WASHINGTON v. UNITED STATES

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ORAL ARGUMENT OF KENNETH O. EIKENBERRY, ESQ. ON BEHALF OF APPELLANTS, WASHINGTON, ET AL.

Chief Justice Burger: We'll hear arguments first this morning in Washington against the United States.

Mr. Attorney General, you may proceed whenever you're ready.

Mr. Eikenberry: Mr. Chief Justice and may it please the Court:

This case involves the effort of the United States, successful so far, to prevent the State of Washington from deriving any sales tax or use tax from the significant federal construction that's going on in our state.

I'd like first to explain what the controversy is about as a practical matter and then proceed on to the decisions of this Court and how we believe they do allow the application of this sales and use tax.

Washington imposes a general retail sales tax on the sales of tangible personal property and other services in the State of Washington.

We do have the usual complementary use tax on the other side of it.

There is a single rate of 5.4 percent embodied in a single statute applicable to all of these sales occurring in the State, and this by far is our single largest source of general revenue in the State of Washington.

We do not have, as is common, an income tax, because that is prohibited by our Constitution.

Under our system federal contractors are treated the same way as most other buyers of tangible personal property.

When they buy bricks or nails or cement for incorporation into a construction project, they're treated the same way that you or I would be treated if we were buying the same things to improve our homes.

5.4 percent would be added on to the cost of those materials and we would pay it to the seller.

The same is true if we bought an automobile or food or cigarettes or whatever.

The legal problem arises because we treat federal contractors differently from nonfederal contractors in the construction projects.

Ironically, the Federal Government is challenging our system, which gets more revenue out of nonfederal construction than it does for federal construction, and this is true because for nonfederal construction projects the 5.4 percent tax is added to the entire price of a nonfederal job.

That is, not just for materials but also for labor and profit and overhead.

All of these go into the tax base.

Meanwhile.

Unidentified Justice: I take it when you... the contractor adds that to his price to the owner, is that it?

Mr. Eikenberry: That is correct.

Unidentified Justice: Well, but then he hasn't paid his sales tax on his bricks, I take it; is that it?

Mr. Eikenberry: If we're talking about a nonfederal contractor, Your Honor, that sales tax is added to the price that's finally presented.

Unidentified Justice: But the contractor hasn't paid a tax when he buys his bricks?

Mr. Eikenberry: The private contractor does not buy... does not pay the materials sales tax when he buys his bricks.

Unidentified Justice: Exactly.

Well, a while ago you said that when a contractor buys bricks or his materials he pays a tax.

Well, he doesn't.

Mr. Eikenberry: The federal contractor does, Your Honor.

Unidentified Justice: I know, but the private contractor does not.

Mr. Eikenberry: All right.

Then I didn't present it clearly, because what I was attempting to do in the original way I described the sales tax is to show that across the board on the sale of retail items, whether it be bricks or cars or cigarettes or whatever, there is at that point--

Unidentified Justice: But there isn't when they sell to a private contractor.

Mr. Eikenberry: --That's correct, Your Honor, absolutely.

Unidentified Justice: He is not paying that tax.

General Eikenberry, if the State itself or one of the political subdivisions of the State is building a construction project, what is the tax in that instance.

Mr. Eikenberry: It is the same 5.4 percent at the time--

Unidentified Justice: On the entire construction cost?

Mr. Eikenberry: --Yes, Your Honor, that's correct.

Unidentified Justice: So if the State itself were building it is treated like a private citizen would be--

Mr. Eikenberry: That is true, Your Honor.

Unidentified Justice: --in a building project.

And with respect to private and State contracts, the State taxes the contract price at the time the contractor delivers possession to the owner?

Mr. Eikenberry: That's true, Your Honor, including overhead, profit, materials, and everything that went into it.

Unidentified Justice: General, have you finished?

Mr. Eikenberry: Yes, Your Honor.

Unidentified Justice: I take it you concede that the '75 amendment was to catch federal construction?

Mr. Eikenberry: There's no question but what this statute was designed to apply the sales tax to these transactions, which were significant in our State and we believe deserve to help bear the brunt of cost of services delivered by State government.

Unidentified Justice: In a sense, the State of Washington is a victim of its own legislative move back in 1941, isn't it?

Mr. Eikenberry: I would resist categorizing it as a victim, Your Honor, because, like most states, these taxing schemes evolve over a period of time and as circumstances change and one type of activity increases it becomes more apparent--

Unidentified Justice: But you're a victim only in the sense you have this litigation on your hands--

Mr. Eikenberry: --Well, yes.

Unidentified Justice: --only in the sense you have the litigation on your hands.

Well, if you treated all contractors like you treat Government contractors there wouldn't be any problem, would there?

Mr. Eikenberry: That's certainly true, Your Honor.

Unidentified Justice: Because the federal contractor could pass it on to the Federal Government in terms of his price.

Mr. Eikenberry: That's absolutely true, Your Honor.

We would be back under the rules that were applicable--

Unidentified Justice: Yes, yes.

Mr. Eikenberry: --with the Dravo Contracting case.

Unidentified Justice: In '35, wasn't it?

Mr. Eikenberry: Yes.

1937 I believe was the time that the Court made that step and said that it was entirely appropriate to apply such a tax.

If I may--

Unidentified Justice: Go ahead.

I'm sorry.

Mr. Eikenberry: --In fact, that's the position being taken here by the Government, we believe, in advancing these arguments, that is, that if the same identical tax were applied then to contractors in the private sector then there would be no argument.

On the contrary, we're saying that the fact that everybody pays in our state a retail sales tax, that the tax on the nonfederal construction, applied the way it does, makes all the difference in the world constitutionally speaking, and that the Government's objections are formalistic and hypertechnical.

We believe the principles of federalism and the purpose of the supremacy clause does not require this kind of rigidity or inflexibility.

Further, we believe the objections of the United States disregard the common sense that this Court has embodied in prior decisions beginning with the case of James against Dravo Contracting Company in 1937, proceeding on up through the U.S. against Fresno County case in 1977 and as recently as last year, the same principles being articulated in U.S. against Mexico.

I'd like to suggest a case that illustrates the hypertechnical approach being relied on by the Government.

As long ago as 1939 in Southern Pacific Railway against Gallagher in the State of California, a taxpayer was arguing that application of the use tax to property that they brought into the state from out of state was unfair and discriminatory as far as the interstate commerce clause was concerned because it did not equate with a state retail sales tax, which of course applied to vendors and vendees in that state.

One of the reasons for the complaint was the theory that the retailer might be able to absorb part of that tax, and this Court said no, that that was hypertechnical, the difference in the legal incidence in the way those taxes were applied made no constitutional difference at all.

And as the Court said, there is an equal charge against what is used, whatever its source.

And this is the approach we're urging on the Court to take today with regard to this hypertechnical, what we believe formalistic complaint.

We're submitting the Court should construe the supremacy clause so as to protect the Federal Government against a state tax which places the Government at a competitive disadvantage in obtaining resources necessary to perform its functions, but at the same time construing the supremacy clause so as to allow the state the greatest flexibility to fashion a tax scheme that will fit our particular circumstances.

We certainly acknowledge, just to lay the groundwork, that the state may not lay the incidence of a tax directly on the Federal Government.

That is McColluch against Maryland, starting 160 years ago.

And that is why the legal incidence of this tax was not imposed on the Government here in the State of Washington.

And of course, just to make the step, this Court held that a state... it diverted from that and said that the state may impose a tax on people dealing with the Federal Government in 1937 in the James against Dravo case, and this Court held that that may occur even though the cost of that tax is passed on to the Federal Government, even though that becomes an expense of doing that business.

So that brings us, I believe, to the test, the question here before the Court today: What is the test that should be applied to determine whether a tax with those dealing with the Federal Government is discriminatory under the supremacy clause?

Now, the Court, as I say, indicated it was all right for a state to tax contractors dealing with the Federal Government if the same tax is imposed on all other contractors, and in so doing the Court implicitly accepted the principle that economic forces will work the same in both the federal and the nonfederal sectors.

And we suggest that we can go from that case to say that they become economic burden partners in both the federal and the nonfederal sectors.

By economic burden partners, we'd suggest that we have a case where parties to a transaction which is subject to a tax, where the legal incidence of the tax falls on one party or the other and the economic burden of the tax will be determined as part of the negotiations in response to market forces which would apply to those kinds of transactions at that time.

So of course the question is, does this economic burden partner principle carry over to the case we're presenting to the Court today, and we believe that it does.

The question is, does this principle apply when the legal incidence of a tax is on a different partner in the federal transaction than it does on the partner in the nonfederal transaction.

Unidentified Justice: In that sense the state tax is discriminating against contractors with the Federal Government, isn't it?

Mr. Eikenberry: In that sense, Your Honor, the incidence is on different partners in the transaction, but I believe we can show that it is not a discriminatory tax simply because that incidence is placed on different partners to the transaction.

Unidentified Justice: How do you distinguish the Moses Lake Homes and Phillips Chemical Company cases that are relied upon by the Solicitor General?

Mr. Eikenberry: Each of those discrimination cases, Your Honor, are a situation where the taxes were different from the taxes being applied against other people that might be in comparable transactions.

In the Moses Lake case, as you recall, we had a state sales tax on leasehold interests of people renting federal housing, and because of the way the tax was applied it was simply higher than any other tax for similar leaseholds.

In the case of Phillips, where we had a manufacturing company leasing a property from the Federal Government, producing ammonia, because of the way the tax was applied again, it was simply higher than it was to any other leasehold interest, and it states so factually, we believe they're significantly different.

Here we have the same tax.

Unidentified Justice: Wasn't the concern of the Court, at least in Phillips and perhaps in Moses Lake too, that the state treated contractors dealing with the state more favorably than contractors dealing with the Federal Government?

Mr. Eikenberry: There was... there was some discussion about whether people in the same identical situation as federal contractors were treated the same.

But I believe that the bulk of the concern of the opinion was concerned with the fact that across the board the tax was not the same.

Unidentified Justice: Do you think that analyzing the Washington... the economic burdens of the Washington transaction, it can be fairly said that Washington, that the State of Washington treats those contracting with the Federal Government less favorably than those contracting with the State of Washington?

Mr. Eikenberry: We say we do not treat them less fairly, Your Honor, and--

Unidentified Justice: Less favorably.

Mr. Eikenberry: --We say that they're being treated equally in both the federal sector and the nonfederal sector.

And let me use the way this thing developed in the Detroit case, U.S. versus City of Detroit in 1958, where you had a situation of the tax being imposed on the leasehold interest of the Borg-Warner Corporation, doing private manufacturing, and the Court upheld that tax because there was a comparable tax on landowners who passed their cost on to their tenants.

So there was incidence falling in different places.

It was on... in the federal situation the tax was on the tenant, and on the nonfederal situation the tax was on the landlord.

Nevertheless, the Court held that there was an equalization process going on there, that it was inevitable that these burdens would be shared.

The Court did not use that expression, but it was obvious that it was viewed as the burden of the tax passing from the private landlord to his tenant and the possessory interest tax passing from the Federal Government's tenant to the Federal Government, and there was an equalization of the tax that fell on the use of property in that state, and therefore it was not regarded as being discriminatory.

Unidentified Justice: Well, Mr. Attorney General, the federal contractor nevertheless has to put out the money when he buys, five or six percent more when he buys his materials.

He's going to need more working capital in that respect.

As he goes along, he's going to perhaps have progress payments.

But beyond that, he won't be treated the same economically unless he can get the money from the Federal Government.

Mr. Eikenberry: The economic forces of the marketplace--

Unidentified Justice: Right, he's going to have to pay it and then he's going to risk whether or not he can... how much of it he can get from the Federal Government.

Mr. Eikenberry: --Your Honor is mentioning, of course, the up-front money problem that we have mentioned in our brief.

Unidentified Justice: Yes.

Mr. Eikenberry: And there is at least three different aspects that need to be touched on in responding to that.

First of all, the economic forces of the marketplace are going to see to it that the parties in negotiating the terms of their contract will balance out, we believe, as between federal and nonfederal.

In other words, in the federal sector there are such things as advance funding accounts that can be used and have been used, that may completely eliminate that problem for the private contractor, and over on the nonfederal side there are comparable arrangements that can be worked out.

In any event, it's significant, I think, to point out that the Federal Government has not complained of that as being a problem, nor is there evidence before the Court or in the record on that matter.

If we can go ahead and, discussing this same issue that's been raised here by the Court, compare what occurred in the case of United States versus County of Fresno, where we again had the legal incidence falling on one partner in the federal transaction and a different partner in the nonfederal transaction.

There, of course, under authority of state law a possessory... a leasehold possessory interest tax was imposed against tenants of the Federal Government.

A comparable tax, a property tax, was imposed by the state on landlords in the private sector.

And the Court in writing that opinion presumed that the economic burden of that real property tax on the landlord would be passed to the tenant.

Now, of course the presumption then has to be compared with the federal situation, and the Court said nevertheless that the tax was reasonable, that it was fair, that the same market forces applied to both parties as they arrived at their pricing level, and that the placement of the legal incidence in that case was irrelevant.

Now, of course there is another matter that comes out of that case that needs to be addressed, and that was the matter, the reasons indicated by Justice Stevens in his dissent that the tax did appear on its face to be discriminatory because of the fact that the Government initially, at least, in its pricing scheme was collecting both the cost... because they were basing their prices on comparable market value or prices for rental units, was including both the possessory interest tax and the... or rather, including the value of property tax and then the tenant was having to pay the possessory interest tax.

Unidentified Justice: Refresh my recollection.

Wasn't it also true in that case that the possessory interest tax was paid on state-owned property as well?

Mr. Eikenberry: That is true, Your Honor.

Unidentified Justice: Which is different from this case.

Mr. Eikenberry: But nevertheless, the principle is the same, because the only way to explain the case and I believe the bottom line is that the tax did not discriminate against the Government and thereby breach the protective mantle of the supremacy clause in that case, because the Government, even if it assumed the burden of the tax by lowering its rents, would not be placed at a competitive disadvantage vis a vis other landlords who had to pay over a portion of their rent to the state government.

Unidentified Justice: Mr. Attorney General, if you're right couldn't the State of Washington say with respect to federal contractors, we're going to put a five percent tax on you measured by the contract price to the Government, and we're not putting the legal incidence on the Government; you can do what you want to.

You can try to get the money back from the Government or not.

But anyway, you have a tax on you for the full amount of the contract price, just like it's placed on private contractors.

The only thing there is that we make them pass it on.

Mr. Eikenberry: This would be an alternate scheme that could be used, Your Honor, a gross receipts tax of sorts applied to--

Unidentified Justice: Applied solely to federal contractors?

Mr. Eikenberry: --Well, I believe that we would have to have a comparable tax on contractors--

Unidentified Justice: Well, I just say... your argument is that really in effect, that your sales tax is a comparable tax the way you now arrange it, namely five percent added to the contract price that the owner must pay.

Mr. Eikenberry: --Oh, yes.

Let me agree with the Court.

Then the only distinction I was drawing is that in our situation we have an identical tax, although it's applied... the incidence falls on a different party in the nonfederal transaction.

Unidentified Justice: Well, wouldn't you agree that if your argument's right Washington could put whatever your rate is, a five percent tax, on the contract price of the Government contractor?

Mr. Eikenberry: If I correctly understand what's being posed here and the tax were identical in its rate, yes, I believe we could, Your Honor.

Unidentified Justice: As long as you didn't attempt to put the legal incidence on the Government.

Mr. Eikenberry: Absolutely.

That would be the final test, Your Honor.

Unidentified Justice: General Eikenberry, what is Washington law with respect to the obligation, duty of a contractor with the state to pass along the sales tax?

Is that simply a question of the bargaining between the parties?

Mr. Eikenberry: It's bargaining between the parties, Your Honor, and the forces that happen to be in play in the marketplace at that time.

Unidentified Justice: I thought you answered Justice O'Connor a while ago that you... that contractors contracting with the state government are treated just like private contractors.

Mr. Eikenberry: Yes, I did.

Did I misunderstand?

Unidentified Justice: No.

I wanted to ask, if contractors with the state government and private contractors are treated alike, what is the law with respect to the contractor's duty to pay and the permissibility of his passing along the tax to the ultimate owner, whether it's the state or a private entity?

Mr. Eikenberry: It's identical as between the private and the state government being the customer, Your Honor.

Unidentified Justice: But aren't they required to pass it on?

Mr. Eikenberry: Yes, that's true, Your Honor.

Unidentified Justice: I think perhaps we haven't been as explicit in our questions, or perhaps you haven't been as explicit in your answers.

If I'm a contractor in the State of Washington and I contract with the Alpha Delta Retirement Home to build a retirement home for them, does Washington state law impair in any way the freedom of bargaining between me as contractor and the Alpha Delta Retirement Home as to who shall bear the incidence of the tax?

Mr. Eikenberry: Oh.

No, you may not bargain who bears the incidence of the tax.

Legally it falls definitely on the one party.

Unidentified Justice: On which party?

Mr. Eikenberry: It would fall on the private party or the State.

Nevertheless, the two parties to that transaction may--

Unidentified Justice: It falls on the owner.

Mr. Eikenberry: --The owner of the property for whom the construction is being done.

Nevertheless, the two parties may recognize that the market forces in work today say to me as a customer that I'm not willing to accept the total price that results from what you said the materials and your labor and your profit will be, plus that tax.

And therefore they can bargain and arrive at a new price, so that the results will work out the same.

Unidentified Justice: But the legal incidence of the tax is on the owner who is getting the building from the contract.

Mr. Eikenberry: Yes, sir.

If I may, I would save the remaining time for rebuttal.

Unidentified Justice: Let me ask you one more question.

How does the State... it's not, then, a tax on doing business, the way a sales tax is; it's a use tax on the use of the property by the owner?

Mr. Eikenberry: Yes.

We have the comparable use tax if sales tax has not been paid and things have been brought in from out of state.

So we have both the sales tax on the retail sales and the use tax for--

Unidentified Justice: How does the State collect that from an owner?

The contractor is supposed to collect it, isn't he?

Mr. Eikenberry: --Yes.

Your Honors, if we're dealing in a nonfederal situation the contractor prepares a bill for his labor, materials costs, et cetera, and then calculates a retail sales tax and presents that, collects the money from the customer and remits it to the State.

Unidentified Justice: So that the contractor is actually the entity through which the Tax Department of the State of Washington collects the tax, even though you say the legal incidence is on the owner.

Mr. Eikenberry: That's true.

And if I may add one thing to that, Your Honor, there is an advantage to the State in doing it that way because also we have the legal ability if the tax is not collected to hold the contractor seller liable, or we could go after the--

Unidentified Justice: How can you hold the contractor liable if the incidence of the tax is on the owner?

Mr. Eikenberry: --Because we've said it's his duty to collect it from the customer.

Unidentified Justice: So as a practical matter, it's really the contractor that pays.

Mr. Eikenberry: I understand the point, Your Honor.

But legal incidence we believe is on the customer.

Unidentified Justice: General, is the contractor's profit included in the base of the tax?

Mr. Eikenberry: Is... I'm sorry, I didn't quite hear.

Unidentified Justice: I understood that the tax when you're dealing with parties other than the United States Government is based on the cost of the project--

Mr. Eikenberry: Yes, sir.

Unidentified Justice: --to the landowner.

Mr. Eikenberry: Yes, sir.

Unidentified Justice: Does that cost of the project include the contractor's profit?

Mr. Eikenberry: Absolutely, yes, sir.

Profit, services, labor, and the whole cost of the project.

Chief Justice Burger: Mr. Smith.

ORAL ARGUMENT OF STUART A. SMITH, ESQ., ON BEHALF OF THE UNITED STATES

Mr. Smith: Mr. Chief Justice, may it please the Court:

As the Court is well aware, there is a fundamental tenet in our Constitution providing for the immunity of the Federal Government absolutely from state taxation.

McCulloch established that federal tax immunity, as Chief Justice Marshall said, is the unavoidable consequence of that supremacy which the Constitution has declared.

Now, we all agree that McCulloch established that the states cannot lay a direct tax upon the United States.

But there is an important corollary to that doctrine which is equally unquestioned.

It is, as the Court has said on numerous occasions, that a tax may be invalid, even though it does not fall directly upon the United States, if it operates so as to discriminate against the Government or those with whom it deals.

The Court said that in the United States versus City of Detroit and has reaffirmed that in Phillips Chemical Company, Moses Lake Homes, and a whole host of precedents.

This corollary is essential to the integrity of the federal tax immunity principle, because otherwise the very functioning of the Federal Government would be impaired.

For example, if a state attempted to tax the income solely of federal employees, that tax would be indisputably invalid.

But an income tax laid upon all residents of the state, which includes federal employees, would be constitutional, as indeed this Court held in Graves ex rel. versus O'Keefe.

So the rule that has emerged in more recent terms from the decisions of this Court is that the economic burden on a federal function of a state tax imposed upon those who deal with the Federal Government renders the tax invalid if it is not imposed equally on the other similarly situated constituents of the state.

In our view, the Court of Appeals correctly identified the Washington sales tax at issue here as a classic example of discriminatory taxation.

All will agree, and the State indeed properly concedes, that the Washington legislature engaged in a purposeful attempt to circumvent the immunity of the United States.

The statutory history--

Unidentified Justice: Well, you use the term

"circumvent the immunity of the United States. "

Mr. Smith.

If the Washington legislature looked around and said, look, there are some people contracting with the Federal Government who we think the decisional law will let us tax, but our tax structure just isn't framed to get that tax, so let's change it to tax what we can, would you say that was a desire to circumvent the immunity of the Federal Government?

Mr. Smith: --It would be an attempt to do it, but our view is that they haven't done it correctly here under the precedents of the United States.

Unidentified Justice: There are some ways they can circumvent it and other ways--

Mr. Smith: Exactly.

Unidentified Justice: --The difference between tax evasion and tax avoidance?

[Laughter]

Mr. Smith: I think--

Unidentified Justice: Mr. Smith, if the tax here, instead of requiring the owner of the property to pay a tax based on the full contract price, had a separate sales tax, one on the owner for the labor involved and one on the contractor for the cost of materials incorporated in the project, and the tax on the federal contractors remained the same as it is now, I assume you would say that's constitutional.

Is that right?

Mr. Smith: --Well, the important thing, Justice O'Connor, is that the federal contractors be treated the same as all other contractors.

Unidentified Justice: And under that assumption it would be--

Mr. Smith: Under that assumption that would be right.

Unidentified Justice: --and it would be fine.

Mr. Smith: In other words, so that the Federal Government's immunity would prevent the state from imposing a tax on the... you know, on the contractor's profit, you know, which would be the cost borne by the Federal Government.

But the statutory history reveals that that really, and the statute indicates, that that really isn't what happened here, because in 1935 when this tax was enacted the tax was on, the Washington sales tax, was on sales to building contractors.

That is, to use the Attorney General's example, if a contractor purchased a nail or some other component that went into a house from a hardware company, that contractor would have to pay the sales tax.

All contractors would pay that sales tax, whether... no matter whom they dealt with, the Federal Government, the state government, or a private party.

The tax was imposed on contractors.

In 1941 the State wanted to... the State changed the tax, and what it did was it changed the tax to sales by contractors, so that the tax began to be paid by consumers.

Now, the State did this legitimately in order to increase its tax base, in order to include the contractor's profit in the tax base.

But because it did this and imposed the tax at the customer level, of course, the Federal Government was a customer; all those transactions became immune under the absolute immunity of the Federal Government that this Court has never questioned.

So now, for more than 30 years the State was apparently content with this choice, that is, an enhanced tax base in the private and state sphere, gaining enhanced revenues from these sources at the price of sacrificing... and indeed, at the constitutional price of sacrificing revenue from Federal Government contractors.

And in 1975 it saw that, when federal construction activity in the State of Washington became greater and more intense, the State sought to include somehow the Federal Government's contracting activity in its tax base, while retaining the enhanced tax base on private construction.

The State did not want to give up that aspect of its tax law.

So in 1975 the State amended its sales tax to impose, as we have it now, a tax upon contractors for the United States, but not upon other contractors.

Now, there's no doubt, indeed, that this... these amendments intended to circumvent the federal tax immunity.

The legislative history indicates that, the staff reports indicate it, that there some question as to whether this was discriminatory under the decisions of this Court, and indeed the State so acknowledges that intent.

Now, in our view these 1975 amendments effectively single out the Federal Government's contractors for state taxation, and therefore runs afoul of the discrimination corollary under the immunity--

Unidentified Justice: Regardless of the economic effect?

Mr. Smith: --Regardless of the economic effect.

Unidentified Justice: Even if it's perfectly clear that the Federal Government contractor, the whole transaction of contracting with the Federal Government, will suffer a lesser economic burden than the state contractors?

Mr. Smith: Well, that's true, regardless of that effect.

Unidentified Justice: And that's your position?

That's your position?

Mr. Smith: That is our position, and we think it's a position which is supported by the decisions of this Court, because rather than engaging in... the supremacy clause, as this Court has interpreted it countless times, presuppose... indicates the Founding Fathers' attempt to avoid this clash of sovereigns, clash of sovereigns between the Federal Government and the state government.

And because of that, the supremacy clause betrays this apt principle that the Federal Government and those with whom it deals cannot be singled out for discriminatory taxation.

Now, in our--

Unidentified Justice: Why do you call it discriminatory?

Mr. Smith: --Well, it is--

Unidentified Justice: It's just different.

Mr. Smith: --It's different, but--

Unidentified Justice: It's not discriminatory.

It's discriminatory against the state and private contractors.

Mr. Smith: --Indeed.

Unidentified Justice: It puts a lesser burden on the Federal Government than it does on the State.

Mr. Smith: Yes, but I think as the Court indicated in County of Fresno in describing the McCulloch rationale, the Court said if the state's power to tax the bank were recognized in principle, the Court doubted the ability of federal courts to review each exercise of such power to determine whether the tax would or would not destroy a federal function.

The important thing, as the Court of Appeals recognized here, is that once you have... once you have a state legislature's identification of federal activity for different tax treatment, that that indicates a potential for abuse which triggers the application of the immunity clause.

Unidentified Justice: Whether discriminatory or not.

Mr. Smith: Whether discriminatory or not.

And in our view this fits in perfectly, fits in appropriately, with the Court's... with the entire panoply of decisions which examine the state taxes in terms of where the legal incidence is imposed.

Unidentified Justice: Although if they treated all contractors alike and just put a sales tax on the purchases of a contractor from all of his suppliers and left it up to the contractor to pass it on to his owner if he could, the fact that the United States would end up paying the tax would not invalidate it.

Mr. Smith: Indeed, that was the situation in 1935, and that really flows from the Court's statement in King & Boozer.

Unidentified Justice: Even though the... even though now the burden on the Federal Government, if you accept, if you accepted the Washington tax, is no greater.

Mr. Smith: Indeed.

But you know, that argument--

Unidentified Justice: It's just different.

Mr. Smith: --It's just different.

But that argument is frighteningly reminiscent of what the State of Maryland must have argued before the Court in McCulloch versus Maryland.

It said: Trust us; we're not going to make this that onerous or difficult.

Unidentified Justice: Well, but I think one might fairly say your argument is reminiscent of a good deal of the decisional law of this Court before James versus Dravo and King & Boozer, where it was simply an exultation of form over substance.

Mr. Smith: I don't think so, Mr. Justice Rehnquist, and the reason I don't think so is that we are examining here where the legal incidence of this tax falls.

It's a tax, it's a sales tax which is imposed only on federal contractors.

And we look around and say to ourselves, if company A goes into the State of Washington and it engages in a federal contract, it has to pay this tax and it has to, as Justice White pointed out, put up this money up front and whether it gets back the money or not is really wholly problematic.

And if it does business with a private party it doesn't have to pay the tax.

Now, that--

Unidentified Justice: That's a burden... that's an economic burden argument you're making now.

Mr. Smith: --No, it isn't.

It is not an economic burden argument.

In our view it is an examination of where the legal incidence of this tax falls.

I have no quarrel--

Unidentified Justice: It's just a description of how they're treated differently?

Mr. Smith: --It's a description of how they're treated differently.

And indeed, as I think the Court indicated in County of Fresno, once the principle is breached this different treatment indicates that, you know, the constitutional principle is also breached.

And in our view this--

Unidentified Justice: Mr. Smith, in the County of Fresno we have exactly the same situation we have here.

The tax was placed on renters who rented from the Federal Government, and we got around that in County of Fresno by making certain assumptions about who was going to bear the economic burden.

Why can't we make the same assumptions here and assume that, for instance, that the tax couldn't be shifted from the federal contractor to the Federal Government itself?

Mr. Smith: --I think that kind of assumption... well, first of all, let me answer that in two parts.

I think, to begin with, the assumption that the Court engaged in in County of Fresno, equating the renters in private property with the Forest Service rangers, was an appropriate, an arguably appropriate analogy between two parties who occupied similar positions in the economic spectrum, that is, renters of property.

Here we have a situation where the State is attempting to save its tax by pointing to the customers, the private customers, and saying, we don't have to worry about the fact that we're not taxing the private contractors because we're taxing the private customers.

The private customers are not comparable to contractors.

They're really quite different.

And the point... in response on another level, Justice O'Connor, let me simply say that that argument, the point is that somehow it's all going to work out because the customers are bearing the tax, I think places unnecessary or improper emphasis on the fact that these taxpayers here are projects, they are construction projects.

The taxpayers in this case, in these cases, are not projects; they are parties.

And in this particular instance we have a situation where the contractor who deals with the Federal Government is subject to tax and the contractor who deals with a private party and the State is not subject to tax.

In fact, the State responds by saying, as you've suggested, that the discriminatory treatment could be cured simply if the United States would reimburse its contractors.

But really, that turns the immunity principle on its head.

It identifies the federal tax immunity, the absolute immunity that this Court has repeatedly indicated it has never questioned, as the cause of the discriminatory treatment here.

The immunity is not the problem, we submit.

It is the first principle that's to be considered, the unavoidable consequence of that supremacy that the Constitution has declared.

We think that the State cannot seek to identify the Federal Government's either refusal or disinclination to reimburse its contractors as an affirmative justification for its invalid discriminatory or indeed different treatment of federal contractors.

And--

Unidentified Justice: Of course, the Government got into this case only because it reimbursed and then sued for a refund, didn't it?

Mr. Smith: --I assume so, I assume so.

Unidentified Justice: You assume?

Mr. Smith: I assume that the Government... although I suppose that the Government... the Government is a party in this case.

I'm not sure that the Government has reimbursed it, but I assume that that's probably right.

Unidentified Justice: I thought you did reimburse them.

Mr. Smith: I think that's probably right.

But again--

Unidentified Justice: But we're talking about a case where the contractor suffered no economic burden whatsoever.

Mr. Smith: --But again, Justice White, I don't think that we can... I don't think that we can assume that the Federal... to assume that the Federal Government will make that kind of reimbursement is in effect to really, you know, make a farce of the Federal Government's immunity.

Because if you structure a state's taxing statute on the assumption that the Federal Government will make this contribution and that's the way we're going to achieve equal treatment, it seems to me that the immunity principle is seriously threatened.

Unidentified Justice: It sounds a lot like your brief in Fresno.

Mr. Smith: No, I don't think it sounds like my brief in Fresno, for one simple reason.

I think that the Court will recall Fresno, in Fresno the principal argument we made was that the tax on the Forest Ranger's possessory interest endangered and impaired the ability of him to discharge his duties.

And the Court indicated that there could be a segregation, a separation of his private residential aspect, of his house, with the Court's... you know, with the taxation of his axe, et cetera, et cetera.

So I think the cases are really quite different.

But I think that the Fresno principle is something that it seems to us that the Court of Appeals correctly identified as the appropriate rule on which to invalidate this tax.

That is, that you can't treat those who deal with the Federal Government differently than those who deal with other parties, that that difference in treatment triggers the kinds... the clash of sovereigns that the supremacy clause was designed to prevent.

Unidentified Justice: Mr. Smith, before you leave Fresno, I should have reread the case before today, but is it not true that in the California possessory interest tax, not only did the tax apply to tenants of all publicly owned property, but to any property the owner of which was tax exempt, such as charities?

Wasn't there a broad class of properties?

Mr. Smith: I think that's right.

Unidentified Justice: Doesn't that make it quite different from this case?

Mr. Smith: I think it does.

Unidentified Justice: But if you admit that, then what if Washington were to amend its tax to take the approach it now applies just to the Federal Government and create a class of contracts including state agencies and the like and treat them the way they now treat the Federal Government?

Would that save it?

Mr. Smith: Well, I'm not sure it would save it, only because you then would have... you then have to examine whether it included a sufficient number of similarly situated constituents within the tax to protect the Federal Government.

In fact, the dissenting opinion... the dissenting opinion in Montana versus United States really sort of raises that problem, although it was--

Unidentified Justice: Well, yes, but--

Mr. Smith: --talking about the merits, it was talking about the merits of a case that the Court never reached.

Unidentified Justice: --So did the dissenting opinion in Fresno, but it wasn't very persuasive.

Mr. Smith: But let me simply say that I think that when you're talking about who is a similarly situated constituent you have to, I think, start from the notion that the Federal Government is entitled to a full measure of protection and the inclusion of all similarly situated constituents.

Because I don't... I think it would be... I would counsel against the Court engaging in a kind of quantification of how much is enough.

It seems to us that the supremacy clause, if it's going to have any meaning, has to protect the Government by... in other words, the notion should not be that these people have sufficient political clout and these... and that will carry the day, because those things are terribly ephemeral.

I think from a constitutional point of view the Federal Government has to be protected by including all similarly situated people within the tax, and that in our view here means the contractors, and that, the absence of the contractors here which deal with the State and with private parties, is glaringly absent.

If the State wants to return to 1935, we don't have any quarrel with that.

If it wants to impose a tax based on the gross receipts of all contractors, James versus Dravo Contracting Company establishes the validity of that kind of tax.

But here we have a situation where the State really wants to have it both ways.

It wants its enhanced tax revenue from the enhanced base in the private sphere, but it also wants to catch the federal contracts.

And in our view it can't do that in this context.

And in that respect, I simply want to identify, we talked at the beginning about purposeful circumvention.

There are... there are precedents of this Court that indicate that the identification by a state of federal activity or tax-immune income for taxation by circumvention is improper and imperils the supremacy clause.

And I would refer the Court to an old, but in our view perfectly appropriate, decision, Miller versus Milwaukee, which dealt with that sort of thing; and Moses Lake Homes, which in fact... Moses Lake Homes--

Unidentified Justice: Hasn't Miller versus Milwaukee been rather substantially limited by comments in later opinions?

Mr. Smith: --I don't think it's been limited.

I think what the Court indicated was it still stands for the important proposition that you can't discriminate against the Federal Government and those with whom it deals.

And in fact, Moses Lake Homes, it seems to us, answers the very attempt of the state here to recast the absolute immunity that the Court has never questioned in terms of a no competitive disadvantage principle.

If the Court will recall in Moses Lake Homes, a case which also came from the State of Washington, the State of Washington imposed a higher tax on federal lessees than state... than private lessees.

And the Court... the Ninth Circuit struck that tax down and remanded it to the district court for recomputation to impose an equivalent tax on the federal lessees.

And when the case came to this Court, this Court had no trouble saying that a discriminatory tax like that was invalid.

Without further discussion, the whole tax was invalid.

So we're not really... it seems to us it would be wrong to demean the absolute immunity of the United States from federal taxation and the anti-discrimination principle which is part and parcel of that by saying that somehow, as long as the Federal Government or federal construction contracts bear the same cost in the marketplace, that that's sufficient, the Federal Government simply is protected against paying any more.

In our view, the decisions of this Court convincingly refute that kind of relegation of the immunity principle to what I might call a most favored nation clause in a tariff treaty.

This is an essential part of the Constitution.

It protects the Federal Government from impairment of its functions by insisting that those who deal with the Federal Government are not singled out for discriminatory tax treatment.

We submit that the Court of Appeals decision, the judgment should be affirmed.

Chief Justice Burger: Do you have anything further, Mr. Attorney General?

REBUTTAL ARGUMENT OF KENNETH O. EIKENBERRY, ESQ. ON BEHALF OF APPELLANTS, WASHINGTON, ET AL.

Mr. Eikenberry: Yes, Mr. Chief Justice.

We submit that the test which this Court may apply in this case is inherent in the Fresno case and the Detroit case, and I would state it as follows: A state may properly tax those doing business with the Federal Government where the same tax is imposed on comparable nonfederal situations and transactions, where the same tax on those dealing with the United States is no greater than the tax on nonfederal transactions.

And that's what we have here.

In fact, the Federal Government even has a cushion, if you will, because the tax in the federal situation, the tax base is lower.

This test provides the United States not being placed at a competitive disadvantage in carrying out its functions, and it provides that those who are similarly situated in other transactions will be treated alike.

It ensures, we believe also, that there will be a political check, because this broad class has been created and the taxes will therefore not be raised abusively.

And that would conclude our argument, Your Honor.

Chief Justice Burger: Thank you, gentlemen.

The case is submitted.