On Monday, the Supreme Court ruled 5-4 that Maryland’s individual income tax system unconstitutionally discriminates against interstate commerce. The Court’s decision in Maryland Comptroller v. Wynne is a decisive victory for free interstate trade. The Court’s majority opinion relied heavily on economic principles detailed in an amicus brief filed by myself, Alan J. Auerbach, Alex Brill, Christopher DeMuth, Brian Galle, Kevin A. Hassett, R. Glenn Hubbard, and Robert J. Shapiro and similar arguments in an amicus brief filed by Michael Knoll and Ruth Mason. David Daniels and Margaret Meyers of Richards Kibbe & Orbe LLP provided us with superb pro bono legal representation in the filing of our brief.
As I previously explained, Maryland, like most states, taxes residents on both their in-state and out-of-state income and also taxes nonresidents on their in-state income. Unlike most states, which offer a full credit for income taxes that residents pay to other states on their out-of-state income (up to the amount of taxes the residents owe at home on the out-of-state income), Maryland allows only a partial credit. Maryland’s system forces residents to pay a minimum tax at home on their out-of-state income, no matter how heavily that income has been taxed by other states.
Brian and Karen Wynne challenged Maryland’s tax scheme as a form of double taxation, complaining that Maryland was taxing income that other states had already taxed. As Maryland pointed out, though, the Wynnes’ argument did not justify the remedy they were seeking. If two states exercising their legitimate tax powers happen to tax the same transaction, why should either of them have to give way? And who would decide which state should be the one to step aside?
The real problem with Maryland’s tax system is not double taxation, but its discrimination against interstate commerce. Economic neutrality toward interstate commerce requires that a state’scombined tax burden on the two interstate income flows – nonresidents’ in-state income and residents’ out-of-state income – be no larger than the state’s tax burden on residents’ in-state income. Maryland’s tax system flunks that requirement.
Maryland taxes all three types of income at similar rates, which makes the combined burden on the two interstate income flows roughly double the burden on residents’ in-state income. To eliminate this discrimination against interstate income, Maryland would need to stop taxing one of the two interstate income flows (or tax both of them at lower rates than residents’ in-state incomes). While even a full credit for out-of-state taxes would not fully eliminate the problem, it would greatly reduce the discrimination and it would put Maryland in line with other states’ policies. But, Maryland’s only effort to alleviate the discrimination is its partial credit, which clearly falls short.
Calling the economic analysis in our brief and the Knoll-Mason brief “undisputed,” Justice Samuel Alito homed in on the key economic issue of discrimination. In an opinion joined by Chief Justice John Roberts and Justices Anthony Kennedy, Stephen Breyer, and Sonia Sotomayor, Justice Alito found that Maryland’s tax system was discriminatory because it was internally inconsistent – if every state copied its tax system, interstate income would face higher tax burdens than intrastate income. As the two briefs pointed out, this internal consistency test is a convenient short-cut for looking at the combined tax burden that goes into the economic neutrality condition. Justice Alito emphasized the distinction between “discriminatory tax schemes,” which are unconstitutional, and “double taxation that results only from the interaction of two different but nondiscriminatory tax schemes,” which is constitutional. Because Maryland’s tax scheme fell into the former category, it had to be struck down.
The threat of state tax discrimination against interstate commerce may never go away. But, the Wynne ruling strengthens the constitutional guarantee of free interstate trade and helps protect the nationwide flows of labor, capital, goods, and services on which our national prosperity depends.
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