on state bonds does not violate the intergovernmental tax immunity doctrine, one could argue that any law exempting state bond interest from the tax applicable to interest on other bonds is, in effect, a subsidy, and
South Carolina also filed a number of exceptions to the Master’s findings that the registration requirement imposed little financial or administrative burden on States and had little effect on States’ ability to raise capital. These exceptions, and the NGA’s exception to the Master’s failure to find an interest rate differential between registered and bearer bonds, raise no issue concerning the operation of the national political process, and we need not address them here.
See generally Hearings on S. 1570 before the Subcommittee on Labor of the Senate Committee on Labor and Human Resources, 99th Cong., 1st Sess. (1985); The Impact of the Supreme Court’s Garcia Decision Upon States and Their Political Subdivisions: Hearing before the Subcommittee on Economic Goals and Intergovernmental Policy of the Joint Economic Committee, Congress of the United States, 99th Cong., 1st Sess. (1985).
The Secretary also argues that we need not reach the tax immunity issue on the ground that, because all state bonds have been issued in registered form since § 310 became effective, no federal tax on state bearer bond interest has ever actually been imposed. We see no reason, however, why
Income indirectly derived from a contract with the government was treated differently. See, e. g., Willcuts v. Bunn,
The sources of the state and federal immunities are, of course, different: the state immunity arises from the constitutional structure and a concern for protecting state sovereignty whereas the federal immunity arises from the Supremacy Clause. The immunities have also differed somewhat in their underlying political theory and in their doctrinal contours. Many of this Court’s opinions have suggested that the Constitution should be in
Prior to that the Court had already confined Collector v. Day to its facts in Helvering v. Gerhardt,
South Carolina and the Government Finance Officers Association as amicus curiae argue that the legislative history of the Sixteenth Amendment, which authorizes Congress to “collect taxes on incomes, from whatever source derived, without apportionment,” manifests an intent to freeze into the Constitution the tax immunity for state bond interest that existed in 1913. We disagree. The legislative history merely shows that the words “from whatever source derived” of the Sixteenth Amendment were not affirmatively intended to authorize Congress to tax state bond interest or to have any other effect on which incomes were subject to federal taxation, and that the sole purpose of the Sixteenth Amendment was to remove the apportionment requirement for whichever incomes were otherwise taxable. 45 Cong. Rec. 2245-2246 (1910); id., at 2539; see also Brushaber v. Union Pacific R. Co.,
All federal activities are immune from direct state taxation, see Graves,
South Carolina distinguishes the taxes by arguing that the interest paid to a State’s bondholders is more essential to the maintenance of a state government than the salaries paid to employees. This strikes us as counterintuitive in fact. More importantly, the essential/nonessential distinction it invokes is exactly the type of distinction we concluded was unworkable in Garcia,
“ ‘There is not, and there cannot be, any unchanging line of demarcation between essential and non-essential governmental functions. Many governmental functions of today have at some time in the past been nongovernmental. The genius of our government provides that, within the sphere of constitutional action, the people — acting not through the courts but through their elected legislative representatives — have the power to determine as conditions demand, what services and functions the public welfare requires.’” Id., at 546, quoting Gerhardt,
Similarly, Justice O’Connor would have us judge the constitutionality of each tax imposing an indirect burden on state and local governments by determining whether the tax had “substantial” adverse effects on those governments. Post, at 531-533. We fail to see how this substantiality test distinguishes taxes on state bond interest from taxes on state employees’ salaries. More importantly, we disagree -with Justice O’Connor’s apparent assumption that if this Court does not undertake the open-ended and administratively daunting inquiry required by her test, we leave
Because we hold that Congress could have prohibited States from issuing any unregistered bonds by direct regulation, we necessarily reject South Carolina’s argument that § 310(b)(1) is an impermissible regulatory tax because it imposes a tax on activities not subject to federal regulatory power. That § 310(b) is purely regulatory in purpose and effect and was never intended to raise any federal revenue does not alone render it unconstitutional. See Minor v. United States,
Concurrence Opinion
concurring.
Although the Court properly finds support for its holding in Garcia v. San Antonio Metropolitan Transit Authority,
Concurrence Opinion
concurring in the judgment.
Today the Court reaches two results regarding § 310(b)(1) of TEFRA that I believe are analytically distinct. First, the Court finds that § 310(b)(1) does not violate the Tenth Amendment by compelling States to issue bonds in registered form. Second, the majority concludes that the statute
The Special Master appointed by the Court made a number of factual determinations about the impact that the TEFRA registration requirements would have upon the States. Most notably, the Special Master found that the registration requirements have had no substantive effect on the abilities of States to raise debt capital, on the political processes by which States decide to issue debt, or on the power of the States to choose the purpose to which they will dedicate the proceeds of their tax-exempt borrowing. After an exhaustive investigation, the Special Master summarized: “TEFRA has not changed how much the States borrow, for what purposes they borrow, how they decide to borrow, or any other obviously important aspect of the borrowing process.” Report of Special Master 118.
This well-supported conclusion that § 310(b)(1) has had a de minimis impact on the States should end, rather than begin, the Court’s constitutional inquiry. Even the more expansive conception of the Tenth Amendment espoused in National League of Cities v. Usery,
Dissenting Opinion
dissenting.
The Court today overrules a precedent that it has honored for nearly 100 years and expresses a willingness to cancel the constitutional immunity that traditionally has shielded the interest paid on state and local bonds from federal taxation. Henceforth the ability of state and local governments to finance their activities will depend in part on whether Congress voluntarily abstains from tapping this permissible source of additional income tax revenue. I believe that state autonomy is an important factor to be considered in reviewing the National Government’s exercise of its enumerated powers. Garcia v. San Antonio Metropolitan Transit Authority,
Section 310(b)(1) of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), 26 U. S. C. § 103(j)(1), provides that the interest paid on state and local bonds will be subject to federal income tax unless the bonds are issued in registered form. The Court readily concludes that Congress could have prohibited outright the issuance of bearer bonds without violating the Tenth Amendment. Ante, at 511-513. But regardless of whether Congress could have required registration of the bonds directly under its commerce power, I agree with the Court that Congress may not accomplish the same end by an unconstitutional means. Ante, at 515-516.
The Court never expressly considers whether federal taxation of state and local bond interest violates the Constitution. Instead, the majority characterizes the federal tax exemption for state and local bond interest as an aspect of intergovernmental tax immunity, and it describes the decline of the intergovernmental tax immunity doctrine in this century. But constitutional principles do not depend upon the rise or fall of particular legal doctrines. This Court has a continuing responsibility “to oversee the Federal Government’s compliance with its duty to respect the legitimate interests of the States.” Garcia, supra, at 581 (O’Connor, J., joined by Powell and Rehnquist, JJ., dissenting). In my view, the Court shirks its responsibility because it fails to inquire into the substantial adverse effects on state and local governments that would follow from federal taxation of the interest on state and local bonds.
Long-term debt obligations are an essential source of funding for state and local governments. In 1974, state and local governments issued approximately $23 billion of new municipal bonds; in 1984, they issued $102 billion of new bonds. Report of Special Master 20. State and local governments rely heavily on borrowed funds to finance education, road construction, and utilities, among other purposes. As the Court recognizes, States will have to increase the interest rates they pay on bonds by 28-35% if the interest is subject to the federal income tax. Ante, at 511. Governmental op
In the pivotal cases which first set limits to intergovernmental tax immunity, this Court paid close attention to the practical effects of its decisions. The Court limited the government’s immunity only after it determined that application of a tax would not substantially affect government operations. Thus in the first case to uphold federal income taxation of revenue earned by a state contractor, this Court observed that “neither government may destroy the other nor curtail in any substantial manner the exercise of its powers.” Metcalf & Eddy v. Mitchell,
The instant case differs critically from the cases quoted above because the Special Master found that, if the interest on state and local bonds is taxed, the cost of borrowing by state and local governments would rise substantially. This
I do not think the Court’s bipartite test adequately accommodates the constitutional concerns raised by the prospect of applying the federal income tax to the interest paid on state and local bonds. This Court has a duty to inquire into the devastating effects that such an innovation would have on state and local governments. Although Congress has taken a relatively less burdensome step in subjecting only income from bearer bonds to federal taxation, the erosion of state sovereignty is likely to occur a step at a time. “If there is any danger, it lies in the tyranny of small decisions —in the prospect that Congress will nibble away at state sovereignty, bit by bit, until someday essentially nothing is left but a gutted shell.” L. Tribe, American Constitutional Law 381 (2d ed. 1988).
Federal taxation of state activities is inherently a threat to state sovereignty. As Chief Justice Marshall observed long ago, “the power to tax involves the power to destroy.” McCulloch v. Maryland,
Concurrence Opinion
concurring in part and concurring in the judgment.
I join in the Court’s judgment, and in its opinion except for Part II. I do not join the latter because, as observed by The Chief Justice, post, at 529-530, it unnecessarily casts doubt upon FERC v. Mississippi,