Ragsdale v. Department of Revenue

• Decision Date: 02 June 1995
• Citation: 895 P.2d 1348,321 Or. 216
• Parties: , 63 USLW 2785 Julia D. RAGSDALE, Appellant, v. DEPARTMENT OF REVENUE, State of Oregon, Respondent. OTC 3535; SC S41581.
• Court: Oregon Supreme Court

Page 1348

895 P.2d 1348

321 Or. 216, 63 USLW 2785

Julia D. RAGSDALE, Appellant, v. DEPARTMENT OF REVENUE, State of Oregon, Respondent.

OTC 3535; SC S41581.

Supreme Court of Oregon In Banc.

Argued and Submitted March 9, 1995.

Decided June 2, 1995.

Gary R. DeFrang, of Wetzel DeFrang & Sandor, Portland, argued the cause for appellant. With him on the brief were Joseph Wetzel and Russell A. Sandor.

Marilyn J. Harbur, Asst. Atty. Gen., Salem, argued the cause for respondent. With her on the response was Theodore R. Kulongoski, Atty. Gen., Salem.

VAN HOOMISSEN, Justice.

In this direct appeal from the Oregon Tax Court, ORS 305.445, taxpayer challenges a judgment that denied her claim for a refund of state income taxes paid on her federal retirement benefits for the tax year 1991. Ragsdale v. Dept. of Rev., 13 OTR 143, 1994 WL 396303 (1994). She claims that Oregon discriminates in taxation between state and federal retirees in violation of the federal constitutional and statutory doctrine of intergovernmental tax immunity. ¹ This court reviews de novo. ORS 305.445; 19.125(3). For the reasons that follow, we affirm the judgment of the Tax Court.

At all times relevant to this appeal, retired public employees of the State of Oregon and of its political subdivisions and instrumentalities have received retirement benefits attributable to their employment under the Public Employes' Retirement System (PERS). ² See ORS chapter 237 (Public Employes' Retirement). Before 1991, ORS 237.201 (1989) provided that PERS retirement benefits were exempt from all state taxes. ³ Further, ORS 316.680(1)(d) (1989) excluded PERS retirement benefits from the taxable income base on which state income taxes were computed. There was no comparable statutory provision exempting federal retirement benefits from state taxes. As a result, Oregon taxed federal retirement benefits, but not PERS retirement benefits. ⁴

In 1989, the Supreme Court of the United States decided Davis v. Michigan Dept. of Treasury, 489 U.S. 803, 817, 109 S.Ct. 1500, 1508, 103 L.Ed.2d 891 (1989). At issue in Davis was whether a Michigan statute that fully taxed all federal retirement benefits, but excluded from taxable income all retirement benefits received from the State of Michigan or its political subdivisions, violated the principle of intergovernmental tax immunity by favoring retired state and local government employees over retired federal employees based on the source of the benefits. ⁵

In Davis, the Supreme Court held that, if a state exempts retirement benefits paid by state and local governments from state income taxes without similarly exempting retirement benefits paid by the federal government from state income taxes, then that state violates the principle of intergovernmental tax immunity. Davis, 489 U.S. at 810-17, 109 S.Ct. at 1505-09. That is to say, a state may not discriminate in taxation between state and federal retirement benefits, based on the source of the benefits. ⁶ The Supreme Court stated: "It is undisputed that Michigan's tax system discriminates in favor of retired state employees and against retired federal employees." Id. at 814, 109 S.Ct. at 1507. Moreover, Michigan's inconsistent tax treatment of retired state employees and retired federal employees was not justified by "significant differences between the two classes" of employees. Id. at 817, 109 S.Ct. at 1508. The Court concluded that, by favoring retired state and local government employees over retired federal employees, the Michigan statute violated the principle of intergovernmental tax immunity. Id. ⁷

The appropriate remedy, the Court announced, is a mandate of "equal treatment, a result that can be accomplished by withdrawal of benefits from the favored class as well as by extension of benefits to the excluded class." Id. at 817-18, 109 S.Ct. at 1509.

"[A]ppellant's claim could be resolved either by extending the tax exemption to retired federal employees (or to all retired employees), or by eliminating the exemption for retired state and local government employees. * * * [T]he Michigan courts are in the best position to determine how to comply with the mandate of equal treatment." Id. at 818, 109 S.Ct. at 1509.

This court later applied Davis and held that Oregon's taxation scheme, which was similar to the Michigan taxation scheme challenged in Davis, "impermissibly discriminated against employees of the federal government in violation of the constitutional doctrine of intergovernmental tax immunity." Ragsdale v. Dept. of Rev., 312 Or. 529, 823 P.2d 971 (1992). ⁸

In response to Davis, the 1991 Oregon legislature amended ORS 237.201 (1989) by repealing the tax exemption previously granted to PERS retirement benefits. Or.Laws 1991, ch. 823, § 1. The 1991 legislature also repealed ORS 316.680(1)(d) (1989), which excluded PERS retirement benefits from the state taxable income base. Or.Laws 1991, ch. 823, § 3. Following those statutory amendments, federal and PERS retirement benefits have been taxed alike under state income tax statutes.

The 1991 legislature also increased PERS retirement benefits payable to some state retirees. Or.Laws 1991, ch. 796. The increased PERS retirement benefits are based on an employee's years of service and range from one percent (10 to 20 years of service) to four percent (30 or more years of service). Id. at § 6. The benefits are not calculated on actual or even potential tax liability. That is to say, there is no mathematical correlation between taxes and the benefits created in 1991. Some state retirees who will be required to pay state income taxes on their PERS retirement benefits will receive no additional benefits under the 1991 law. Conversely, some state retirees who will pay no state income taxes will receive additional benefits. The benefits received pursuant to the 1991 statute are themselves subject to state and federal income taxation. The 1991 increase in PERS retirement benefits is funded by the PERS retirement trust fund. See ORS 237.271 (the Public Employes' Retirement Fund is a trust fund separate and distinct from the General Fund. Public employers that make contributions to the fund have no proprietary interest in the fund or in their contributions to the fund.).

Oregon Laws 1991, chapter 796 also provides that those increased PERS retirement benefits "shall not be paid in any tax year in which the retirement benefits payable under the Public Employes' Retirement System are exempt from Oregon personal income taxation." Id. at § 12. Oregon Laws 1991, chapter 796, section 12, further provides:

"In the event increased benefits under chapter 796, Oregon Laws 1991, are paid in a tax year in which the retirement benefits payable under the system are exempt from Oregon personal income taxation, the benefits shall not be recoverable by the system, but the Public Employes' Retirement Board shall insure that no additional amounts are paid under the provisions of chapter 796, Oregon Laws 1991."

Although the 1991 legislature chose to increase PERS retirement benefits payable to some state retirees, it did not extend any reciprocal benefits to federal retirees taxed under Oregon Laws 1991, chapter 823.

Current and retired state employees affected by the 1991 legislative changes that subjected PERS retirement benefits to state income taxation sued the state for breach of their employment contracts. In Hughes v. State of Oregon, 314 Or. 1, 33, 838 P.2d 1018 (1992), this court held that, by subjecting PERS retirement benefits to state income taxation, the state had breached certain contracts between the state and its current and retired employees:

"[B]y repealing the tax exemption previously afforded by former ORS 316.680(1)(d) (1989), section 3 of the 1991 law results in the taxation of PERS retirement benefits, an action in breach of the tax exemption term of the PERS contract. In other words, the state has chosen, pursuant to section 3 of the 1991 law, to breach the tax exemption term of the PERS contract that the state has with its employees. This the state may not do with impunity. Anyone whose PERS benefits are contractually exempt from taxation, in whole or in part, is entitled to a remedy for the state's breach."

This court declined to fashion a remedy for that breach of contract, leaving it to the legislature, in the first instance, to choose among the available remedies. Id. at 33 n. 36, 838 P.2d 1018. ⁹ Federal retirees, of course, were not parties to the Hughes litigation and, thus, they were not direct beneficiaries of its holding.

Taxpayer is a federal retiree and a resident of Oregon. During 1991, she received federal retirement benefits totaling $31,184, as compensation for services that she had rendered as an employee of the United States. The state tax liability attributable to that income was $2,865.06, which she paid in a timely manner. In 1992, taxpayer filed an amended individual income tax return requesting a refund of the $2,865.06, plus interest, arguing that Oregon impermissibly discriminated in the taxation of federal retirement benefits as compared to the taxation of PERS retirement benefits. The Department of Revenue (department) denied the refund.

Taxpayer appealed to the Oregon Tax Court, which sustained the department's order, explaining:

"[Taxpayer's] argument is based on an economic analysis which assumes the state may not do with the left hand what it cannot do with the right. An appropriate response to [taxpayer's] argument echoes the language of Davis: What the state does with regard to compensation of its employees, current or retired, is simply irrelevant to an inquiry as to the tax treatment of state and federal pensions.

"In essence, [taxpayer] argues that the state cannot change the compensation of its employees without forfeiting the right to tax federal pension income. This is the very type of interference that the doctrine of intergovernmental tax immunity was intended to...