Davis v. Michigan Department of Treasury

Decision Date28 March 1989
Docket NumberNo. 87-1020,87-1020
Citation103 L.Ed.2d 891,109 S.Ct. 1500,489 U.S. 803
PartiesPaul S. DAVIS, Appellant v. MICHIGAN DEPARTMENT OF TREASURY
CourtU.S. Supreme Court
Syllabus

In each of the years 1979 through 1984, appellant, a Michigan resident and former federal employee, paid state income tax on his federal retirement benefits in accordance with the Michigan Income Tax Act, which exempts from taxation all retirement benefits paid by the State or its political § bdivisions, but taxes retirement benefits paid by other employers, including the Federal Government. After the State denied appellant's request for refunds, he filed suit in the Michigan Court of Claims, alleging that the State's inconsistent treatment of retirement benefits violated 4 U.S.C. § 111, which authorizes States to tax "pay or compensation for personal services as [a federal] officer or employee . . ., if the taxation does not discriminate against the . . . employee because of the source of the pay or compensation." The Court of Claims denied relief, and the Michigan Court of Appeals affirmed, ruling that appellant is an "annuitant" under federal law rather than an "employee" within the meaning of § 111, and that that section therefore has no application to him. The Court of Appeals also held that the doctrine of intergovernmental tax immunity did not render the State's discriminatory tax scheme unconstitutional, since the discrimination was justified under a rational-basis test: The State's interest in attracting and retaining qualified employees was a legitimate objective which was rationally achieved by a retirement plan offering economic inducements.

Held:

1. Section 111 applies to federal retirees such as appellant. The State's contention that the section is limited to current federal employees is refuted by the plain language of the statute's first clause. Since the amount of civil service retirement benefits is based and computed upon an individual's salary and years of service, it represents deferred compensation for service to the Government, and therefore constitutes "pay or compensation . . . as [a federal] employee" within the meaning of that clause. The State's contention that, since this quoted language does not occur in the statute's second, nondiscrimination clause, that clause applies only to current employees, is hypertechnical and fails to read the nondiscrimination clause in its context within the overall statutory scheme. The reference to "the pay or compensation" in the latter clause must, in context, mean the same "pay or compensation" defined in the section's first clause and thus includes retirement benefits. The State's reading of the clause is implausible because it is unlikely that Congress consented to discriminatory taxation of retired federal civil servants' pensions while refusing to permit such taxation of current employees, and there is nothing in the statutory language or legislative history to suggest such a result. Pp. 808-810.

2. Section 111's language, purpose, and legislative history establish that the scope of its nondiscrimination clause's grant or retention of limited tax immunity for federal employees is coextensive with, and must be determined by reference to, the prohibition against discriminatory taxes embodied in the modern constitutional doctrine of intergovernmental tax immunity. Pp. 810-814.

3. Michigan's tax scheme violates principles of intergovernmental tax immunity by favoring retired state and local government employees over retired federal employees. Pp. 814-817.

(a) The State's contention that appellant is not entitled to claim the protection of the immunity doctrine is without merit. Although the doctrine is based on the need to protect each sovereign's governmental operations from undue interference by another sovereign, this Court's precedents establish that private entities or individuals who are subjected to discriminatory taxation on account of their dealings with a sovereign can themselves receive the protection of the constitutional doctrine. See, for example, Phillips Chemical Co. v. Dumas Independent School Dist., 361 U.S. 376, 387, 80 S.Ct. 474, 481, 4 L.Ed.2d 384. Pp. 814-815.

(b) In determining whether the State's inconsistent tax treatment of federal and state retirees is permissible, the relevant inquiry is whether the inconsistency is directly related to and justified by "significant differences between the two classes." Phillips, supra, at 384-385, 80 S.Ct., at 479-480. The State's claimed interest in hiring qualified civil servants through the inducement of a tax exemption for retirement benefits is irrelevant to this inquiry, since it merely demonstrates that the State has a rational reason for discriminating between two similar groups of retirees without demonstrating any differences between those groups themselves. Moreover, the State's claim that its retirement benefits are significantly less munificent than federal benefits in terms of vesting requirements, rate of accrual, and benefit computations is insufficient to justify the type of blanket exemption at issue here. A tax exemption truly intended to account for differences in benefits would not discriminate on the basis of the source of those benefits, but would, rather, discriminate on the basis of the amount of benefits received by individual retirees. Pp. 815-817.

4. Because the State concedes that a refund is appropriate in these circumstances, appellant is entitled to a refund to the extent he has paid taxes pursuant to the invalid Michigan scheme. However, his additional claim for prospective relief from discriminatory taxation should be decided by the state courts, whose special expertise in state law puts them in a better position than this Court to fashion the remedy most appropriate to comply with the constitutional mandate of equal treatment. Pp. 817-818.

160 Mich.App. 98, 408 N.W.2d 433 (1987), reversed and remanded.

KENNEDY, J., delivered the opinion of the Court, in which REHNQUIST, C.J., and BRENNAN, WHITE, MARSHALL, BLACKMUN, O'CONNOR, and SCALIA, JJ., joined. STEVENS, J., filed a dissenting opinion, post, p. 818.

Paul S. Davis, for appellant.

Michael K. Kellogg, Washington, D.C., for the U.S., as amicus curiae, supporting appellant, by special leave of Court.

Thomas L. Casey, Lansing, Mich., for appellee.

Justice KENNEDY delivered the opinion of the Court.

The State of Michigan exempts from taxation all retirement benefits paid by the State or its political subdivisions, but levies an income tax on retirement benefits paid by all other employers, including the Federal Government. The question presented by this case is whether Michigan's tax scheme violates federal law.

I

Appellant Paul S. Davis, a Michigan resident, is a former employee of the United States Government. He receives re- tirement benefits pursuant to the Civil Service Retirement Act, 5 U.S.C. § 8331 et seq. In each of the years 1979 through 1984, appellant paid Michigan state income tax on his federal retirement benefits in accordance with Mich.Comp.Laws Ann. § 206.30(1)(f) (Supp.1988).1 That statute defines taxable income in a manner that excludes all retirement benefits received from the State or its political subdivisions, but includes most other forms of retirement benefits.2 The effect of this definition is that the retirement benefits of retired state employees are exempt from state taxation while the benefits received by retired federal employees are not.

In 1984, appellant petitioned for refunds of state taxes paid on his federal retirement benefits between 1979 and 1983. After his request was denied, appellant filed suit in the Michigan Court of Claims. Appellant's complaint, which was amended to include the 1984 tax year, averred that his federal retirement benefits were "not legally taxable under the Michigan Income Tax Law" and that the State's inconsistent treatment of state and federal retirement benefits discriminated against federal retirees in violation of 4 U.S.C. § 111, which preserves federal employees' immunity from discriminatory state taxation. See Public Salary Tax Act of 1939, ch. 59, § 4, 53 Stat. 575, codified, as amended, at 4 U.S.C. § 111. The Court of Claims, however, denied relief. No. 84-9451 (Oct. 30, 1985), App. to Juris. Statement A10.

The Michigan Court of Appeals affirmed. 160 Mich.App. 98, 408 N.W.2d 433 (1987). The court first rejected appellant's claim that 4 U.S.C. § 111 invalidated the State's tax on appellant's federal benefits. Noting that § 111 applies only to federal "employees," the court determined that appellant's status under federal law was that of an "annuitant" rather than an employee. As a consequence, the court concluded that § 111 "has no application to [Davis], since [he] cannot be considered an employee within the meaning of that act." Id., at 104, 408 N.W.2d, at 435.

The Michigan Court of Appeals next rejected appellant's contention that the doctrine of intergovernmental tax immunity rendered the State's tax treatment of federal retirement benefits unconstitutional. Conceding that "a tax may be held invalid . . . if it operates to discriminate against the federal government and those with whom it deals," id., at 104, 408 N.W.2d, at 436, the court examined the State's justifications for the discrimination under a rational-basis test. Ibid. The court determined that the State's interest in "attracting and retaining . . . qualified employees" was a "legitimate state objective which is rationally achieved by a retirement plan offering economic inducements," and it upheld the statute. Id., at 105, 408 N.W.2d, at 436.

The Supreme Court of Michigan denied appellant's application for leave to appeal. 429 Mich. 854, 412 N.W.2d 220 (1987). We noted probable jurisdiction. 487 U.S. 1217, 108 S.Ct. 2868, 101 L.Ed.2d 904 (1988).

II

Appellant places principal reliance on 4 U.S.C. § 111. In relevant part, that section provides:

"The United States consents to...

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