tax exemption

Issues

Currently, Kentucky taxes interest income earned by holders of out-of-state municipal bonds but does not tax interest income earned by holders of in-state municipal bonds. Catherine and George Davis, Kentucky taxpayers and owners of out-of-state bonds, argue that Kentucky’s tax policy violates the Commerce Clause of the United States Constitution by interfering with interstate commerce. Kentucky argues, in response, that it is free to set the economic terms of the bonds it sells, and that its policy represents a legitimate balance between its desire to encourage investment in local public infrastructure and its need to raise tax revenue. The Kentucky Court of Appeals agreed with the Davises and found Kentucky’s tax scheme unconstitutional. The Supreme Court’s decision in this case will impact the validity of similar tax schemes in at least 41 other states. A ruling in the Davises’ favor would eliminate tax considerations in an investor’s decision between bonds issued by the investor’s State and bonds issued by another State, arguably benefiting all states by eliminating inefficient market segmentation. On the other hand, a ruling in Kentucky’s favor would prevent a disruptive change in the status quo, which would permit states to exercise greater discretion as they strike a balance between economic development and revenue collection.

Questions as Framed for the Court by the Parties

Additional Resources