Opinion analysis: Maryland’s personal income tax violates the Commerce Clause

Bradley W. Joondeph is the Inez Mabie Distinguished Professor and Associate Dean for Academic Affairs at the Santa Clara University School of Law.

On Monday, a sharply divided Supreme Court held in Comptroller v. Wynne that Maryland’s personal income tax scheme – which failed to offer Maryland residents a full credit for income taxes paid to other states on income they earned in those states – was unconstitutional. By a vote of five to four, an ideologically diverse majority (consisting of Chief Justice John Roberts and Justices Anthony Kennedy, Stephen Breyer, Samuel Alito, and Sonia Sotomayor) concluded that Maryland’s scheme violated the dormant Commerce Clause because it discriminated against interstate commerce. Justices Antonin Scalia, Clarence Thomas, and Ruth Bader Ginsburg each authored dissenting opinions, on widely divergent grounds, revealing a fundamental dissensus on the Court regarding the dormant Commerce Clause.

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At issue in the case was a feature of Maryland’s personal income tax scheme denying a full credit to Maryland residents for income taxes paid to other states. Somewhat confusingly, Maryland’s state-level personal income tax comprises two distinct components: a state component (retained entirely by the state) and a county component, which ultimately flows to the taxpayer’s county of residence. Like other states, Maryland nominally imposes its personal income tax on the entirety of its residents’ income, regardless where that income is earned. With respect to the state component, Maryland grants its residents a credit for taxes paid to other states, but it offers no such credit against the county component. Consequently, the county component of Maryland’s tax causes some Maryland residents – those earning out-of-state income that is taxed by another state – to be taxed twice on that income: once by the state where it is earned, and then again by Maryland.

The Wynnes are Maryland residents who had earned much of their income in other states. They argued that, by subjecting their income to duplicative state-level taxation, the county component of Maryland’s income tax scheme ran afoul of the dormant Commerce Clause.

In an opinion authored by Justice Alito, the Court agreed. The two critical steps in the Court’s analysis were its conclusions that (1) to survive dormant Commerce Clause scrutiny, Maryland’s tax needed to be “internally consistent,” and (2) in addressing the tax’s internal consistency, the Court needed to examine Maryland’s personal income tax scheme “as a whole.” This second step was important because Maryland does not just impose the county component of its tax on Maryland residents; it also imposes that tax on non-residents (through a special non-resident tax) on the portion of their incomes earned within Maryland.

By framing the inquiry this way, the Court essentially answered the question presented. These premises foreordained that the tax would be found internally inconsistent – and thus a violation of the dormant Commerce Clause as discriminating against interstate commerce.

The internal consistency test had appeared in at least seven Supreme Court state tax decisions prior to this one. It asks whether interstate and intrastate commerce would be taxed equally if every state were to adopt the precise tax scheme at issue. The county component of Maryland’s tax failed that test. Were every state to adopt Maryland’s scheme (including the special non-resident tax), taxpayers living in one state but earning income in another would be taxed twice on their out-of-state income. But taxpayers confining their income-earning activity to their states of residence would be taxed only once. Interstate commerce would be disadvantaged relative to purely intrastate commerce.

This internal inconsistency, reasoned the Court, showed that Maryland’s scheme was “inherently discriminatory.” The unfavorable treatment of interstate commerce was “not simply the result of [the Maryland tax scheme’s] interaction with the taxing schemes of other states” but a structural feature of the tax. As such, Maryland’s scheme effectively “operate[d] as a tariff.” And “[t]his identity between Maryland’s tax and a tariff is fatal because tariffs are ‘the paradigmatic example of a law discriminating against interstate commerce.’”

None of the dissenting Justices actually contended that Maryland’s tax scheme was internally consistent. Rather, they argued that the Court’s analysis on this question was beside the point. Justices Scalia and Thomas argued that it was beside the point because the dormant Commerce Clause is not a part of the Constitution, “a judicial fraud.” (Justice Scalia would nonetheless apply the Court’s clear dormant Commerce Clause holdings as a matter of stare decisis, but found that Maryland’s tax was not condemned by those holdings.)

Justice Ginsburg’s dissenting opinion (joined by Justices Scalia and Kagan) accepted both the dormant Commerce Clause and the internal consistency test. But she argued that neither was fatal to Maryland’s tax because the internal consistency test was inapposite. In essence, she contended that Maryland’s tax was distinct from those previously invalidated on internal consistency grounds in that it was imposed on the income of natural persons who are state residents. A sovereign’s relationship with its actual, living residents is qualitatively different than the one that it shares with other taxpayers (such as corporations or non-residents) in a manner that justifies taxing one hundred percent of their income, wherever earned. At a minimum, argued Justice Ginsburg, this relationship means that the state of residence is not required to take a backseat when a source state attempts to tax the same income. Indeed, the Court’s decisions have long acknowledged that “[a] nation or State ‘may tax all the income of its residents, even income earned outside the taxing jurisdiction.’”

In response, the Court wrote that Justice Ginsburg was confusing the distinct requirements of the Due Process and Commerce Clauses. To be sure, Maryland (like any state of residence) had the jurisdiction (or “raw power”) to impose a tax on a resident’s worldwide income, wherever earned. But this did not mean that any tax imposed pursuant to that jurisdiction consisted with the Commerce Clause. The Court has invalidated scores of state taxes under the dormant Commerce Clause that were plainly within the scope of the states’ taxing jurisdictions as a matter of due process. The constitutional imperatives of jurisdiction and nondiscrimination are distinct.

More generally, the Court rejected this “special relationship” understanding of personal income taxes imposed by states on their own residents. To the Court, there was no reason to treat personal income taxes differently than corporate income taxes, or taxes imposed on income differently than those imposed on gross receipts. The inexorable logic of the Court’s opinion was that all such tax schemes must be internally consistent to comport with the Commerce Clause.

Interestingly, the Court left unresolved what options are available to states like Maryland to cure the constitutional defect in a scheme like this. Plainly, Maryland could solve the constitutional problem by granting the Wynnes the relief they sought – namely, a credit against the county component of the tax for taxes the Wynnes paid other states on their out-of-state income. But Maryland might also render its scheme internally consistent (despite continuing to deny residents like the Wynnes such a credit) by repealing the county component of its tax on non-residents (the special non-resident tax). Or, to take the logic even further, Maryland conceivably could eliminate all of the credits it affords its residents for income taxes paid other states on out-of-state income, and completely repeal any income tax it imposes on non-residents. That is, a state could simply tax one hundred percent of its residents’ income, wherever earned, and abstain from taxing any non-residents’ income.

Such a scheme would be internally consistent, as the Court’s opinion concedes. But it would not “fairly apportion” a taxpayer’s income among the states in which it was earned – a requirement the Court has held the Commerce Clause imposes on corporate income taxes. Did yesterday’s decision, in finding no reason to distinguish personal from corporate income taxes, implicitly doom such an unapportioned personal income tax as well?

The Court was conspicuously evasive on this point. “[W]e do not foreclose the possibility that [the state] could comply with the Commerce Clause in some other way” than providing a credit to taxpayers like the Wynnes. “[W]e do not decide the constitutionality of a hypothetical tax scheme that Maryland might adopt because such a scheme is not before us.” We are thus left to speculate.

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The Court’s opinion is significant, for it conclusively holds that internally inconsistent state personal income tax schemes violate the dormant Commerce Cause. Historically, states have avoided such internal inconsistency by providing their residents credits for income taxes paid to other states on the income they earn in those states. But the practice has not been universal (as Maryland’s scheme showed us here). And it has always been unclear whether these credits were granted as a matter of policy or as a presumed constitutional necessity. Wynne goes a long way towards clarifying these matters, but some important questions obviously remain.

In plain English

In Comptroller v. Wynne, the Supreme Court invalidated the county component of Maryland’s personal income tax as violating the Commerce Clause because it discriminated against interstate commerce. The Court applied its “internal consistency” test for state taxes: If every state in the Union adopted an identical tax scheme, would commerce that crosses state lines be taxed the same as commerce staying entirely within one state? Because Maryland failed to offer a credit to Maryland residents against the county tax for taxes paid to other states – and Maryland nonetheless imposed the county tax on non-residents earning income in Maryland – the tax scheme was internally inconsistent. Were every state to adopt the same tax scheme, commerce crossing state lines would be taxed more heavily than commerce occurring exclusively in one state.