Section of Taxation Publications
  VOL. 60
NO. 3

Contents | TTL Home


Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.

Department of Revenue v. Davis: Why the Supreme Court Should Strike Down the Differential Tax Treatment of In-State and Out-of-State Municipal Bonds
Adam Pekor


Justice Cardozo once wrote, “[t]he Constitution . . . was framed upon the theory that the peoples of the several states must sink or swim together, and that in the long run prosperity and salvation are in union and not division.” Nowhere does this principle resound more deeply than in the dormant component of the Commerce Clause, which delineates the constitutional command prohibiting the states from discriminating against interstate commerce. As straightforward as that limitation may appear, the dormant Commerce Clause has proven to be one of the most controversial and ambiguous areas of constitutional jurisprudence. The problem of determining the bounds of state power in light of the Commerce Clause becomes even more difficult when the “indispensable [state] power of taxation” is at issue.

In Department of Revenue of the Finance and Administration Cabinet v. Davis, on review from the Kentucky Court of Appeals, the Supreme Court will find its latest vehicle for contributing to the “quagmire” of its dormant Commerce Clause tax decisions to date. In Davis, the Kentucky Court of Appeals invalidated the state’s bond taxation system, which taxed interest earned on out-of-state municipal bonds but exempted from taxation interest earned on in-state municipal bonds, on the ground that the tax violated the dormant Commerce Clause.

Davis has the potential to play an important role in both tax law and dormant Commerce Clause jurisprudence because there is widespread use of bond taxation systems similar to the one that the Kentucky Court of Appeals struck down as unconstitutional. Currently, 42 states tax interest earned on out-of-state bonds while exempting most or all in-state bonds from taxation. When the Supreme Court hears Davis this term, the scope of the state power of taxation will be tested yet again.

Part I of this Note provides a brief history of the dormant Commerce Clause with a particular focus on those cases implicating a state’s power to tax. Part II outlines the relevant facts of Davis and of the system of differential taxation of municipal bonds used by Kentucky and other states. Part III and IV then analyze the two critical issues in Davis: (1) whether the differential tax treatment of in-state and out-of-state municipal bonds constitutes discrimination for purposes of the dormant Commerce Clause in light of the Supreme Court’s recent decision in United Haulers Ass’n, Inc. v. Oneida-Herkimer Solid Waste Management Authority; and (2) if Kentucky’s bond taxation is discriminatory, whether it is protected by the market-participant exception to the dormant Commerce Clause.

As discussed in Parts III and IV, this Note posits that the Kentucky Court of Appeals decided Davis correctly; Kentucky’s bond taxation system is discriminatory and therefore subject to strict scrutiny under the dormant Commerce Clause, and further, the market-participant exception cannot protect the discriminatory taxation of out-of-state municipal bonds.


Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


If you are an ABA member, you can receive The Tax Lawyer and the Section NewsQuarterly, both quarterly publications, when you join the Section of Taxation. Anyone can subscribe to The Tax Lawyer by contacting the ABA Service Center.