More on Murphy — and a Response to Critics

Why Justice Alito’s sports gambling opinion really is a big deal for state tax systems

Daniel Hemel
May 17, 2018 · 6 min read

The Supreme Court’s decision Monday in Murphy v. NCAA has sparked a sort of pop-up symposium among law prof bloggers here (see my first post, Brian’s take, and my follow-up), at the Volokh Conspiracy (see Ilya Somin’s post there), and at PrawfsBlawg (see Rick Hills’s contribution to the debate). Ilya and Rick — both leading federalism scholars whose work I greatly admire — take the view that Murphy isn’t as big of a deal as Brian and I think it is. Please go read their thoughtful analyses, and then come back here to see why I still believe that Justice Alito’s opinion for the majority in Murphy calls into doubt the constitutionality of a number of federal statutes that limit the states’ power to tax. (It’s a really big number: see Brian’s list of 85 federal provisions restricting state taxing authority.)

On the way toward striking down the Professional and Amateur Sports Protection Act (PASPA), Murphy announced the “basic principle” that “Congress cannot issue direct orders to state legislatures” (p. 19 of the slip opinion). Murphy makes clear that this basic principle applies regardless of whether Congress commands state legislatures to take “affirmative” action or prohibits them from passing particular laws. The Court gives three justifications for this basic principle: (1) so that states can serve as effective checks on federal power; (2) so that voters “know who to credit or blame”; and (3) so that Congress cannot shift costs to state governments (pp. 17–18).

Murphy also recognizes two exceptions to this basic principle (and overlooks a third exception which no doubt still applies: federal laws enacted pursuant to the enforcement clauses of the Reconstruction Amendments). The first is the Reno v. Condon exception, which kicks in when a law “applie[s] equally to state and private actors” (p. 20). The second is the exception for “valid preemption provisions.” According to Murphy:

“[A] valid preemption provision . . . must satisfy two requirements. First, it must represent the exercise of a power conferred on Congress by the Constitution; pointing to the Supremacy Clause will not do. Second, since the Constitution confers upon Congress the power to regulate individuals, not States, the . . . provision at issue must be best read as one that regulates private actors” (p. 21).

Justice Alito elaborates:

“Our cases have identified three different types of preemption — ‘conflict,’ ‘express,’ and ‘field’ — but all of them work in the same way: Congress enacts a law that imposes restrictions or confers rights on private actors; a state law confers rights or imposes restrictions that conflict with the federal law; and therefore the federal law takes precedence and the state law is preempted. . . . [E]very form of preemption is based on a federal law that regulates the conduct of private actors, not the States” (pp. 21–22, 24).

Ilya takes this to mean that “federal restrictions on state regulations” are not implicated by Murphy’s holding. Here’s a helpful thought experiment to test whether that reading is right. Let’s say that Congress passes a law that’s essentially the reverse of PASPA (we’ll call it APSAP). All APSAP says is that “no state shall pass any law regulating sports gambling”; it does not establish any federal regulatory regime for sports gambling. Would APSAP be constitutionally valid under Murphy?

I think not. Conceivably, APSAP could be rewritten to say that “everyone has a right to engage in sports gambling notwithstanding any state law to the contrary,” and in that respect it might be interpreted as a law enacted by Congress that “confers rights on private actors.” But the hypothetical APSAP says nothing about private actors, and it applies to private actors only insofar as it regulates state actors. The question under Murphy is whether APSAP is “best read” as a law “that regulates private actors.” I leave it to the reader, but my own view is that APSAP would not so qualify.

Now let’s move from thought experiment to reality. The Internet Tax Freedom Act (ITFA) provides that “[n]o State or political subdivision thereof may impose any . . . [t]axes on Internet access.” See 47 U.S.C. § 151 note. A grandfather clause allows states to continue to impose taxes on Internet access that were generally imposed and actually enforced before October 1, 1998, though the grandfather clause lapses on June 30, 2020. The states currently governed by the grandfather clause are Hawaii, New Mexico, Ohio, South Dakota, Texas, and Wisconsin. Thus, ITFA currently bars 44 states from taxing Internet access, and in 2020 the ban will apply to all 50 states.

Does ITFA survive Murphy? Ilya’s position seems to be yes. He writes that “[f]ederal laws restricting state taxes fall squarely within Alito’s explanation of preemption.” I disagree. Sure, ITFA could be read as a law that gives private actors the right to be free from state Internet access taxes as long as they don’t happen to find themselves surfing the web in Hawaii, New Mexico, Ohio, South Dakota, Texas, or Wisconsin before June 30, 2020. But is that the “best” reading of ITFA? Really?

Rick’s reading generally converges with Ilya. He concludes:

“In short, a federal law setting aside state law (‘deregulatory nationalism,’ if you will) is safely insulated from ‘state autonomy’ doctrine just so long as a private party can assert that federal law as a defense in litigation against the preempted state law.”

Well, ITFA would certainly fit Rick’s bill. If a state other than Hawaii, New Mexico, Ohio, South Dakota, Texas, or Wisconsin hauls you into court and says that you’re liable for a tax on Internet access, then ITFA — if it’s valid — would be a very good defense. The problem is that Rick’s federal-law-as-a-defense test, while creative, is not the test that Justice Alito lays out. For that test, see again page 21: “[A] valid preemption provision . . . must be best read as one that regulates private actors” (emphasis added).

ITFA matters. Michael Mazerov of the Center on Budget and Policy Priorities estimates that as of 2012, grandfathered states raised about $500 million a year from taxes on Internet access and non-grandfathered states could raise an additional $6.5 billion a year if they applied their state sales taxes to broadband services. Those figures are likely even higher today.

A harder question, I think, is the taxation of Treasury securities. Under 31 U.S.C. § 3124, “obligations of the United States Government are exempt from taxation by a State or political subdivision of a State.” The statute goes on to make exceptions for nondiscriminatory state corporate franchise taxes and state estate and inheritance taxes. Is 31 U.S.C. § 3124 a regulation of state actors or private actors? It’s the same as saying that “no state or political subdivision may impose any tax — other than a nondiscriminatory corporate franchise tax or estate or inheritance tax — on federal government obligations.” It’s also the same as saying that “all private actors have a right to be free from state taxes on federal government obligations, with the exception of nondiscriminatory state corporate franchise taxes and state estate and inheritance taxes.” (Interest on Treasury bonds is subject to federal taxation just like any other interest income on a bond that’s not eligible for the muni bond exemption.)

Perhaps the answer is that because Congress taxes interest on Treasury bonds, and state taxes on interest on Treasury bonds would conflict with the federal tax, so those state taxes are preempted. See again page 22 of the slip opinion. But that’s quite a stretch. Congress also taxes interest on corporate bonds; the 43 states with their own income taxes all tax interest on corporate bonds too; and I don’t know of anyone who thinks that those state taxes conflict with the federal one such that preemption might apply.

U.S. banks, insurance companies, businesses, and individuals own more than $3 trillion in federal public debt. Assuming a 3% interest rate and a 5% state income tax rate, we’re talking about something like an additional $5 billion for the states each year. That won’t solve, say, the Illinois pension crisis. But it’s not chump change.

One last note: The tried-and-true way to determine whether a legal rule applies in an otherwise-ambiguous case is to ask whether the justifications for the legal rule apply to that case. Here, all three justifications for Murphy’s “basic principle” seem to support its application to federal statutes restricting state tax authority. First, federal laws that interfere with the ability of states to raise revenue make it harder for states to serve as effective checks on federal power. Second, these federal laws raise the same political accountability concerns as classic commandeering: Congress gets the credit for reducing your taxes, and state lawmakers take the blame when they have to raise other taxes or cut spending to compensate. And third, while these laws do not exactly shift costs to state governments, they do much the same by making it harder for states to shoulder the costs they already bear. So I don’t view this as a wild application of Murphy. I see it as very much consistent with Murphy’s core concerns.

Whatever Source Derived

Thoughts on tax and the law

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