485 U.S. 505 (1988), 94, South Carolina v. Baker

Docket Nº:No. 94, Orig.
Citation:485 U.S. 505, 108 S.Ct. 1355, 99 L.Ed.2d 592, 56 U.S.L.W. 4311
Party Name:South Carolina v. Baker
Case Date:April 20, 1988
Court:United States Supreme Court

Page 505

485 U.S. 505 (1988)

108 S.Ct. 1355, 99 L.Ed.2d 592, 56 U.S.L.W. 4311

South Carolina



No. 94, Orig.

United States Supreme Court

April 20, 1988

Argued December 7, 1987



Section 310(b)(1) of the Tax Equity and Fiscal Responsibility Act of 1982 removes [108 S.Ct. 1357] the federal income tax exemption for interest earned on publicly offered long-term bonds (hereinafter referred to as bonds) issued by state and local governments (hereinafter referred to collectively as States) unless those bonds are issued in registered (as opposed to bearer) form. South Carolina invoked this Court's original jurisdiction, contending that § 310(b)(1) is constitutionally invalid under the Tenth Amendment and the doctrine of intergovernmental tax immunity. A Special Master was appointed. After conducting hearings and taking evidence, he concluded that § 310(b)(1) is constitutional, and recommended entering judgment for the defendant. South Carolina and the National Governors' Association (NGA), as an intervenor, filed exceptions to various factual findings of the Master and to his legal conclusions concerning their constitutional challenges.


1. Section 310(b)(1) does not violate the Tenth Amendment or constitutional principles of federalism by effectively compelling States to issue bonds in registered form. Pp. 511-515.

(a) The Tenth Amendment limits on Congress' authority to regulate state activities are structural, not substantive -- that is, the States must find their protection from congressional regulation through the national political process, not through judicially defined spheres of unregulable state activity. In this case, South Carolina has not even alleged that it was deprived of any right to participate in the national political process or that it was singled out in a way that left it politically isolated and powerless. The allegations South Carolina does make -- that Congress was uninformed and chose an ineffective remedy -- do not amount to an allegation that the political process operated in a defective manner. Pp. 512-513.

(b) NGA's contention that § 310 is invalid because it commandeers the state legislative and administrative process by coercing States into enacting legislation authorizing bond registration and into administering the registration scheme finds no support in the claim left open by FERC v. Mississippi, 456 U.S. 742. Section 310 regulates state activities; it does not, as did the statute in FERC, seek to control or influence the

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manner in which States regulate private parties. That a State wishing to engage in certain activity must take administrative and sometimes legislative action to comply with federal standards regulating that activity is a commonplace that presents no constitutional defect. Moreover, under NGA's theory, any State could immunize its activities from federal regulation by simply codifying the manner in which it engages in those activities. Pp. 513-515.

2. Section 310(b)(1) does not violate the doctrine of intergovernmental tax immunity by taxing the interest earned on unregistered state bonds. Section 310(b)(1) is inconsistent with this Court's holding in Pollock v. Farmers' Loan & Trust Co., 157 U.S. 429, that state bond interest was immune from a nondiscriminatory federal tax, but that decision has been effectively overruled by subsequent case law. Under the intergovernmental tax immunity jurisprudence prevailing at Pollock's time, neither the Federal nor the State Governments could tax income that an individual directly derived from any contract with the other government. 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. That rationale has been repudiated by modern intergovernmental tax immunity case law, and the government contract immunities have been, one by one, overruled. The owners of state bonds have no constitutional entitlement not to pay taxes on income they earn from the bonds, and States have no constitutional [108 S.Ct. 1358] entitlement to issue bonds paying lower interest rates than other issuers. The nondiscriminatory tax under § 310 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. Moreover, 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. Pp. 515-527.

Exceptions to Special Master's Report overruled, and judgment entered for defendant.

BRENNAN, J., delivered the opinion of the Court, in which WHITE, MARSHALL, BLACKMUN, and STEVENS, JJ., joined, and in which SCALIA, J., joined except for Part II. STEVENS, J., filed a concurring opinion, post, p. 527. SCALIA, J., filed an opinion concurring in part and concurring in the judgment, post, p. 528. REHNQUIST, C.J., filed an opinion concurring in the judgment, post, p. 528. O'CONNOR, J., filed a dissenting opinion, post, p. 530. KENNEDY, J., took no part in the consideration or decision of the case

Page 507

BRENNAN, J., lead opinion

JUSTICE BRENNAN delivered the opinion of the Court.

Section 310(b)(1) of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub.L. 97-248, 96 Stat. 596, 26 U.S.C. § 103(j)(1), removes the federal income tax exemption for interest earned on publicly offered long-term bonds issued by state and local governments unless those bonds are

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issued in registered form.1 This original jurisdiction case presents the issues whether § 310(b)(1) of TEFRA either (1) violates the Tenth Amendment and constitutional principles of federalism by compelling States to issue bonds in registered form or (2) violates the doctrine of intergovernmental tax immunity by taxing the interest earned on unregistered state bonds.


Historically, bonds have been issued as either registered bonds or bearer bonds. These two types of bonds differ in the mechanisms used for transferring ownership and making payments. Ownership of a registered bond is recorded on a central list, and a transfer of record ownership requires entering the change on that list.2 The record owner automatically receives interest payments by check or electronic transfer of funds from the issuer's paying agent. Ownership of a bearer bond, in contrast, is presumed from possession and is transferred by physically handing over the bond. The bondowner obtains interest payments by presenting bond coupons to a bank that in turn presents the coupons to the issuer's paying agent.

In 1982, Congress enacted TEFRA, which contains a variety of provisions, including § 310, designed to reduce the federal deficit by promoting compliance with the tax laws. Congress had become concerned [108 S.Ct. 1359] about the growing magnitude of tax evasion; Internal Revenue Service (IRS) studies indicated that unreported income had grown from an estimated range of $31.1 billion to $32.2 billion in 1973 to a range of $93.3 billion to $97 billion in 1981. Compliance Gap: Hearing before the Subcommittee on Oversight of the Internal

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Revenue Service of the Senate Committee on Finance, 97th Cong., 2d Sess., 126 (1982). Unregistered bonds apparently became a focus of attention because they left no paper trail, and thus facilitated tax evasion. Then Assistant Secretary of the Treasury for Tax Policy John Chapoton testified before the House Ways and Means Committee that a registration requirement would help prevent tax evasion because bearer bonds often represent unreported and untaxed income that, without a system of recorded ownership, the IRS has difficulty reconstructing. Hearings on H.R. 6300 before the House Committee on Ways and Means, 97th Cong., 2d Sess., 35 (1982). He also expressed concern that bearer bonds were being used to avoid estate and gift taxes and as a medium of exchange in the illegal sector. Ibid. In reporting out the bill containing the provision that eventually became § 310 of TEFRA, the Senate Finance Committee Report expressed the same concerns:

The committee believes that a fair and efficient system of information reporting and withholding cannot be achieved with respect to interest-bearing obligations as long as a significant volume of long-term bearer instruments is issued. A system of book-entry registration will preserve the liquidity of obligations while requiring the creation of ownership records that can produce useful information reports with respect to both the payment of interest and the sale of obligations prior to maturity through brokers. Furthermore, registration will reduce the ability of noncompliant taxpayers to conceal income and property from the reach of the income, estate, and gift taxes. Finally, the registration requirement may reduce the volume of readily negotiable substitutes for cash available to persons engaged in illegal activities.

S.Rep. No. 97-494, Vol. 1, p. 242 (1982). Section 310 was designed to meet these concerns by providing powerful incentives to issue bonds in registered form.

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Because § 310 aims to address the tax evasion concerns posed generally by unregistered bonds, it covers not only state bonds but also bonds issued by the United States and private corporations. Section 310(a) requires the United States to issue publicly offered bonds with a maturity of more than one year in registered form.3 With respect to similar bonds issued by private corporations, §§ 310(b)(2) (6) impose a series of tax penalties on nonregistration. Corporations declining to issue the covered bonds in registered form lose tax...

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