A federal appeals court yesterday ruled that economic development incentives given by the State of Ohio to automobile manufacturer DaimlerChrysler violated the interstate Commerce Clause of the United States Constitution.
A three-judge panel of the U.S. Sixth District Court of Appeals unanimously overturned a significant part of a district court’s judgment, which had found that $280 million in state corporate franchise tax credits complied with the Commerce Clause.
Likening the case to previous Supreme Court decisions, the panel determined that Ohio’s investment tax credit “is to encourage further investment in-state at the expense of development in other states, and the result is to hinder free trade among the states.”
Legal minds were reluctant to say that the decision, if upheld under further expected court challenges, would affect all state incentives programs.
“I think it’s a first step in the right direction,” said Robert Orr, a former state Supreme Court justice who leads the recently formed North Carolina Institute for Constitutional Law. “I think this is an emerging area with the use of the Commerce Clause to selectively challenge certain types of incentives.”
The institute is considering state constitutional challenges to North Carolina’s incentives programs.
In 1998 DaimlerChrysler agreed with Ohio and the City of Toledo to build a Jeep assembly plant near an existing facility in exchange for incentives, which included a 10-year, 100 percent property tax exemption and a tax credit of 13.5 percent against the state corporate franchise tax for certain investments. The total value of the tax incentives – usable against purchases of new manufacturing machinery and equipment installed in the state — was estimated at $280 million.
Two years later a lawsuit was filed against the city, state, and DaimlerChrysler over the constitutionality of the incentives, based on the Commerce Clause. Plaintiffs in Cuno v. DaimlerChrysler included two Michigan residents, because the company’s alternative to expanding in Ohio was building a new plant across the state line.
“According to plaintiff counsel Peter Enrich, the Commerce Clause was designed to prohibit state regulation and tax policy from interfering with economic activity between the states,” wrote Michael LaFaive and Jeffery Weeden of the Mackinac Center for Public Policy, in a report titled “Are Targeted Incentives Constitutional.” “For example, one state may not raise barriers to competition with another state in order to protect its own interests.”
But Enrich argued that the clause applies when states utilize their taxing power to discriminate against companies based on where they build or develop their facilities.
“In other words,” wrote LaFaive and Weeden, “when one state provides financial incentives to a business to build or expand a facility within its borders, and those incentives make the investment less costly than it would otherwise be if it were invested in another state, the incentive is unconstitutional.”
While the district court ruled against the plaintiffs, the appeals panel agreed that basing incentives on where businesses invest violates the Constitution.
“This case reminds us that the interstate Commerce Clause is there for a reason,” said State Rep. Paul Stam, a Wake County Republican and an attorney who mostly opposes targeted incentives. “Everyone is more prosperous if we have a common economic market where we don’t reward some businesses and punish others because of their location, or their ability to curry favor from politicians.”
Without thoroughly reviewing the decision, Stam couldn’t immediately determine what, if any, of North Carolina’s tax incentives programs might be affected. He said that a cigarette export tax credit passed in a special legislative session last December, which requires shipping out of state ports in order to earn the break, “might run afoul” of the Commerce Clause.
Because so much is at stake, Enrich told Carolina Journal that he expects the defendants’ attorneys to request arguments to be heard before the full 6th Circuit Court of Appeals. The panel ruling requires that the incentives to be ceased immediately, so DaimlerChrysler’s lawyers could request a stay of the panel decision pending an appeal. The Cuno plaintiffs did not seek retroactive payback of incentives already disbursed.
The Cuno lawyers also challenged property tax abatement incentives, but the appeals panel found that those complied with the Commerce Clause. The judges also ruled that the challenged tax incentives did not violate the Equal Protection Clause of the Ohio Constitution.
Orr said the fact that a federal court found the incentives illegal was a significant development. He said the most common argument from state politicians in favor of targeted economic incentives is that “everybody is doing it,” therefore they can’t let their own state be at a competitive disadvantage.
“I think what you’ll now see is that there is a successful legal theory under the Commerce Clause, so you can go into federal court and not impact just one state’s program, but come out with a decision that impacts all 50 states, and therefore no one state is at a disadvantage,” he said.
“I do think it’s an extraordinarily important decision.”
Paul Chesser is associate editor of Carolina Journal. Contact him at [email protected].