High Court Overturns Alabama Tax Favoring Home-State Industry

The Supreme Court, in a ruling that limits the taxing power of the states, held Tuesday that they may not impose higher taxes on out-of-state firms to promote home-state industry.

The justices, in a 5-4 decision, decided that the aim of an Alabama “domestic-preference” tax law favoring Alabama-based insurance companies represented the “very sort of parochial discrimination” that the equal protection clause of the Constitution was intended to prevent.

A group of major national insurance firms, led by Metropolitan Life Insurance, had challenged the Alabama law, saying it unfairly discriminated against out-of-state insurers. They noted that the 32 states with similar laws were collecting up to $1.7 billion a year in revenue as a result of the laws.

Drew a Distinction

In its decision, the court drew a distinction between the Alabama law and a California law that it approved four years ago. The California statute imposed a “retaliatory tax” on firms from states that discriminated against California insurers.

“Unlike the retaliatory tax,” Justice Lewis F. Powell Jr. wrote for the court, “the domestic-preference tax gives the ‘home team’ an advantage by burdening all foreign corporations seeking to do business within the state, no matter what they or their states do.”

The court did not rule out all taxes that favor home-state firms, limiting its decision to those laws whose only purpose was to encourage in-state economic development. Nor did its ruling impair the widespread use of tax incentives--favorable tax provisions--to attract investments from out of state.

Nonetheless, four justices issued a sharp dissent, calling the ruling “astonishing.” An opinion by Justice Sandra Day O’Connor, joined by Justices William J. Brennan Jr., Thurgood Marshall and William H. Rehnquist, declared:

“This holding is unsupported by precedent and subtly distorts the constitutional balance, threatening the freedom of both state and federal legislative bodies to fashion appropriate classifications in economic legislation.”

The Alabama law imposed a significantly lower gross-premiums tax rate on Alabama insurance companies than on out-of-state firms. “Domestic” insurers were defined in the law as companies that are both incorporated in the state and have their principal offices there. Out-of-state firms that invested in Alabama could reduce their tax--but never to the low level paid by domestic insurers.

An Alabama court that reviewed the law upheld it on the ground that it served the legitimate purposes of encouraging new insurance companies to form in Alabama and more capital investment there by out-of-state firms.

Constitutional Limits

But the Supreme Court, in its ruling Tuesday (Metropolitan Life vs. Ward, 83-1274), said neither purpose could justify what it called the “purely and completely discriminatory” provisions of the law. While attracting business was a “legitimate and often admirable” goal, Powell wrote, the Constitution does not permit a tax policy like Alabama’s penalizing out-of-state firms.

“If we accept the state’s view here, then any discriminatory tax would be valid if the state could show it reasonably was intended to benefit domestic business,” Powell said.

“This case does not involve or question . . . the broad authority of a state to promote and regulate its own economy,” he stressed. “We hold only that such regulation may not be accomplished by imposing discriminatorily higher taxes on non-resident corporations solely because they are non-residents,” he said.