Triple Taxation and the Non-Dangers of Interstate Competition
by Neil H. Buchanan
For a relatively minor and unheralded case, Comptroller of the Treasury of Maryland v. Wynne presents a surprisingly large number of interesting issues, in both constitutional law and tax policy. Because constitutional and tax issues are the bread and (vegan) butter of the Dorf on Law team, we have been having some fun analyzing that case. Professor Dorf has written a Verdict column and a Dorf on Law post discussing Wynne, while I have written a short piece for The George Washington Law Review and a Dorf on Law post. Meanwhile, I published a new Verdict column yesterday that addresses additional issues raised by the decision. Here, I will complete our blanket coverage of Wynne with some discussion of two further issues, one a simple (but unappreciated) concept in tax policy, and the other a broad question about the Commerce Clause.
Suppose that you have received $1 million in taxable income in a given year. That does not, of course, mean that you earned only a million dollars, because taxable income is what remains after all of your deductions, exemptions, and so on have been subtracted from your gross income (which, itself, is not a full measure of your income, but I digress). Suppose further that you earn all of that income in your home state, and that your home state charges a single-rate income tax of 5% on taxable income. You thus pay $50,000 in state income tax.
Your neighbor also has $1 million in taxable income. Again, that does not actually mean that both of you have the same access to resources, or that you are similarly situated economically, but only that the neighbor ended up with $1 million when she computed her taxable income. Twenty percent of her income, however, was earned in another state: $800,000 was in-state income, $200,000 was earned elsewhere. Suppose that your home state imposes a 2% tax on out-of-state income (perhaps on the theory that the home state's resources were only partly responsible for the ability to earn the income, and that this taxpayer did not use local resources as heavily), but it does not provide a credit for any taxes paid elsewhere. The tax bill to the home state is $44,000 (five percent of $800,000 plus 2% of $200,000). If the other state also taxes the income earned there at a 2% rate, the tax bill to the other state is $4,000. The total tax bill for this taxpayer is $48,000.
Why go through this example? To make the very simple point that the second taxpayer, but not the first, has been subject to "double taxation," yet she has paid a smaller amount in taxes than the first taxpayer. As I pointed out in my Verdict column yesterday, the dissents as well as the majority opinion in Wynne all used the term "double taxation" as if being subject to taxes twice is automatically worse. It is obviously not. During the first week of my Federal Income Taxation class every semester, I ask rhetorically, "Would you rather pay a 99% tax rate once, or a 1% tax rate twice?"
Interestingly, I was recently describing the Maryland system (which, prior to the Wynne decision, did not provide a credit for out-of-state taxes paid), and before I even talked about the various tax rates involved, the person said, "Well, that's not fair, because some Marylanders are subject to triple taxation." Triple? "They also pay federal income tax." This misunderstanding is surprisingly widespread. Indeed, in a paper that I published in 1999, I described (starting at p. 516) a political document called "the Kemp Commission Report" that had tried to claim that every dollar earned in America is subject to multiple levels of taxation. The idea was that one could follow the path of a dollar, as it is earned in profits by a corporation, then paid in salary to a worker, then used to buys goods and services, which then makes it part of another company's profits, and so on, such that one could describe the system as quadruple taxation, or any multiple one chooses.
The narrower point here, then, as I described in my Verdict column yesterday, is that the supposed problem of double taxation is actually better labeled "cross-border disadvantage." It does not matter (other than any administrative inconvenience) whether one pays taxes on both sides of the border. The Eighteenth Century border wars that led to abandonment of the Articles of Confederation were a problem because the former colonies were discouraging cross-border trade by taxing imports into the states, and the interaction of states' income tax systems can end up mimicking such effects.
The broader point, however, concerns the Commerce Clause, which courts over the years expanded to include its "dormant" or indirect aspect, by which states are not supposed to be permitted to adopt policies that have the effect of disadvantaging cross-border economic activity. As I have pointed out in my Dorf on Law post earlier this week, however, the Wynne decision did not actually prevent the states from adopting tax systems that create real cross-border disadvantages. The majority in Wynne merely requires that Maryland adopt a system that is "internally consistent," which in practice would allow an even bigger cross-border penalty than Maryland's current system imposes.
To be clear, the actual rates adopted in Maryland and elsewhere did cause Marylanders who earned some income outside the state to pay more total state taxes (to all relevant states) than did Marylanders who stayed home and received the same amount of taxable income. Even if no other state currently taxed Marylanders' out-of-state income, however, Maryland's system would still have violated the Dormant Commerce Clause (DCC), according to the majority's logic, because that system was internally inconsistent, which means that (misnamed) double taxation was theoretically possible, simply because other states could decide to tax Marylanders' income.
As I also discuss in yesterday's Verdict column, the Wynne majority never seriously addressed the possibility that the other state could be required to mitigate any cross-border disadvantage. That is, if the other state chooses to tax out-of-state income, it could be required to credit taxes paid to the home state, rather than the other way around.
Setting aside the question of which state must provide the remedy, however, the constitutional issue comes down to whether the states can be prevented by the courts from adopting policies that create, or theoretically could create, cross-border disadvantages. The worry in the late 1700's, based on real experience, was that states would engage in policies that were deliberately discriminatory against interstate commerce. Thus, the Constitution gave Congress the power to regulate interstate commerce, acting as a brake on the supposedly inexorable tendencies of state politicians to favor the home team.
Is that still an issue today? Possibly. Consider, however, the examples of cross-border competition that I mentioned in my post on Tuesday. Courts (and Congress) have allowed the states to impose clearly discriminatory taxes on out-of-state residents who travel into a state, by imposing high user taxes on convention facilities, hotels, and so on. But so what? If the concern is that states' political processes will naturally disadvantage out-of-state residents, what about the political pressure that the state's politicians will feel from the people who own and work in the businesses that cater to non-locals? After all, the hotel tax in New Orleans (for example) is not 1,000%. Even for those who wish to draw revenue from a particular non-local source, the locals have a reason to prevent matters from getting out of hand.
Similarly, Maryland's now-disallowed system had the effect of encouraging people who expected to have out-of-state income to live elsewhere. And Maryland's state legislature could take that very real possibility into account. (I say "very real" because tiny Maryland, of all states, knows that it is possible to move out of the state without moving very far.) There are, in other words, clear and obvious considerations that would limit a state's decision to adopt discriminatory policies. One major difference between the late Eighteenth Century and today is that trade has been nationalized (and globalized), and thus it is much more likely that every state's legislature will be aware (or will be lobbied by people who are acutely aware) that trade is a two-way street.
There is thus a parallel between the Dormant Commerce Clause and the non-dormant Commerce Clause. In the context of the ACA case that the Supreme Court decided in 2012, some people reasonably argued that there really is no such thing as non-interstate commerce in the 21st century. The tides of history have thus made the Commerce Clause applicable to all economic activity, which means that the limitation on congressional action currently only applies to non-economic activity, not purely in-state activity. This is not because the courts should redefine what the Commerce Clause means, but because the modern patterns of commerce are simply different than they used to be, which necessarily changes how it should be applied.
Similarly, if the idea behind the DCC is, as Professor Dorf rightly described it, that the courts act as a "failsafe," dealing with the smaller cross-border problems that Congress cannot be bothered to fix, then maybe the world has outgrown that justification for the DCC. It is possible that the modern understandings of mutual economic interdependence, which were simply unknown in a world where Adam Smith's work was barely having an impact on widespread Mercantilist attitudes, will stop things from getting too far out of hand.
After all, even in international trade, the last half-century or so has seen trade barriers radically reduced by international agreements. And unlike in international arena, the failsafe in the interstate context in the U.S. is Congress itself. Maybe there is simply no need for the courts to get involved any more, because the cross-pressures of politics are keeping states from going too far, and Congress can deal with any big deviations.
There is an interesting, ongoing debate about whether judicial review is a good idea, as Professors Dorf and Segall recently debated, here and here. Even though I agree with Professor Dorf's views on that matter, the question here is not whether unelected courts should or should not be able to review states' decisions. Instead, the question is whether the political process will reasonably confine the range of outcomes, such that there is no need for the courts to intervene. (Compare same-sex marriage.)
There might have been a time when it made sense for the courts to prevent Congress from regulating purely in-state trade. And there might have been a time when states could not stop themselves from engaging in ruinous cross-border competition. Those times have passed. If we are worried about legislatures and Congress adopting laws that will be economically harmful, then we can confidently rely on the give-and-take of the political process to moderate those outcomes.
For a relatively minor and unheralded case, Comptroller of the Treasury of Maryland v. Wynne presents a surprisingly large number of interesting issues, in both constitutional law and tax policy. Because constitutional and tax issues are the bread and (vegan) butter of the Dorf on Law team, we have been having some fun analyzing that case. Professor Dorf has written a Verdict column and a Dorf on Law post discussing Wynne, while I have written a short piece for The George Washington Law Review and a Dorf on Law post. Meanwhile, I published a new Verdict column yesterday that addresses additional issues raised by the decision. Here, I will complete our blanket coverage of Wynne with some discussion of two further issues, one a simple (but unappreciated) concept in tax policy, and the other a broad question about the Commerce Clause.
Suppose that you have received $1 million in taxable income in a given year. That does not, of course, mean that you earned only a million dollars, because taxable income is what remains after all of your deductions, exemptions, and so on have been subtracted from your gross income (which, itself, is not a full measure of your income, but I digress). Suppose further that you earn all of that income in your home state, and that your home state charges a single-rate income tax of 5% on taxable income. You thus pay $50,000 in state income tax.
Your neighbor also has $1 million in taxable income. Again, that does not actually mean that both of you have the same access to resources, or that you are similarly situated economically, but only that the neighbor ended up with $1 million when she computed her taxable income. Twenty percent of her income, however, was earned in another state: $800,000 was in-state income, $200,000 was earned elsewhere. Suppose that your home state imposes a 2% tax on out-of-state income (perhaps on the theory that the home state's resources were only partly responsible for the ability to earn the income, and that this taxpayer did not use local resources as heavily), but it does not provide a credit for any taxes paid elsewhere. The tax bill to the home state is $44,000 (five percent of $800,000 plus 2% of $200,000). If the other state also taxes the income earned there at a 2% rate, the tax bill to the other state is $4,000. The total tax bill for this taxpayer is $48,000.
Why go through this example? To make the very simple point that the second taxpayer, but not the first, has been subject to "double taxation," yet she has paid a smaller amount in taxes than the first taxpayer. As I pointed out in my Verdict column yesterday, the dissents as well as the majority opinion in Wynne all used the term "double taxation" as if being subject to taxes twice is automatically worse. It is obviously not. During the first week of my Federal Income Taxation class every semester, I ask rhetorically, "Would you rather pay a 99% tax rate once, or a 1% tax rate twice?"
Interestingly, I was recently describing the Maryland system (which, prior to the Wynne decision, did not provide a credit for out-of-state taxes paid), and before I even talked about the various tax rates involved, the person said, "Well, that's not fair, because some Marylanders are subject to triple taxation." Triple? "They also pay federal income tax." This misunderstanding is surprisingly widespread. Indeed, in a paper that I published in 1999, I described (starting at p. 516) a political document called "the Kemp Commission Report" that had tried to claim that every dollar earned in America is subject to multiple levels of taxation. The idea was that one could follow the path of a dollar, as it is earned in profits by a corporation, then paid in salary to a worker, then used to buys goods and services, which then makes it part of another company's profits, and so on, such that one could describe the system as quadruple taxation, or any multiple one chooses.
The narrower point here, then, as I described in my Verdict column yesterday, is that the supposed problem of double taxation is actually better labeled "cross-border disadvantage." It does not matter (other than any administrative inconvenience) whether one pays taxes on both sides of the border. The Eighteenth Century border wars that led to abandonment of the Articles of Confederation were a problem because the former colonies were discouraging cross-border trade by taxing imports into the states, and the interaction of states' income tax systems can end up mimicking such effects.
The broader point, however, concerns the Commerce Clause, which courts over the years expanded to include its "dormant" or indirect aspect, by which states are not supposed to be permitted to adopt policies that have the effect of disadvantaging cross-border economic activity. As I have pointed out in my Dorf on Law post earlier this week, however, the Wynne decision did not actually prevent the states from adopting tax systems that create real cross-border disadvantages. The majority in Wynne merely requires that Maryland adopt a system that is "internally consistent," which in practice would allow an even bigger cross-border penalty than Maryland's current system imposes.
To be clear, the actual rates adopted in Maryland and elsewhere did cause Marylanders who earned some income outside the state to pay more total state taxes (to all relevant states) than did Marylanders who stayed home and received the same amount of taxable income. Even if no other state currently taxed Marylanders' out-of-state income, however, Maryland's system would still have violated the Dormant Commerce Clause (DCC), according to the majority's logic, because that system was internally inconsistent, which means that (misnamed) double taxation was theoretically possible, simply because other states could decide to tax Marylanders' income.
As I also discuss in yesterday's Verdict column, the Wynne majority never seriously addressed the possibility that the other state could be required to mitigate any cross-border disadvantage. That is, if the other state chooses to tax out-of-state income, it could be required to credit taxes paid to the home state, rather than the other way around.
Setting aside the question of which state must provide the remedy, however, the constitutional issue comes down to whether the states can be prevented by the courts from adopting policies that create, or theoretically could create, cross-border disadvantages. The worry in the late 1700's, based on real experience, was that states would engage in policies that were deliberately discriminatory against interstate commerce. Thus, the Constitution gave Congress the power to regulate interstate commerce, acting as a brake on the supposedly inexorable tendencies of state politicians to favor the home team.
Is that still an issue today? Possibly. Consider, however, the examples of cross-border competition that I mentioned in my post on Tuesday. Courts (and Congress) have allowed the states to impose clearly discriminatory taxes on out-of-state residents who travel into a state, by imposing high user taxes on convention facilities, hotels, and so on. But so what? If the concern is that states' political processes will naturally disadvantage out-of-state residents, what about the political pressure that the state's politicians will feel from the people who own and work in the businesses that cater to non-locals? After all, the hotel tax in New Orleans (for example) is not 1,000%. Even for those who wish to draw revenue from a particular non-local source, the locals have a reason to prevent matters from getting out of hand.
Similarly, Maryland's now-disallowed system had the effect of encouraging people who expected to have out-of-state income to live elsewhere. And Maryland's state legislature could take that very real possibility into account. (I say "very real" because tiny Maryland, of all states, knows that it is possible to move out of the state without moving very far.) There are, in other words, clear and obvious considerations that would limit a state's decision to adopt discriminatory policies. One major difference between the late Eighteenth Century and today is that trade has been nationalized (and globalized), and thus it is much more likely that every state's legislature will be aware (or will be lobbied by people who are acutely aware) that trade is a two-way street.
There is thus a parallel between the Dormant Commerce Clause and the non-dormant Commerce Clause. In the context of the ACA case that the Supreme Court decided in 2012, some people reasonably argued that there really is no such thing as non-interstate commerce in the 21st century. The tides of history have thus made the Commerce Clause applicable to all economic activity, which means that the limitation on congressional action currently only applies to non-economic activity, not purely in-state activity. This is not because the courts should redefine what the Commerce Clause means, but because the modern patterns of commerce are simply different than they used to be, which necessarily changes how it should be applied.
Similarly, if the idea behind the DCC is, as Professor Dorf rightly described it, that the courts act as a "failsafe," dealing with the smaller cross-border problems that Congress cannot be bothered to fix, then maybe the world has outgrown that justification for the DCC. It is possible that the modern understandings of mutual economic interdependence, which were simply unknown in a world where Adam Smith's work was barely having an impact on widespread Mercantilist attitudes, will stop things from getting too far out of hand.
After all, even in international trade, the last half-century or so has seen trade barriers radically reduced by international agreements. And unlike in international arena, the failsafe in the interstate context in the U.S. is Congress itself. Maybe there is simply no need for the courts to get involved any more, because the cross-pressures of politics are keeping states from going too far, and Congress can deal with any big deviations.
There is an interesting, ongoing debate about whether judicial review is a good idea, as Professors Dorf and Segall recently debated, here and here. Even though I agree with Professor Dorf's views on that matter, the question here is not whether unelected courts should or should not be able to review states' decisions. Instead, the question is whether the political process will reasonably confine the range of outcomes, such that there is no need for the courts to intervene. (Compare same-sex marriage.)
There might have been a time when it made sense for the courts to prevent Congress from regulating purely in-state trade. And there might have been a time when states could not stop themselves from engaging in ruinous cross-border competition. Those times have passed. If we are worried about legislatures and Congress adopting laws that will be economically harmful, then we can confidently rely on the give-and-take of the political process to moderate those outcomes.