Comment: Conceptions of Fiscal Federalism: Dual and Shared Sovereignty

2 Colum. J. Eur. L. 565 (1996)

Bradley C. Karkkainen. Associate Professor of Law, Columbia University School of Law.

The principal papers presented here, by Lerke Osterloh and Richard Briffault, are highly informative and illuminating. The authors analyze the factual realities and practical limitations, as well as the legal underpinnings, of the “fiscal constitutions” of three federal systems: the United States, Germany, and the European Union. These papers thus provide an excellent basis for comparisons among those three systems. Of course, the papers themselves do not do the work of comparative analysis, but this is no criticism, for such was not their assigned task. The drawing of comparative conclusions is left instead principally to the hearers and readers of these papers.

In the spirit of making a modest contribution toward that comparative project, which I take to be the central mission of this symposium, I offer a few brief observations on the taxation side of fiscal federalism.

I shall address two observations made by the presenters of these papers. First, Richard Briffault reminds us that, at least as a formal matter, American federalism is based on a theory of dual sovereignty’ – that is, both the states and the national government exercise sovereign authority simultaneously over their respective spheres of competence, and equally important for our purposes here, there is considerable overlap between the spheres of competence of the two levels of government. So, for example, in social welfare policy, or in environmental protection, or increasingly even in criminal law, state and national governments often proceed independently on parallel planes. Their efforts sometimes advance in the same direction, whether by chance or by conscious design. But not always; sometimes policies clash, or at any rate strain in different directions, as the different levels of government seek to achieve the same ends by different means, or seek different ends entirely. Of course, our federal constitution as interpreted by the courts makes it abundantly clear that in cases of conflict – or really almost anytime the national government declares it to be so – federal, that is national law is supreme, and trumps contrary state law. Nonetheless, the states retain an important residual and more or less autonomous role in many areas where they have not been preempted, or have been only partially preempted by the national government. This dual sovereignty no doubt appears as something of a puzzlement to many Europeans – and indeed to many Americans as well. It is perhaps the central puzzle of our federal constitutional architecture.

Professor Briffault goes on to point out, quite accurately in my view, that at least with respect to the spending side of the fiscal equation, formal dual sovereignty is often accompanied in fact by an informal division of authority and both vertical and horizontal policy coordination. An elaborate set of informal mutual understandings and expectations has evolved between the states and the federal government. But in the realm of taxation, I submit that dual sovereignty remains the best description of the relationship between the national government and the states. Each has competence to chart its own autonomous course. Subject only to a few relatively narrow exceptions, there are no restraints on either the levels or the subjects of taxation at either level of government. The most important of these exceptions are those Professor Briffault mentioned: a prohibition against states taxing imports (arising out of the federal government’s exclusive competency to regulate interstate and foreign commerce), a vertical restraint prohibiting states from taxing the federal government and its instrumentalities, and two somewhat imprecise horizontal restraints – a due process clause proscription against taxation of wholly out-of-state entities, and a dormant commerce clause prohibition against taxation that discriminates against or excessively burdens interstate commerce. The result in fact is substantial overlap between federal and state taxation. Both states and the national government can and do tax individual and corporate incomes, payrolls, and decedents’ estates; and both states and the national government impose excise taxes on such items as motor fuels, alcohol, and tobacco products.

No constitutional provision, federal statute, agreed-upon policy statement, or informal understanding determines which level of government will tax what, and at what level; the national Congress and the state legislatures make those determinations autonomously. And not only is tax policy established independently at each level, but tax collection is also administered separately. Nor is any significant effort made at horizontal harmonization among states; each state sets its own tax policy by its own lights, and as a consequence taxation may vary considerably from one state to the next.

This is not to suggest, of course, that federal tax policy has no influence on state and local taxation. Indeed, states appear eager – as they should be – to exploit opportunities for advantageous treatment under the federal tax code. So, for example, because taxpayers who itemize their deductions (generally higher- income taxpayers) can deduct state and local income and property tax payments from their income for purposes of calculating federal income tax liability, states have at least some incentive to rely on these taxes rather than non-deductible ones; the federal treasury effectively contributes a portion of the state tax revenue. Similarly, because the federal tax code exempts from taxation interest earned on public-purpose state and municipal bonds, states and localities have an incentive to finance capital improvements through debt rather than through current taxation. But these incentives do not add up to a coordinated state- federal tax policy. Instead, they represent limited, ad hoc political concessions to state and local governmental interests and, equally important, to private beneficiaries of the differential tax treatment, such as the housing industry which  benefits from the property tax deduction, and the municipal bond underwriting industry and wealthy investors who take their cut of the municipal bond interest exemption.

Nor do I mean to suggest that the lack of horizontal tax policy coordination among states necessarily produces radical dissimilarities in the tax structure from one state to the next. Indeed, although there is significant variance, on the whole the similarities among states outweigh the differences. But this is not the result of policy coordination. Instead, it arises because states imitate each other in exploiting new sources of tax revenue; compete amongst themselves to keep overall tax burdens and particular taxes at levels which do not induce the flight (or retard the influx) of capital, jobs, and residents; and act in parallel (but autonomously) to exploit the incentives built into the federal tax code, which I have just described.