Transcript

IN THE SUPREME COURT OF THE UNITED STATES

AMERADA HESS CORPORATION, ET AL., Appellants v. DIRECTOR, DIVISION OF TAXATION, NEW JERSEY DEPARTMENT OF THE TREASURY; and TEXACO, INC., AND TENNECO OIL COMPANY, Appellants v. DIRECTOR, DIVISION OF TAXATION, NEW JERSEY DEPARTMENT OF THE TREASURY

No. 87-453, No. 87-464

November 29, 1988

The above-entitled matter came on for oral argument before the Supreme Court of the United States at 1:55 o'clock p.m.

APPEARANCES:

MARK L. EVANS, ESQ., Washington, D.C.; on behalf of the Appellants.

MRS. MARY R. HAMILL, ESQ., Deputy Attorney General of New Jersey, Trenton, New Jersey; on behalf of the Appellee.

PROCEEDINGS

1:55 p.m.

CHIEF JUSTICE REHNQUIST: We will hear argument next in No. 87-453, Amerada Hess v. the Director of the Division of Taxation; and No. 87-464 Texaco v. the Director.

Mr. Evans, you may proceed whenever you're ready.

ORAL ARGUMENT OF MARK L. EVANS ON BEHALF OF THE APPELLANTS

MR. EVANS: Thank you, Mr. Chief Justice, and may it please the Court:

These appeals are about New Jersey's novel attempt to raise its own state tax revenues at the expense of only out-of-state economic interests. Most of the paths to that tempting goal have been shut off over the years by this Court's decisions which have made it crystal clear that while interstate business must bear its fair share of local tax burdens, it must be made to bear no more than its fair share.

But New Jersey seems to feel it has found a loophole. Under the formula apportionment method of taxation, a state first determines the total income from the entire enterprise from sources both inside and outside the state and then takes a slice of that income for itself by using a fair apportionment formula. The Court's decisions have insisted that the formula be geographically neutral so that the state does not impute to itself a greater portion of total net income than can be reasonably attributed to the company's activities within the state.

What New Jersey has done is used a perfectly reasonable apportionment formula, but it has applied it to a geographically skewed base. It has not skewed the base by adding out-of-state revenues to it in an inappropriate way or overstating out-of-state revenues; what it has done is found a cost that is incurred only outside the state, only by crude oil producers, and has disallowed it. The result of that has been to drastically raise the income that New Jersey taxes from the oil companies.

And the question that is raised, in our view, by this is whether a state can sidestep the usual apportionment mechanisms on the theory that income tax deductions are purely a matter of legislative grace.

I'd like, if I may, to start with describing a little bit of the context in which this case arises. The Appellants are all integrated interstate petroleum companies. They do business in New Jersey, but they produce crude oil only outside New Jersey. There is no crude oil produced at all in New Jersey.

During the years at issue each of the companies incurred very substantial windfall profit tax liabilities. That tax operates much as a severance tax does: it is imposed on the removal of each barrel of crude oil from the producing premises, and it is measured by a portion of the barrel's wellhead value. Under New Jersey's formula apportionment method, it requires the Appellants to include in their preapportionment base all of their income from all sources. That means that the base includes the income from, derived from the production activities outside the state.

At the same time, New Jersey law, as construed by the state Supreme Court, disallows a deduction for these billions of dollars of windfall profit taxes that Appellants incurred solely in the course of those out-of-state production activities.

QUESTION: The New Jersey allow the Appellants to deduct their federal income tax?

MR. EVANS: No, it does not.

QUESTION: Do you claim that is a violation of any constitutional principle?

MR. EVANS: No, we do not, Mr. Chief Justice. The distinction, as I hope to develop a little bit further in a moment, is that the activities that give rise to the federal income tax liability are activities that take place everywhere, including New Jersey, and as a consequence, the cost of federal income taxes is not site-specific and geographically localized to any specific activity.

QUESTION: May I ask you a question, too, Mr. Evans?

MR. EVANS: Sure.

QUESTION: Before you get -- what is the allocation factor that New Jersey applies after they use their three factor formula to your company?

MR. EVANS: Well, there actually are, there are 13 companies involved.

QUESTION: Well, roughly what is the factor?

MR. EVANS: They vary quite a lot, Justice Stevens. There is a chart in the back of our brief, on the second -- well, it says page 3a of the Appendix to our blue brief, which reflects the allocation factor for each of the companies in the left-hand column for 1980, and then there are slightly different ones for the companies who have 1981 year as an issue.

QUESTION: Well, taking Chevron, for example, it is a little over 4 percent.

MR. EVANS: That is correct.

QUESTION: Now would you tell me, supporting Chevron had 4 percent of its producing wells in New Jersey, would they have -- would you be able to make the claim you're making here?

MR. EVANS: I think the issues would be altogether different, Justice Stevens.

QUESTION: Would you have any constitutional objection to this scheme if that were the fact?

MR. EVANS: We would not have the objection that we're raising here. There may be other objections, but they're not what we're arguing about.

QUESTION: But you are based entirely on the geographic factor.

MR. EVANS: Exactly, exactly.

QUESTION: But if they did have 4 percent of their wells in New Jersey, you'd still have the same rather dramatic distortion by this bank by not allowing this particular deduction.

MR. EVANS: Well, there might be --

QUESTION: It wouldn't be quite as dramatic.

MR. EVANS: Right. There might be some element of disproportion, but the Court has never insisted on and we don't ask for mathematically precise apportionment mechanisms. It has always recognized that states need a margin of error, and it has used phrases like rough approximation, and we have no objection to that. What we do think is that the Court can reasonably expect that before a state disallows a large deduction, that it have some substantial in-state effect, some impact on the in-state economy that serves as some kind of a check against the imposition of burdensome taxation.

That is not the case here, and in fact, it has zero impact because there's absolutely not a drop of oil being produced in New Jersey.

QUESTION: Do you think 4 percent would be a substantial, substantial enough impact? I'm not sure that's fair. What about .001 percent?

MR. EVANS: I don't --

QUESTION: I mean, we would have to draw some line, wouldn't we? We'd have to figure out what percent is substantial enough for New Jersey for this particular exclusions, and there are all sorts of other exclusions. We will have to figure out some percentage of substantial enough in-state impact.

MR. EVANS: I think that there are some techniques that the Court, this Court and the state courts can use to make that process a bit more manageable. Certainly one can look at the proportion or the ratio of in-state production to nationwide average production by state or per capita. One could look at the proportion or the ratio of oil production and its related industries to the state's total economy or could look at the employees who are involved in oil production activities or in related service industries as a proportion of total work force.

And in the end, there may have to be some line.

QUESTION: And what -- you mean if the proportion in New Jersey is not the same as the -- it has to match what? It has to be one-fiftieth, or it has to be one what?

MR. EVANS: Well, I don't, I don't know that this is the case in which to draw the line, Justice Scalla. I think that --

QUESTION: I want to know what kind of a line you're asking me to draw. That's what I want to know before I even decide that I want to draw a line.

MR. EVANS: Right. Wells, in this case -- and I'll try to answer that question, but in this case I want to make sure that we start from the same foundation.

No matter where you draw the line, this case falls on the other side of it, that is, on the side of unconstitutionality because there is zero.

QUESTION: If you draw a line.

MR. EVANS: If we draw a line.

QUESTION: Right, but whether I draw a line depends on, to some extent, on whether I can draw a line.

Now, you tell me what a line would look like.

MR. EVANS: Well, let me suggest that I can't stand here today and tell you what percentage is the cutoff. I think that the Court has always used and has drawn comfort from concepts that are based in questions of substantiality. It has used burdens of proof and presumptions to help it make these kinds of judgments.

But in the end, there may come a day when a line has to be drawn at a difficult spot.

QUESTION: But a judgment of what? I don't even know what you're asking me to Judge. What is the criteria? What am I looking for?

MR. EVANS: The disproportion, the --

QUESTION: But some disproportion --

MR. EVANS: Whether there is a substantial in-state effect that is reasonably proportional in the circumstances that would give the Court confidence that the in-state economy and the political forces within that state will be a check on the burdensome imposition of taxes.

QUESTION: Proportional to what? You say proportional, sufficiently proportional. Proportional to what?

MR. EVANS: Well, I started to talk about some possibilities. You could use proportional to the national average or the statewide national average. Two percent of the average production, for example, which would, which would give you a number something like 65 million barrels a year would be the average state crude oil production.

If you did it on a per capita basis, it might come out a little bit differently.

I think that there are ways you can find a base on which to use a denominator in making the proportionality.

QUESTION: It's not just this court that's going to be handling this sort of a doctrine; it's court all over the country.

MR. EVANS: That's right.

QUESTION: And it sounds like they're going to be casting about pretty much.

MR. EVANS: Well, these things may develop, Mr. Chief Justice, but let me suggest that I think there's a self-regulating mechanism here. To the extent that there are truly substantial in-state effects, they are less likely to be, to arise. The only states that have thus far taken the position that windfall profit taxes are not deductible for purposes of state income taxes are six. Five of them have no production at all. Some of them have done this by way of statutory provisions, some have done it by way of interpretation. One has negligible production, New York, which has something like .03 percent of the nation's crude oil production.

It may be that the issue won't have to really come up because when you start moving up the percentage line, when you start getting substantial in-state economic ties to the industry, that it is unlikely that it will be viewed as a target for this kind of taxation.

Now, I think it's important to emphasize that no one has produced, or certainly the state hasn't produced, and we haven't either, an example of any other disallowed deduction that affects in a disproportionate, geographically disproportionate way the activities that are subject to the disallowance.

QUESTION: Is it your submission that the severance taxes from other, imposed by other states should be deducted from gross income by New Jersey?

MR. EVANS: Yes, and they are.

QUESTION: And are they, all the time?

MR. EVANS: They are.

QUESTION: And is that theory that it is a cost of production?

MR. EVANS: Correct.

QUESTION: Just like the windfall profits tax is?

MR. EVANS: That's correct.

It is a theory that it is a cost of production, it is geographically site-specific in the sense that the liability arises on account of activities that occur in a specific place at a specific time, and it is --

QUESTION: But it isn't the kind of a cost that's associated with producing the gas out of the ground, is it?

MR. EVANS: Well, what, severance taxes?

QUESTION: Well, it's just a tax, it's just a tax, but it isn't how much does it cost me to drill down to 20,000 feet?

MR. EVANS: Well, but it functions the same way. It's going to cost me, those dollars that I have to pay in severance taxes and windfall profit taxes I have to pay to get that oil out of the ground and taken off the premises. It's a liability -- as a crude oil producer, there is like a toll gate that surrounds the producing premises, and every barrel that I move off those premises I have to pay the toll right there. And you can say that it's not like putting money into the ground, but what's the point of putting the money in the ground?

QUESTION: What did the -- did the United States file some amicus brief here?

MR. EVANS: Yes, it did. The Solicitor General filed a brief at the Court's invitation at the jurisdictional stage.

QUESTION: And what -- how do you read that?

MR. EVANS: I read it as quite favorable. The Solicitor General's position -- I'm going to be careful not to overstate it because the Solicitor General did not reach a bottom line conclusion with respect to the correctness or incorrectness of the New Jersey Supreme Court's decision, but the Solicitor General did set up a framework for analysis which we think is very much consistent with our own view of the case, and he had no trouble with what I think is the starting point for the analysis, which is whether this windfall profit tax is or isn't a site-specific cost of oil production. He agreed that it was. He didn't think that was a hard question.

He thought that the real question in the case, the dispositive one, was whether the windfall profit tax was more like a severance tax or more like an income tax, on the theory that if it was more like an income tax, there were similar in-state outlays that were being disallowed by the state.

The state operates this disallowance under what it calls its -- what the state Supreme Court referred to as an add-back provision. Like most states, New Jersey starts with a federal taxable income as the starting point for computing local taxation, and then it makes adjustments up and down, and one of them is an add-back which provides that the taxpayers must add back taxes paid or accrued to the United States on or measured by profits or income.

The issue, statutory issue in the court below was is this that kind of case. The court ultimately held it was, although it recognized, and recognized that the base on which the windfall profit tax is assessed is quite different from the base on which the federal income taxes is assessed. In fact, it specifically said something that the state's brief on the merits at least quite clearly repudiates, that the tax, windfall profit tax is imposed on production at the wellhead and is based on values measured at the time of removal.

So the states, the state court ultimately concluded that for statutory interpretation purposes this was a tax of the sort described in that add-back provision. What is significant, though, is that this is the only tax affected by that add-back provision. There's no reason, there's no necessity for adding back federal income taxes because they're not deducted in the first place. So the adjustment, although the provision has been read for purposes of, I suppose, comfort by the tax administrator in New Jersey as being confirmation that the federal income tax is not in fact deductible by taxpayers in New Jersey, nothing has to be done mechanically the way the statute is set up.

This is the only tax that is in fact covered by the add-back provision in a practical way. It is also the only tax in the category of taxes on profits or income within the New Jersey designation that is in fact based on transaction oriented tax liability rather than tax liability incurred on account of transactions throughout the country.

QUESTION: Mr. Evans, if I sat down and wanted to draw up a list of those disallowed deductions that we wouldn't have to worry about for purposes of policing commerce clause activity, I really think number one on that list would be disallowance of federal income taxes, for the simple reason that if the federal government doesn't think that that should be disallowed, it could say so when it imposes the tax, if it really thinks that that's what the commerce clause requires.

Isn't this the least worrisome of them that we would have to worry about?

MR. EVANS: For federal income tax, I would agree with you.

QUESTION: Well, any federal tax, federal income or other tax.

MR. EVANS: I think --

QUESTION: All the federal government had to do was to say when it imposed this tax it shall not be -- it shall be deducted from income for purposes of any state income tax.

MR. EVANS: What it did say, Justice Scalia is -- it anticipated that states would permit this tax to be deducted for state tax purposes. That was an expectation.

QUESTION: That's in the statute?

MR. EVANS: No, it's not in the statute. The statute --

QUESTION: It's in the legislative history, which is just as good.

MR. EVANS: Well, it's, I'm not -- I think it's relevant. If you are looking for what Congress thought about, the conference report usually is some guide to that, and the conference report made clear that the windfall profit tax not only was going to be deducted for purposes of federal income taxation, but it expected, the Congress expected --

QUESTION: It could have said that in the statute, though, very easily.

MR. EVANS: It's rare to find those kinds of -- rare to --

QUESTION: A lot of our other problems we wouldn't be able to say that. A lot of our other ones we'd have to say, see, if we didn't police it, you know, the Congress wouldn't get to it, why would it ever come to Congress's attention.

This can come to Congress's attention every time it passes a tax.

MR. EVANS: Well, I think Congress was operating, Justice Scalia, on an assumption. Maybe it was an unwise assumption, but the assumption was that states, like the federal government, treat excise taxes quite differently than they do income taxes.

QUESTION: Well, the New Jersey statute was on the books when the excess profits tax was passed, was it not?

MR. EVANS: That's correct, it was on the books and, as I say, this language disallowing federal, federal taxes on or measured by profits or income is inoffensive and unremarkable on its face because no one would argue, certainly we wouldn't argue that a state could not disallow general federal income tax.

QUESTION: Well, do you have authority which requires us to invalidate state laws even though they were valid when enacted because the economy changes and the law is then seen to -- is viewed as discriminatory in effect?

MR. EVANS: Well, there certainly have been, Justice Kennedy, cases in which the Court has struck down interpretations by state tax administrators of inoffensive on their face state tax laws. An example is the Halliburton case which is cited in our briefs that involved a use tax that, as interpreted by or as applied, I should say, by the tax administrator, worked a disadvantage to products that were manufactured out of the state rather than manufactured in the state, and the Court said --

QUESTION: Well, but I would suggest that here the New Jersey statute was clear at all times.

MR. EVANS: Well, it was clear, but what I'm suggesting is that the interpretation it is being given, whether it is right or not under state law, the Supreme Court of New Jersey imputed to the legislature of New Jersey an intention to reach this tax or to disallow this tax under that provision.

I don't think for constitutional purposes that the rule should be any different for a state like New Jersey that reaches the result by interpretation of administrators or by courts than for the state like Iowa or Minnesota that does it by virtue of a specific statutory provision.

QUESTION: Well, it certainly writes out of the equation any intent to discriminate.

MR. EVANS: Well, I think that's, I think that's right. Certainly you can't, impute an intent to a 1958 legislature to discriminate against a tax incurred during -- against those who incur a tax enacted later.

QUESTION: So under your theory, all states have the obligation to constantly revise their state tax laws in order to take account of new economic conditions?

MR. EVANS: Well, I think that's, I think that's -- I wouldn't put it quite that way. I think there may be situations arise --

QUESTION: But that's the principle you're arguing for, isn't it?

MR. EVANS: I don't think so because I don't think this happens frequently. This is the first time a case like this has ever arisen, and I can't think of and the state hasn't offered any other examples. This is a unique situation. It was a pot of honey, and the bees started to be attracted to it. It was a large pot of $78 billion of federal windfall profit taxes that were paid during the life of that statute, which, incidentally, I should mention has been repealed as of last August, and some --

QUESTION: Well, tax authorities find a universe of honey that they are attracted to.

MR. EVANS: I know, but this one is an out-of-state pot. It costs nothing in terms of in-state impact to disallow that cost. It raises tax revenues by enormous amounts.

Let me just, just to give you a sense of the magnitude, I mean, this is really an extraordinary situation. We have in the first page of our appendix to our brief a fold-out chart that gives you a sense of what the impact has been on the companies involved. There are two years at issue here, 1980 and 1981. 1980 was the phaseout of controls, and during that, during that year there was still a substantial amount of federal price control in effect; as a consequence, the amount of windfall profit taxes was quite a bit smaller.

But even during that year, look at the amounts, the percentages by which New Jersey was able to increase the total tax burden of these taxpayers by simply denying that deduction. And then look at the next year --

QUESTION: That's which column, the second from the right?

MR. EVANS: I'm sorry, one, two, three, the fourth column over shows the percentage increase in the tax burden on account of this disallowance.

QUESTION: And for Amerada it's 15 percent.

MR. EVANS: That's correct.

QUESTION: And they actually paid New Jersey what that year, $12 million?

MR. EVANS: Well, they had reported on their return $10 million.

QUESTION: What was Amerada's gross income in that year?

MR. EVANS: That is in the record, Mr. Chief Justice. I don't have that accessible.

QUESTION: Can you give me an order of magnitude?

MR. EVANS: Well, we could probably figure it out. Well, no, I don't know that I could even figure it out from the chart here.

QUESTION: Well, was it billions or --

MR. EVANS: Yes, I'm sure it was billions.

QUESTION: New Jersey --

MR. EVANS: It might have been millions.

QUESTION: In terms of money, New Jersey --

MR. EVANS: Pardon me. I'm sorry.

QUESTION: New Jersey collected now much more money from --

MR. EVANS: New Jersey for that year from Amerada Hess, if you just look across these columns, the first column shows what New Jersey's -- what Amerada Hess's reported tax liability is.

QUESTION: Right.

MR. EVANS: The second column shows what the tax administrator assessed after denying the disallow -- the deduction for windfall profit tax.

The third column shows the difference, that is, the additional tax liability. And the fourth column is the percentage.

Does that answer your question?

QUESTION: Seven times as much tax, seven times as much tax.

MR. EVANS: No, not -- oh, I'm sorry, for 1981 it is, yes, almost eight times as much.

QUESTION: Yes, exactly.

MR. EVANS: And I mean, this is, if you look on the next page -- well, let me just look at this fourth column for 1981. 1981 was the year when the windfall profit tax really was at its height, and you can see what this does to a company. For example, look at, look at Cities Service which had reported no net income at all for 1981 and it suddenly winds up owing $912,000 after disallowance. You can't even compute the impact on there, on that company in terms of percentages.

And for Gulf it was more than ten times as much. I mean, it's not -- this is not -- we're not working around the edges here. This goes right to the heart of tax liability.

If you look at the next page --

QUESTION: It is very important for New Jersey to get that money, I would guess.

MR. EVANS: I'm sure it is.

QUESTION: I mean, it's important on both sides.

MR. EVANS: It's important --

QUESTION: So long as it legitimately can, right?

MR. EVANS: It's important for New Jersey to get it, but it is important for New Jersey to get it in a balanced, geographically balanced fashion so that the people burdened by that, in effect, that additional tax burden, are not exclusively out-of-state actors.

The next page is I think worth just looking at quickly because it shows what New Jersey would have had to do to its a allocation factor to achieve the same result that it achieved by virtue of disallowing the windfall profit tax deduction. What it shows that for Amerada Hess, it would have had to increase the allocation factor from 23 percent, which is already pretty substantial, to 204 percent.

So if you accept the premise ;that the deduction of the windfall profit tax is a proper thing, what New Jersey has done is to tax Amerada Hess on twice of its total -- twice its total income nationwide.

These are the kinds of distortions that occur when a state goes after this huge pot of out-of-state cost and disallows it.

QUESTION: May I interrupt with another question?

If -- we've already talked about the possibility that they had the same percentage of their wells in the state that the allocation factor -- supposing they just had one well, so it was a trivial amount? How -- this is kind of the line drawing problem that Justice Scalia asked about, I guess.

MR. EVANS: Right.

QUESTION: But what is your position? Does your claim just apply to factors that are totally outside the state or whenever there's a substantial distortion?

MR. EVANS: Let me answer that this way. I think in a way that New York presents that issue because New York's level of production is really quite, quite small, and I'm not prepared to stand here and say that our principle will not reach New York. I thin it probably does reach New York.

But I think one could draw the line at New Jersey if one chose to do so. I don't think it would really hold up to scrutiny but the difference is that in New Jersey, every single taxpayer who is affected by this disallowance has his base dramatically skewed. There may be in a state like New York or Pennsylvania or Michigan, as the state suggests, there may be substantial enough production that some producers are entirely in-state producers, and as to them, maybe the skewing doesn't work that way. Maybe they have more in-state costs that are disallowed than out-of-state costs.

Maybe that's a basis for drawing the line right there. I don't know. I don't think it is, probably, and I've thought about that a great deal, and I'm not comfortable with a line that I can defend at that point. That's why I think a better approach is to assure oneself that the impact of a disallowance does have some significant effect on the in-state economy. If it has that, then there's some protection, some reason to hope at least that the political forces will operate in a way to make sure these kinds of things don't happen the way they have here.

QUESTION: One of the troublesome things about the case is just the fact that they disallowed this cost is itself, it seems somewhat unfair because it is such a large item, but that we can't really -- that really is constitutionally irrelevant, I guess.

MR. EVANS: Well, I don't think it's totally irrelevant. I suppose as a matter of principle it is, but it certainly would make a difference if we are talking about $1000 here.

QUESTION: Yes.

MR. EVANS: I mean, it might have the same principle, but first of all, the market wouldn't probably justify bring the case to the Court, but I think --

QUESTION: You say they could still do this, as outrageous as it seems, so long as they did it to in-state companies.

MR. EVANS: That's right, that's right. If we -- if there were in-state producers of a substantial number so that the economy was tied to it, and if New Jersey disallowed the production, on our geographic skewing theory we would not be able to make our argument, and there may be other arguments, but that wouldn't be -- this wouldn't be one of them.

QUESTION: [Inaudible] -- add back from cut-of-staters.

MR. EVANS: Well, then for sure we would make the case.

QUESTION: So that's --

MR. EVANS: Then it would be, then it would be facially discriminatory.

QUESTION: Yes. Well, that's really what you're saying here. It's the same kind of an argument.

MR. EVANS: That's right.

QUESTION: Thank you, Mr. Evans.

Mrs. Hamill, we will hear now from you.

ORAL ARGUMENT OF MRS. MARY R. HAMILL ON BEHALF OF APPELLEES

MRS. HAMILL: Mr. Chief Justice, and may it please the Court:

I'd really like to make just two points on behalf of New Jersey today. The first is that New Jersey is not discriminating against interstate commerce nor skewing the income base of the corporation tax by denying a deduction for the windfall profit tax. All New Jersey is doing is applying a longstanding statutory provision which denies a deduction for all federal income or profits-based taxes, regardless of where the taxed activity takes place.

And I think the Chief Justice picked up on this point in his first question to Mr. Evans. We deny a deduction for all federal income-based taxes, and the New Jersey Supreme Court concluded that this was an income-based tax.

The second point I'd like to make is that the company's proposed constitutional rule would be difficult to apply, as I think Justice Scalia pointed out, and would severely restrict the state's ability to define net income, and the Court has made clear that there is a very large leeway that the states have in defining net income. The case where the Court indicated that was Atlantic Coastline Railway v. Daughton.

To to back now to my point that all we're doing is applying a longstanding statutory provision, since 1958 New Jersey has had a corporate franchise tax measured by income that taxes unitary net income apportioned to New Jersey, and included in that unitary net income, as this Court has held is permissible, is income attributable to the production of crude oil in other states.

Since 1958, more than 20 years before the enactment of the windfall profit tax, New Jersey has had a statutory provision that denies a deduction for taxes paid or accrued to the United States on or measured by profits or income. That provision applies to all federal income or profits-based taxes, including the federal income tax, the federal minimum tax. It would apply to federal excess profits taxes, and we believe it applies to the windfall profit tax, and the New Jersey Supreme Court so held because it concluded that the windfall profit tax is an income-based tax.

I don't understand the Appellants --

QUESTION: May I interrupt with a question, Ms. Hamill?

MRS. HAMILL: Yes.

QUESTION: Supposing that the federal government recast this tax a little bit, a little different, and made it definitely a severance tax so that it unquestionably and as a matter of federal law was a severance tax?

Or perhaps I should ask the question, do you think New Jersey could constitutionally treat severance taxes imposed by states in the same way it has treated this tax?

MRS. HAMILL: I think it could under its present taxing scheme because New Jersey, while it allows a deduction currently -- are you speaking of the windfall profit tax specifically or any --

QUESTION: No, my question really is if -- there are really two parts to it. One, is there a constitutional objection to treating severance taxes the way New Jersey treats this tax, and if so, could you overcome the objection by just calling it an income tax? Because arguably, what you have -- what we have before us is something that at least the Solicitor General suggests could be treated as a site-specific tax and therefore comparable to a severance tax, even though in construing your statute your Court has called it an income tax.

MRS. HAMILL: Well, I think New Jersey could deny a deduction for severance taxes. It in fact does not because it follows the federal income tax treatment of severance taxes, and they are deductible. New Jersey has no severance tax, so that even if the windfall profit tax, under the Solicitor General's theory, is akin to a severance tax, I don't see the in-state favoritism. How can there be any favoritism if we don't have that tax? We don't have severance taxes. So it wouldn't make any difference if the windfall profit tax is characterized as a severance tax, it seems to me.

QUESTION: Well, there's an argument the other way, I suppose, on that.

QUESTION: I think it's just the reverse. If you had a severance tax, it wouldn't be a problem because then you'd be affecting yourself, you'd be denying deductions to people in your state as well as deductions to people elsewhere.

It precisely becomes a problem when you do not allow a deduction for severance tax which is cost free to you because you don't have any severance taxes.

MRS. HAMILL: Well, again, though, but the question is whether you are really doing something that is advantaging the in-state economy, at least as I read the Court's commerce clause cases, and I can't see that you're forcing out-of-state activity into the state if you deny a deduction for a cost that can't be performed in the state.

QUESTION: You may be keeping it out.

MRS. HAMILL: If you don't have it, if you simply don't have a particular --

QUESTION: Or you may be keeping it out.

QUESTION: Well, is that --

QUESTION: Do you suppose, could New Jersey say to these oil, the oil company, we are not going to allow you to deduct from gross income any of your labor costs associated with producing oil?

MRS. HAMILL: No, I don't think it could.

QUESTION: Why not?

MRS. HAMILL: Because I think there would be labor costs incurred by these oil companies in state. They wouldn't be in producing oil --

QUESTION: No, I just said in connection with producing of oil.

MRS. HAMILL: No, we couldn't -- I don't think we could deny that deduction.

QUESTION: Well, there wouldn't be anybody in New Jersey who would be denied the deduction because there's no oil produced in New Jersey.

MRS. HAMILL: But we would have other costs incurred by these oil companies that would be labor costs.

I think the comparison --

QUESTION: Well, all I'm talking about are -- if we define labor any way you want to, it's the kind of labor that is spent at the point of -- labor costs at the point of producing the oil and gas.

Could you deny that deduction?

MRS. HAMILL: I don't think we could. I don't think we could.

QUESTION: Why not? Why not?

MRS. HAMILL: Well, because what I -- I do think that the difference would be that we clearly have labor costs, they're not on oil and as, that's true, production of oil and gas, but we have labor costs that are costs in states, and we would be allowing those deductions.

QUESTION: Well I --

MRS. HAMILL: So there would be a disparity.

QUESTION: Well, if you call a windfall profit tax a cost of production like you do severance taxes, you would have the same objection because you, certainly you allow your own citizens all the costs that they incur in the production of income.

MRS. HAMILL: But there's no distinction, Justice White, based here on the citizenship of the companies. We are taxing -- we deny this deduction to all companies that do business in New Jersey that pay the windfall profit tax. We are not even singling out integrated producers. We deny the deduction to a wholly intrastate real estate development company, for instance that might have a partnership investment in a drilling, oil drilling ventures.. That company would pay the windfall profit tax, and we would deny it just the way we would deny that company a deduction for the federal income tax.

You see, we are treating this windfall profit tax as an income-based tax. The New Jersey Supreme Court held it was an income-based tax. In that respect it is similar under our law to the federal income tax. The federal income tax could clearly be imposed really almost exclusively with respect to out-of-state activities; we would deny the deduction. It could be imposed exclusively with respect to in-state activities; we would deny the deduction.

So in our view, the so-called site-specific nature of the windfall profit tax is just irrelevant. It's another federal income-based tax.

QUESTION: Ms. Hamill, is there any reason why the -- why New Jersey or any other state could not impose a gross income tax, duly apportioned, on a company like Amerada or one of the other oil companies, allowing no deductions for anything? Really, it would be in effect a form of sales tax, I suppose.

MRS. HAMILL: Your Honor, if New Jersey -- on New Jersey receipts?

QUESTION: Yes.

MRS. HAMILL: Yes, it certainly could, and in fact, in Appendix I think it is C to our brief, we show that a gross receipts tax of 1 percent or less on these companies' New Jersey receipts would have yielded a greater tax liability than their liability under the apportioned net income, tax without a deduction for the windfall profit tax.

So there is -- this talk we've heard about the excessiveness of the tax effect is really not supported by what's going on. They had very, very large New Jersey receipts. Moreover, for all we know, their incomes in those years may have increased enormously from the pre-decontrolled period, so that the simple increase in their liability in New Jersey is not, standing alone, something that should be taken to be suggestive that the windfall profit tax treatment, denial of the deduction, is unconstitutional.

QUESTION: Ms. Hamill, what about a gross, gross receipts tax on nationwide receipts, apportioned, that is, not just on sales in New Jersey, but the state uses the theory that some difficult-to-ascertain proportion of all the money this company makes nationwide is attributable to its New Jersey activities on the basis of salary or whatever, uses some formula, and it applies that formula to nationwide gross receipts, and the tax is on nationwide gross receipts.

Would that be constitutional?

MRS. HAMILL: Well, I think in conceptually, theoretically, one could possibly do that, but in fact the problem is that the Court has held that gross receipts may be taxed by the state where the receipt is realized, so that if you had that taxing scheme that's fairly well accepted, and then some states started to apportion gross receipts, you might very well have double taxation of those receipts.

So in practice, I think it would be hard to do that.

QUESTION: In one of your earlier answers you indicated that the sole or controlling rationale for our cases requiring apportionment is so that a state does not try to encourage industry to move to New Jersey, and of course, that fits very well here because there's no oil in New Jersey, but is that the sole rationale of those cases? Don't they go beyond that and say that a state simply may not reach beyond its borders and tax a transaction that doesn't occur there?

MRS. HAMILL: Well, that's certainly --

QUESTION: It's a jurisdictional concept, almost, although it's within the interstate commerce clause.

MRS. HAMILL: Well, that's certainly part of the commerce clause analysis. I was focusing more on just pure discrimination, but that's certainly true.

I don't think in this case there's the slightest tenable argument that we are reaching out and taxing a transaction that's outside of New Jersey. We are denying a deduction against the unitary net income which is then apportioned to New Jersey. The amount of the deduction is equal to the windfall profit tax, but there's no reaching out and imposing a windfall profit tax on transactions elsewhere.

There really is no discrimination against interstate commerce here, I really believe, for the same reason that I made in the very beginning, that we are simply treating the windfall profit tax as an income-based tax, and in that respect, like the federal income tax. If we deny a deduction for the federal income tax with respect to activities incurred in New Jersey, it seems to me there's no discrimination in denying a deduction for the federal windfall profit tax that's incurred outside New Jersey.

I'd like to go back to, a minute to the question that Justice White raised of whether the windfall profit tax is a production cost similar to a severance tax because I really think that we don't have to reach that question of whether we would deny a deduction for severance taxes here because this is not akin to a severance tax. This tax is always a net amount. It is an income computation. The company is allowed to deduct at least its actual costs at the wellhead.

QUESTION: [Inaudible] figured at the wellhead, isn't it?

MRS. HAMILL: At the wellhead, that's absolutely true, but there are, there are many, many definitions of income, and many states treat production income at the wellhead as -- producing states, as the basis for imposing a state income tax. Percentage depletion under the federal Internal Revenue Code is computed based on income at the wellhead. There's no magic in the fact that we are taxing a segment of income and not overall income.

We also believe that the windfall profit tax really is not site-specific, if we got to that point at all. We first believe it is just irrelevant, but even if the windfall profit tax, if we get to the question of whether it's site-specific, it seems to us that when you start computing the windfall profit tax with the removal price, which for an integrated company like these is the posted price of oil in the field, and the posted price is the price that a refiner would pay for that oil in the field but taking into account the value of the oil at the refinery, it seems to us that you're measuring that windfall profit tax by offsite factors and thus, while the activity may take place at a certain place, the measurement of that activity is not site-specific. It relates to factors elsewhere.

And the prime example of that which we discuss in our brief is the case of Alaska North Slope Oil. Since there are no markets on the North Slope, these companies value their crude oil for windfall profit tax purposes by determining the market value of that crude in the lower 48 states, based on what the oil would bring in those markets. The price may vary from the Gulf coast to the east coast to the west coast, and then they net back from that figure to reach the wellhead price. But since they start with a figure that's in the lower 48 states, and for Exxon that figure is the value of the oil for Exxon's oil sent to the east coast, it's the value of that oil at Exxon's refinery in Linden, New Jersey, I don't see how that can be called a site-specific cost when that's the basis for the computation of the windfall profit tax.

Justice Kennedy had a question about whether there was any authority for the Court striking down a state law which was unobjectionable when enacted, but the economic facts have changed, and that therefore it becomes objectionable, and the case that came to my mind when that question was raised was the very recent case of Shell Oil v. Iowa. Iowa, like New Jersey, has a unitary net income tax. The tax statute was enacted before development on the outer continental shelf began, before the outer continental shelf Lands Act was enacted, but the Court held that since Congress had not preempted the states from taxing income earned in part on the outer continental shelf, Iowa could tax this outer continental shelf income, or it could tax the income derived from that outer continental shelf income, and so the Iowa tax continued to be valid despite the change in circumstances, despite the fact that you had development of oil and gas somewhere else.

QUESTION: Yes, but if one of the changed circumstances had been a congressional statute saying you can't impose any tax on this oil, it would have been unconstitutional to apply it to it.

MRS. HAMILL: That's right, but that would have been a a changed federal law --

QUESTION: And that would have been a subsequent event.

MRS. HAMILL: -- Your Honor, and that could very well have happened here. Congress could very well have preempted New Jersey from denying a deduction for the windfall profit tax.

QUESTION: Or if Iowa had started to tax, interpreted its law in a way that suddenly taxed out-of-state transactions at double the rate that local transactions, I suppose it would be invalid even though it was an old law.

MRS. HAMILL: That's true, but --

QUESTION: And here's we've got a brand new interpretation of this statute because this problem just hadn't arisen.

MRS. HAMILL: Well, that's true, too. We have a -- that's absolutely true, Your Honor.

QUESTION: In other words, I don't think the fact it was constitutional when it was passed makes it immune from constitutional attack forever.

MRS. HAMILL: I understand.

We tend to think that that colors the situation, that there's clearly no discriminatory intent here. We just are applying our statutory provision that's been on the books for a long time to a newly enacted federal statute, and we analogize that to the federal income tax for which we deny a deduction.

The final point that I would like to make is just to reiterate the point that was made in questions to my opponent. This constitutional rule that the Appellants propose would be very difficult to apply. New York, which is an amicus in this case, had 853,000 barrels of crude oil production in 1986 and denies a deduction for the windfall profit tax. Kansas denies a deduction for the windfall profit tax, and in 1986 had 67 million barrels of crude oil production.

So despite Mr. Evans' point that the in-state political forces would operate to prevent a state legislature from denying a deduction for the windfall profit tax if there was crude oil production in the state, that seems not to have been the case in the case of Kansas.

But anyway, going back to these figures, the question is does New York have too little crude oil to deny a deduction for the windfall profit tax? Does Kansas have enough? Where would the line be drawn?

The rule would also severely restrict the states' ability to define net income, and --

QUESTION: I presume Texas does not deny the deduction.

MRS. HAMILL: Texas doesn't have a corporate income tax, Your Honor.

(Laughter.)

MRS. HAMILL: Even better.

QUESTION: Better still, right.

MRS. HAMILL: Yes.

As shown in Appendix B to New Jersey's brief, over 30 states follow the federal income tax treatment of depletion. Some of these states, including New Jersey, have no crude oil but do have hard minerals. Those states which have hard minerals and no crude oil are currently in violation of the companies' proposed constitutional rule because the depletion, the federal income tax depletion deduction for oil and gas is generally less favorable than the depletion deduction for hard minerals.

So they are doing -- and that's a great many states that would be in violation of this rule.

This example shows the difficulty that the states would be put in if the companies' rule were accepted. Before following the federal income tax treatment of a particular cost, the states would have to survey the domestic economy, determine if a particular activity occurred in state and how much of it occurred in state, and then take action in the state legislature.

We believe that the Court to date has not construed the commerce clause in such a rigid fashion. There seems to us to be no need to change that rule now and adopt a more rigid one when there's really no singling out of out-of-state crude oil production; we are simply applying our unitary tax. We are including oil production values in the net income base just the way the Court has said we could. In fact, all we're doing really is preserving the net income base in an amount which was equal to what it was before Congress enacted the windfall profit tax.

It's simply -- the windfall profit tax is simply a segment of the windfall profit. The windfall profit is that crude oil production income or value. It may not be included dollar for dollar in the unitary net income base, but that net profit, that windfall profit flows through to the bottom line, and it is simply unitary net income, the same amount of unitary net income that we always taxed that we believe we should be able to continue to tax.

QUESTION: May I ask one question before you sit down?

In the appendix to their brief they have a table -- It's Appendix B that was called to my attention earlier -- which compares the actual allocation factor with the effective allocation factor and shows the percentage increase by reason of the denial of this deduction.

I am never sure whether these things are in the record or just prepared in the briefs.

Do you disagree at all with the figures there, or just --

MRS. HAMILL: No, I don't, Your Honor.

QUESTION: Okay. I just wanted to be sure.

MRS. HAMILL: I think they are all right, but I just would point out that what this table doesn't show, and I believe it's in the record but I'm not sure. You'd have to look back at the annual reports of these companies for the years at issue and compare those years to '78 and '79, but these companies, perhaps with the exception of Cities Service, were vastly more profitable in these years, so that while these percentage increases may appear large, you can't take those numbers in a vacuum and assume that the are --

QUESTION: In other words, they made a lot of money during the windfall profits years.

MRS. HAMILL: Yes.

QUESTION: That's not surprising.

MRS. HAMILL: If the Court has no further questions, that's all I have to say.

QUESTION: Thank you, Ms. Hamill.

Mr. Evans, you have four minutes remaining.

REBUTTAL ARGUMENT OF MARK L. EVANS ON BEHALF OF APPELLANTS

MR. EVANS: Just a couple of things I'd like to, I'd like to say.

First of all, we agree that the Constitution does not prescribe any set of tax deductions. It does not say which particular ones must be granted or may be denied. It may even be that a state could disallow all deductions, tax gross receipts or gross income on some kind of apportionment mechanism, for purposes of our argument, although I should say that the Solicitor General has a footnote in his brief in which he expresses some reservation about whether the theory of apportionment really applies to gross rather than net income.

But in any event, the key there is that if that was what a state decided to do, it would burden everybody equally, out-of-staters and in-staters would suffer the same tax consequences and we would not have the kind of skewing problem that we have here.

I think one thing I did not mention earlier but I think is a counterpoint, Justice Scalia, to the concerns that we discussed earlier about where to draw the line, if you decide that no line is to be drawn, what it does is it opens up to the states an open field. There's just no way to stop a state once it's been told it can find and burden purely out-of-state costs from just spending a good deal of their tax energies looking for such things because they are just natural targets.

Now, there aren't any that happen right now, but there are even in New Jersey some things that you can't find everywhere. There are casinos in New Jersey, and in fact, there's a casino control tax imposed on casinos. There are ports in New Jersey, and there's a federal harbor use tax that's based on the value of the cargo loaded or unloaded.

Well, if New Jersey can do this to Louisiana or Texas producers, Louisiana or -- Texas is not a good example, but Louisiana or Oklahoma legislatures can just start disallowing from any unitary business that is affected by ports or by casinos, the deduction for those taxes.

So it just opens up exactly the kind of succession of retaliatory measures that the commerce clause was designed to prevent.

QUESTION: Maybe if they had a general tax, a general disallowance of deduction that happened to embrace casino taxes it would be okay.

MR. EVANS: Well, it could have the same type --

QUESTION: If they enacted a special tax that says we are going to disallow casino taxes, that might be a different question.

MR. EVANS: Justice Scalia, the same thing could happen in Louisiana and Oklahoma that happened here. You could look at a general disallowance, call it an add-back or whatever, that deals with income taxes or something similar, or gift taxes. As one of our amici says, you could call it a gift tax for purposes of statutory interpretation; it makes no constitutional difference. But the administrator could simply construe income taxes to embrace value-based excise taxes, which is essentially what New Jersey has done here.

I'd like to just get back to one of the -- what I think is ultimately one of the key questions here, which is whether this is or isn't like a severance tax. Well, this Court has done some work on severance taxes. In Commonwealth Edison it discussed a coal severance tax in Montana, and the guidance from that decision is that there are two things to look at. You look at the operating incidence of the tax -- in this case it's the removal of each barrel of crude oil -- and you look at the measure -- in this case it's wellhead values -- identical in significant, in all significant respects to the kind of tax that was at issue in Commonwealth Edison. And what the Court found there was that only Montana could tax that event and that measure because it is purely site-specific to Montana.

And I think the same principle applies here.

CHIEF JUSTICE REHNQUIST: Thank you, Mr. Evans.

The case is submitted.

(Whereupon, at 2:50 o'clock p.m., the case in the above-entitled matter was submitted.)