Lumberton officials are using an unprecedented taxation defense in an Internet sweepstakes lawsuit before the state Supreme Court that features constitutional separation of powers issues and arcane legal protections dating from the Great Depression.
Joined by the powerful North Carolina League of Municipalities, the city is advancing the novel legal argument that the judiciary has no constitutional authority to review legislative branch decisions setting rates for business privilege taxes.
Attorneys for the plaintiff Internet café businesses say if the Supreme Court upholds the Court of Appeals ruling in the case, it will swing open the doors of municipal mischief by creating an unchecked legal framework for state and local governments to abuse their taxing authority.
Government would be granted “unfettered, unreviewable power to tax anybody and anything within its municipal reach,” said Richard Gottlieb, an attorney with the Winston-Salem law firm of Kilpatrick Townsend, which is defending the businesses against 2010-11 tax increases ranging from 6,000 to 11,000 percent.
“No court has ever said that it didn’t have the power” to decide constitutional cases involving the state’s just and equitable tax clause, Gottlieb said.
Sweepstakes operators The Internet Business Center, G&M Co., Sweep-Net Internet Business Center and EZ Access of North Carolina say they were targeted with exorbitant taxes to drive them out of business. The business owners and the city cross-filed for summary judgment in Robeson County Superior Court.
The city won, and a divided Court of Appeals upheld the trial court. The Supreme Court is expected to hear the consolidated cases in October or November and issue a ruling in the first half of next year.
The just and equitable tax clause is an unusual taxpayer protection among the states. It passed as an amendment to the state constitution in 1936 to replace common law provisions proscribing confiscatory taxes.
The sweepstakes parlors claim the clause requires that tax levels must be reasonable and related to the purpose for which they were levied. They aver in a brief filed July 30 with the Supreme Court that the Court of Appeals erred in deciding the case based on the outdated common law.
“I take the position of not commenting on pending litigation,” Lumberton City Attorney James Bryan said. Instead, he provided the city’s filing, which advances the opposite claim of the businesses.
“When adopted in 1936, the Just and Equitable Tax Clause neither expanded nor created taxpayer challenges to the amount of taxation,” the city’s brief states.
“Several restrictive protections were conceived by the Constitutional Commission and implemented by the North Carolina General Assembly to replace judicial challenges,” the brief states. Those include the use of a gubernatorial veto, debt limit mechanisms, oversight by the General Assembly, and a popular vote to oust legislative members.
Since the constitutional amendment was adopted, “judicial review has been limited to distinctions between taxpayers and not the tax rate or amount,” the brief states.
“If the tax survives the challenge, it will really give government a new tool to regulate businesses that they don’t like,” said Adam Charnes, an attorney with Kilpatrick Townsend. That regulatory intent would be “an impermissible use of the tax power.”
Richard Dietz, also an attorney with Kilpatrick Townsend, said elements of the case extend to the seminal 1803 Marbury v. Madison case, in which U.S. Supreme Court Chief Justice John Marshall rendered “a principle that we now consider obvious, that the courts can overturn a legislative decision.” A case in North Carolina established a right of judicial review 16 years earlier.
Still, the city’s brief contends: “For the most part there is a dearth of cases on point for judicial challenges to tax amounts. This is because it has been long and firmly understood that there was no judicial challenge available.” Setting the amount of taxes has been reserved to the legislature, it says.
Jeanette Doran, executive director and general counsel of the North Carolina Institute of Constitutional Law, acknowledges the just and equitable tax clause has not been heavily litigated.
But since being added to the state constitution in 1936 “there have been at least three significant decisions that all address lawsuits that were based on the just and equitable clause,” Doran said. “It’s not as though the business owners down in Lumberton are trying to invent some new right.”
She soon expects to file an amicus brief supporting the business owners.
The safeguard of the constitutional clause “doesn’t mean everyone gets to have the exact same tax rate,” Doran said. “It means if we’re going to have different tax rates on different classifications, it needs to be reasonable.” She believes Lumberton failed that test.
“Everyone else in Lumberton pays business privilege taxes of no more than a few hundred dollars” and some get a privilege license for as little as $12.50, Doran said. Yet some sweepstakes operators are now charged as much as $137,500 “and the city doesn’t bother to explain anything about the reason for that.”
If the Court of Appeals decision stands, “then I think cities would have the green light to use the taxing authority to gouge McDonald’s for selling Happy Meals or gun shop owners for selling guns,” she said.
“If we allow the government to abuse the taxing power to injure the unpopular and unsavory, it is only a matter of time until the government will wield the taxing power on good and productive taxpayers and individuals,” Doran said. “We are right now at a time in our state and our nation where the taxing power is, frankly, being abused, and we need to stop it before the situation gets out of control.”
But the city’s brief contends the sweepstakes parlors failed to demonstrate “substantial evidence” that the tax amounts would harm their businesses.
In its amicus brief, the 540-member League of Municipalities states that Lumberton should be accorded “a high bar for demonstration of a constitutional violation” because courts traditionally provide great deference to “complicated, policy-laden, legislative-executive decisions involving resource allocations.”
The state constitution contains no “explicit limitation … pertaining to local taxes such as the property tax or the privilege license tax,” the brief argues, and the only specific constitutional cap is for the state income tax.
Attempts to reach league officials were unsuccessful.
In their filing, the Internet café lawyers contend that the court should not accept arguments by the city invoking claims that the court has no jurisdiction over the amount of taxes levied because the city did not present that argument in the lower courts. Thus, the city waived the right to that claim now.
For the same reason, the lawyers say, the city’s claim that the tax hikes were needed for its budget was not raised before now and must be rejected.
Indeed, in a separate case before the Supreme Court involving these businesses, attorney Lonnie Player said the city presented “no evidence of any kind” that it experienced higher costs for police, fire or other services, and the revenue from the tax was not even included in that year’s budget.
Dan E. Way is an associate editor of Carolina Journal.