South Carolina v. Baker

485 U.S. 505

Case Year: 1988

Case Ruling: 7-1

Opinion Justice: Brennan

More Information

Concurring Opinions

Dissenting Opinions

Court Opinion Joiner(s):

Blackmun, Marshall, Rehnquist, Scalia, Stevens, White


1st Concurring Opinion

Author: Rehnquist


1st Dissenting Opinion

Author: O'Connor


2nd Concurring Opinion

Author: Scalia


2nd Dissenting Opinion



3rd Concurring Opinion

Author: Stevens


3rd Dissenting Opinion



Other Concurring Opinions:



Municipal and state bonds traditionally have been issued either as bearer bonds or as registered bonds. Interest from bearer bonds is presumed to belong to the person who owns the bonds, and the interest is paid when the owner redeems coupons attached to the bond. Owners of registered bonds are recorded on a central list, and if a bond is sold the transaction must be recorded. The owner of record automatically receives interest payments by check or electronic transfer of funds. State and municipal bonds of both types have been free from federal taxation on interest earned since the Supreme Court's decision in Pollock.

In 1982 Congress passed the Tax Equity and Fiscal Responsibility Act (TEFRA). Section 310(b)(1) of that statute removed the federal income tax exemption for interest earned on publicly offered long-term bonds issued by state and local governments unless the bonds were issued in registered form. The primary purpose of Section 310 was to increase compliance with federal tax laws and thereby increase federal revenues. Congress estimated that income of $97 billion was going unreported. Bearer bonds became a target of reform efforts because of the ease with which they could be bought and sold. If the ownership transfer was not registered, the bondholder could evade income tax on capital gains. Unregistered bonds also were used to evade estate taxes. Other provisions in this law encouraged the federal government and private corporations to stop issuing nonregistered long-term bonds.

The state of South Carolina sued the United States, in the name of Secretary of the Treasury James Baker, to have the law declared unconstitutional as a violation of the Tenth Amendment and the intergovernmental tax immunity doctrine. The federal government responded that the law did not violate the Constitution or the immunity doctrine because it did not eliminate the state's power to issue bonds exempt from federal taxation. The law required only that for such bonds to be tax exempt, they must be issued in a particular format. The case was heard on original jurisdiction. A special master appointed by the Court to give preliminary consideration to the case recommended that the justices uphold the validity of the law.



South Carolina contends that even if a statute banning state bearer bonds entirely would be constitutional, §310 unconstitutionally violates the doctrine of intergovernmental tax immunity because it imposes a tax on the interest earned on a state bond. We agree with South Carolina that §310 is inconsistent with Pollock v. Farmers' Loan & Trust Co. (1895), which held that any interest earned on a state bond was immune from federal taxation....

Under the intergovernmental tax immunity jurisprudence prevailing at the time, Pollock did not represent a unique immunity limited to income derived from state bonds. Rather, Pollock merely represented one application of the more general rule that neither the federal nor the state governments could tax income an individual directly derived from anycontract with another government. Not only was it unconstitutional for the Federal Government to tax a bondowner on the interest she received on any state bond, but it was also unconstitutional to tax a state employee on the income earned from his employment contract, to tax a lessee on income derived from lands leased from a State, or to impose a sales tax on proceeds a vendor derived from selling a product to a state agency. Income derived from the same kinds of contracts with the Federal Government were likewise immune from taxation by the States....

This general rule was based on the rationale that any tax on income a party received under a contract with the government was a tax on the contract and thus a tax "on" the government because it burdened the government's power to enter into the contract.... Thus, although a tax was collected from an independent private party, the tax was considered to be "on" the government because the tax burden might be passed on to it through the contract. This reasoning was used to define the basic scope of both federal and state tax immunities with respect to all types of government contracts....

The rationale underlying Pollock and the general immunity for government contract income has been thoroughly repudiated by modern intergovernmental immunity case-law....

With the rationale for conferring a tax immunity on parties dealing with another government rejected, the government contract immunities recognized under prior doctrine were, one by one, eliminated....

In sum, then, under current intergovernmental tax immunity doctrine the States can never tax the United States directly but can tax any private parties with whom it does business, even though the financial burden falls on the United States, as long as the tax does not discriminate against the United States or those with whom it deals. A tax is considered to be directly on the Federal Government only "when the levy falls on the United States itself, or on an agency or instrumentality so closely connected to the Government that the two cannot realistically be viewed as separate entities." The rule with respect to state tax immunity is essentially the same, except that at least some nondiscriminatory federal taxes can be collected directly from the States even though a parallel state tax could not be collected directly from the Federal Government.

We thus confirm that subsequent case law has overruled the holding in Pollock that state bond interest is immune from a nondiscriminatory federal tax. We see no constitutional reason for treating persons who receive interest on government bonds differently than persons who receive income from other types of contracts with the government, and no tenable rationale for distinguishing the costs imposed on States by a tax on state bond interest from the costs imposed by a tax on the income from any other state contract.... Likewise, the owners of state bonds have no constitutional entitlement not to pay taxes on income they earn from state bonds, and States have no constitutional entitlement to issue bonds paying lower interest rates than other issuers....

TEFRA §310 thus clearly imposes no direct tax on the States. The tax is imposed on and collected from bondholders, not States, and any increased administrative costs incurred by States in implementing the registration system are not "taxes" within the meaning of the tax immunity doctrine.... Nor does §310 discriminate against States. The provisions of §310 seek to assure that all publicly offered long-term bonds are issued in registered form, whether issued by state or local governments, the Federal Government, or private corporations. Accordingly, the Federal Government has directly imposed the same registration requirement on itself that it has effectively imposed on States. The incentives States have to switch to registered bonds are necessarily different than those of corporate bond issuers because only state bonds enjoy any exemption from the federal tax on bond interest, but the sanctions for issuing unregistered corporate bonds are comparably severe. Removing the tax exemption for interest earned on state bonds would not, moreover, create a discrimination between state and corporate bonds since corporate bond interest is already subject to federal tax.

Because the federal imposition of a bond registration requirement on States does not violate the Tenth Amendment and because a nondiscriminatory federal tax on the interest earned on state bonds does not violate the intergovernmental tax immunity doctrine, we uphold the constitutionality of §310....

It is so ordered.


The Court today overrules a precedent that it has honored for nearly a hundred years and expresses a willingness to cancel the constitutional immunity that traditionally has shielded the interest paid on state and local bonds from federal taxation. Henceforth the ability of state and local governments to finance their activities will depend in part on whether Congress voluntarily abstains from tapping this permissible source of additional income tax revenue. I believe that state autonomy is an important factor to be considered in reviewing the National Government's exercise of its enumerated powers. I dissent from the decision to overrule Pollock v. Farmers' Loan & Trust Co. (1895), and I would invalidate Congress' attempt to regulate the sovereign States by threatening to deprive them of this tax immunity, which would increase their dependence on the National Government....

Long-term debt obligations are an essential source of funding for state and local governments. In 1974, state and local governments issued approximately $23 billion of new municipal bonds; in 1984, they issued $102 billion of new bonds. State and local governments rely heavily on borrowed funds to finance education, road construction, and utilities, among other purposes. As the Court recognizes, States will have to increase the interest rates they pay on bonds by 28–35% if the interest is subject to the federal income tax. Governmental operations will be hindered severely if the cost of capital rises by one-third. If Congress may tax the interest paid on state and local bonds, it may strike at the very heart of state and local government activities....

Federal taxation of state activities is inherently a threat to state sovereignty. As Chief Justice Marshall observed long ago, "the power to tax involves the power to destroy." Justice Holmes later qualified this principle, observing that "[t]he power to tax is not the power to destroy while this Court sits." If this Court is the States' sole protector against the threat of crushing taxation, it must take seriously its responsibility to sit in judgment of federal tax initiatives. I do not think that the Court has lived up to its constitutional role in this case. The Court has failed to enforce the constitutional safeguards of state autonomy and self-sufficiency that may be found in the Tenth Amendment and the Guarantee Clause, as well as in the principles of federalism implicit in the Constitution. I respectfully dissent.