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Court Weighs Cases That Could Impact State Tax Revenues

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WASHINGTON--At a time when state finances have been racked by the recession, the U.S. Supreme Court is considering a number of cases that could have major implications--either adverse or positive--for state tax revenues.

The cases do not deal directly with school finance or with the spending side of states' ledgers. But their impact on revenues could affect the amount of money that cash-strapped states have available for public education and other services.

"State officials have to be concerned'' about the outcomes of these cases, said Christopher Zimmerman, the chief economist of the National Conference of State Legislatures. "There is the threat of almost instant damage to state tax bases.''

In a case from Kansas decided last week, the Justices ruled that the state could not tax the pensions of federal military retirees while exempting the pensions of retired state- and local-government employees. The High Court sidestepped a potentially costly issue in that case that will likely return soon: whether states have to pay perhaps hundreds of millions of dollars in refunds for taxes that have been struck down by the Court.

In another case that could affect the distribution of billions of dollars in revenue nationwide, the Court is re-examining the way states tax the corporate income of companies doing business in several states.

And in the only case in which a change in the status quo could be a financial boon to state coffers, the Justices may clear the way for the states to begin collecting use taxes on out-of-state phone and mail-order sales of goods.

In that case, Quill Corporation v. North Dakota (Case No. 91-194), the National Governors' Association and other state groups have estimated that states are missing out on $2 billion to $3 billion in tax revenue annually from purchases their residents make from out-of-state mail-order and phone-order firms.

The Justices heard arguments in January in the case, which stems from North Dakota's attempts to force a Chicago-based office-products company to collect the use tax, a levy that is similar to a sales tax paid by in-state residents when they purchase from local stores.

North Dakota has urged the High Court to overturn a 25-year-old precedent that declared that companies must have a physical presence in a state to be subject to such taxes. The state argues that such a standard has been made obsolete by modern sales trends and technology.

Taxing Public Pensions

While a High Court ruling favoring North Dakota would open up a new revenue source for states, the outcomes of other cases could take away at least as much revenue.

The Court has pending before it several cases stemming from the states' once-common practice of taxing the pensions of retired federal employees differently from those of state-government retirees. In a 1989 case, Davis v. Michigan Department of Treasury, the Court ruled on constitutional and other legal grounds that states could not tax the pensions of federal retirees while exempting the pensions of retired state and local workers.

At least 20 states made such distinctions prior to the Michigan ruling. Since that time, most have changed their tax structure to end the disparate treatment.

But Kansas continued its tax on the pensions of federal military retirees, arguing that because the retirees were subject to recall to active duty, their pay was not really a pension. The Kansas Supreme Court agreed.

The High Court last week overturned the Kansas court, declaring that the state's tax scheme was illegal under the ruling in Davis. The decision came April 21 in Barker v. Kansas (No. 91-611).

The Justices chose not to use the Kansas case to address a major issue left unresolved in the wake of the Davis ruling: the obligation of states to pay refunds after wrongly collecting taxes in such instances.

The Court already has several other cases at its door where the retroactivity issue presents itself more squarely.

For example, Virginia changed its law after the Davis ruling to end its disparate treatment of federal and state retirees. But some federal retirees have pressed for refunds of the taxes they paid under the old system.

Virginia is home to more retired federal employees than any other state--some 192,000. If the High Court were to rule that the states must refund the illegally collected taxes, Virginia would owe estimated tax refunds of more than $440 million, state officials say.

The Virginia Supreme Court has twice ruled that the Davis ruling was not meant to apply retroactively. Now, the retirees have asked the U.S. Supreme Court to review their case, Harper v. Virginia Department of Taxation (No. 91-794). At least four other similar petitions are also pending before the Court.

Nationwide, the refund claims against states affected by the Davis ruling total an estimated $2.2 billion, according to documents filed with the High Court.

"The states are concerned. If they have to pay rebates, that is going to be money they don't have for other things in their budgets,'' said Michael G. Dzialo, a lawyer with the State and Local Legal Center, a Washington-based organization that aids state and municipal groups.

Multi-State Companies

Meanwhile, the Supreme Court dropped a surprise into the state-taxation picture last month when it ordered the reargument of a complicated New Jersey case involving the taxation of the investment income of out-of-state companies.

The Justices asked the parties in the case, Allied-Signal Inc. v. Director, Division of Taxation (No. 91-615), to address in new arguments what constitutional principles should govern state taxation of corporations doing business in several states. The case was reargued last week.

Some legal analysts have suggested the broadly worded question may result in a ruling that will make many companies subject to more tax liability in a greater number of states, which could have a further, yet unpredictable, impact on state revenues.

In another closely watched case, the High Court is considering the constitutionality of a key provision of California's Proposition 13 property-tax-limitation law. (See Education Week, March 4, 1992.)

If the Justices overturn the provision, the state's entire property-tax system could be thrown into political chaos, some analysts believe.

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