Related Case May Resolve Kentucky Case Regarding Constitutionality Of State Municipal Bond Taxation

The U.S. Supreme Court has linked the outcome of the closely watched case of Davis v. Kentucky Dep't of Revenue of the Finance and Admin. Cabinet, 97 S.W.3d 557 (2006) to the outcome of a solid waste disposal case to be decided by the Court in the next few months. Although the exact impact of the Court's treatment of the Davis case as a "related case" to United Haulers v. Oneida-Herkimer Solid Waste Management Authority will not be known until the Court hands down its Oneida decision, it now appears likely that the Court will not grant full review of the Davis case, but will either affirm or reverse it simultaneously with the issuance of its Oneida decision or remand it to the Kentucky state court system for reconsideration in light of the principles to be articulated in Oneida. The outcome of the Davis case remains uncertain, but, as discussed below, supporters of the status quo in the municipal bond market may have reason to be optimistic in light of this development.

Description of the Davis Case and Issue Presented

The Davises, residents of Kentucky who paid Kentucky income tax on the interest they received on their out-of-state bonds, challenged the state's tax policy, which they claim constitutes illegal favoring of in-state versus out-of-state commerce. The Davises base their claim on the so-called "dormant Commerce Clause," a judicial interpretation of the Commerce Clause of the U.S. Constitution that prohibits states from competing against each other in a way that burdens interstate commerce. A Kentucky appellate court ruled in early 2006 that Kentucky's tax policy violates the dormant Commerce Clause. That court reasoned that by granting an exemption only to its own bonds, the state was dissuading its residents from investing in bonds issued in other states and thereby was impeding interstate commerce. The Kentucky Supreme Court subsequently declined to hear an appeal of the matter, and the State of Kentucky sought review by the U.S. Supreme Court. The National Association of State Treasurers filed a friend-of-the-court brief urging the Court to review the Davis case, emphasizing the need for certainty and nationwide consistency regarding this widely used technique for making municipal bonds more attractive to residents of the state in which they are issued.

The U.S. Supreme Court has never considered the specific question of the permissibility of state tax preferences for bonds issued in the taxing state, and only two state...