This article was updated to include arguments from Wednesday’s Supreme Court session and to clarify that the 1978 case involving Iowa had to do with taxing business income from certain sales.
The U.S. Supreme Court today heard arguments in a long-standing interstate tax dispute, the outcome of which could cost one state tens of millions of dollars and potentially shake up a fragile balance among states over how they tax their residents’ income when they earn it elsewhere.
The case comes out of Maryland, brought by a couple who sued over how the state taxed income they earned out of state. Maryland — like every other state with an income tax — offers a credit to taxpayers on their income tax bills for what they pay in taxes where the income is earned.
But unlike the others, Maryland’s credit is only partial. It offers no credit on a small part of its income tax that is distributed to counties, meaning that its residents pay taxes on the same income twice.
The plaintiffs in the case say the practice is unconstitutional, citing a string of cases that have generally blocked so-called double taxation, often in the name of protecting interstate commerce. The argument is that through its double taxation, Maryland creates an incentive for its residents to work only in Maryland.
During Wednesday’s arguments, Chief Justice John Roberts and Justice Samuel Alito seemed troubled by the potential threat to interstate commerce. Alito cited a submitted brief arguing that Maryland’s tax “operated exactly like a tariff.” Roberts later said that if every state did what Maryland did, “that sounds to me like a tariff.”
But the acting solicitor general of Maryland, William Brockman, said his state should not have to change its tax practices in deference to those of another state, even if there is a concern over double taxation.
“There is no reason a state should have to subordinate this taxing power,” Brockman told the justices. Further, he added, “Maryland is not required to provide a credit at all.”
Justice Antonin Scalia seemed to welcome the point. “That’s my problem with this,” he said, referring to the thinking that one state would have to give in to another’s tax decision. Scalia said opponents were citing “imaginary” constitutional arguments to back up their claims.
The U.S. and Maryland chambers of commerce, the Tax Foundation and the American Legislative Exchange Council (ALEC), which lobbies for conservative causes, agree with the plaintiffs. Maryland, the federal government, the Multistate Tax Commission (a membership group of state departments of revenue) and others defend the practice. Click here for a full list of the briefs filed in the case.
For decades, states have operated under the assumption that double taxation is not allowed, hence their practice of offering credits for taxes levied by other states. But experts say the core question of whether states are forbidden from taxing income twice has never been truly settled.
As they see it, the uncertainty applies to every state’s tax system, and pits federalism and state sovereignty against principles of free trade that have governed more than two centuries of commerce among states.
“It’s a fundamental, foundational question,” said Bradley W. Joondeph, the associate dean for academic affairs at the Santa Clara University School of Law, who wrote his own preview of the case. “When you have a state being told that its income tax system, which is in many respects critical to its raising of revenue, is unconstitutional, that’s something that’s going to get the court’s attention.”