The United States has one of the largest subsovereign debt markets in the world,1 and the municipal securities market—its structure, and its regulation—is markedly different from the corporate securities market. Although the distinctions are readily apparent, the historical and legal basis for the distinctions is less so. All legal entities, public and private, are creatures of statute, but municipal entities, which include municipalities and other governmental entities, are units of government that derive their authority from state general laws and state and federal constitutions.2 Many of the powers, privileges, and protections of municipal entities run deeper than the state laws that purport to define them, as they are firmly rooted in constitutional and common law and have essential attributes of sovereignty that cannot be transferred or encumbered. This history helps explain the different historic growth patterns of the corporate and municipal securities markets, and it should help inform future market evolution, whether designed to address the perceived lack of consistency in debt structure, transparency in terms of municipal entities disclosure, or otherwise. For those interested in pruning or shaping both markets, that same history is also instructive as to those actions likely to encourage core market strengths and those more likely to hinder them.
I. A Short Reprise of American Constitutional History
Before the adoption and ratification of the Constitution of the United States in 1789, the concept of “general purpose government” was already well entrenched in the daily lives of Americans.3 The thirteen original colonies had been operating as independent states since the signing of the Declaration of Independence4 and the adoption of the Articles of Confederation, under which state governments possessed plenary legislative power limited by applicable state constitutions or charters.5 The federal Constitution, by comparison, is generally understood as a limited grant of express and implied powers (i.e., not plenary) to the national government by the states.
B. Rejection of England’s Unitary System of Government, Failure of the Articles of Confederation, and Adoption of the U.S. Constitution
England’s system of government was and remains centralized. In such a unitary system, large amounts of power reside with Parliament.6 Replication of that concentration of power and its correlative risk of tyranny was deemed dangerous in 1777, and the original Articles of Confederation expressly rejected Britain’s unitary system in favor of a confederation system, with strong states and a weak national government.7 Indeed, the framers of the Articles of Confederation were so protective of the individual states’ needs, as well as each state’s independence, that the national government did not possess the power to regulate interstate commerce or collect taxes, among other things.8 This confederation, or “firm league of friendship” as it is declared in the Articles,9 failed in many respects. By 1787, the Constitutional Convention had been convened to replace it,10 and the U.S. Constitution was drafted. With it, America’s federal system was established. Some powers were delegated to the national government and simultaneously protected by principles of supremacy; other powers were reserved to the states.11
Support for this structure was initially neither unanimous nor uniform. The tensions within the compromises that the Nationalists and the Federalists made to draft the Constitution and form this system of government are evident in the Constitution itself and, in many respects, remain ongoing today.12
C. Evolution of State and General Purpose Government Powers over Time
Delineation of U.S. governmental power and authority began with debate and disagreement about the drafts of both the Articles of Confederation and the U.S. Constitution. Evolution of governmental power has continued since that time, and the paths taken, and reasons therefor, are instructive.
Evolution of Federalism. As originally envisioned in 1789, states and the national government were co-sovereign, each with their own powers and obligations. In the 1950s, Morton Grodzins was the first to use a layer cake metaphor to describe this early “dual federalism” period in our history.13 Over time, the U.S. system became more complex. In response to the Great Depression, under the New Deal, many federal grant-in-aid programs were established at the federal level that were administered at the state level. The layer cake became a marble cake and an era of “cooperative federalism” began. The federalism pendulum has swung back and forth repeatedly in the last century.14 The new constant, however, is strength through interdependence. The federal government now depends on states and their input to achieve its goals,15 and state spending is now inextricably linked to federal matching funds and conditional grants.
Evolution of State Sovereignty. The U.S. Constitution contemplates a system where police powers reside with sovereign states, not the federal government.16 Following ratification of the Constitution in 1789, the principles of sovereignty and sovereign immunity charted an evolutionary course not dissimilar to that of federalism and one sometimes intertwined with public finance. For example, after the Revolutionary War, many states attempted to repudiate their war debts. In 1792, Alexander Chisholm attempted to sue the State of Georgia in the U.S. Supreme Court over payments due for goods supplied to Georgia during the American Revolutionary War. The State of Georgia claimed that, as a sovereign state, it could not be sued without granting its consent to the suit and refused to appear.17 The Supreme Court disagreed in the 1793 decision Chisolm v. Georgia, holding that under Article III, Section 2 of the then relatively new Constitution, a state could be sued in federal court, thereby eliminating the claim of state sovereign immunity.18 On the legal front, backlash against this decision led to adoption of the Eleventh Amendment, embedding the concept of state sovereign immunity firmly into the Constitution.19 Simultaneously on the political front, the concept of a national bank and federal assumption of state debts was floated.20 The Alexander Hamilton (the first U.S. Secretary of the Treasury) contingent21 prevailed, and the federal government assumed state debts.22 Fears receded, and issues of state sovereign immunity lay largely dormant for many years. Following a second series of state repudiations of Civil War reconstruction debts, the Supreme Court again stepped into immunity issues, expanding interpretation of the Eleventh Amendment to bar federal question claims against states in Hans v. Louisiana.23
Fast forward to the Rehnquist Court, which significantly expanded state sovereign immunity concepts in Seminole Tribe v. Florida24 and Alden v. Maine,25 where the Court made it clear that Congress’s Article I constitutional authority to abrogate immunity of the states under the Eleventh Amendment is limited.26
Evolution of the Republican States. Regarding state and general purpose governments, the Constitution requires only that the “United States shall guarantee to every State in this Union a Republican Form of Government.”27 To steal a phrase from biology: diversity begets stability; however, in the evolution of states’ republican forms of government, it may be that diversity begets more diversity. The Constitution did not dictate the details of the republican form of government, and individual states were left to evolve on their own in a somewhat parallel but not identical manner. The thirteen original states evolved from the thirteen original colonial governments. Many subsequently admitted states began as organized territories created by the federal government,28 while others began via separation from an existing state29 or entered statehood already as a sovereign entity.30 One state, California, entered statehood as a result of the ceding of land from Mexico to the United States.31
From these varied origins, state constitutions and legislative structures were formed, some following the lead of earlier states and some creating a different path based upon influences of early settlers.32 While republican in form, the distinctions among the states are many, including the fact that four states are called commonwealths and that state legislative bodies may be known as “legislatures,” “assemblies,” or in the case of Nebraska (the only unicameral legislature), the “senate.” The states each have their own constitutions, many of which are similar to the U.S. Constitution. While that similarity aids understanding of where state constitutional rights are grounded, the relationship between each state and its political subdivisions is not always consistent with the Tenth Amendment. This dichotomy is discussed later in more detail.33
Implications for Municipal Securities Markets. The municipal securities markets are fundamentally different than the corporate markets.34 First, in the corporate arena, there is a level of general legislative uniformity not found in the municipal arena. This uniformity allows for a level of homogenization of standard types of corporate securities not seen with municipal securities. Second, due to different state constitutions, fundamental differences exist in the power and authority of the same units of government (such as cities) in different states. A city in one state may be authorized to issue bonds for purposes prohibited for a city in a different state. These differences are not oversights or mistakes. They are the natural outgrowth of fundamental principles of our federal Constitution. They are also premised on the truth that, as governments, certain essential attributes of sovereignty cannot be conveyed or hypothecated.35 As noted above, certain aspects of government are more than just property rights, and their delegation is therefore significantly limited. Furthermore, the U.S. securities markets rely heavily on the unique U.S. interrelationships among the different layers of American governments. As U.S. Supreme Court Justice Anthony Kennedy so eloquently described it, “The Framers split the atom of sovereignty.”36 What is important in the evaluation of the municipal securities market today, however, is not the exact boundaries of national or state powers on any given day, but the undeniable conclusion that these powers are stronger when deployed together, and stronger when deployed consistently with fundamental constitutional principles of governmental power and authority.
II. A Brief Constitutional Law Refresher
A. Constitutional Principles Particularly Relevant to the Development of U.S. Governmental Structures and the Law of Public Finance
The United States has one of the most complicated systems of national, state, and local governments anywhere in the world,37 with levels of autonomy, power, and control varying widely by jurisdiction. This complexity did not happen by accident. It is firmly embedded in important principles of republicanism and the U.S. Constitution, and the intentional outgrowth of this system’s original dual federalism construct, including, in particular, intentional tensions between and among certain constitutional and pre-ratification sovereignty principles.
Both constitutionally based and non-constitutional legal principles are referenced in this article. The following terminology is important to aid further discussion:
Fundamental State Sovereign Immunity. Sovereign immunity is the inability of a governmental unit to be sued without its consent. The sovereign immunity of states, a common law principle that pre-dates the Constitution,38 which is generally understood to apply in state court, as federal courts frequently deal with both constitutional and common law immunity under the Eleventh Amendment label described below.
Comity Doctrine. Also a concept external from the Constitution, the international law principle that co-equal sovereigns respect each other’s laws, judgments, and interests.39
The Right to a Remedy. With roots in the Magna Carta, the principle that “it is a general and indisputable rule, that where there is a legal right, there is also a legal remedy by suit or action at law, whenever that right is invaded.”40
Express Provisions and Constitutionally Based Principles.
Bankruptcy Clause. The provision of the Constitution that provides “[t]he Congress shall have Power [t]o . . . establish . . . uniform Laws on the subject of Bankruptcies throughout the United States . . . .”41
Commerce Clause. The provision of the Constitution providing that Congress shall have power “[t]o regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes . . . .”42
Contracts Clause. Applicable only to states and local governments, the provision of the Constitution providing that “[n]o State shall . . . pass any . . . law . . . impairing the Obligation of Contracts.”43
Due Process Clause. Derived from the Fifth (generally) and Fourteenth (states, specifically) Amendments, the provisions of the Constitution providing that no person shall be deprived “of life, liberty, or property, without due process of law.”44
Enforcement Clause. The provision of the Fourteenth Amendment to the Constitution providing that “[t]he Congress shall have power to enforce, by appropriate legislation, the provisions of this article,”45 giving it power to adopt laws aimed at ensuring due process and equal protection, also commonly referred to as its Fourteenth Amendment section 5 power.
Equal Protection Clause. Derived from the Fifth and Fourteenth Amendments, the provisions of the Constitution providing people with “the equal protection of the laws.”46
Supremacy Clause. The provision of the Constitution providing that “[t]his Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land. . . .”47
Takings Clause. Derived from the Fifth Amendment, made applicable to states through the Fourteenth Amendment, the provisions of the Constitution affirming that private property shall not “be taken for public use, without just compensation.”48
Tenth Amendment. The provision of the Constitution providing that “[t]he powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”49
Eleventh Amendment Sovereign Immunity. The provision of the Constitution providing that “[t]he Judicial power of the United States shall not be construed to extend to any suit in law or equity, commenced or prosecuted against one of the United States by Citizens of another State, or by Citizens or Subjects of any Foreign State.”50 Eleventh Amendment sovereignty applies in federal court, though it is often conflated with pre-ratification principles of state sovereign immunity in state court. The Eleventh Amendment does not apply to a municipal government or other government entity, unless either (a) such entity is deemed to be an “arm of the State” or (b) it is determined that the State is the real party in interest.51
Reserved Powers Doctrine. The judicial doctrine, based on constitutional sovereignty concepts, that a government cannot surrender essential attributes of its sovereignty, such as police or eminent domain powers.
Reciprocal Immunity Doctrine. The historical judicial doctrine, based on constitutional sovereignty concepts that, just as a state may not tax the federal government, the federal government may not tax the means and instrumentalities of a state.
Anti-Commandeering Doctrine. The judicial doctrine, based on constitutional Tenth Amendment concepts, that a government cannot impose affirmative duties on state legislative or executive branch officials.
B. Constitutional Tensions Particularly Relevant to the Development of U.S. Governmental Structures and the Law of Public Finance
The law of public finance is replete with examples of the counter-balancing tensions embedded in the U.S. Constitution by its framers. The current law of public finance is a complex weave, but four repeating threads, plaited in two distinct directions, are identified and described here.
The Tenth Amendment and the Supremacy Clause, Often in Conflict.
As noted above, the exact boundaries of federalism have shifted in both directions over time. In a string of cases beginning with National Labor Relations Board v. Jones and Laughlin Steel Corp, the Supreme Court expanded federal power in 1937.52 In 1976, in National League of Cities v. Usery, the Supreme Court, by a majority opinion penned by future Chief Justice Rehnquist, checked this expansion, limiting the power of Congress under the Commerce Clause to impair state sovereignty.53 Less than ten years later, in Garcia v. San Antonio Metropolitan Transit Authority, the Supreme Court overruled Usery.54 Fast-forwarding to the 1990s, the federalism landscape again shifted with decisions in New York v. United States (invalidating a federal law requiring states with inadequate environmental laws to “take title” to certain radioactive waste),55 and Printz v. United States (a 1997 decision invalidating a provision of the Brady Handgun Violence Prevention Act requiring state officials to run background checks on prospective handgun purchasers).56 These latter cases generally stand for the principle that the federal government cannot affirmatively commandeer state legislative or executive branches. In 2018, in Murphy v. NCAA,57 the Court invalidated a federal law prohibiting states from authorizing sports gambling, clarifying that anti-commandeering rules apply equally to both affirmative requirements and prohibitions adopted by Congress under its Commerce Clause powers. In Justice Alito’s majority opinion, he notes, “The anti-commandeering doctrine may sound arcane, but it is simply the expression of a fundamental structural decision incorporated into the Constitution, i.e., the decision to withhold from Congress the power to issue orders directly to the States.”58
There will always be Federalists and Nationalists. For purposes of this article, the exact boundaries at any given time are largely irrelevant. Rather, what is interesting is the impact that this ever-present tension has had historically in the development of the municipal securities market and assessing the tensile strength of future developments.
Sovereign Immunity and the Commerce Clause, Often in Conflict.
The principles of sovereign immunity embodied in both common law and the Eleventh Amendment have faced challenges under competing constitutional concepts, including the Bankruptcy Clause, the Enforcement Clause, and the Commerce Clause. The tension, obviously, is between the respected sovereign rights of states and the counterbalancing supreme rights of the federal government, under the Constitution, to abrogate those rights.
The case law is clear that when the tension is between the Eleventh Amendment and the Bankruptcy Clause59 or between the Eleventh Amendment and the Due Process or Equal Protection Clauses,60 sovereign immunity generally does not withstand the challenge. The tension between the Eleventh Amendment and the Commerce Clause, however, is a more interesting story61 and one unique to public finance that does not have a real parallel in corporate finance.62 From Hans v. Louisiana63 through Seminole Tribe of Florida v. Florida64 and Justice Kennedy’s majority opinion in Alden v. Maine,65 it has been clear that “the powers delegated to Congress under Article I of the United States Constitution do not include the power to subject nonconsenting States to private suits for damages in state courts.66 Sovereign immunity boundaries are still being defined today, with the Supreme Court, in 2020, striking down a federal copyright law abrogating state sovereign immunity in Allen v. Cooper.67 These boundaries will continue to have an interesting impact on the continued evolution of the municipal market regulatory framework.
III. Historical Evolution of the Public Finance Market
The Constitutional principles and tensions outlined in Part II above have informed development of key aspects of public finance law from the beginning, as detailed below in this Part III, including a proliferation of differing state approaches to general law matters, as well as the evolution of the federal bankruptcy, securities, and tax laws applicable to the municipal securities market.
A. Differing State Approaches to the Power and Authority of Political Subdivisions and Local Governments
The framers of the Constitution designed a federal government that is dependent on the states, while the states are free to self-govern (with certain limitations).68 The federal government derives its power from those expressly listed (or implied) in the Constitution, and the Tenth Amendment reserves to the states all the powers that are not given to (or prohibited by) the federal government in the Constitution. Most state constitutions are consistent with the U.S. Constitution; however, with respect to the concept of state sovereignty, some states did not take the same approach to their political subdivisions that the federal Constitution took toward states. Through adoption of the Constitution, the federal government was created by and empowered by the states. Likewise, through the fifty state constitutions and state laws, political subdivisions of the states (and other local government entities) were created and empowered, but not on a consistent basis across jurisdictions. The U.S. Supreme Court in Atkins v. Kansas stated that local governments are mere political subdivisions of the states for the purpose of exercising a part of the states’ powers.69 Understanding that local governments are creatures of state governments, the next two sections discuss the existing dichotomy in local governments’ powers and authority.
History of Dillon’s Rule
The doctrine commonly referred to as Dillon’s Rule is based on decisions by Justice Dillon, including the Supreme Court of Iowa decision in 1868, City of Clinton v. Cedar Rapids and the Missouri River Railroad Co.70 The City of Clinton filed an injunction in Iowa state court to restrain the Cedar Rapids and the Missouri River Railroad Company from building a railroad line through any city streets. The railroad company argued it was acting under the power granted to it by the state, which permitted it to construct a railroad line across the entire State of Iowa. The Supreme Court of Iowa ruled that the city did not possess the power to prevent the construction of a railroad and that the railroad company did not need to obtain the city’s consent to build the railroad line.71 Iowa Supreme Court Justice John Dillon stated:
A municipal corporation possesses and can exercise the following powers and no others: First, those granted in express words (from the state); second, those necessarily implied or necessarily incident to the powers expressly granted; third, those absolutely essential to the declared objects and purposes of the corporation-not simply convenient, but indispensable; and fourth, any fair doubt as to the existence of a power is resolved by the courts against the corporation.72
To summarize, under Dillon’s Rule, local governments possess only the power that the state governments specifically give them and whether such authorization exists is likely to be construed against the local government.
Under Dillon’s Rule, states give local governments the power to take actions, such as zoning, planning, parts of taxation, and other activities where government closest to the people is most effective. If a local government wants to exceed the scope of power delegated by the state, the local government will have to ask the state for permission to do so. Some local government leaders contend that they are handcuffed by Dillon’s Rule and that it prohibits and hinders growth within the municipality. Others contend that Dillon’s Rule provides consistency in law across the state and avoids renegade local political legislation.73
History of Home Rule (the Cooley Doctrine)
The origin of Home Rule in the United States can be traced to Judge Thomas Cooley of the Michigan Supreme Court who, in 1871, stated that local governments possess some inherent rights of self-government. This sentiment was included in Judge Cooley’s concurring opinion in People ex rel. Leroy v. Hurlburt,74 where the court invalidated a state law that purported to appoint members to a board of public works for the City of Detroit. The court found that while the state had the power to legislatively dictate whether the board members would be elected by local citizens or appointed by the local government, the state had no power to actually appoint members of that board.75
Home Rule generally permits local governments the authority to self-govern to the extent that enacted local laws do not conflict with and are not prohibited by state laws and constitutions. Under Home Rule, local governments can make a wide range of legislative decisions that have not been addressed by the state. The first state to pass a Home Rule charter was Missouri in 1875.76 During the next few decades, states such as California, Washington, Minnesota, Colorado, Virginia, Oregon, Oklahoma, Michigan, Arizona, Ohio, Nebraska, and Texas all adopted some form of the Home Rule. Currently, more than forty states have adopted some form of Home Rule. 77
In Florida, the adjustment from Dillon’s Rule to Home Rule for cities and charter counties came at a time after World War II, during which the population began to drastically increase. The legislature was flooded with local legislative bills asking for permission from municipalities to solve local issues.78 This surge led to a Home Rule provision being included in the 1968 constitutional revision, but the conversion to Home Rule did not apply uniformly to all local governments. In Florida, only cities and counties that have adopted charters (so-called “charter counties”) possess expansive Home Rule powers. Other local government bodies in Florida possess only those powers that are bestowed upon them by the Florida Legislature. In fact, at least thirty-one states apply a combination of Dillon’s Rule and Home Rule.79
The Value and Challenge of Divergent State Approaches
Understanding the diversity of state approaches to delegating power to local governments to govern within their borders helps to explain the tremendous diversity that developed in the U.S. municipal securities market. Because the scope of powers, privileges, and protections for any given public corporation is a function not only of its authorizing statute but also its particular state’s constitution and constitutional delegation of taxing, spending, and police powers; Home Rule principles; and Dillon’s Rule scope, municipal securities issuers have widely divergent powers with respect to a number of seemingly unrelated matters today. Examples include (1) the meaning of “general obligation” indebtedness;80 (2) the ability of states, general purpose governments, and special purpose governments to execute bank loans;81 (3) the availability of securitization and monetization authority;82 (4) the availability of bankruptcy protection;83 and (5) the availability and scope of statutory lien protections. The rationale for a particular state’s approach is often found in the state’s constitution and its case law.
The lack of uniformity in these and other areas prevents credit “homogenization” and requires municipal bond investors to review the provided disclosure with respect to each particular issuer, as well as to understand the distinctions between similarly titled bond issues of different issuers in different states. Ultimately, however, this diversity of legal premise and scope of authority among various states and their local jurisdictions is fundamentally intertwined with the very deliberate constitutional definition of federalism.
The diversity of state law approaches to a myriad of legal issues has been a challenge since the Declaration of Independence. In an effort to bring some uniformity to laws among the various jurisdictions, a group of lawyers met in the late 1890s to discuss the prospect of “a greater unanimity of law throughout the country in those matters in which such unanimity is both desirable and possible.”84 Their quest became the basis for the creation of the Uniform Law Commission in 1892.85 The Commission released the first uniform act, the “Uniform Negotiable Instruments Law” in 1896.86 Since its establishment, the Commission has published more than 300 uniform laws and model legislation, more than 100 of which have been adopted in at least one state.87 Perhaps the most widely adopted uniform law is the Uniform Commercial Code, some version of each article of which has been adopted in every state.88 The goal of uniform laws is not necessarily that the laws of all states will be identical because each state, when considering and adopting a version of a uniform law, will make adjustments for its particular jurisdiction. The value of a uniform law (to lawyers in particular) is, very simply, the ability to understand how the laws of each state vary from the uniform law. The uniform laws that have been the most widely adopted govern areas where predictability and fairness are viewed as necessary in the context of the growing mobility of people and commerce in the country.89
Consider the value of uniform laws such as the Uniform Commercial Code and the Uniform Enforcement of Foreign Judgments Act, but also the value of such socially related acts as the Uniform Child Custody Jurisdiction and Enforcement Act and the Uniform Interstate Family Support Act, all of which have been adopted in most states (with some variations).90 Does the diversity of public finance laws across the country raise such challenges that a set of uniform laws would be desirable? Is organic law diversity so great as to make such a uniform approach impossible? Would some aspect of public finance laws be more manageable in the context of a uniform or model law, such as enforcement provisions and/or statutory lien laws?91
Development and Expansion of the U.S. Municipal Securities Market
The first reported issuance of municipal bonds in the United States was by the City of New York in 1812, when it issued general obligation bonds to finance the construction of a canal, followed by forty-two separate bond issues to fund construction of the Erie Canal.92 Over the next fifty or so years, municipal bonds were issued to fund other infrastructure projects, such as public education facilities and railroad construction across the country.93 The railroad bonds were, perhaps, the first “public-private partnership” bonds issued, with the primary obligor being the railroad company with municipal assistance through the local government’s credit or guarantee.94 The economic downturn (or “panic”) in 1873 resulted in numerous railroad insolvencies and municipal bond defaults.95 In 1870, total local government debt is estimated to have been around $500 million, with twenty percent in default as a result of the economic downturn and railroad defaults.96 In the reaction to the assistance provided by local governments to private companies and the resulting fiscal difficulties, a flurry of state constitutional limitations and prohibitions were enacted across the country, not all with the same degree of restriction. These constitutional restrictions included prohibiting the pledging of public credit to private entities, limiting tax millage rates or budgetary expenditures, and limiting debt maturities, among others.97 As an alternative to outright prohibitions, some states enacted procedural requirements, such as voter approval, as a means to restrict local government debt issuance.98
Although these restrictions did somewhat slow the growth of the municipal securities market, they did not curtail its growth, and, in some respects, the restrictions enhanced the municipal securities market by encouraging more conservative fiscal debt policies, thus enhancing investor confidence.99 Restrictions on tax millage also cleared the path for non-tax supported debt (e.g., revenue bonds). From that first reported issuance in 1812 through 1890, the total volume of outstanding state and local government obligations grew to $2 billion.100 In 1996, the total volume of outstanding municipal debt was $1.26 trillion, and in 2019 it was $3.85 trillion.101 The following table reflects the growth of the municipal securities market since 1950.
B. Growth of the Municipal Securities Market
The growth in the size of the municipal securities market has also been a function of the growth in the number of municipal issuers, as well as the transition from primarily general-obligation debt to predominately revenue-backed debt. With the introduction of special purpose governmental entities (e.g., special districts), the number of municipal issuers is estimated by various regulatory agencies at approximately 50,000 in 2020.102
State and Local Debt Outstanding103
C. Bankruptcy Law
Municipal bankruptcy is another legal arena where constitutional principles and tensions have driven legislative evolution in a direction quite different than that applicable in the corporate markets. Governmental units cannot liquidate under federal bankruptcy, and a municipal bankruptcy under Chapter 9, Title 11, of the United States Code, is quite different in scope than a corporate bankruptcy under Chapter 11, Title 11, of the United States Code. These differences are based in part on the fact that municipalities are not simply creatures of statute. Their organizational status runs deeper and is rooted in federal and state constitutional tenants creating them as stewards of the people’s public property and limiting their power and authority by the public purpose doctrine, that is, that public monies can only be used for public purposes. It is in the municipal bankruptcy context that these differences and the further balancing of state and federal sovereignty is perhaps most visible, in part because it was the subject of litigation since inception. Since the nineteenth century, the judicial system has made clear a fundamental distinction between public and private corporations; property held by municipalities for public purposes generally cannot be attached for the payment of municipal debts.104 Furthermore, even given broad constitutional authority, there are significant subject areas in which the federal government is without authority to act. The first municipal bankruptcy statute, adopted in 1934, was invalidated by the U.S. Supreme Court in the Ashton case, on grounds that it violated the Tenth Amendment.105 In response to Ashton, Congress tweaked the legislation’s contents and adopted a new municipal bankruptcy statute in 1937. The 1937 statute was upheld by the U.S. Supreme Court two years later in United States v. Bekins.106 The Bekins Court, quoting extensively from the House of Representatives Committee Report on the 1937 Act,107 blessed a framework that is still in existence today, affirming the primacy of a federal framework of adjustments in voluntary bankruptcy proceedings adopted by Congress not under Commerce Clause powers but under the Bankruptcy and Supremacy Clauses, which contain limitations designed to assure that the federal process does not unduly interfere with independent states’ rights and powers to legislate policy with respect to the making and enforcement of contracts.108
The structural differences between corporate and municipal bankruptcies are striking and reflective of constitutional rights and powers differences. Among the most fundamental in a current-day Chapter 9 case are the following: (1) only a debtor109 can initiate a Chapter 9 case and only can do so if there is authority at the state level; (2) no creditor can force a filing; (3) municipalities cannot be liquidated; (4) there is no bankruptcy estate in a Chapter 9 case; (5) there is an “insolvency” requirement that does not exist in other chapters of the Bankruptcy Code;110 (6) post-petition (after the filing of the bankruptcy petition), municipalities, not judges or creditors, control operations, decisions, finances, and restructuring plans (subject to applicable law); and (7) post-petition, with a few minor exceptions, there is no creditor access to general municipal assets and no ability to force creditor distributions.111 Three particular attributes warrant further discussion here.
First and most importantly, Chapter 9 is permissive (i.e., left to state law). As of 2012, twenty-seven states had granted some access channels (state law authorization for federal bankruptcy) for certain types of municipalities, and twenty-three states had not authorized access at all.112 In his Opinion Regarding Eligibility,113 relating to the City of Detroit bankruptcy, Judge Steven W. Rhodes sets forth a thorough analysis of the importance of this permissiveness to the conclusion that Chapter 9 does not violate the Tenth Amendment. He highlights that “[t]he federal government cannot and does not compel states to authorize municipalities to file for chapter 9 relief, and municipalities are not permitted to seek chapter 9 relief without specific state authorization.”114 Judge Rhodes distinguishes the holdings in New York v. United States115 and Printz v. United States,116 noting that state consent differentiates unconstitutional commandeering from federal programs where states voluntarily agree to legislate according to federal terms in exchange for federal benefits or forbearance. Through this consent, states have access to an impairment of contract remedy not otherwise available. Judge Rhodes quotes the Bekins Court, in part, as follows: “The State acts in aid, and not in derogation, of its sovereign powers. It invites the intervention of the bankruptcy power to save its agency which the State itself is powerless to rescue. Through its cooperation with the national government the needed relief is given.”117
Second, Section 903 of the Bankruptcy Code expressly provides that the Bankruptcy Code “does not limit or impair the power of a State to control, by legislation or otherwise, a municipality of or in such State in the exercise of the political or governmental powers of such municipality, including expenditures for such exercise . . . .”118 Legislative history on the scope of this provision is sparse, but, in the City of Stockton, California, and Detroit bankruptcies, the courts helped clarify, distinguishing state laws establishing pension protections, categorized in each case as contracts subject to impairment under the Supremacy Clause, from voting, taxing, and regulatory approval laws, categorized as sovereign powers, protected and preserved even within a Chapter 9 proceeding.119
Third, Section 904 of the Bankruptcy Code expressly provides that “the court may not, by any stay, order, or decree, in the case or otherwise, interfere with . . . any of the property or revenues of the debtor; or . . . the debtor’s use or enjoyment of any income-producing property.”120 In connection with the Puerto Rico PROMESA121 proceeding and treatment of its Highways and Transportation Authority, the First Circuit U.S. Court of Appeals issued an opinion,122 concluding that the Bankruptcy Code, in and of itself, does not mandate the application of pledged special revenues to debt during the pendency of a proceeding. In other words, the Bankruptcy Code (as incorporated into PROMESA), in and of itself, does not provide the mandated payment protection of “special revenue” bonds that many in the municipal bond market had presumed existed. Section 928 preserves the prepetition pledge lien but does not mandate bond payments. In light, perhaps, of the unique nature of Puerto Rico’s local Moratorium Act (normal local statutory payment obligations were not fully applicable thereunder), the question with respect to special revenue was whether Sections 922 and 928 (as incorporated into PROMESA) mandated, in and of themselves, application of special revenues during pendency. The decision, though initially contrary to the expectations of some regarding the protection of special revenue bonds, can be read as generally consistent with the deference of Chapter 9 to sovereignty principles and applicable local laws.
As a result of these constitutionally based principles and unlike in the corporate bankruptcy context, other than through its general ability to withhold plan confirmation, the federal system can do little to compel particular municipal behavior. Rather, the Bankruptcy Code, through the power of the Supremacy Clause, shares with local governmental units a federal power that states are prohibited under the Contracts Clause from giving local governmental units the power to impair contracts.123 The sovereign rights of our constitutional democracy instruct and inform this unique structure and balance.
D. Securities Law: The 1933 and 1934 Act Exemptions, Prior Crises, the Tower Amendment, and Evolution of the Current Regulatory Approach
In his magisterial The History of the Decline and Fall of the Roman Empire, Edward Gibbon describes Rome’s steady loss of hegemony in Europe, Africa, and Asia as stemming from a series of sieges and sacks on Rome by the Visigoths, the Vandals, and other uncivilized bands of invaders.124 The gradual regulation of the municipal securities market over the last century, too, can be said to be marked by a series of sieges on the largely unregulated market mounted in response to four crises in the market—namely, the New York City debt default125 of the 1970s, the Washington Public Power Supply System debt default126 of the 1980s, the Orange County debt default127 of the 1990s, and the Jefferson County debt default (and subsequent bankruptcy)128 of the 2000s. Four sieges but—thus far—no sack. What is the explanation for this? The explanation lies in the constitutional principles outlined above and the defense of the market mounted by stakeholders through a battlement known as the Tower Amendment.129 The size and diversity of the municipal market itself also account for its steadfastness against regulatory encroachment.
The importance of the Tower Amendment in the history of municipal securities market regulation is best understood in the context of the history of regulation of all U.S. securities markets. An avalanche of securities laws was enacted by the U.S. Congress in the 1930s after collapse of the U.S. stock market in 1929, including the Securities Act of 1933,130 the Securities Exchange Act of 1934,131 and the Trust Indenture Act of 1939.132 Municipal securities were exempt from the 1933 Act, and the legislative history does not contain an extensive debate on the exemption’s propriety. The December 1933 Yale Law Journal (Volume XLIII, No. 2) states simply, “Constitutional problems and political expediency may have dictated the exemption of securities issued by states and their political subdivisions and certain instrumentalities thereof.”133 This is consistent with the doctrine of reciprocal tax immunity which existed at the time. The 1933 Act House Report provides:
The line drawn . . . corresponds generally with the line drawn by the courts as to what obligations of States, their units and instrumentalities created by them are exempted from Federal taxation. By such a delineation, any constitutional difficulties that might arise with reference to the inclusion of State and municipal obligations are avoided.134
The 1975 amendments to the Securities Acts were drafted in response to the New York City financial crisis. Notwithstanding that crisis, the Senate committee report on the amendments provides that, apart from the anti-fraud provisions, municipal securities remain exempt from substantive requirements, “for the Committee is not aware of any abuses which would justify such a radical incursion on states’ prerogatives,” a clear reference to the underlying constitutional threads.137
The U.S. Congress has enacted other federal securities laws since the 1930s in response to perceived abuses (e.g., the Sarbanes-Oxley Act of 2002 was enacted in response to the Enron, Worldcom, and other corporate scandals,138 and the Dodd-Frank Act of 2010 was enacted in response to the 2007–2008 financial crisis139). Full and fair disclosure is the guiding principle of the federal securities laws; no assessment of meritworthiness of securities is made under the federal securities laws.140
Although securities issued by corporate issuers have been subjected to almost all federal securities laws since 1933,141 securities issued by the U.S. government have almost completely escaped regulation,142 and securities issued by state and local governments (that is, municipal securities) occupy a middle ground, as they generally are exempt from the registration requirements of the federal securities laws but are subject to the antifraud provisions of the federal securities laws.143
Although there may be debate over the extent to which issuers of municipal securities were covered by the federal securities laws prior to the mid-1970s,144 and although it enacted the Tower Amendment as part of the same legislative package, the U.S. Congress’s enactment of other provisions in the Securities Acts Amendments of 1975 in response to the New York City fiscal crisis clearly was a congressional incursion on the municipal securities market. Market observer Robert Doty explains the legislative bargain of the Securities Acts Amendments of 1975 in the following way:
In those Amendments, which among other things, created the Municipal Securities Rulemaking Board (MSRB), Congress enacted the Tower Amendment. The Tower Amendment prohibits the [U.S. Securities and Exchange Commission (SEC)] (and the MSRB) from requiring pre-sale filings of municipal bond offerings and imposes more stringent prohibitions on the MSRB.
At the same time, as a part of the bargain, Congress also amended the definition of “person” in Section 3(a)(9) of the Securities Exchange Act of 1934 to extend the definition to “a government or political subdivision thereof.” What may appear to have been a minor statutory change gave affirmative congressional authority—a green light—to the SEC for post-offering pursuit of state and local governmental entities and their officials not only for acts of fraud in violation of SEC Rule 10b-5, but also pursuant to Section 17(a)(2) and (3) of the Securities Act of 1933 for negligence.145
Doty goes on to say that “[i]n the absence of affirmative authority to regulate municipal securities issuers directly—through pre-offering review and pre-offering disclosure mandates or more than generalized guidance—the Commission is now, both in effect and in reality, “regulating” by enforcement—post-offering review.”146 In other words, a Congressional sacking of the municipal securities market (that is, grant of authority to the SEC to undertake pre-offering review and/or to promulgate pre-offering disclosure mandates) was averted only by furnishing the SEC’s Enforcement Division with legislative tools to lay siege to the market through post-offering enforcement proceedings.147 In 2007, in the aftermath of the SEC’s enforcement actions against the City of San Diego and Orange County in his native California, SEC Chairman Christopher Cox summarized the post-1975 regulatory environment of the municipal securities market in the following way:
So while the SEC has anti-fraud authority—allowing us to come in and clean up messes like these after the fact—neither we nor any other federal regulator has the authority in the municipal market that we have in the corporate securities market to insist on full disclosure of all material information to investors at the time the securities are being sold. . . . We’d all prefer a sign saying “Bridge Out Ahead” to an ambulance at the bottom of the canyon. Yet our current tools in the area of municipal offerings are more like the ambulance that arrives to pick up the pieces.148
Although the Tower Amendment limits the SEC’s authority to regulate municipal securities issuers directly, the Securities Acts Amendments of 1975 created the MSRB and granted new authority to the SEC that has been used to regulate brokers, dealers, and municipal securities dealers directly. As illustrated by the second and third sieges on the municipal securities market (that is, the SEC’s rulemaking in response to the Washington Public Power Supply System debt default of the 1980s and the Orange County debt default of the 1990s, respectively), the SEC also has used its authority under the 1975 Amendments to regulate municipal securities issuers indirectly.
In response to the Washington Public Power Supply System debt default, the SEC in 1989 promulgated the primary market disclosure rules of SEC Rule 15c2-12, which generally require brokers, dealers, and municipal securities dealers to obtain, review, and deliver to investors official statements in connection with primary offerings of municipal securities.149 In response to the Orange County debt default, the SEC in 1994 amended and expanded SEC Rule 15c2-12 to require brokers, dealers, and municipal securities dealers to ensure, in connection with primary offerings of municipal securities, that issuers and certain other obligated persons agree to make periodic financial and event filings first with the cumbersome and now obsolete Nationally Recognized Municipal Securities Information Repositories (NRMSIRs) and, since 2009, with the MSRB’s Electronic Municipal Market Access (EMMA) system.150
Congress got back into the business of laying siege to the municipal securities market with its enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. The act’s nearly 900 pages overhauled many aspects of the U.S. financial and securities markets in response to the financial crisis beginning in 2007,151 and, although numerous municipal securities market participants, including Jefferson County, Alabama,152 were players in this crisis, the Dodd-Frank Act effected few changes in the municipal securities market. The principal changes included (1) protection of municipal issuers through regulation of municipal advisors;153 (2) protection of municipal issuers participating in interest rate and other derivatives transactions;154 (3) modification of the composition of the MSRB’s board of directors;155 (4) expansion of the MSRB’s mission to include issuer protection;156 and (5) expansion of aider and abettor liability from an actual-knowledge standard to a recklessness standard.157
Although the Dodd-Frank Act did not effectuate a sack of the municipal securities market (that is, grant authority to the SEC to undertake pre-offering review and/or to promulgate pre-offering disclosure mandates), the act mandated studies of the market that may, ultimately, lead to an attempted sack.158 One of these studies, the U.S. Government Accountability Office (GAO) Municipal Securities: Options for Improving Continuing Disclosure,159 reported that one path for improvements would be to repeal the Tower Amendment and repeal the exemption of municipal securities from the registration requirements under the 1933 Act.160 This report ignores the constitutional principles outlined both in this article and by the Congressional Research Service.161 It also ignores the interrelationship between public and private securities enforcement162 and the fact that a true public finance parallel to corporate market enforcement could not be created legislatively due to the sovereign immunity of all states. On or about the date that the GAO released its study, the SEC released its Report on the Municipal Securities Market,163 in which the SEC outlined both legislative164 and regulatory165 proposals for overhauling the municipal securities market. Finally, in 2016, perhaps responding to the GAO study and the SEC report, legislation was introduced in the U.S. Congress that would overhaul the municipal securities market.166
The 2016 legislation received very little support in the U.S. Congress,167 but calls for legislative overhaul of the municipal securities market have, at times, gained widespread congressional support since the New York City debt default of the 1970s.168 Market stakeholders typically have been able to defeat these legislative efforts by demonstrating that, through voluntary efforts,169 market participants do a more than passable job policing themselves. But what if members of the U.S. Congress no longer believed market participants were capable of regulating themselves? What if a siege turned into a sack and the SEC was granted authority to undertake pre-offering review and/or to promulgate pre-offering disclosure mandates? Would the sack succeed in the face of a constitutionally mounted defense?
SEC Commissioner Elisse B. Walter addressed this constitutional question in 2009, remarking, “No one seriously questions anymore the Constitutional right of the federal government to regulate municipal issuers.”170 In light of recent U.S. Supreme Court jurisprudence on states’ rights, is Commissioner Walter correct? The answer to this question depends on the answer to two subsidiary questions. First, what is a “municipal issuer”? Second, what does Commissioner Walter mean by the term “regulate”?
On the question of what constitutes a municipal issuer, interpreting Eleventh Amendment sovereign immunity principles, the courts generally have distinguished between states and their departments and agencies on the one hand and states’ political subdivisions (for example, cities and counties) on the other hand. Courts have concluded that, in the federal courts, the former enjoy Eleventh Amendment sovereign immunity and the latter do not.171 However, even with respect to states, the courts generally have found that, although states are not subject to suit by private litigants in the federal courts, they are subject to administrative and enforcement actions brought by the SEC in the federal courts.172 Hence, both states and their political subdivisions should be viewed as municipal issuers.
On the question of what constitutes regulation, the courts generally have found that the SEC has the authority to regulate municipal issuers (both states and their political subdivisions) through post-offering review of their actions and inactions (that is, through administrative and enforcement actions brought by the SEC).173 However it is unclear, whether, by rule or legislation, the SEC could regulate municipal issuers through pre-offering review and/or promulgation of pre-offering disclosure mandates.
Inclusion of the Tower Amendment provisions in the 1975 amendments to the Securities Acts was premised, in part, on Congress’s policy determination that there were no widespread abuses in the municipal securities market that necessitated a radical departure from the historical approach to regulating the market.174 But that is not the full story. There is evidence that Congress also expressed concerns about limits on its power to regulate municipal issuers through pre-offering review and/or promulgation of pre-offering disclosure mandates.175 These limits are most likely embodied in the U.S. Supreme Court’s Tenth Amendment anti-commandeering caselaw.
In the most recent of these cases, the Supreme Court explained the anti-commandeering principle in the following way:
The legislative powers granted to Congress are sizable, but they are not unlimited. The Constitution confers on Congress not plenary legislative power but only certain enumerated powers. Therefore, all other legislative power is reserved for the States, as the Tenth Amendment confirms. And conspicuously absent from the list of powers given to Congress is the power to issue direct orders to the governments of the States. The anticommandeering doctrine simply represents the recognition of this limit on congressional authority.176
The Court went on to explain that adherence to the anti-commandeering principle is important for the following three reasons: (1) it serves to protect liberty by creating a healthy balance of power between the states and the federal government that reduces the risk of tyranny and abuse from either front; (2) it promotes political accountability; and (3) it prevents Congress from shifting the costs of regulation to the states.177
In another of these anti-commandeering cases involving the Brady Handgun Violence Prevention Act, the Supreme Court amplified the political accountability and cost-shifting point when it noted:
By forcing state governments to absorb the financial burden of implementing a federal regulatory program, Members of Congress can take credit for ‘solving’ problems without having to ask their constituents to pay for the solutions with higher federal taxes. And even when the States are not forced to absorb the costs of implementing a federal program, they are still put in the position of taking the blame for its burdensomeness and for its defects. . . . Under the present law, for example, it will be [the county sheriff involved in the litigation] and not some federal official who stands between the gun purchaser and immediate possession of his gun. And it will likely be [the sheriff], not some federal official, who will be blamed for any error (even one in the designated federal database) that causes a purchaser to be mistakenly rejected.178
Based on these arguments, the Court held that “[t]he Federal Government may neither issue directives requiring the States to address particular problems, nor command the States’ officers, or those of their political subdivisions, to administer or enforce a federal regulatory program.”179
Given the logic of the anti-commandeering cases, federal legislation granting authority to the SEC to undertake pre-offering review and/or to promulgate pre-offering disclosure mandates without concomitant federal funding could well face constitutional scrutiny. It would force state governments and their political subdivisions to absorb the financial burden of implementing a federal regulatory program and would command the states’ officers, or those of their political subdivisions, to administer or enforce a federal regulatory program. Such legislation could also be subject to scrutiny under principles of state sovereign immunity, in light of issues regarding private rights of action.
There is an understandable logic in the desire to have components of the capital securities markets regulated similarly. When it comes to the municipal and corporate securities markets, however, that logic fails when countered with a nuanced understanding of the unique constitutional underpinnings of the municipal securities market. The call for further regulation of the municipal market is not grounded in market realities. Rather, it is largely a symmetrical solution in search of a problem.
E. Tax Law: Imposition of a Federal Income Tax, Reciprocal Immunity, South Carolina v. Baker and Evolution of the Current Approach
The United States Constitution, as originally adopted (including the Bill of Rights), barely addresses taxes that may be imposed by the national government. Congress is given the power to lay and collect taxes, duties, imposes, and excises to pay debts and provide for the common defense and general welfare of the country,180 and “direct taxes”181 must be apportioned among the several states according to their respective numbers (e.g., population).182 By contrast, the states’ reserved powers, including taxation, were recognized in the Tenth Amendment.183
The limits of the state’s authority to impose taxes was at issue in the 1819 Supreme Court case McCulloch v. Maryland.184 In that case, Chief Justice John Marshall held that the State of Maryland could not impose taxes on a congressionally chartered bank (the Second Bank of the United States) because the “power to tax involves, necessarily, a power to destroy.”185 Marshall stated that the creation of the bank was an appropriate and legitimate exercise of power by Congress pursuant to Article I, Section 8, of the Constitution and that, although the states retained the power of taxation, the Constitution and the laws made in pursuance thereof are supreme and cannot be controlled by the states. And so, the Supreme Court recognized the doctrine of mutual or reciprocal immunity.186
Although the doctrine of immunity recognized by McCulloch only applies to immunity of the federal government and was designed to prevent the states from destroying the federal government through taxation, it quickly led to an understanding of the mutual doctrine of immunity. In Collector v. Day,187 the Court held that the taxing power of the national government could not be used to interfere with the essential workings of state governments and stated that a tax created by Congress on incomes of over $1,000 could not be imposed on a state judge in Massachusetts because it constituted a burden on an instrumentality of the state government.
As described earlier in this article, municipal bonds have been issued since the early 1800s, and the tax exemption for interest on municipal bonds predates the first Internal Revenue Code in 1913. The question of whether the federal government should tax interest on municipal bonds was first raised following the passage of the Wilson-Gorman Tariff Act of 1894, which imposed the first general income tax, including on interest income from state and local bonds. It has been argued188 that the doctrine of mutual immunity was a basis for the decision in Pollock v. Farmers’ Loan & Trust Co., in which the Supreme Court held that the 1894 federal income tax was invalid as applied to income derived from municipal bonds. In fact, a close reading of Pollock suggests that the problem was that these taxes were a direct taxation scheme—taxes imposed upon persons and not property—and not properly apportioned among the states as required by Article I, Section 2.189
Nonetheless, Pollock created a problem for proponents of a federal income tax—if incomes taxes were required to be apportioned based upon population, one could readily imagine that the tax rate paid by persons in states with higher per capita incomes would be less than the tax rate paid by persons in states with lower incomes and that national taxes would be perceived as being unfairly imposed. Accordingly, in 1913 the Sixteenth Amendment was proposed and adopted. The Sixteenth Amendment states that “[t]he Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”190
It was noted by several state governors at the time the Sixteenth Amendment was proposed that the language “from whatever source derived” might allow the federal government to impose taxes on income derived from municipal bonds, with some arguing that, if the language could be so interpreted, the amendment should be defeated.191 The language “without apportionment among the several States” would have been sufficient to overrule Pollock. Still, the Sixteenth Amendment was adopted with the language “from whatever source derived,” and there have been arguments since then as to whether the Sixteenth Amendment would override the concept of mutual immunity.192 It is interesting to note that there was a proposal, commented on by Andrew Mellon, Secretary of the Treasury, to amend the Constitution to specifically permit Congress to tax municipal bonds, which was adopted by the House but defeated in the Senate in 1924.193
Over the next several decades, the doctrine of mutual immunity took a number of hits in the courts. Some of the decisions rested upon the taxed activity’s remoteness from essential state or local governmental services, while other decisions focused on the relative burden imposed on the state or local government as a result of the tax. In South Carolina v. United States, the Supreme Court held that a federal liquor license tax could be imposed on a liquor dispensary system conducted by the State of South Carolina, apparently because the operation of package liquor stores was not an ordinary function of government.194 In Metcalf & Eddy v. Mitchell, the Court held that the salary of an engineer employed by a state is subject to federal income taxation.195 There, the Court noted that the taxing power of either a state or the federal government, when exercised in an admittedly necessary and proper manner, unavoidably has some economic effect upon the other. The Court concluded that the burden imposed upon the state was remote and could be ignored. Other cases drastically limited the immunity of states from federal taxation.196 In Helvering v. Gerhardt, the Court, when discussing taxation of New York Port Authority employee salaries, said that it should be left to Congress to delineate the scope of a state’s immunity from federal taxation and that any implied immunity from federal taxation should be narrowly limited.197 Finally, in New York v. United States, the Court ruled that the State of New York was not immune from taxes imposed by Congress upon mineral waters.198
As stated earlier, the Internal Revenue Code of 1913 provided a specific exemption from taxation of interest on state and local government bonds.199 This exemption was carried through to the Internal Revenue Code of 1954 with little or no restrictions on the extent of the exemption. In the late 1960s, the section was amended to prevent states from borrowing funds at a lower tax-exempt interest rate for the purpose of (a) investing the proceeds at a higher taxable investment rate (“tax arbitrage”) or (b) making loans for private business use (“industrial development bonds” or, later, “private activity bonds”), in each case with a slew of exceptions and special rules. However, these restrictions did not give rise to general concerns about the exempt status of municipal debt.
In 1982, however, the Internal Revenue Code of 1954 was amended by the Tax Equity and Fiscal Responsibility Act (TEFRA) 200 to, among other things, restrict the use of so-called “bearer bonds” in an effort to combat income-tax evasion and money laundering. Prior to TEFRA, corporate and government debt could be issued in “bearer” form, meaning that whoever possessed the bond was the owner and thus entitled to payment, and no record of ownership or transfer of ownership was required to be maintained. TEFRA restricted the ability of corporate debt issuers to deduct interest payments on bearer debt obligations and also imposed an excise tax on the unregistered obligation.201 With regard to municipal bonds, TEFRA required that in order for interest on a municipal bond to be exempt, it must be issued in registered form.202 The imposition of this seemingly minor restriction led to a challenge by the State of South Carolina and provided the opportunity for the Court to finally and directly address the ability of the federal government to tax interest derived from municipal bonds.
In South Carolina v. Baker, South Carolina brought suit against the federal government, claiming that the federal government did not have the power to tax interest on unregistered bearer bonds issued under TEFRA.203 The state argued that its ability to issue tax-free bonds was guaranteed by Pollock. In a seven to one decision, the Court found that its decisions since Pollock had weakened Pollock, that Pollock should be explicitly overruled, and that state bond interest is not immune from a nondiscriminatory federal tax. The Court noted that TEFRA imposed no direct tax upon the states, but rather upon the bondholders, and that the tax was nondiscriminatory because the restrictions on unregistered bearer bonds were imposed upon private corporations and the federal government, as well as state governments.
Four attributes of the South Carolina v. Baker case are worthy of note and dissection: (1) the factual issue at hand; (2) the two distinct holdings; (3) the different perspectives of the justices comprising the majority; and (4) how the holdings fit in the constantly evolving fabric of constitutional law.
- The South Carolina v. Baker decision includes the broad finding that a nondiscriminatory tax on the interest earned on state bonds does not violate the intergovernmental tax immunity doctrine.204 At issue before the Court, however, was only the taxation of the interest on municipal bonds issued as unregistered bearer instruments. The Court noted that the TEFRA registration requirement was intended to address income tax evasion concerns posed by unregistered bearer bonds and that the requirement encompassed debt obligations issued by the United States, states, and private corporations. The TEFRA provision was non-discriminatory and affected all unregistered debt obligations, not just municipal bonds.205
- The South Carolina v. Baker decision has two separate holdings. The first is that the TEFRA registration requirement does not violate the Tenth Amendment by effectively compelling states to issue bonds in registered form.206 The second holding is that taxing interest on unregistered state bonds does not violate the doctrine of intergovernmental tax immunity.207
- The South Carolina v. Baker decision was 7–1, with the four-justice majority decision written by Justice Brennan, coupled with partial concurrences by Justices Scalia and Rehnquist whose perspectives were different. In his concurrence, Chief Justice Rehnquist observed that the conclusion that the TEFRA registration would have a de minimis impact on the states “should end, rather than begin, the Court’s constitutional inquiry” and that “the Court unnecessarily casts doubt on the protective scope of the Tenth Amendment.”208 In his concurrence, Justice Stevens observes that “neither the Court’s decision today nor what I have written in the past expresses any opinion about the wisdom of taxing the interest on bonds issued by state or local governments.”209
- The South Carolina v. Baker decision was issued just three years after the Court in Garcia overruled National League of Cities. The Court cites Garcia as holding that Tenth Amendment limits on congressional powers are structural and that states must find their protection through the national political process,210 a holding that Justice Scalia did not read in Garcia. Fast-forward a decade and, regardless of its then-implied scope, the Court’s decisions in New York211 and Printz212 walk Garcia back, establishing clear anti-commandeering limitations on Commerce Clause powers. Fast-forward to 2018, and the Court further flushes out the anti-commandeering standards in Murphy v. NCAA.213
It is clear the doctrine of full reciprocal tax immunity did not survive South Carolina v. Baker intact. What was historically viewed by some as a constitutionally protected municipal bond tax exemption became, at some level, merely a statutorily protected one. South Carolina v. Baker did not, however, change the fundamental structure of dual sovereignty in this country. In her dissent, Justice O’Connor, stated:
The Court never expressly considers whether federal taxation of state and local bond interest violates the Constitution. Instead, the majority characterizes the federal tax exemption for state and local bond interest as an aspect of intergovernmental tax immunity, and it describes the decline of the intergovernmental tax immunity doctrine in this century. But constitutional principles do not depend upon the rise or fall of particular legal doctrines. This Court has a continuing responsibility “to oversee the Federal Government’s compliance with its duty to respect the legitimate interests of the states.” Garcia, supra, at 469 U.S. 581 (O’CONNOR, J., joined by Powell and REHNQUIST, JJ., dissenting).214
So, after South Carolina v. Baker, does anything remain of a constitutionally implied exemption for interest on municipal bonds from federal taxation? The immediate consequence of South Carolina v. Baker was confirmation of the federal requirement that only registered municipal bonds would have the benefit of tax exemption. Would the Court’s decision have been the same if the question presented was full federal taxation of interest on all municipal bonds, thus leaving states and local governments unable to finance essential governmental improvements without diverting additional resources away from other governmental services to pay the increased interest costs? Does the “power to tax” really provide the unfettered “power to destroy” when applied in the dual sovereignty context? Would the current Supreme Court, with some members ostensibly following the lead of Justices Scalia, Rehnquist, and Stephens, resuscitate the implied exemption and draw a line against the full elimination of the federal income tax exemption for all municipal bonds?
It can be argued that the Sixteenth Amendment was not intended to specifically allow taxation of municipal bond interest given the speeches and writings at the time of its adoption and at the time of the proposed amendment specifically allowing Congress to tax municipal interest.215 Nevertheless, the Sixteenth Amendment’s language and its interpretations in the courts are mostly clear that in general terms, the Amendment means what its text says—that Congress may tax income “from whatever source derived.”
IV. Where Does the Municipal Market Go From Here?
As outlined in this article, the structure and regulation of the U.S. subsovereign debt market is largely the result of the power-sharing dual sovereignty envisioned by the framers of the U.S. Constitution. The deliberate tension inherent in this latticework generally creates a strong, counter-balanced governmental system, and its related subsidiarity generally creates efficient, effective, and locally endorsed taxing and spending decisions. Constitutional federalism protects this structure. Administrative federalism, the consideration of state input by federal agencies,216 informally reinforces the strength that is built when state and national powers are deployed collaboratively.
The municipal bond market is strong,217 but future demands on the market will arise from the need to make substantial investments in public infrastructure218 to providing flexible funding for cash flow needs. Given the significant need for capital, structural and regulatory expansion of the market’s financing mechanisms to address this need should be tailored to promote economic efficiency, market capacity, and reliable legal enforceability. A learned student of American history will understand that these ends are dependent on the combined, coordinated efforts of federal, state, and local governments.
Accordingly, any legislation or regulation to further shape municipal markets necessarily involves a nuanced analysis of dual sovereignty and a focus on the valuable benefits of encouraging core municipal bond market strengths. In Preserving the Federal-State-Local Partnership: The Role of Tax-Exempt Financing, an October 1989 report to Congressman Beryl F. Anthony, Jr. by the Anthony Commission on Public Finance, the Commission noted:
The Anthony Commission believes the federal government should establish a policy to work with state and local governments in a partnership to provide public services. The federal government must recognize that its judicially unfettered power to control the tax exemption of state and local government bonds must be exercised with the full recognition of the impact on state and local taxpayers as well as on the federal Treasury. State and local governments cannot fulfil their responsibilities to provide public services and meet federal standards and mandates without the cooperation of the Congress and the Administration. Specifically, the federal government should preserve tax exemption so that public services and projects can be provided at the lowest possible cost.219
Homogenous corporatization of public finance is neither viable220 nor optimal. After all, when states and municipal governments are able to effectively access an efficient municipal finance market and issue debt at an attractive cost, they are able to finance more infrastructure and programs than they could otherwise, relieving a burden on the United States government. In addition, it continues to allow the states to determine how best to operate and where best to apply the subsidy received from tax-exemption and registration exemption, to continue to operate as the laboratories of self-government across the nation.
1. In 2020, the U.S. municipal bond market had approximately $4.0 trillion of bonds outstanding and average daily trading of approximately $12 billion. SIFMA 2021 Capital Markets Fact Book (2021).
2. For purposes of this article, we use the U.S. Census Bureau’s government categorizations: states, general purpose governments, and special purpose governments, the latter being established to fulfill only a limited number of purposes. U.S. Census Bureau, Government Finance and Employment Classification Manual 1-1 (2006). Similarly, to avoid using terms like “political subdivision,” which have different meanings in different contexts, we sometimes use the term “municipal entity” to distinguish governmental units from private business corporations, even though the term is intended to include all forms of state and local government entities.
3. The first American municipalities arose in the colonies largely as an outgrowth of early settler history. The Mayflower Compact of 1620, signed by the Pilgrims and settlers before even reaching North American shores, established a set of rules based on the principle of self-governance. This notion of self-determination, and construction of a constitution as a compact among the people, is a cornerstone of the current governmental system. As the colonies evolved, all thirteen colonies began to formalize the structure for general purpose governments, generally following Virginia’s lead and adopting the English system of counties (now called parishes in Louisiana and boroughs in Alaska). Establishment of general purpose township governments was less uniform. Following the end of the Revolutionary War and the signature of the Treaty of Paris, the young country struggled to plan for westward expansion through a series of land ordinances that ultimately became the Northwest Ordinance of 1787. Those ordinances established 6x6 square mile survey townships, which later served as the basis for many civil townships. Each township was divided into thirty-six sections with a sixteen-section center area generally reserved for school purposes to facilitate public education and make schools easily accessible on horseback to all township residents. Particularly in the Midwest, this system remains largely intact today. For more information, see, for example, Creating the United States: Road to the Constitution, Libr. of Cong., https://www.loc.gov/exhibits/creating-the-united-states/road-to-the-constitution.html (last visited Jan. 2, 2023) and Foundations of American Government, Indep. Hall Ass’n, https://www.ushistory.org/gov/2.asp (last visited Jan. 2, 2023).
4. The Declaration of Independence para. 32 (U.S. 1776) (declaring, interestingly, the independence not of the “United States of America” as a national entity but rather as “Independent States” with the right to, among other things, “levy War, conclude Peace, contract Alliances, establish Commerce, and to do all other Acts and Things which Independent States may of right do”).
5. Thomas M. Cooley, A Treatise on the Constitutional Limitations Which Rest upon the Legislative Power of the States of the American Union (1903). It is an interesting historical note that Rhode Island and Connecticut each operated, initially and well into the 1800s, without a formal state constitution, relying instead on an English Royal Charter document and the “Fundamental Orders of Connecticut,” respectively, to inform their republican forms of government. Additionally, the tax and debt limits of many current state constitutions are the result of the evolution of public policy and were not components of the initial versions of these documents.
6. Additionally, in a unitary system, the national government is sovereign, and states and other subsovereigns possess only delegated powers.
7. See, e.g., Foundations of American Government, supra note 3.
8. Alfred H. Kelly & Winfred A. Harbison, The American Constitution: Its Origins and Development 76–81 (1991).
9. Articles of Confederation art. III (1781).
10. The period before, during, and after the Constitutional Convention was filled with public and private debate, with competing views espoused, most notably, by Alexander Hamilton, a committed Nationalist, and James Madison, a committed Federalist, coming together to publish a compilation of essays supporting the final U.S. Constitution, entitled The Federalist: A Collection of Essays Written in Favour of the New Constitution, As Agreed upon by the Federal Convention September 17, 1787 (1788) (commonly referred to as the Federalist Papers).
11. Unlike the unitary system, states in the American federal system are not administrative units with delegated powers but independent polities with independent powers.
12. See, e.g., Eugene Boyd & Michael K. Fauntroy, Cong. Rsch. Serv., RL30772, American Federalism, 1776 to 2000: Significant Events (2000).
13. See, e.g., Paul E. Peterson, The Changing Politics of Federalism, in Evolving Federalisms: The Intergovernmental Balance of Power in America and Europe 25–42 (Craig Parsons & Alasdair Roberts eds., 2003).
14. See Boyd & Fauntroy, supra note 12.
15. See, e.g., Miriam Seifert, States, Agencies, and Legitimacy, 67 Vand. L. Rev. 443, 443–59 (2014); David S. Rubenstein, Administrative Federalism as Separation of Powers, 72 Wash. & Lee L. Rev. 171, 171–255 (2015). The concept of subsidiarity provides a theoretical foundation for why it is important for the federal government to rely on states to achieve its goals. See generally Jerome M. Organ, Subsidiarity and Solidarity: Lenses for Assessing the Appropriate Locus for Environmental Regulation and Enforcement, 5 U. St. Thomas L.J. 262, 264 (2008) (“The principle of subsidiarity posits that the common good is best served when decision-making regarding actions and activities is delegated to the local entity—to the smallest organization—best able to make the decision.”); George A. Bermann, Taking Subsidiarity Seriously: Federalism in the European Community and the United States, 94 Colum. L. Rev. 331, 339–41 (1994) (explaining that subsidiarity expresses a preference for governance at the most local level consistent with achieving a government’s stated purposes based on the values of self-determination and accountability, political liberty, flexibility, preservation of identities, diversity, and respect for internal divisions of component states). One scholar further explains subsidiarity in the following way:
According to the philosopher John Finnis, the principle of subsidiarity has its source in the fact that “[h]uman good requires not only that one receive and experience benefits or desirable states; it requires that one do certain things, that one should act, with integrity and authenticity; if one can obtain the desirable objects and experiences through one’s own action, so much the better.” Because of the danger that the political order or intermediary associations may stifle individual self-constitution, the principle
. . . affirms that the proper function of association is to help the participants in the association to help themselves or, more precisely, to constitute themselves through the individual initiatives of choosing commitments (including commitments to friendship and other forms of association) and of realizing these commitments through personal inventiveness and effort in projects (many of which will, of course, be co-operative in execution and even communal in purpose).
Subsidiarity informs not only the relationship between an individual and an association of which he may be a member. In the context of multiple layers of larger and smaller associations, the subsidiarity principle, as stated by John Paul II in the encyclical Centesimus annus, requires that “a community of a higher order should not interfere in the internal life of a community of a lower order, depriving the latter of its functions, but rather should support it in case of need and help to co-ordinate its activity with the activities of the rest of society, always with a view to the common good.” Accordingly, “neither the state nor any larger society should substitute itself for the initiative and responsibility of individuals and intermediary bodies.”
Peter Widulski, Bakke, Grutter, and the Principle of Subsidiarity, 32 Hastings Const. L.Q. 847, 854–55 (2005) (citations omitted). The concept of subsidiarity provides not only a theoretical foundation for coordination of relations between the federal government and the states but also a theoretical framework for coordination of relations between the states and their local units of government.
16. U.S. Const. amend X. It should be noted that “police” in eighteenth century vernacular did not just mean law enforcement but rather is derived from the Latin polita, meaning civil administration. For more historical and etymological information, see Santiago Legarre, The Historical Background of the Police Power, 9 U. Pa. J. Const. L. 745 (2007).
17. See Boyd & Fauntroy, supra note 12.
18. Chisolm v. Georgia, 2 U.S. 419 (1793).
19. See Cong. Rsch. Serv., The Constitution of the United States of America; Analysis and Interpretation (cent. ed.) (2017).
20. See id.; Boyd & Fauntroy, supra note 12.
21. Alfred H. Kelly, Winfred A. Harbison, & Herman Belz, The American Constitution: Its Origins and Development 125 (7th ed. 1991).
22. It is interesting to note that Alexander Hamilton established the first national bank, which served as the vehicle to assume state debts. Following his election, in 1833 President Andrew Jackson caused all federal funds to be withdrawn from the national bank, and its federal charter expired in 1836. National banks did not exist again in any meaningful fashion until the New Deal. The transfer of deposits to state banks enabled credit-funded land and infrastructure speculation, fueling inflation, which ultimately led to the Panic of 1837. The demise of a national bank also necessitated the development of public debt markets at the state and local government level. By 1843, cities had $25 million in bonds outstanding, and the municipal securities market had emerged in a fashion that is still recognizable today.
23. Hans v. Louisiana, 134 U.S. 1, 14–15 (1890). It should be remembered that this immunity does not apply at the local government level. See Lincoln County v. Luning, 133 U.S. 529 (1890), for the correlative decision with respect to municipal bond repudiation. Per the Supreme Court, “The eleventh amendment limits the jurisdiction only as to suits against a state.” Id. at 530.. For an interesting essay on state debt crises as potential drivers of sovereign immunity law, see Ernest A. Young, Its Hour Come Round at Last? State Sovereign Immunity and the Great State Debt Crisis of the Early Twenty-First Century, 35 Harv. J.L. & Pub. Pol. 593, 593–622 (2012).
24. Seminole Tribe of Fla. v. Florida, 517 U.S. 44 (1996).
25. Alden v. Maine, 527 U.S. 706 (1999).
26. Id. at 758.
When Congress legislates in matters affecting the States, it may not treat these sovereign entities as mere prefectures or corporations. Congress must accord States the esteem due to them as joint participants in a federal system, one beginning with the premise of sovereignty in both the central Government and the separate States. Congress has ample means to ensure compliance with valid federal laws, but it must respect the sovereignty of the States.
27. U.S. Const. art. IV.
28. One example is the Nebraska Territory, which became Kansas, Nebraska, Montana, and the Dakotas.
29. Maine separated from Massachusetts in 1820, and West Virginia was separated from Virginia at the beginning of the Civil War.
30. The Republic of Texas and the Vermont Republic. For more information on the history of state and state constitutional development, see Randy J. Holland, Stephen R. McAllister, Jeffrey M. Shaman, & Jeffrey S. Sutton, State Constitutional Law: The Modern Experience (2010).
31. Peverill Squire, The Evolution of American Legislatures: Colonies, Territories, and States, 1619–2009, at 1–10 (Janet M. Box-Steffensmeier & David Canon eds., 2012).
32. Louisiana, for example, which the U.S. purchased from France in 1803, fashioned its state laws after the civil law system used by European countries and colonies not founded under British law, hence these laws are not based upon English Common Law. See, e.g., Holland et al., supra note 30.
33. See discussion infra Section II.B.
34. For a good discussion on the fundamental differences between business corporations, states, and general purpose governments in the area of finance, see Robert A. Fippinger, The Securities Law of Public Finance ch. 1 (3d ed. 2011) (updated Nov. 2020); see also Gov. Acct. Stds. Bd., Concepts Statement No. 1 Objectives of Financial Reporting (1987), https://gasb.org/page/PageContent?pageId=/standards-guidance/pronouncements/summary-of-concepts-statement-no-1.html&isStaticPage=true; Gov. Acct. Stds. Bd., Why Governmental Accounting and Financial Reporting Is—And Should Be—Different (2017), https://www.gasb.org/page/PageContent?pageId=/reference-library/whitepaper.html&isPrintView=true.
35. In A.L.A. Schechter Poultry Corp. v. United States, the Supreme Court stated that “Congress is not permitted to abdicate or to transfer to others the essential legislative functions with which it is thus vested.” A.L.A. Schechter Poultry Corp. v. United States, 295 U.S. 495, 529 (1935). Particularly when it comes to state and local governmental powers constituting the residual sovereignty retained under the Tenth Amendment, a large body of state-level, private non-delegation doctrine law prohibits or significantly restricts the delegation of these powers to private parties, especially legislative, taxation, police (in the broad original constitutional sense of the word), and eminent domain powers not based in contract or real property rights. See James M. Rice, The Private Nondelegation Doctrine: Preventing the Delegation of Regulatory Authority to Private Parties and International Organizations, 105 Calif. L. Rev 540, 539–72 (2017). The impact of this limit in the municipal securities market is sometimes self-evident and sometimes more obtuse. For instance, market participants cannot short positions in the municipal securities market like the corporate securities market, as tax exemption is not an assignable contract right. It is an attribute of essential sovereignty. See, e.g., Securities Exchange Act Release No. 33743 (Mar. 9, 1994), 59 Fed. Reg. 12767, 12769 n.24 (Mar. 17,1994) (citing I.R.C. § 6045(d)).
36. U.S. Term Limits, Inc. v. Thornton, 514 U.S. 779, 838 (1995).
37. See, e.g., Steven G. Calabresi & Nicholas K. Terrell, The Number of States and the Economics of American Federalism (Nw. Univ. Sch. of Law Faculty Working Paper No. 187, 2009), https://scholarlycommons.law.northwestern.edu/cgi/viewcontent.cgi?article=1186&context=facultyworkingpapers.
38. State sovereign immunity is a pre-ratification attribute of sovereignty, described by the U.S. Supreme Court as extending “to everything which exists by its own authority, or is introduced by its permission . . . .” McCulloch v. Maryland, 17 U.S. 316, 429 (1819). It is a doctrine of English law originating in medieval theories that the “king could do no wrong.” The rights of American colonies were first derived from the authority of the British king. When the king’s authority was extinguished with the Revolution, the new states rose to the level of sovereigns. The essential attributes of sovereignty, separate and distinct from the Constitution, were recognized by Justice Holmes in Kawanakoa v. Polyblank. Kawanakoa v. Polyblank, 205 U.S. 349, 353–54 (1907). “[T]he rights that exist are not created by Congress or the Constitution, except to the extent of certain limitations of power.” Id.; see also Alden v. Maine, 527 U.S. 706 (1999). For a more robust discussion of these nuanced principles, see Fippinger, supra note 34, § 16:1 et seq.
39. For an interesting discussion of application of the principles of comity to federal-state relations, see Gil Seinfeld, Reflections on Comity in the Law of American Federalism, 90 Notre Dame L. Rev. 1309, 1309–43 (2015).
40. Marbury v. Madison, 5 U.S. 1, 163 (1803) (quoting 3 William Blackstone, Commentaries *23).
41. U.S. Const. art. I, § 8.
42. Id. art. I, § 8, cl. 3.
43. Id. art. I, § 10, cl. 1.
44. Id. amend. XIV, § 1, cl. 2.
45. Id. amend XIV, § 1, cl. 5.
46. Id. amend XIV, § 1, cl. 2.
47. Id. art. VI, cl. 2.
48. Id. amend. V.
49. Id. amend. X.
50. Id. amend XI.
51. For an excellent description of the history and scope of the sovereign immunity defense as applicable to public finance, see Fippinger, note 34, § 16:1 et seq.
52. N.L.R.B. v. Jones, 301 U.S. 1 (1937); see also United States v. Darby, 312 U.S. 100 (1941).
53. Nat’l League of Cities v. Usery, 426 U.S. 833 (1976).
54. Garcia v. San Antonio Metro. Transit Auth., 469 U.S. 528 (1985).
55. New York v. United States, 505 U.S. 144, 175 (1992).
56. Printz v. United States, 521 U.S. 898, 944–45 (1997).
57. Murphy v. Nat’l Collegiate Athletic Ass’n, 138 S. Ct. 1461 (2018).
58. Id. at 1475.
59. See, e.g., Cent. Va. Cmty. Coll. v. Katz, 546 U.S. 356 (2006).
60. See, e.g., Fitzpatrick v. Bitzer, 427 U.S. 445 (1976).
61. See, e.g., Miles McCann, State Sovereign Immunity, Nat’l Ass’n of Att’ys Gen. (Nov. 11, 2017), https://www.naag.org/attorney-general-journal/state-sovereign-immunity.
62. Chapter 16 of Fippinger, supra note 34, is entitled “The Sovereign Immunity Defense.” A portion, § 16:2:2, has a thorough and thoughtful analysis of abrogation powers, before and after 1996, under the Commerce Clause, together with a discussion of abrogation powers, by contrast, under the Bankruptcy Clause and under section 5 of the Fourteenth Amendment. The reader is encouraged to review these materials, which are not repeated here.
63. Hans v. Louisiana, 134 U.S. 1 (1890).
64. Seminole Tribe of Fla. v. Florida, 517 U.S. 44 (1996).
65. Alden v. Maine, 527 U.S. 706 (1999).
66. Id. at 712.
67. Allen v. Cooper, 140 S. Ct. 994 (2020).
68. Jon D. Russell & Aaron Bostrom, Federalism, Dillon Rule and Home Rule (Jan. 2016), https://alec.org/wp-content/uploads/2016/01/2016-ACCE-White-Paper-Dillon-House-Rule-Final.pdf.
69. Atkins v. Kansas, 191 U.S. 207, 220 (1903).
70. City of Clinton v. Cedar Rapids & Mo. R.R. Co., 24 Iowa 455 (1868).
72. Russell & Bostrom, supra note 68, at 2 (referencing 1 John F. Dillon, Commentaries on the Law of Municipal Corporations 173 (2d ed. 1873)).
74. People ex rel. Leroy v. Hurlburt, 24 Mich. 44, 93–113 (1871).
76. Russell & Bostrom, supra note 68, at 6.
78. City of Boca Raton v. State, 595 So. 2d 25, 27 (Fla. 1992).
79. Russell & Bostrom, supra note 68, at 8.
80. See, e.g., Nat’l Ass’n of Bond Laws., General Obligation Bonds: State Law, Bankruptcy and Disclosure Considerations (2014), https://www.nabl.org/wp-content/uploads/2023/02/20140831-NABL-Report-on-General-Obligation-Bond-Considerations.pdf.
81. See, e.g., Nat’l Ass’n of Bond Laws., Municipal Bankruptcy: A Guide for Public Finance Attorneys (3d ed. 2015), https://www.nabl.org/wp-content/uploads/2023/02/20150827-NABL-Primer-on-Municipal-Bankruptcy_3rd-Edition.pdf.
82. See, e.g., P3 Infrastructure Delivery: Principles for State Legislatures, Nat’l Conf. of State Legislatures (July 2017), https://www.ncsl.org/Portals/1/HTML_LargeReports/P3_Infrastructure_1.htm.
83. See, e.g., Nat’l Ass’n of Bond Laws., Direct Purchases of State or Local Obligations by Commercial Banks and Other Financial Institutions (2017), https://www.nabl.org/wp-content/uploads/2023/02/20170720-NABL-Direct-Purchase-Report.pdf.
84. Robert A. Stein, Forming A More Perfect Union: A History of the Uniform Laws Commission (2013), https://higherlogicdownload.s3.amazonaws.com/UNIFORMLAWS/b7c515db-1895-4387-bb2d-ee99e58c0066/UploadedFiles/z2VTbVJSwqAhFymN7LnQ_Forming%20a%20More%20Perfect%20Union.pdf.
87. 2020–2021 Guide to Uniform and Model Acts, Unif. L. Comm’n (2022), https://www.uniformlaws.org/HigherLogic/System/DownloadDocumentFile.ashx?DocumentFileKey=a3443fdb-39c0-dd91-b9b9-ef7405181b6f&forceDialog=0.
88. Id. at 44–51.
91. See discussion infra Section III.C.
92. Jenna Ross, From Coast to Coast: How U.S. Muni Bonds Help Build the Nation, Visual Capitalist (Nov. 4, 2019), https://www.visualcapitalist.com/municipal-bonds-build-nation.
93. Id.; John A. Dove, Financial Markets, Fiscal Constraints, and Municipal Debt: Lessons and Evidence from the Panic of 1873, 10 J. Inst. Econ. 71, 71–106 (2014).
94. Dove, supra note 93.
95. Id. at 75.
96. Id. at 76.
97. Id. at 78.
98. Id. at 79.
99. Id. at 97.
100. Pub. Secs. Ass’n, Fundamentals of Municipal Bonds (Gordon L. Calvert ed., 3d ed. 1990).
101. Fixed Income Outstanding, SIFMA, https://www.sifma.org/resources/research/fixed-income-chart (last visited Jan. 13, 2023).
102. See, for example, the May 4, 2020, joint statement by then U.S. Security and Exchange Commission Chairman Jay Clayton and Office of Municipal Securities Director Rebecca Olson, The Importance of Disclosure for Our Municipal Markets, SEC (May 4, 2020), https://www.sec.gov/news/public-statement/statement-clayton-olsen-2020-05-04.
103. Compiled from Pub. Secs. Ass’n, supra note 100, and SIFMA, supra note 101. Data based upon fixed income account information compiled by the Federal Reserve System.
104. “Property held for public uses . . . and generally everything held for governmental purposes, cannot be subjected to the payment of the debts of the City. . . . The power of taxation is legislative and cannot be exercised otherwise than under the authority of the legislature. . . . If no such authority exists, the remedy is by appeal to the legislature.” Meriwether v. Garrett, 102 U.S. 472, 501 (1880).
105. Ashton v. Cameron Cnty. Water Imp. Dist. No. 1, 298 U.S. 513, 532 (1936).
106. United States v. Bekins, 304 U.S. 27, 54 (1938).
107. Id. at 51 (“It is the opinion of the committee that the present bill removes the objections to the unconstitutional statute, and gives a forum to enable those distressed taxing agencies which desire to adjust their obligations and which are capable of reorganization, to meet their creditors under necessary judicial control and guidance and free from coercion, and to affect such adjustment on a plan determined to be mutually advantageous.”).
109. States themselves cannot file for bankruptcy under Chapter 9, and local governments can only pursue Chapter 9 relief if authorized by their host states.
110. 11 U.S.C. § 109(c)(2).
111. Id. § 109(c)(3); 11 U.S.C. §§ 903, 941.
112. H. Slayton Dabney, Jr., et. al, Municipalities in Peril: The ABI Guide to Chapter 9 (2012).
113. In re City of Detroit, Mich., 504 B.R. 191 (Bankr. E.D. Mich. 2013).
114. Id. at 241.
115. See New York v. United States, 505 U.S. 144, 175 (1992); Printz v. United States, 521 U.S. 898, 944–45.
116. See id.
117. In re City of Detroit, Mich., 504 B.R. at 241.
118. 11 U.S.C. § 903.
119. “While § 903 protects the basic incidents of state sovereignty—described as ‘political and governmental’ powers—from encroachment, contractual relations as between state and municipality are generally outside the ambit of ‘political or governmental’ powers.” See In re City of Stockton, 526 B.R. 35, 38 (Bankr. E.D. Cal. 2015). Similarly, “[b]ecause the state and local officials must authorize the filing of a chapter 9 petition, 11 U.S.C. §109(c)(2), and because they retain control over ‘the political and governmental powers’ of the municipality, these state officials remain fully politically accountable to the citizens of the state and municipality. See New York v. United States, 505 U.S. at 186 (‘The States thereby retain the ability to set their legislative agendas; state governmental officials remain accountable to the local electorate.’).” In re City of Detroit, Mich., 504 B.R. at 242.
120. 11 U.S.C. § 904.
121. PROMESA is not a Chapter 9 case, but many of the Chapter 9 (and other bankruptcy provisions) were incorporated into PROMESA.
122. In re Fin. Oversight & Mgmt. Bd. for Puerto Rico, 919 F.3d 121 (1st Cir. 2019).
123. For a more thorough analysis, see Nat’l Ass’n of Bond Laws., supra note 83.
124. See generally 4 Edward Gibbon, The History of the Decline and Fall of the Roman Empire (John B. Bury ed., 1986).
125. See SEC, Staff Report on Transactions in Securities of the City of New York (1977), https://www.sec.gov/info/municipal/staffreport0877.pdf.
126. See SEC, Staff Report On the Investigation in the Matter of Transactions in Washington Public Power Supply System Securities (1988).
127. See SEC, Report on Investigation in the Matter of County of Orange, California as it Relates to the Conduct of the Members of the Board of Supervisors (1996), https://www.sec.gov/litigation/admin/3436761.txt.
128. Jim White, The Municipal Advisor Under Dodd-Frank, Porter White, & Co. (Sept. 8, 2016), https://pwco.com/the-municipal-advisor-under-dodd-frank.
129. The Tower Amendment is part of Section 15B(d) of the Securities Exchange Act of 1934, is codified at 15 U.S.C. § 78o-4(d), and provides as follows:
(1) Neither the [U.S. Securities and Exchange] Commission nor the [Municipal Securities Rulemaking] Board is authorized under this chapter, by rule or regulation, to require any issuer of municipal securities, directly or indirectly through a purchaser or prospective purchaser of securities from the issuer, to file with the Commission or the Board prior to the sale of such securities by the issuer any application, report, or document in connection with the issuance, sale, or distribution of such securities.
(2) The Board is not authorized under this chapter to require any issuer of municipal securities, directly or indirectly through a municipal securities broker, municipal securities dealer, municipal advisor, or otherwise, to furnish to the Board or to a purchaser or a prospective purchaser of such securities any application, report, document, or information with respect to such issuer: Provided, however, that the Board may require municipal securities brokers and municipal securities dealers or municipal advisors to furnish to the Board or purchasers or prospective purchasers of municipal securities applications, reports, documents, and information with respect to the issuer thereof which is generally available from a source other than such issuer. Nothing in this paragraph shall be construed to impair or limit the power of the Commission under any provision of this chapter.
130. Thomas L. Hazen, Treatise on the Law of Securities Regulation §§ 1:16 –1:20 (May 2021 update).
133. William O. Douglas & George E. Bates, The Federal Securities Act of 1933, 43 Yale L.J. 171, 183 n.53 (1933).
134. H.R. Rep. No. 73-85 (1033), reprinted in Legislative History of the Securities Act of 1933 and Securities Exchange Act of 1934 (J.S. Ellenberger & Ellen P. Mahar eds., 1973).
135. Cf. Fippinger, supra note 34, § 10A:2.
136. S. Rep. No. 76-1016 (1939).
137. S. Rep. No. 94-75, at 95 (1975).
138. Hazen, supra note 130, § 1:22.
139. Id. § 1:23.
140. Id. § 1:17.
141. Id. § 1:12. For a humorous angle on what an offering document for securities issued by the U.S. government might look like, see Philip R. Davis, U.S. Treasury Bonds Prospectus, Would You Invest?, Mkt. Oracle (Apr. 14, 2010), http://www.marketoracle.co.uk/Article18633.html.
142. Hazen, supra note 130, § 4:11.
144. Robert Doty, Expanding Municipal Securities Enforcement: Profound Changes for Issuers and Officials, page 12, Bond Buyer (July 12, 2016).
145. Id. at 2.
146. Id. at vi–vii.
147. Cf. id. at vii.
148. Christopher Cox, Speech by SEC Chairman: Integrity in the Municipal Market, Address at the Biltmore Hotel, SEC (July 18, 2007), https://www.sec.gov/news/speech/2007/spch071807cc.htm; see also SEC, Disclosure and Accounting Practices in the Municipal Securities Market (2007), https://www.sec.gov/news/press/2007/2007-148wp.pdf. Chairman Cox’s comparison of the municipal securities market with the corporate securities market needs to be tempered with an understanding of two principal differences between these markets, namely, (1) as a result of the constitutional principles discussed in this paper, municipal securities by their nature are far less standardized than the financial products that have evolved in the corporate securities market, and, as a result, the prospect of meaningful municipal securities standardization across the municipal market may well be a practical impossibility; and (2) municipal issuers generally are creditworthy and stable and issue only debt securities.
149. SEC Release 34-26100, Proposed Rule: Amendments to Municipal Securities Disclosure – Rule 15c2-12 (Sep. 22, 1988); SEC Release 34-26985, Final Rule: Amendment to Municipal Securities Disclosure – Rule 15c2-12 (Jul. 10, 1989); see Fippinger, note 34, § 9:4.
151. See Fippinger, supra note 34, § 1:7.6.
152. White, supra note 128.
153. See Fippinger, supra note 34, § 1:7.6.
154. Id. § 4:4.
155. Id. § 10:3.2[B].
156. Id. § 10:3.2[D].
157. See Doty, supra note 144.
158. Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, 111th Cong. §§ 976, 977 (2010).
160. U.S. Gov’t Accountability Off., supra note 159, at 23–26.?
162. See Elisse B. Walter, The Interrelationship Between Public and Private Securities Enforcement, Harv. L. Sch. F. on Corp. Governance & Fin. Regul. (Dec. 11, 2011), https://corpgov.law.harvard.edu/2011/12/11/the-interrelationship-between-public-and-private-securities-enforcement. Then SEC Commissioner Elisse B. Walter stated, “The impact of changes in the parameters or existence of private actions on the enforceability of the federal securities laws is simply not well understood. And yet, it is critical to investors, our securities markets, and our economy overall that these laws remain fully enforceable.” Id.
163. SEC, Report on the Municipal Securities Market (2012), https://www.sec.gov/news/studies/2012/munireport073112.pdf [hereinafter 2012 SEC Report].
164. The SEC Report outlines legislation that would (1) authorize the SEC to regulate disclosure and financial statements; (2) authorize the SEC to require municipal securities issuers to have their financial statements audited; (3) provide a mechanism to enforce compliance with continuing disclosure; and (4) amend the municipal securities exemptions in the Securities Act and Exchange Act to eliminate the availability of such exemptions to conduit borrowers who are not municipal entities under Section 3(a)(2) of the Securities Act. 2012 SEC Report, supra note 163, at 134–39.
165. The SEC Report outlines changes to SEC Rule 15c2-12 that would (1) amend the definition of “final official statement” to include required disclosure about the terms of the offering, including the plan of distribution, any retail order period, and the price of the municipal securities in the initial issuance; (2) mandate more specific types of disclosures in municipal securities official statements and ongoing disclosures, including event disclosures relating to issuance of new debt, primary offering disclosures relating to risks of the municipal securities, and disclosures about underlying obligors; (3) provide a method to address noncompliance issues regarding continuing disclosure undertakings, including possibly by adding conditions that would require issuers to have disclosure policies and procedures in place regarding their disclosure obligations, including those arising under continuing disclosure undertakings; and (4) improve the accessibility of disclosures, including the use of shortened or summary official statements and increased use of websites. Id. at 139–40.
166. H.R. 6488 was introduced by Rep. Gwen Moore (D-WI) and adopted some of the proposals advanced in the 2012 SEC Report, including eliminating registration exemptions for conduit borrowers; having direct SEC regulation of annual disclosures and event filings, offering document content, and accounting methods; and establishing mandatory disclosure controls and systems. The legislation also granted the SEC broad discretion to establish exemptions and standards and permitted the SEC to recognize standard-setting bodies for municipal disclosure and accounting standards. H.R. 6488 (114th): Municipal Securities Disclosure Act of 2016 (Dec. 8. 2016), H.R. 6488, GovTrack.us, https://www.govtrack.us/congress/bills/114/hr6488 (last visited Jan. 13, 2023).
168. See Fippinger, supra note 34, §§ 1:7.1, 9:2.2; Am. Bar Ass’n Section of State & Local Gov’t L., Am. Bar Ass’n Section of Bus. L. Comm. on Fed. Regul. of Sec., & Nat’l Ass’n of Bond Laws., Disclosure Roles of Counsel in State and Local Government Securities Offerings 21–22 (2009).
169. See 2012 SEC Report, supra note 163, at 56–58.
170. Elisse B. Walter, SEC Commissioner, Regulation of the Municipal Securities Market: Investors Are Not Second-Class Citizens, Speech at Tenth Annual A. A. Sommer, Jr. Corporate, Securities and Financial Law Lecture New York, New York (Oct. 18, 2009) (transcript available at https://www.sec.gov/news/speech/2009/spch102809ebw.htm).
171. Fippinger, supra note 34, § 16:4.
172. Id. § 16:2.6.
174. Id. §§ 9:4, 10:3.6[D].
175. Note, Federal Regulation of Municipal Securities: Disclosure Requirements and Dual Sovereignty, 86 Yale L.J. 919 (1977).
176. See Murphy v. Nat’l Collegiate Athletic Ass’n, 138 S. Ct. 1461 (2018).
177. Id. at 1477.
178. Printz v. United States, 521 U.S. 898, 930 (1997) (citations omitted).
179. Id. at 935 (emphasis added).
180. U.S. Const. art I, § 8; see also id. § 9, cl. 4.
181. This is hardly a clear term. The holding in Pollock v. Farmers’ Loan & Trust Co., 157 U.S. 429 (1894), discussed below, apparently rests, in part, upon a conclusion that a “direct tax” is a tax upon a person, while an “indirect tax” is a tax upon property. See, e.g., Flint v. Stone Tracy Co., 220 U.S. 107 (1911) (holding that a tax on corporate income was an indirect tax).
182. U.S. Const. art I, § 2.
183. Apparently, the states also reserved the power to incur debt and to control how subsovereigns, such as cities and counties, incurred debt.
184. McCulloch v. Maryland, 17 U.S. 316 (1819).
185. Id. at 327.
186. Congress later provided for State non-discriminatory taxation on shares of national banks held by individuals. H.R. 395, 38th Cong. (1864).
187. Collector v. Day, 78 U.S. 113 (1870), overruled by Graves v. People of State of New York ex rel. O’Keefe, 306 U.S. 466 (1939); see also Ambrosini v. United States, 187 U.S. 1 (1902).
188. See, e.g., Carter Glass, III, A Review of Intergovernmental Immunities from Taxation, 4 Wash & Lee L. Rev. 48 (1946).
189. Pollock v. Farmers’ Loan and Trust Co., 158 U.S. 601, 695 (1871) (Brown, J., dissenting) (stating that the majority’s “decision involves nothing less than the surrender of the taxing power to the moneyed class”).
190. U.S. Const. amend XVI.
191. See, e.g., Edward S. Corwin, Constitutional Tax Exemption: The Power of Congress to Tax Income from State and Municipal Bonds, 13 Nat’l Mun. Rev. 51, pt. 4 (1924). To complete the history lesson, it is important to note that, following adoption of the Sixteenth Amendment, the Revenue Act of 1913 (ch. 16, 38 Stat. 114), establishing the Internal Revenue Code, was adopted, excluding municipal bond interest from gross income for purposes of income taxation. The exclusion has remained a feature of the Internal Revenue Code ever since.
192. It is interesting to note that the doctrine arose in the context of trying to prevent the states from destroying the federal government, while the arguments that have been made against taxation of interest on municipal debt by the federal government are largely based on the idea that the federal government would otherwise destroy the states.
193. Andrew W. Mellon, Taxation: The People’s Business ch.VIII (1924).
194. South Carolina v. United States, 199 U.S. 437 (1905).
195. Metcalf & Eddy v. Mitchell, 269 U.S. 514 (1925).
196. See supra text accompanying note 188.
197. Helvering v. Gerhardt, 304 U.S. 405 (1938); see also Graves v. People of State of New York ex rel. O’Keefe, 306 U.S. 466 (1938).
198. New York v. United States, 326 U.S. 572 (1946).
199. See supra note 191.
200. Pub. L. 97–248, 96 Stat. 324 (1982).
203. South Carolina v. Baker, 485 U.S. 505 (1988).
204. Id. at 526.
205. Id. at 508–10.
206. Id. at 515.
207. Id. at 526.
208. Id. at 529.
209. Id. at 528.
210. Id. at 512.
211. New York v. United States, 505 U.S. 144 (1992).
212. Printz v. United States, 521 U.S. 898 (1997).
213. See supra note 57 and accompanying text.
214. Baker, 485 U.S. at 530.
215. See, e.g., Evans v. Gore, 253 U.S. 245, 260–61 (1920):
True, Governor Hughes of New York, in a message laying the amendment before the legislature of that state for ratification or rejection, expressed some apprehension lest it might be construed as extending the taxing power to income not taxable before, but his message promptly brought forth from statesmen who participated in proposing the amendment such convincing expositions of its purpose, as here stated, that the apprehension was effectively dispelled, and ratification followed.
216. Exec. Order No. 13,132, 3 C.F.R. 206 (1999) requires agencies to consult with states when developing regulations with federalism impacts. Some scholars argue that courts should limit deference to federal agencies made without such state input.
217. In its 2012 report entitled Municipal Securities—Overview of Market Structure, Pricing and Regulation, the United States Governmental Accountability Office estimated the size of the entire market for municipal securities at $3.7 trillion, with individuals holding seventy-fiver percent of the total debt outstanding. 2012 SEC Report, supra note 163. According to SIFMA, in comparison, the corporate bond market is approximately $4.0 trillion, and the entire corporate securities market is approximately $47.2 trillion. SIFMA, 2021 Capital Markets Fact Book (2021).
218. According to the Congressional Budget Office, in the decade from 2007 to 2016, states and local governments invested $64 billion (in 2017 dollars) in transportation and water infrastructure, averaging $43 billion in tax-exempt bonds, $9 billion in loans by state banks, $8 billion (in 2009–2010) in tax credit bonds, and $4 billion in federal credit programs. Cong. Budget Off., Federal Support for Financing State and Local Transportation and Water Infrastructure (2018), https://www.cbo.gov/system/files/2018-10/54549-InfrastructureFinancing.pdf. Despite these investments, the American Society of Civil Engineers has given the U.S. infrastructure a cumulative grade of C-. 2020 Infrastructure Report Card, ASCE, www.infrastructurereportcard.org (last visited Nov. 29, 2022).
219. Anthony Commission on Public Finance, Preserving the Federal-State-Local Partnership: The Role of Tax-Exempt Financing 12 (1989).
220. As noted earlier, alignment of the municipal bond market with the corporate securities market is essentially untenable. Even if identical regulatory frameworks existed, the distinct constitutional nature of individual states and municipalities, as detailed in this article, means that identical bond markets could not exist. Public-private partnership transactions and municipal bankruptcy-remote transactions look quite different both from state to state, and between the United States and other countries. Public purpose and reserved powers doctrines inform the primary role of governments and would slow down corporatization.