Department of Revenue of Kentucky v. Davis - Oral Argument

Argument of C. Christopher Trower

Chief Justice Roberts: We'll hear argument next in Case 06-666, Department of Revenue of Kentucky v. Davis.

Mr. Trower.

Mr. Trower: Mr. Chief Justice, and may it please the Court: Kentucky's tax exemption for municipal bond interest paid by Kentucky and its political subdivisions to Kentucky taxpayers treats all private entities the same, and favors only Kentucky and its political subdivisions.

This Court has never held that a law which favors government, whether the State or local government, rather than private business enterprises violates the dormant Commerce Clause.

The Court's decision last term in United Haulers holds that State laws which favor government but which treat all private business entities in State and out of State the same does not discriminate against interstate commerce.

Justice Alito: Is what you just said true about conduit bonds, where Kentucky issues bonds to finance private construction?

Is the statement that you just made accurate?

Mr. Trower: Yes, it is, Your Honor.

Private activity bonds, a subset of which are conduit bonds, account for approximately 20 percent of all municipal bonds issued.

And I think your question has, has two point to it.

First of all is whether or not a State or a municipality ought to be able to use its tax exempt borrowing power to further a project chosen by the municipality to achieve public purposes, such as for example tax exempt hospitals or other facilities that are tax exempt, should it be able to use that tax exempt borrowing power constitutionally?

The answer there is, yes.

Congress has already made that decision.

The second question is whether there's a Commerce Clause problem if a State exempts it's own private activity bonds but taxes private activity bonds issued in other States?

Justice Alito: That's what you do, isn't it?

Mr. Trower: Yes, sir.

Justice Souter: Doesn't that raise, in effect, sort of a distinction between Carbone and United Haulers?

Or at least one way of understanding the distinction between those two cases?

In Carbone the facility, in fact, was not the facility of the government.

Mr. Trower: That's correct.

Justice Souter: Here the, the immediate beneficiary of the bonds is, in Justice Alito's hypo, is a private entity?

Mr. Trower: That's correct, that the immediate beneficiary of the bonds or of the loan is a, is a nongovernmental entity.

It's not necessarily a private business.

As we point out in our reply brief, 80 percent of all private activity bonds go for--

Justice Souter: But... correct me if I'm wrong, just a matter of fact.

I thought in most instances the immediate beneficiary would be a private entity who, in effect, was enabled to borrow at a lower rate?

Mr. Trower: --That is correct.

It would be a nongovernmental entity that would be able to borrow at a tax exempt rate.

Justice Souter: So don't you have to take... therefore, if you're going to answer Justice Alito as you did, don't you have to take the position that Carbone really is not good law and the Carbone/United Haulers distinction is not a... is simply not a relevant distinction?

As a dissenter in Carbone, I naturally do not find that the worst answer you could give.

[Laughter]

But don't you have to give that answer?

Mr. Trower: I thought the distinction that you drew in your dissenting opinion in Carbone between the one entity that has got to get the job done within the jurisdiction is the key distinction in observing United Haulers.

Justice Alito: Well, as a dissenter in United Haulers, I also don't think it's a good distinction.

[Laughter]

But couldn't there be instances where some, an industrial, a company is trying to... is deciding to locate a plant and is choosing between Kentucky and Ohio, and Kentucky says, come to Kentucky because we'll issue private activity bonds so that you can finance this more cheaply than if you went into Ohio?

And when you do that, aren't you, aren't you doing exactly what the dormant Commerce Clause is supposed to prevent?

Mr. Trower: No.

You're doing... the dormant Commerce Clause in no way restricts the ability of States to provide economic incentives for in-State business activity.

Justice Ginsburg: Mr. Trower, were private activity bonds considered at all below?

As far as I understand, this is not a private activity bond, it's not, what's at issue here.

And there was no adjudication with respect to that type of bond--

Mr. Trower: That's exactly--

Justice Ginsburg: --in the lower courts.

Mr. Trower: --That is exactly right, ma'am.

And our position is that Respondents have no standing to make a claim focused solely on private activity bonds, because there is no evidence in the record as to whether Respondents own any private activity bonds.

Justice Breyer: Suppose that you... and I have the same hypothetical for both you and your brothers on the other side with some adjustment here, because I'm finding the case quite difficult.

And the, the... for you, imagine we have some milk producers in Kentucky.

They are farmers.

And they go to the legislature and they say, you know, we can sell a lot more milk in Kentucky if you will pass a law imposing a tax on Missouri farmers who want to ship milk into Kentucky.

That's the classic unlawful... all right.

It's unlawful, unconstitutional, right.

Mr. Trower: Yes, sir.

Justice Breyer: All right.

Now, what is the difference if a city in Kentucky that wants to finance its schools says now to the legislature, we're going to find it easier to sell bonds in Kentucky or elsewhere, in Kentucky, for our school system if you'll only put a tax on similar bonds that Missouri is offering to finance their city schools?

That will help, just like the milk.

Now, what's the difference?

Mr. Trower: The difference is, is twofold.

One, the favoritism in the first example, the dairy cases, which have come up a million times, is a favoritism of a private industry, whereas in your second hypothetical the favoritism is to the most public of industries, education.

The second difference is that a tax on out-of-State dairy products increases the cost of out-of-State dairy products to in-State consumers with no detriment to in-State dairy producers, whereas, as our Respondents have pointed out in their brief, when a tax is imposed by a government on a transaction where the government itself is paying the money, which is what we have here, a tax on interest income paid by the government, the effect is to impose a dollar-for-dollar reduction in the government's tax revenues equal to the amount of the exemption.

So you've got an in-State entity, namely, the government itself, that is suffering a revenue loss.

That's not at all comparable to the dairy hypothetical.

Justice Breyer: We have consumers in the dairy products that are suffering loss.

They're all the voters in the States.

Everyone drinks milk.

Mr. Trower: Yes, sir.

Justice Breyer: So they are suffering a dollar-for-dollar loss, because their milk becomes more expensive.

I don't know if that's analogous.

I think it's a pretty strong analogy.

As to the first, that's of course the point that's worrying me.

It is true that this is a public matter.

Mr. Trower: Yes, sir.

Justice Breyer: Would it make a difference in the first case if it happened to be some dairy farmers who... there are so few in Massachusetts now, unfortunately, that they all work on State-owned dairy farms that are put up for, you know... does it make a difference?

Mr. Trower: I think it would make a difference.

Justice Breyer: It would make a difference?

Mr. Trower: If a hamburger stand is owned by the State, it's okay under United Haulers.

If the State wants to go into the dairy business, the Commerce Clause doesn't prevent the state from doing that.

That's our answer, is that the Commerce Clause does not extend to activities by a State on behalf of all of its people.

Chief Justice Roberts: We have a different variation here that wasn't present in United Haulers, which, of course, is that Kentucky does compete with other public entities in the municipal bond market.

In other words, I think you have a strong case with respect to discrimination against private bonds, but Kentucky competes against Ohio bonds as well.

And they're making the Kentucky bonds more attractive through this discriminatory tax on the Ohio bonds.

Why isn't that a sufficient distinction from United Haulers?

Mr. Trower: The key distinction in the United Haulers, Mr. Chief Justice, was between an entity with the responsibility for the welfare of the citizens within the jurisdiction versus all other entities.

It just happened to be in United Haulers that that was a public entity versus private entities.

But United Haulers, we submit, would have reached exactly the same result if the trash haulers had wanted to take the garbage to a municipal or a public facility in New Jersey, as opposed to a private facility in New Jersey.

And the second answer to your question is that other public entities, other States, other municipalities have no responsibilities in Kentucky for the public welfare.

They're no different than private borrowers in Kentucky.

They don't have sovereign immunity in Kentucky if they default on their bonds.

They can be sued in Kentucky court.

That's the essential difference.

The question I think that the Justice Breyer brought up would also lead me to talk about what are the purposes of the Commerce Clause writ large, or the dormant Commerce Clause not writ large, that have motivated this Court's jurisprudence?

I think there are three: Economic protectionism, which the Court has repeatedly said does not apply to activity by the State on its open behalf; secondly, the free market or free trade rationale, which has motivated many of the Court's decisions, but at the same time the Court has always been careful to say that the free trade rationale, Maine v. Taylor for example, does not value free trade above all other values that we have.

And we would submit that the value here is the fundamental sovereignty of the States.

Our political system subdivides responsibility for government and responsibility for public works in America.

Bonds are not issued by the States to make a profit or to leverage their return on equity.

Bonds aren't issued to create an investment opportunity for Wall Street or for Main Street.

Bonds are issued to finance the essential work of government.

And this Court's decision should look at that part of the equation as much more significant and weigh those values much more heavily than the values of the free market, which don't really apply to the State's provision of goods and services.

In all the dairy cases--

Justice Kennedy: Suppose a State said that it was unlawful for anyone other than a State resident to purchase the bond?

Mr. Trower: --That would be completely constitutional.

Justice Stevens: What if... what if the State offered its taxpayers a higher interest rate than purchasers from other States?

Would that be permissible?

Mr. Trower: Yes, sir, that would be totally permissible and would achieve the same result as the exemption that we've got here.

So what you've got before you is--

Justice Alito: How would that achieve the same result if these bonds weren't negotiable and they'd be hard to sell, hard for you to sell, if people who bought them couldn't sell them, and they could sell them to somebody out of State and get the higher interest rate?

Mr. Trower: --I thought the question was if the bonds increased the interest rate and limited the purchasers to Kentucky citizens.

Justice Alito: And these would be bonds that Kentucky citizens could not sell to anyone else?

Mr. Trower: They could sell them to anyone else.

Justice Alito: Anyone who wasn't a Kentucky citizen?

Mr. Trower: It would be... let me back up.

I think I got ahead of myself there.

It would be entirely constitutional for a State to offer bonds for sale and limit the sale to Kentucky residents and limit the payment of interest to Kentucky residents and have a mechanism to assure that that would be the case.

For example, contract submissions by brokers.

The SEC does that right now thousands of times each day with Rule 144 sales.

The administrative mechanism would be there.

Would it be constitutional?

Yes, sir.

Our point is we've got a giant market upon which the States depend for the financing of public goods and services.

Justice Kennedy: Would it be constitutional to say that the holder of the bond must always be a Kentucky resident or, if you sold the bond, it has to be to another Kentucky resident?

Mr. Trower: Yes, it would be.

We've got the same analogy in the securities law, where the intrastate exemption is conditioned upon the holder of the security being an in-State resident who must agree not to transfer the security out of State.

Chief Justice Roberts: Well, I suppose you could achieve the same result simply by providing you're not going to pay interest to somebody who is not a Kentucky resident.

Mr. Trower: Yes, sir, you could.

Justice Kennedy: So if New York has a very strong financial community, it can really benefit its citizens by keeping the market in New York bonds for itself, if it chooses?

Mr. Trower: Yes, it could.

Justice Kennedy: And your case for that is what, United Haulers?

Mr. Trower: Yes, sir, as well as an attention... as I was going to earlier, the larger principles that are behind the dormant Commerce Clause jurisprudence of the Court.

The Court has... we talked about economic protectionism.

We talked about the free trade rationale.

And then the third rationale which comes up often in the Court's opinions is political solidarity.

That is to say that the Commerce Clause was not a grant of power to the national government to enact free trade laws, but rather it was a grant of power to the national government to prevent Union-dividing friction between the States.

We don't have that friction here.

All 49 States support Kentucky's position.

Where that political friction is not an issue, the need for judicial invalidation of the laws of 42 States is commensurately less.

On the other hand, what are the things that we think that the Commerce Clause doesn't require... doesn't require the States to do?

It doesn't require the States to give up incentives to local business activities within the State.

The Commerce Clause doesn't throw into the maw of the free market, the--

Justice Stevens: How do you reconcile that with the Bacchus case?

Mr. Trower: --Well, Bacchus was a case which favored the in-State pineapple wine producers--

Justice Stevens: Correct.

Mr. Trower: --with a tax.

Justice Stevens: I've always thought it was incorrectly decided, to be honest with you, but it's there.

It's been there a long time.

Mr. Trower: That doesn't surprise me at all, Justice Stevens, because your concurring opinion in Alexandria Scrap said the same thing.

We agree with that position.

Chief Justice Roberts: So we have to overrule Bacchus to agree with you?

[Laughter]

Mr. Trower: No, sir.

No, sir.

The suggestion that we're making here today is that a tax exemption which applies directly and exclusively to the payment of money by a government to its direct trading partners is all you're dealing with here.

That would not change the result in Bacchus, Boston Stock Exchange, or any of the other discriminatory tax cases because all of those cases involved a... a tax or an exemption.

Chief Justice Roberts: Does your argument depend upon the uses to which Kentucky is putting these proceeds?

Mr. Trower: No, sir.

Chief Justice Roberts: Well, I thought it would because you're saying nobody else is responsible for public works in Kentucky and so on.

Mr. Trower: I'm sorry, Mr. Chief Justice.

I thought you meant it made a difference whether they spent them on an airport or--

Chief Justice Roberts: No.

Just a public facility.

Mr. Trower: --Yes, sir.

Governmental.

Chief Justice Roberts: So, if Kentucky had a law that it could only... no out-of-State car dealer could sell cars in Kentucky, that benefited Kentucky car dealers, and then it had a special tax on Kentucky car dealers to fund local hospitals, airports, roads, whatever... that would be all right?

Mr. Trower: I don't think that would be all right.

I think that's the West Lynn Creamery case in reverse.

Chief Justice Roberts: So it doesn't matter?

So the use to which the proceeds are put doesn't save an otherwise discriminatory activity?

Mr. Trower: The... it is the... it is the entity which chooses the use to which the proceeds are put that determines the Commerce Clause situation.

The choice of... of sewers, airports, schools, that's up to the governmental entity to make.

I'll reserve my time for rebuttal.

Argument of G. Eric Brunstad, Jr.

Chief Justice Roberts: Thank you, Mr. Trower.

Mr. Brunstad.

Mr. Brunstad: Mr. Chief Justice, and may it please the Court: This is a tax case and that makes a difference.

It's not a case about a monopoly, and what's key about that is that Kentucky has not taken over the national municipal bond market.

It hasn't taken over the market.

It is trying to regulate the market with this facially discriminatory tax.

It is facially discriminatory because on its face the statute says if you buy in Kentucky an in-State bond you have a tax exemption.

If you're in Kentucky and you buy the out-of-State bond, we tax you.

This is no different from the Bacchus case or the Fulton case or Boston Stock Exchange.

Chief Justice Roberts: Or United Haulers.

Mr. Brunstad: It's very different, Your Honor.

Oh, no, it's very different, Mr. Chief Justice, from United Haulers.

There inherent in the power to take over... the State took over the local trash handling market... the power to create a monopoly is the power to exclude all competition.

Here Kentucky does not have a monopoly.

They merely issue the commodity.

Then, once it is in private hands, an interest is being paid.

Justice Breyer: Then of course you win as soon as we say the commodity is the same as milk.

Obviously to me you would, but that's the issue.

And in United Haulers what the question was, I thought, is if it is a traditional governmental function, anyway... say, like producing electricity, or cleaning the streets... there they discriminate and say you have to buy in State... well, it's different, and indeed it may be okay.

So what you've just heard your brother... brother argue is if this is a fortiori, because here it's not even making electricity; it's not even collecting trash; it is financing the most basically governmental of all governmental institutions... libraries, schools, streets.

Now, why isn't it a fortiori from United Haulers, given the nature of the task that they are raising the money to finance?

Mr. Brunstad: Three reasons, Justice Breyer.

First, as this Court stated in Oregon Waste, the purpose of or justification for a law has no bearing on whether it is facially discriminatory.

Secondly, as this Court held in Bacchus, as long as there is some competition between the locally produced exempt product and nonexempt products from outside the State, there is a discriminatory effect.

Here if you look at what... what are these bonds?

Justice Stevens: Can a State--

Justice Breyer: You're arguing... but can a State do this?

It produces a service or product; it sells the service or product to in-State people at a price 50 percent less than it sells to out-of-State people.

Mr. Brunstad: Certainly, Your Honor.

Under the market participant doctrine, if... if you want to sell cement and you own the State-owned cement plant, you can choose.

You recall in South-Central--

Justice Breyer: No, no, you're saying if the State owns cement, it can sell 50 percent less to its in-State citizens than out-of-State?

Mr. Brunstad: --That's what this Court held in Reeves v. Stake.

Justice Breyer: Fine.

Then could it do this?

Could it say that if you buy cement from out of State, the answer is no, right?

Mr. Brunstad: Through a tax, no.

And I think the Court's precedent in South-Central--

Justice Breyer: All right.

Suppose what they are selling is education?

Can the University of California say that when you send your child to the University of California, you will get a thousand dollars back on your income tax.

But if you send the child to an out-of-State school, you don't?

Mr. Brunstad: --There the State is supplying educational services to its citizens, and under the market participant doctrine that would be fine.

I think this hypothetical--

Justice Breyer: Well if that's fine, then what they say is we sell you participation in the financing of the project.

Mr. Brunstad: --But that's not what the tax--

Justice Breyer: And if you buy... we sell you the participation.

It's called a bond, and if in fact you give the money to us, and you are in-State, you get a thousand dollars back.

But if in fact, when you do the identical thing, and you buy a similar thing from out-of-State, you do not get the money back?

How is that different from what you just said was okay in respect to the University of California?

Mr. Brunstad: --Justice Breyer, that would be a subsidy, and this Court drew the very distinction in the New Energy case as the difference between subsidy and a tax.

And that I think is absolutely critical; and I think here Justice Holmes' admonition that a page of history is worth a volume of logic makes sense.

The rallying cry for the American Revolution was "no subsidies without representation", it was "no taxation without representation".

Justice Breyer: No, I'm sorry, then I wasn't clear in the hypothetical.

The hypothetical was that you get a thousand-dollar rebate on your income tax.

So I was trying to make it exactly like this case.

You pay a lower State tax.

Mr. Brunstad: But I think... I think there you would look through the form to the substance, and the substance there is we will charge you X amount for tuition and we are giving you part of that back as a rebate.

That is no different from a subsidy.

Here is completely different, Your Honor.

Justice Ginsburg: Why is it any different from a tax credit?

Mr. Brunstad: Well here, Your Honor, as the Court made plain... made plain in the Camps case, Camps Newfound/Owatonna, a tax exemption is not the sort of direct State involvement in the market that falls within the market participation doctrine.

There is a key difference between a tax and a subsidy.

Justice Souter: But in that case, the only thing the State was doing was taxing.

Here in Justice Breyer's hypothetical, in the case we've got, the State is also participating in a bond market.

Mr. Brunstad: No, Your Honor, not in... the part that they are taxing is not their participation part.

I think a hypothetical will crystalize this.

Justice Souter: Why do we draw that line?

I mean, you... a moment ago you were talking about the... the realities of subsidy.

Why don't we confront the realities of... of the fact that the State's participation in the bond market and the... and the tax exemption go together hand in hand?

It's unrealistic to divide them.

Mr. Brunstad: Because, Justice Souter, there is a fundamental difference between the two.

A tax tears down; a subsidy builds up.

If you want to subsidize your local park--

Justice Souter: So what?

The economic reality is precisely the same.

Mr. Brunstad: --But not constitutionally, Justice Souter, and here is why--

Justice Souter: Not constitutionally, we have said, in cases in which the State is not acting purely as the regulator.

Here the State is not acting purely as the regulator.

The State has a dual capacity, and you say ignore one side of that capacity for the other; and my question is why?

Mr. Brunstad: --Because, Justice Souter, here what the State is taxing is the out-of-State commodity.

It is taxing... it is doing a downstream regulation.

The State issues a commodity... just like in South-Central; the State issued the timber; the State owned the timber, and then it imposed a downstream regulation on the purchase--

Justice Souter: Yes, but it's not taxing an out-of-State commodity in the sense of a commodity which is manufactured or produced out-of-State.

Mr. Brunstad: --But Your Honor, it's no different than the Boston Stock Exchange case, where we are talking about securities... or in Fulton, Your Honor... shares of stock.

Justice Souter: In which case the State was not a participant, but the State is here.

Mr. Brunstad: But the State is using its taxing power to regulate... to regulate interstate commerce, whereas in United Haulers, Chief Justice Roberts, there was no tax.

There was no discriminatory tax.

And inherent in the power to create a monopoly is the inherent power to preclude competition.

Here there is competition.

There is economic gamesmanship, Justice Souter.

They want to sell their bonds nationally but hoard their own investment dollars locally, which is precisely--

Chief Justice Roberts: So you want to suggest... I'm sorry.

Justice Souter: No.

Please.

Chief Justice Roberts: Are you suggesting that the result in United Haulers would have been different if there were a competing trash processing facility out-of-State?

Mr. Brunstad: --No, Your Honor, because there again we have a monopoly.

The State took over the entire market... the trash disposal facility of recycling and everything else in the United Haulers case.

Inherent in the power to create a monopoly is the power to exclude competition.

There is no discrimination by definition.

Here they have not taken over the market.

They are imposing a downstream regulation by taxing the out-of-State commodity, and the distinction is exactly--

Chief Justice Roberts: Well, they are not taxing the out-of-State commodity.

Their tax is imposed simply on Kentucky taxpayers.

Mr. Brunstad: --I think, Chief Justice Roberts, the analysis that the Court made in the New Energy case is directly on point and addresses this.

There the Court said the Commerce Clause does not prohibit all State action designed to give its residents an advantage in the marketplace, but only action of that description in connection with the State's regulation of interstate commerce.

Direct subsidies of domestic industry does not ordinarily run afoul of that prohibition; discriminatory taxation does.

Again--

Justice Souter: And this situation is somewhere in between the two.

Because although we do not have what in form is a subsidy, we have what in economic reality is a subsidy for the benefit of the State's own activity as a bond issuer.

So the question again is, why do we accept your characterization that this case should be treated exactly as if the State were acting merely in a regulatory capacity?

Mr. Brunstad: --Because Justice Souter, the entire purpose of the dormant Commerce Clause jurisprudence is to protect the integrity of the market.

If Kentucky wants to have a subsidy and say we are going to subsidize our own residents, fine.

That builds up something in Kentucky.

Justice Souter: And the whole purpose of... of the combined effect of market participant for the... acting for the purpose of providing an essentially governmental service is to give the State a free hand.

Why do we ignore that in your argument in favor simply of the regulatory side?

Mr. Brunstad: Because, Justice Souter, what they are doing here is imposing a facially discriminatory tax.

They have the burden of saying, under the Court's precedents, they have no other alternative.

Justice Souter: But the question is whether it will be treated as we treat a facially discriminatory tax when there is no market participation, there is no State participation for the purpose of providing a fundamental governmental service.

If... if in fact there is a good reason to treat them differently, then we don't follow the... the facial discrimination test.

Let me... let me ask a... a question with that as the premise.

Assuming... and I obviously do assume... that we have a choice of analysis here, one good reason to choose the analysis that your brother has... that the State is forwarding is the fact that we have historically a bond market which has grown up since New York issued the first tax-exempt or... a bond.

Mr. Brunstad: In 1919, Your Honor.

Justice Souter: And we have an enormous market, the effect of interrupting which we really, as a Court, cannot tell very much.

And that seems to me a very good reason to give the nod to the... to the market participant, the essential services side of what the State is doing, as opposed to the regulatory side, and simply confront the thing under Pike.

Why isn't that a good reason?

Mr. Brunstad: Because, Justice Souter, this case represents a classic race to the bottom where the only reason why we have these discriminatory tax laws is because New York started it in 1919.

It wanted to hoard its own local investment dollars and yet sell its bonds nationally.

Every other State caught on, and that creates a problem in the marketplace which the dormant commerce claim--

Justice Breyer: Well, you have a perfectly good remedy in respect to that.

If the States don't like this race to the bottom, they need only create a compact or go to Congress.

Mr. Brunstad: --But a compact is precisely, Your Honor, what the dormant commerce clause was designed to prevent... States coming together and trying to create regional compacts or trying to create favored trade deals among themselves.

Justice Breyer: You know, I was only... I was only addressing your point that there was a practical problem.

Insofar as there is a practical problem, it seems to me the States have a perfectly good remedy even if they lose this case.

Mr. Brunstad: Even if they lose this case--

Justice Breyer: Or win the case, whatever.

Mr. Brunstad: --But Justice Breyer, the whole point--

Justice Breyer: However.

Mr. Brunstad: --I think... I think that the Court's analysis in Quill is on point here.

In the Court's analysis in Quill the Court said look, we have this very clear rule that says States cannot engage in facially discriminatory taxation.

They can't do it.

And if, in fact, we are wrong... if, in fact, the Court's precedent creates a problem, then it's something that Congress can easily fix.

The States can go to Congress.

Chief Justice Roberts: But our approach in the General Motors case was the exact opposite.

There we couldn't figure out whether the market for natural gas was captive or not captive.

It was a little of each, and we kind of said well, you know, if it's kind of a close question, leave it for Congress.

Because, after all, the Commerce Clause talks about Congress' power.

The dormant Commerce Clause is not mentioned.

So this is an area where Congress can regulate if it wants to, and it has never shown the slightest interest in interfering with State tax exemptions for their own bonds.

Mr. Brunstad: But, Chief Justice Roberts, the same could have been said for the problem in Granholm, where 26 States had the same no direct shipment problem; or the same problem in Bacchus where 36 States had the same discriminatory alcohol tax laws.

Congress didn't--

Chief Justice Roberts: It strikes me as much more fundamental, whether or not a State can issue a tax exemption for its... its bonds.

That seems more fundamental than the more specialized issues in those other cases.

And I think we have said when you're dealing with a specialized issue that may not get the attention of Congress, we have a different approach.

Mr. Brunstad: --But, Chief Justice Roberts, Congress is as unlikely to address this problem now that it's so pervasive as it was to address the problem in Granholm, or the problem in Bacchus, or any of those other cases, or the problem in Fulton.

Congress has plenty of other things to do.

Justice Breyer: That argument cuts against you in context, I think.

You're saying in every case of any kind of discrimination one could go to Congress.

Absolutely right.

And since that's true of every case, now we are back to the more basic question, leaving the practicalities that you were talking about out of it, of whether this case is more like the cows.

Is it more like the garbage collection?

Mr. Brunstad: Correct.

Justice Breyer: Or is it on the far side of the garbage collection, even a stronger case for permission under the Commerce Clause?

Mr. Brunstad: Justice Breyer, this case is like milk.

That's what that--

Justice Breyer: That's where I wanted you to begin.

Mr. Brunstad: --If you look at... it is... it is, Chief Justice Breyer.

If you look at bonds, municipal bonds... and we have some samples of an Alabama bond and a Kentucky bond in the supplemental appendix.

These are standardized forms that are traded as commodities like any other securities.

They have the same regulatory overlay, which is distinct from General Motors v. Tracy.

Chief Justice Roberts: But it's not distinct from United Haulers.

Garbage is garbage, too.

Mr. Brunstad: That's true.

Chief Justice Roberts: But the fact that bonds are bonds doesn't seem to me to be very responsive.

Mr. Brunstad: But the point... two points, Chief Justice Roberts... one is that in United Haulers we did not have a tax on the out-of-State commodity coming in.

Here we do.

The second thing... and I think this is critical... we have a monopoly.

Justice Stevens: --You didn't have a tax on the out-of-State.

You have an income tax charged to Kentucky residents on their income from that bond.

It's quite different.

Mr. Brunstad: But, Justice Stevens, that points out how this is a downstream regulation.

The State's participation ends when it is done issuing the bond.

It goes to underwriters who then trade them in the privately-owned national bond market, no different than in South Central.

The State of Alaska owned the timber.

It sold the timber in the marketplace.

Then it sought to impose this downstream regulation.

It would be the same as if New York City said, we have a local water company, and we have a monopoly.

And now we have someone who we are licensing, a private business, to bottle that water to sell.

And we are slapping a tariff on Poland Springs from Maine, because we want to protect the local business.

That's what's happening here.

The State has already issued the commodity.

It is now in the marketplace, and now they are basically prohibiting the sale of it, or they are restricting the sale, by a discriminatory... in essence, tariff.

If you live in Kentucky, we want to discourage you from buying a Michigan bond.

And they do it by saying we will tax the interest on the... on the out-of-State bond, and not tax the interest on the in-State bond.

They are giving themselves a leg up.

And one of the pernicious aspects of this is that it has the effect of pooling capital within the national market.

It has the effect of creating this discriminatory barrier.

Justice Stevens: The victims under your approach, as I understand it, are the 49 other States, and all of them seem to support your opponent in the briefs that were filed in this case.

Mr. Brunstad: True, Justice Stevens, but they don't want to issue refunds.

You can understand that.

A short-term gain for a long-term solution that would make them all better off, that would end this race to the bottom.

My clients, the Davises, are penalized because they are engaging in interstate commerce.

They are penalized.

Because they own out-of-State bonds, they pay a tax.

Chief Justice Roberts: Your argument that you just presented in response to Justice Stevens' question, I think, relies on the discrimination against the out-of-State issuers.

Mr. Brunstad: Correct.

Chief Justice Roberts: Your clients are not out-of-State issuers.

Mr. Brunstad: That's true.

Chief Justice Roberts: We don't have an overbreadth doctrine under the Commerce Clause.

Why aren't their arguments limited to discrimination against them rather than discrimination against out-of-State issuers?

Mr. Brunstad: Well, for the same reason that it wouldn't be limited with the... the taxpayer in Fulton or the in-State taxpayer in Bacchus, where they are basically arguing that this affects interstate commerce.

And as illustrative of that, we are saying look, in Bacchus you had the local brandy, and the local pineapple wine got a tax rate.

Chief Justice Roberts: So your Kentucky taxpayers can argue about the discrimination against out-of-State bond issuers?

Mr. Brunstad: They can argue about the discriminatory effects of this law on the marketplace as a whole, because they are participants in the market.

They are penalized for engaging in interstate commerce, the same way that all of the same arguments were presented in the Bacchus case with an in-State taxpayer, the Fulton case with an in-State taxpayer.

And the Court has basically made that plain in the New Energy case.

You don't have to demonstrate that there is some overwhelming, you know, sky is falling problem.

Any discrimination with respect to interstate commerce, any discriminatory effect, basically--

Chief Justice Roberts: How do we know that your clients will be better off regardless of how this case is resolved?

One way to resolve it, of course, would be to take away the Kentucky tax exemption, which would hurt your clients.

Another way to resolve it would be to extend the tax exemption to the Ohio bonds, which may hurt your clients if the Kentucky bonds aren't competitive, and the price of the Kentucky bonds goes down.

They are going to lose either way.

Mr. Brunstad: --The remedy, Your Honor, would be for the State to decide whether it wants to make all municipal bonds tax-exempt or to make them all taxable.

Now, in Kentucky there is a constitutional provision which says they cannot... they basically cannot have their own bonds other than tax-exempt.

So unless they change their constitution, the result would be to make all the bond, municipal bonds, tax-exempt in Kentucky, which, of course, would benefit my clients, who hold out-of-State municipal bonds.

But consider this--

Chief Justice Roberts: But whether or not it benefits them, it seems to me, depends on how competitive they are with other States' municipal bonds.

In other words, their advantage now comes from the tax exemption for Kentucky bonds; and it's not clear, if that is eliminated across the board, that Kentucky bonds are going to be competitive with, you know, bonds of whatever other State.

So the value of them may go down, and your clients may lose, whether you win or not.

Mr. Brunstad: --But, Chief Justice Roberts, consider these two critical points: One cardinal principle of investment is diversification.

These discriminatory tax laws basically compel people to hold only the bonds within their particular State.

Prospectuses for these single-State bond funds say: Warning... not diverse.

The second thing is their higher cost.

Chief Justice Roberts: I mean it... it provides an advantage depending on the level of the State income tax and, I suppose, the level of the exemption.

It doesn't necessarily mean that that's the only bonds they are going to hold.

Mr. Brunstad: But that simply means that if the State has a very high income tax, say, in California, that's all the more reason, all the more penalty, for people who want to engage in interstate commerce and diversify their portfolios.

Chief Justice Roberts: And it's less of a problem if it's like Kentucky, which, I assume, has a lower income tax.

Mr. Brunstad: Kentucky has a lower income tax, but I think on the... on the problem that was raised, what if we... if we affirm in this case, what would the impact be?

Well, the State of Kentucky has said, itself, that if it has to pay out refunds, we are talking about a $4 million per year refund obligation the State of Kentucky has said it will have to pay.

The sky is not going to fall.

What would happen is that bond prices might adjust, but we would have the free national market with interstate trade and municipal bonds unimpaired by these artificial constraints.

These artificial discriminatory tax regimes create artificial demand.

They pull assets.

They hoard assets, local investment dollars, within particular States.

And you have a problem where, say, cash-scarce States like, for example, Tennessee have more of a restricted access to capital markets like New York.

If you're an investor in New York and you have money to spend in municipal bonds, you're discouraged from buying Tennessee bonds; you're encouraged from buying New York State municipal bonds.

The relatively capital-scarce States are harmed.

Again, people like the Davises, they are harmed, they are penalized from engaging in interstate commerce.

Justice Kennedy: I can ask your brother who represents Petitioner... maybe I'd better should... I'd get a better answer from him so far as his position.

As you understand his position, as you understand the State's position, would it be permissible for State A to go to State B and say: We... if you make your bonds nontaxable to our residents, we'll make your bonds nontaxable to your residents.

Mr. Brunstad: We actually have that, Justice Kennedy.

Ohio, when it enacted its discriminatory tax scheme here similar to Kentucky's, it basically said: We will tax the bonds of an out-of-State State, unless they do not tax Utah bonds.

So... but you can see that clearly illustrates, to me--

Justice Kennedy: Do you find that consistent with the vision of the framers for our national market under the Commerce Clause?

Mr. Brunstad: --Inconsistent, Justice Kennedy.

Inconsistent.

This is nothing more than an ongoing low-level trade war.

It was started by New York in 1919, when it basically created this discriminatory tax scheme for itself.

It basically incentivizes all the States to follow suit.

And it's easy to understand why.

Justice Ginsburg: What about the example that was given of a interstate compact, say, to operate a port authority that covers a few States, and the compacters agree that they are not going to tax the income on bonds issued by the port authority, but they are going to tax the income from out-of-State municipal, but it's only the bonds from this port authority.

So they... it seems your theory would reach that too.

Mr. Brunstad: It would, Justice Ginsburg.

Justice Ginsburg: And yet Congress has approved compacts that say just that.

Mr. Brunstad: But where Congress specifically speaks to permitting a particular practice, then it can't violate the dormant Commerce Clause.

Here Congress has not spoken.

The States are doing this on their own.

And, Justice Kennedy, again, it is completely inconsistent with the vision of the framers because what's happening here, again, is the race to the bottom, where New York said: All right, we're going to sell our bonds nationally; ah, we're going to create an investment for all the capital in New York to stay in New York.

And you can see why every other State afterwards said: Oh, look what New York is doing.

We have to follow suit to try to equal the playing field.

And, again, that is at the heart of the ongoing low-level trade war with the--

Chief Justice Roberts: Well, it assumes it's all in the definition of your market.

If your market is tax-exempt bonds nationwide, it's one thing; but your brother says the market ought to be people who issue bonds for public works in Kentucky, and Kentucky is the only one who does that so there is no discrimination against anyone else because nobody else is similarly situated to Kentucky with respect to Kentucky public works.

Mr. Brunstad: --But, Chief Justice Roberts, here it's easy to tell what the market is.

Kentucky municipal bonds, in spite of the tax discrimination, sell in a national, single market.

There is a national Federal overlay.

Under Federal income tax purposes, they're all tax exempt.

They're all regulated under the same Federal securities laws.

The fraud parts of the securities laws apply.

They all compete for each other.

It's the fact that they compete for each other.

Justice Stevens: Is there any evidence in the record as to how much... what percentage of the Kentucky bonds are bought by Kentucky residents?

Mr. Brunstad: There is no good data on that information, Justice Stevens.

We do not have an answer to that.

But I think the point--

Justice Stevens: Does it... do we have it for any State?

Mr. Brunstad: --No, we do not, Justice Stevens.

We do not.

Chief Justice Roberts: Well, I thought it was inherent in your argument that most of them... I mean, if you're talking about hoarding capital, it doesn't work very well if a lot of people outside Kentucky are buying these bonds.

There's not much Balkanization if they're circulated widely.

I thought that your argument depended on the proposition that most of these bonds are bought by Kentucky residents.

Mr. Brunstad: There is Balkanization, but it's not complete Balkanization, just like the tax in... that Hawaii imposed on the alcohol didn't prevent the sale of fine California chardonnay imported into Hawaii; it just promoted the sale of the locally produced wine.

It doesn't have to be a complete ban, as this Court explained in Limbach, a complete ban or a discrimination that imposes a burden.

There's no constitutional difference.

And that applies here too, but the market criteria the Court applied in GMC versus Tracy, I think, applies here.

You don't look to define the market by, gee, what's going to happen or what's the purpose of the particular discrimination?

You look at ordinary commercial factors.

And here the ordinary commercial factors are there is one national market in which these standardized commodities trade.

They're issued by the State.

They're owned by individuals.

Kentucky doesn't own the bonds.

Kentucky issues them.

They are then traded in the national market.

Justice Stevens: --not really standardize.

Even without a tax exemption, residents of Kentucky would be interested in public improvements in Kentucky and have... give a slight edge in the market to all Kentucky bonds.

I think there would be just a natural preference for locally issued bonds.

Mr. Brunstad: And if they choose to do that, that's fine.

Justice Stevens: And not totally fungible.

Mr. Brunstad: And of course that would not be prevented by having nondiscriminatory taxes.

Justice Stevens: No, but it's a fact of the market, it seems to me, that Kentucky bonds are characteristically more attractive to Kentucky citizens than they are to out-of-State citizens.

Mr. Brunstad: But, Justice Stevens, I think that's an idiosyncratic value, not shared.

Most investors care about yield and--

Justice Kennedy: I assume there would be a preference to Massachusetts milk for Massachusetts buyers, to Michigan automobiles for Michigan buyers, and the State did not subsidize.

Mr. Brunstad: --But, Justice Kennedy, that strikes me as the argument that Japan made--

Justice Kennedy: --authorities--

Mr. Brunstad: --Justice Kennedy, that strikes me as the argument that Japan made when it said: We should keep American made skis out of the Japanese market because Japanese snow is different from American snow.

I mean you can't use those kinds of justifications to say--

Chief Justice Roberts: Well, that's not fair because Kentucky is going to use the proceeds of the bonds to build a hospital, a school that is going to serve Kentucky residents.

Mr. Brunstad: --But--

Chief Justice Roberts: So there's... it's not just emotional attachment to Kentucky that would promote the purchase of those bonds by Kentucky residents.

It's self-interest.

They want a public hospital nearby, and, therefore, it makes sense to buy the hospital bonds.

Mr. Brunstad: --But, Chief Justice Roberts, every tax serves a public purpose.

Every tax is for the State's purposes.

If this Court opens the door in this case to say that this facially discriminatory tax regime is okay, this Court will open the door to all of the discriminatory taxes the Court has heretofore struck down.

This case... this Court's discriminatory tax precedents--

Chief Justice Roberts: There's a very... there's a very big difference between... and it gets to the difference with the Wisconsin cows, which was addressed in United Haulers.

That's a tax on private activity, and private actors don't have the responsibility of providing government services.

Kentucky does.

Mr. Brunstad: --But every State does that.

And I think we need to maintain three clear distinctions: Taxes, monopolies, and subsidies.

They are constitutionally distinct.

Why?

If you look at the Constitution, you see all kinds of restrictions on discriminatory taxes.

There is no--

Chief Justice Roberts: You don't see a dormant Commerce Clause, though.

[Laughter]

Mr. Brunstad: --But the... this Court's dormant Commerce Clause precedents are directed to preserving the integrity of markets.

Once you stray and you do not have those clear lines between monopolies, United Haulers, discriminatory taxes, and subsidies, then I think you make... you take what is a very clear monument of economic freedom, this idea of no discriminatory taxes certainly not discriminatory taxes on their face, and you blur those distinctions and you pull down this monument the Court has.

As the Court... for the reasons the Court said in Quill, these distinctions are important.

If Congress, in this particular area, does not like the result, it can change the result.

But, jurisprudentially, we need to maintain a distinction between subsidies, between monopolies, and between taxes.

Again--

Justice Ginsburg: The Court, in that old Bonaparte case, it was just kind of very naive because the Court made a decision that didn't... that State A can't create bonds that are going to be exempt from tax in other States, right?

Mr. Brunstad: --Not quite, Justice Ginsburg.

That was a full-faith-and-credit case in which the Maryland resident said: Oh, I own out-of-State bonds; therefore Maryland can't tax me because the out-of-State State wouldn't tax me if I lived there.

A completely different issue, Your Honor.

This issue was not before the Court in Bonaparte.

Thank you.

Rebuttal of C. Christopher Trower

Chief Justice Roberts: Thank you, Mr. Brunstad.

Mr. Trower, you have 12 minutes remaining.

Mr. Trower: Let's start with the idea that the Kentucky tax penalizes Respondents for participating in interstate commerce.

The answer there is no.

The Kentucky tax affords a direct trading partner, that is to say a person that owns Kentucky bonds, a quid pro quo.

If a Kentucky taxpayer loans money to Kentucky, Kentucky gives a tax exemption to that person that loans money to Kentucky.

If a Kentucky resident chooses to loan money to California by buying California bonds, no tax exemption is afforded.

But that different treatment is not a penalty, we would submit, but rather a recognition that the Kentucky resident who loans money to Kentucky is entitled to receive something in return.

Chief Justice Roberts: Well, why do you care, Mr. Trower?

I mean, if you lose your tax exemption, it means you've got to pay more interest to sell your bonds, but it also means you're going to get taxes that you don't get now.

Isn't it kind of a wash?

Does it really matter.

Mr. Trower: It matters tremendously, Your Honor.

Seventy-five percent of all municipal bonds issued in America are issued by municipalities, local agencies, and those bonds... under $10 million in principal amount... those bonds account for only 7 percent of the total volume of bonds outstanding.

We pointed this... citations for this are in our reply brief.

The significance would be that many municipalities might have no market access at all for their bonds.

An investor could ignore 75 percent of all bonds that are issued.

Chief Justice Roberts: Yes, but the State's going to have more money from their income taxes, and if they want to spend it on a project in a particular municipality, they will be free to do that.

Mr. Trower: They would be and that's correct, Mr. Chief Justice.

But that choice is a choice that the Commerce Clause lets the States make, the choice to either raise taxes or to have a tax exemption.

Justice Alito: It seems to me you're making a lot of arguments that, if accepted, would... maybe this isn't true of all of your arguments, but certainly many of them would demonstrate that the Commerce Clause jurisprudence is utterly incoherent.

If taxation is the same thing as a subsidy, if congressional inaction is the same thing as approval, if Kentucky bonds are not really in the same market as out-of-State bonds, what would be left of Commerce, of dormant Commerce Clause jurisprudence if those arguments were accepted?

Mr. Trower: Well, all of the cases in which the tax exemption or... or other restrictive law favored in-State private business would be left untouched.

What we're arguing for here is a rule that would apply only to a transaction between the State itself and the bondholder.

Market participation, contrary to my brother's suggestion, does not end when the bonds are issued any more than when you borrow money your participation with your lender ends once the loan is--

Justice Kennedy: --I think that's true.

There's a national securities market.

Everybody knows that.

Mr. Trower: --Yes, sir.

Justice Kennedy: And I don't think either side can avoid that fact.

He's suggesting that it cuts more in his favor than it does for yours because you are creating artificial barriers to that market.

So that when a person who knows about Kentucky bonds and who knows what the good ones are moves out of state, he all of a sudden loses the advantage to purchase those bonds anymore, or at least he does... he takes a penalty for doing that.

Let me... let me ask you this, the question I asked your co-counsel.

A and D get together and agree on reciprocal advantages for their... for their respective residents.

Is that constitutional?

Mr. Trower: If it's approved by Congress, yes, sir.

Justice Kennedy: Suppose it's not.

And--

Mr. Trower: I think that--

Justice Kennedy: --And isn't that exactly what's happening here?

Isn't that exactly what's happening here?

You have, in effect, a pact among States to favor their own residents.

Mr. Trower: --You could make that argument, Justice Kennedy.

But the... the idea that what has happened here is a race to the bottom is post hoc reasoning extraordinaire.

The Kentucky constitution was enacted in 1890, 40 years before Kentucky had ever enacted an income tax.

The California constitution, which also requires California to exempt its own bonds, was enacted decades before California enacted an income tax.

We would suggest that the record of history is the States saw the opportunity to give their own residents tax exemption as a way of finding a natural market for their bonds, and they chose to do that and that the fact that they chose to do that makes sense for the States that did it.

It also made sense for those states that didn't choose to do that.

I would note that the seven states that--

Justice Kennedy: I suppose any favored legislation favoring local industry helps the State, and the State residents like it.

That's the whole point.

That's why the Commerce Clause exists as a check.

Mr. Trower: --Well, it's... I wouldn't accept that as the reason that the Commerce Clause exists as a check.

But let's examine that analysis.

Where is the political check here?

Well, we know how the other States would vote because they support Kentucky.

SIFMA, which represents 90 percent of the bond trading--

Justice Kennedy: All politics is local.

All States want to protect their residents and make it look like they're doing something for their residents.

And that's exactly the purpose of Commerce Clause prohibition against explicit discrimination, which is what this is.

There's no doubt that this is explicit discrimination.

Mr. Trower: --There's no doubt that the law on its face differentially treats two different kinds of bonds or different bonds issued by different States.

We're not contending that at all.

The question is, is whether that different treatment is permissible?

The suggestion that the commerce--

Justice Scalia: Since we are talking here about the negative Commerce Clause, we really should say that's the reason the Commerce Clause doesn't exist.

[Laughter]

Mr. Trower: --That's right.

That's exactly right.

And if we were... if we were reading the... the negative Commerce Clause, I would call your attention to the decisions in Reeves, which is exactly equivalent to a home embargo, because it kept all the cement in South Dakota; to the decisions in White and Alexandria Scrap, which were exactly equivalent to a border blockade, because they kept all the out-of-State workers from working in Boston or at least up to the extent of 50 percent of the work forces; and under Alexandria Scrap the effect of the legislation was to keep all of the out-of-state towing companies from collecting the bounties.

And then in United Haulers, yes, it wasn't a tax case, but that's a distinction without a difference, because what United Haulers was equivalent to was a home embargo.

And it's the home embargo, the border blockade, and the discriminatory tariff or tax that are always held up as the prototypes of things that our free market prevents, as is the monopoly, which my brother says is okay if a State monopolizes all the trade, but it's not okay if a State still competes in the national market in the issuance of bonds but yet offers a direct financial incentive to its own taxpayers.

We come back to the effect of a tax exemption of this type.

It is exactly equivalent to the payment of money by the State, because every dollar of that tax exemption represents a detriment to the State.

The State is giving up revenue.

Now, you're right, Mr. Chief Justice, it may be a wash at the end of the day, but that's a decision that the Commerce Clause leaves to the States to make.

And your reference earlier to General Motors v. Tracy is directly on point here, because there you had a well-established, long-established market that the Court was loath to jump in without any institutional competence or information to evaluate the effects, where Congress could take action if any was necessary.

What do we know about the historical record here?

We know Congress excruciatingly discussed, just analyzed State tax and their effects on interstate commerce and did nothing.

Justice Alito: Do you want us to... do you want us to hold that if Congress is, quote, unquote, aware of some sort of discrimination that the States are engaging in, that there is, therefore, no dormant Commerce Clause problem?

Mr. Trower: No.

That's not what we're arguing for.

We're not saying that what happened here is equal to the kind of express approval of discrimination, which the Court's precedents have required.

What we're saying is where what we got is a Congress that has studied this problem and done nothing, with a Congress that has routinely approved interstate compacts between the States that provide for differential taxation of bonds, with a Congress that has provided exemption from all tax for territory bonds, Puerto Rico, Guam... those are completely exempt per acts of Congress, but Congress didn't go any further than that, what is the conclusions for this Court to draw?

Does this Court rush in where Congress has failed to tread?

We think not.

Justice Alito: What is the difference between that situation and the sort of flow control ordinance that was involved in Carbone?

Wasn't Congress aware of those?

Mr. Trower: Yes.

In fact, Congress had authorized the kind of flow control ordinance that was set up in Carbone.

But as the... as the Court decided the Carbone case, the facility in Carbone, in the view of the majority, was not a publicly owned facility.

It was a privately owned facility.

If Carbone came up again today, maybe a different analysis.

But the distinction between Carbone and United Haulers was discussed at length in United Haulers, and the Court found that a distinction--

Justice Alito: No, but why wasn't there the same kind of congressional whatever it is, acquiescence, in Carbone that you're claiming there was here?

Mr. Trower: --I don't know that there wasn't that same kind of congressional acquiescence.

The question is... is what... what is the Court to make of that congressional acquiescence or congressional failure to act?

That's what we are arguing for here.

We are not saying Congress has sanctioned differential taxation.

Justice Stevens: We are talking about not just a dormant Commerce Clause, but a dormant Congress.

[Laughter]

Justice Kennedy: What are... what are examples... what are examples of Federal statutes that have allowed explicit discrimination?

Mr. Trower: Prudential versus Benjamin.

I guess that's the insurance case, which of course we've got--

Justice Kennedy: In the insurance industry?

Mr. Trower: --Yes, sir, and that's obviously huge as well.

I think that's enough.

If there are no other questions, thank you.

Chief Justice Roberts: Thank you, Mr. Trower.

The case is submitted.