State of Mich. v. U.S., 92-2295

• Decision Date: 02 February 1995
• Docket Number: No. 92-2295,92-2295
• Citation: 40 F.3d 817
• Parties: -6806, 63 USLW 2330, 94-2 USTC P 50,583, 95 Ed. Law Rep. 846 STATE OF MICHIGAN and Michigan Education Trust, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 817

40 F.3d 817

74 A.F.T.R.2d 94-6806, 63 USLW 2330,

94-2 USTC P 50,583,

95 Ed. Law Rep. 846

STATE OF MICHIGAN and Michigan Education Trust, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

No. 92-2295.

United States Court of Appeals Sixth Circuit.

Argued Aug. 6, 1993.

Decided Nov. 8, 1994.

Rehearing and Suggestion for Rehearing En Banc

Denied Feb. 2, 1995. ^*

Michael R. Atkins, Lawrence D. Owen (briefed), William J. Danhof, Miller, Canfield, Paddock & Stone, Lansing, MI, John J. Collins, Jr. (argued), Stevan Uzelac, Miller, Canfield, Paddock & Stone, Detroit, MI, Frank J. Kelley, Office of Attorney General, Appellate Div., Lansing, MI, Terrence P. Grady, Asst. Atty. Gen. (briefed), Finance & Development, Lansing, MI, for plaintiffs-appellants.

Gary R. Allen, Acting Chief (briefed), Richard Farber, Francis M. Allegra (argued), U.S. Dept. of Justice, Appellate Section, Tax Div., Washington, DC, Daniel M. LaVille, Office of the U.S. Attorney, Grand Rapids, MI, Donald J. Gavin, U.S. Dept. of Justice, Tax Div., Washington, DC, for defendant-appellee.

Before: GUY and NELSON, Circuit Judges; and HOOD, District Judge. ^*

NELSON, J., delivered the opinion of the court, in which HOOD, D.J., joined. GUY, J. (pp. 830-37), delivered a separate dissenting opinion.

DAVID A. NELSON, Circuit Judge.

The question presented here is whether the United States Internal Revenue Code imposes a tax on investment income realized by the Michigan Education Trust. The trust is a state agency established to receive advance payments of college tuition, invest the money, and ultimately make disbursements under a program that lets its beneficiaries attend any of the state's public colleges or universities without further tuition cost.

The district court held the education trust liable for federal income taxes. 802 F.Supp. 120. We conclude that while Congress could, if it wished, tax the investment income of state agencies such as the education trust, it has not chosen to do so. Accordingly, we shall reverse the judgment of the district court.

I

The Michigan Education Trust, created by an act of the Michigan legislature signed into law by the governor on December 23, 1986, ¹ is "a public body corporate and politic." M.C.L.A. 390.1425, Sec. 5(1) of the act. As such, the education trust is a public instrumentality of the state. The grant of corporate powers to such an agency makes it "a quasi corporation" under Michigan law, see Advisory Opinion re Constitutionality of PA 1966, No. 346, 380 Mich. 554, 575, 158 N.W.2d 416, 425 (1968), but the agency "remains an instrumentality of the State." Id.

The Michigan Constitution provides, subject to exceptions not relevant here, that each of the "agencies and instrumentalities of the executive branch of state government" must "be allocated by law" to one of the principal departments of the executive branch. Mich. Const., Art. V, Sec. 2. Pursuant to this constitutional requirement, Sec. 5(1) of the Education Trust Act, M.C.L.A. Sec. 390.1425, provides that the education trust "shall be within the department of treasury...."

Like many government agencies vested with corporate powers, the education trust has a board of directors by which such powers are exercised. Id. (Among the powers of this particular board is an express statutory power to "[e]nter into contracts on behalf of the state." M.C.L.A. Sec. 390.1431, Sec. 11(k) of the act.) The state treasurer is a member of the education trust's board ex officio, and the other board members (eight in number) are appointed by the governor with the advice and consent of the senate. M.C.L.A. Sec. 390.1430, Sec. 10(1) of the act.

Although the education trust is "within" the treasury department, and although the state treasurer (who is the head of that department) serves as a member of the board, the board acts "independently" of the treasury department. M.C.L.A. Sec. 390.1425, Sec. 5(1) of the act. For certain state constitutional purposes, and for purposes of the law governing payment of full-faith-and-credit obligations of the state, M.C.L.A. Sec. 12.61 et seq., assets of the education trust are not considered state money, common cash, or revenue of the state. M.C.L.A. Sec. 390.1429, Sec. 9(2) of the act. (This technical provision means, among other things, that the education trust has broader investment powers than would otherwise be available to it.)

Trust assets may be invested in any manner the trust deems appropriate, and may be pooled for investment purposes with state pension funds and other investments of the state. M.C.L.A. Sec. 390.1429, Sec. 9(4) of the act. It is state employees who invest education trust assets, and trust funds are paid out only through State of Michigan checks or warrants. All income of the education trust is exempt from state income taxes. M.C.L.A. Sec. 390.1435, Sec. 15 of the act. Michigan's auditor general is responsible for auditing the books of the education trust, and the board must submit an annual accounting to the governor and leaders of the Michigan legislature. M.C.L.A. Sec. 390.1432, Sec. 12 of the act. Legal representation is provided to the education trust by the Attorney General of the State of Michigan.

The business of the education trust's board must be conducted in compliance with Michigan's Open Meetings Act, and the education trust is likewise subject to the state's Freedom of Information Act. M.C.L.A. Sec. 390.1430, Secs. 10(5) and 10(6) of the act. All education trust employees are members of the classified civil service of the state; as civil servants, they are subject to state civil service commission rules and regulations. Advance tuition payments collected by the education trust are deposited in a bank trust account under the name of the State Treasurer, State of Michigan, Agent for the Michigan Education Trust. Assets of the trust are earmarked for uses set forth in the statute, including the making of payments to state institutions of higher education on behalf of qualified beneficiaries. M.C.L.A. Sec. 390.1429, Sec. 9(3) of the act.

The Michigan attorney general's department has advised the board of the education trust that the trust is an "agency" of the State of Michigan. The attorney general's department has further advised that the members of the board are "public officers" for purposes of the Michigan Governmental Liability for Negligence Act.

Before we turn to the purposes for which the education trust was created, it will be useful to refer to a bit of early history. On July 13, 1787--two years before the Constitution of the United States was adopted and 50 years before the State of Michigan was admitted to the Union--Congress enacted the Northwest Ordinance. Captioned "An Ordinance for the Government of the Territory of the United States Northwest of the River Ohio," this landmark legislation--which was to have a profoundly important effect on the subsequent development of both state and national law--was the fundamental instrument of government for an area covering more than a quarter of a million square miles. The territory to which the ordinance applied included all of present-day Michigan, plus Indiana, Illinois, Wisconsin, Ohio, and part of Minnesota.

Article III of the Northwest Ordinance began with this famous sentence: "Religion, morality, and knowledge being necessary to good government and the happiness of mankind, schools and the means of education shall forever be encouraged." The framers of both of Michigan's 20th Century constitutions--the first adopted in 1908 and the second in 1963--included articles on education in which the opening language mirrored the language of the first sentence of Article III of the Northwest Ordinance. Thus Article VIII, Sec. 1 of Michigan's present constitution, adopted without change from Article IX, Sec. 1 of the constitution of 1908, perpetuates, as part of the state's basic law, the principle that "schools and the means of education shall forever be encouraged."

As part of Michigan's efforts to make "the means of education" available to its citizens, the state maintains an extensive system of public colleges and universities. (The University of Michigan and Michigan State University are but two of a rather long list of such institutions.) Financial support for these public colleges and universities comes from a variety of sources, including both appropriations from the legislature and tuition payments.

During the first half of the decade of the 1980s, tuition costs at Michigan's public institutions of higher education, like tuition costs at public and private colleges throughout the nation, increased at rates that many found alarming. (Over the decade as a whole, the average tuition at Michigan's four-year colleges and universities more than doubled.) In January of 1986, responding to concern about soaring tuition costs, Michigan's governor proposed in his State of the State Address that Michigan adopt a state-run prepaid tuition program "designed to help parents guarantee to their children the opportunity of a Michigan college education." 1986 Mich. Journal of the House 152. The Michigan Education Trust Act was the embodiment of that proposal.

The act contained an extensive set of legislative findings, beginning with one that the attentive reader will find familiar: "It is an essential function of state government to forever encourage schools and the means of education, as provided in section 1 of article VIII of the state constitution of 1963." M.C.L.A. Sec. 390.1422, Sec. 2(a) of the act. The legislature further found it to be "an essential function of state government to encourage attendance at state institutions of higher education," Sec. 2(c); noted that "[s]tudents in elementary and secondary schools tend to achieve to a higher standard of performance when the payment of tuition for their higher education is secured," Sec. 2(h); and declared that "[p]roviding assistance to assure the...