State Taxation of Commerce

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Since brown v. maryland in 1827 the Supreme Court has decided hundreds of cases determining the extent to which the commerce clause immunizes from state taxation property moving in interstate commerce or businesses engaged in such commerce. From the outset, agreement has existed on one principle—state taxes that discriminate against interstate commerce are invalid. In Welton v. Missouri (1876) the Court held invalid a state tax on local sales because it applied only to goods produced outside the state. Recently, in Boston Stock Exchange v. State Tax Commission (1977), the Court stated that the "fundamental principle" that no state may impose a tax that discriminates against interstate commerce "follows inexorably from the basic purpose of the [Commerce] Clause. Permitting individual states to enact laws that favor local enterprises at the expense of out-of-state businesses "would invite a multiplication of preferential trade areas destructive' of the free trade which the Clause protects."

The Supreme Court recognized early, however, that even formally nondiscriminatory taxes might put interstate commerce at a competitive disadvantage. In philadelphia & reading railroad v. pennsylvania (1873) a tax on transportation companies measured by cents per ton of freight carried within the state (but not apportioned to distance) was held invalid as applied to goods in interstate commerce even though local commerce paid the same tax. The Court noted that if one state could impose this tax all states could and commercial intercourse between states remote from each other might be destroyed. Interstate commerce could bear the imposition of a single tax but "it would be crushed under the load of many." To avoid such burdens the Court formulated broad prophylactic rules. States were not permitted to tax interstate commerce by laying taxes on property in transit in interstate commerce, the business which constituted such commerce, the privilege of engaging in it, or the receipts derived from it.

The Supreme Court did not go so far, however, as to hold that states could never secure revenue from interstate businesses. An immunity that broad would have placed the states in the position of being required to provide governmental services to interstate property and businesses within their borders without being able to secure from them any contribution to the costs of such governmental services. Hence the Court came to recognize a variety of avenues through which states could derive revenue from interstate commerce.

The principal state revenue producer in the last century was the ad valorem property tax. Although property taxes on goods actually moving in interstate commerce were forbidden (because of the risk that they would be applied by more states than one), states were permitted to impose property taxes upon railroad cars and barges if they were apportioned (usually by mileage) so as to apply, in effect, only to the average number of cars present in the state on any one day. The Supreme Court even went so far as to permit states to levy property taxes on the intangible values of interstate transportation companies by permitting the imposition of taxes upon the proportion of the total going-concern value of the companies that track mileage within the state bore to total track mileage.

In other cases activities were characterized as intrastate in order to permit state taxation. Manufacturing, mining, and production were held to be intrastate commerce and taxes upon such activities were permitted even though substantially all of the goods produced were shipped in interstate commerce. Sales involving the transfer of goods from seller to buyer within the state were regarded as intrastate while sales involving no more than solicitation of orders within the state followed by delivery from without were interstate sales. Hence, states could impose nondiscriminatory license taxes on peddlers who carried with them the goods they sold but not on drummers who merely took orders. Later, when modern sales taxes came into existence, the Court applied the same principles. A sales tax could not be imposed when the seller outside the state shipped goods to the purchaser inside the state, but it could be imposed upon the local retailer who brought the goods from outside and then sold and delivered them to customers. In order to protect local merchants from competition by out-of-state sellers, states imposed on purchasers a tax on the "first use" within the state of goods purchased, with an exemption for goods on which the sales tax had been paid. The Supreme Court sustained such taxes on the theory that they were imposed on a local transaction—the use—rather than upon the interstate sale.

Another major boost to the power of states to secure revenues from interstate commerce came in United States Glue Co. v. Town of Oak Creek (1918). The Supreme Court upheld the power of a state to impose taxes measured by net income derived within the state, including net income from interstate activities. The Court distinguished earlier decisions forbidding the imposition of taxes on gross income from commerce by saying that such taxes burdened commerce directly while net income taxes, applied only to the taxpayers' net profits, bore only indirectly upon commerce. The power of the states to impose net income taxes was initially limited only by two principles. First, a net income tax could not be collected if the taxpayer did only interstate commerce within the state, because it would constitute an imposition on the privilege of engaging in interstate commerce—a privilege that the state did not grant. Second, the tax could be imposed only upon that portion of the net income fairly attributable to activities within the taxing state. A rational apportionment formula was required.

In Western Livestock v. Bureau of Revenue (1938), Justice harlan fiske stone sought to derive from the cases a general principle that would abrogate the general rule that interstate commerce itself could not be taxed. He said that it was not the purpose of the commerce clause "to relieve those engaged in interstate commerce from their just share of state tax burden even though it increases the cost of doing business." He noted that gross receipts taxes had often been held invalid. "The vice characteristic of those which have been held invalid is that they have placed on commerce burdens of such a nature as to be capable in point of substance, of being imposed … or added to … with equal right by every state which the commerce touches, merely because interstate commerce is being done, so that without the protection of the commerce clause it would bear cumulative burdens not imposed on local commerce."

The decision in Western Livestock did not mark an end to the older idea that interstate commerce itself could not be directly taxed. As recently as 1946 in Freeman v. Hewit, Justice felix frankfurter speaking for the Court said:

Nor is there any warrant in the constitutional principles heretofore applied by this Court to support the notion that a State may be allowed one single-tax-worth of direct interference with the free flow of commerce. An exaction by a State from interstate commerce falls not because of a proven increase in the cost of the product. What makes the tax invalid is the fact that there is interference by a State with the freedom of interstate commerce.…Trade being a sensitive plant, a direct tax upon it to some extent at least deters trade even if its effect is not precisely calculable.

For nearly three decades after Western Livestock the cases continued to reflect first one and then the other of these conflicting approaches.

Recently, however, the Supreme Court has cleared out most of the underbrush of the cases from the past and has established some relatively simple guidelines for the future. In Complete Auto Transit, Inc. v. Brady (1977) the Court said that it considers not the "formal language" of the tax statute but its "practical effect" and sustains "a tax against commerce clause challenge when the tax is applied to an activity with a substantial nexus with the taxing state, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State."

With respect to ad valorem property taxation, the Court continues to forbid such taxes on goods moving in interstate commerce while reaffirming the rule that properly apportioned taxes may be imposed upon the instrumentalities of commerce such as railroad cars and airplanes. In Japan Line, Ltd. v. County of Los Angeles (1979), however, the Court limited this rule as applied to foreign-owned instrumentalities. It held that a country could not impose even an apportioned tax on the value of shipping containers owned by a Japanese shipping company because Japan was taxing the entire value of the containers. The Court said that its rule permitting apportioned property taxation was based on its ability to force apportionment on all potential taxing jurisdictions. Since Japan could not be required to apportion, the county could not tax at all even though it provided governmental services to the containers when they were in the state.

The distinction between taxes measured by gross income and those by net income has been abolished, along with the rule that states may not tax the privilege of engaging in interstate commerce. In the Brady case and in Department of Revenue of Washington v. Association of Washington Stevedoring Companies (1978) the Court upheld privilege taxes measured by gross receipts derived from exclusively interstate commerce within the taxing state. The Court indicated that the key is apportionment, which avoids multiple burdens. In Washington Stevedoring, for example, it upheld a tax on the gross receipts of a stevedoring company which had as its entire activity loading and unloading in Washington ships engaged in interstate and foreign commerce. It said that the state had "a significant interest in exacting from interstate commerce its fair share of the cost of state government.… The Commerce Clause balance tips against the tax only when it unfairly burdens commerce by exacting more than a just share from interstate activity."

A 1959 federal statute (section 381, Title 18, United States Code) provides that a state may not impose a net income tax if the taxpayer does no more within the state than solicit orders. Beyond that limit the major, current problems relate to the apportionment of an interstate business's income among the states having jurisdiction to tax it. Nearly half of the states are adherents to the Multistate Tax Compact which calls for net income to be apportioned by a three-factor formula based on property, payroll, and sales. Most states, whether or not adherents to the Compact, utilize similar three-factor formulas. Iowa, however, applies a formula under which it taxes that proportion of net income that gross sales within the state bear to total gross sales. In Moorman Manufacturing Co. v. Blair (1978) a challenge to this formula was rejected. The taxpayer argued that to permit Iowa to use a single-factor formula when other states in which it did business used a three-factor formula would result in the taxation by Iowa of income that had been taxed in other states. The Supreme Court would go no further than to examine the particular formula to see that it is reasonable and does not allocate disproportionate amounts of income to the taxing state, leaving to Congress the question whether a uniform formula should be imposed on all states. The Court has also recently rejected challenges to the application of apportionment formulas to the entire net income of integrated companies engaged in production, refining, and distribution of petroleum products. In Exxon Corporation v. Wisconsin Department of Revenue (1980) the Court held that so long as the taxpayer is engaged in a "unitary business" any state in which it does business may apply its apportionment formula to the entire net income of the business without regard to how the taxpayer's own accounting system allocates profits and losses.

With respect to taxes on the sales transaction, existing doctrines permit the state in which goods are sold to tax through either a sales or a use tax. However, collection of the use tax is often impossible if the state cannot compel the seller to collect the tax from the purchaser and remit it to the state. Recent concern has been with the due process jurisdictional problem. The state must show some definite link, some minimum connection, between the seller and the state, before it can impose the duty of collection.

A century and a half after Brown v. Maryland the Supreme Court's approach to state taxation of interstate commerce is relatively simple: so long as the state taxes do not discriminate against such commerce or create a risk of multiplication of similar levies on the same property or activity, they will be upheld. States will be given wide latitude in devising formulas for apportioning income and allocating values. If more protection for commerce is desired, it will have to come from Congress.

Edward L. Barrett, Jr.

(see also: Excise Tax; Import-Export Clause; Impost; Original Package Doctrine; State Regulation of Commerce.)


Barrett, Edward L., Jr. 1953 "Substance" vs. "Form" in the Application of the Commerce Clause to State Taxation. University of Pennsylvania Law Review 101:740–791.

Hartman, Paul J. 1953 State Taxation of Interstate Commerce. Buffalo, N.Y.: Dennis Co.

Note 1975 Developments in the Law: Federal Limitations on State Taxation of Interstate Business. Harvard Law Review 75:956–1036.

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State Taxation of Commerce

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State Taxation of Commerce