RALEIGH — Following through on a threat made three months ago, the nation’s two major providers of satellite television service — DirectTV and EchoStar, which owns Dish Network — have filed a lawsuit challenging the constitutionality of North Carolina’s recently enacted five-percent sales tax on satellite service. The companies say the tax violates the federal constitution’s interstate commerce clause.
They may be right, though the issue is hardly a slam dunk. Perhaps the best thing they have going for them is that North Carolina has a history of defending its tax laws against constitutional challenges. It tends to lose.
When North Carolina policymakers imposed the tax last year, as part of a budget-balancing package (insert snicker), they relied on the advice of counsel that they were merely “closing a loophole” and “ensuring tax fairness.” For years, local governments have charged franchise taxes on cable television firms, just as they have on other utilities with significant physical infrastructure, such as telephone companies. Because these costs were inevitably passed along to customers in their monthly bills, lawmakers were advised — by the cable companies, among others — that this constituted an unfair advantage for the satellite-TV firms competing for those customers, whose services weren’t subject to the same tax.
Gov. Mike Easley and the General Assembly were strongly attracted to this line of reasoning. For one thing, “fixing” the problem would fortuitously result in millions of additional revenue for the state government. Secondly, the cable industry is a major player in state politics, wielding significant lobbying and fundraising heft. Why not make the cable folks happy and find a few extra dollars to help themselves squirm out of the state-budget fix? they thought.
Why not, indeed?
Because the tax-fairness argument was only superficially plausible. The franchise tax is a local one, and bears a close relationship to the cost that a major utility imposes on governments. With lines stretching along roadways and then into many homes and businesses, cable systems consume public right-of-way and create service needs that satellite-television enterprises do not. Basically, say the latter, the franchise tax on cable isn’t really a tax at all. It’s a fee for services rendered, comparable to a charge for water and sewer service or a fee to use public lands.
Meanwhile, there are very real constitutional problems associated with levying a tax that appears to favor one type of competitor over another in a similar line of business, particularly if the favoritism also has the effect of creating an advantage for a locally based company or subsidiary over an out-of-state one. (You can read the legal claims of the satellite industry here, which involve a similar challenge in Ohio and the work of two top-drawer law firms specializing in tax matters.)
This kind of discrimination is precisely how North Carolina has gotten into legal trouble before. One of the costly losses that then-Attorney Gen. Mike Easley had in court in the 1990s involved the state’s levying of an intangibles tax that hit stockholders of out-of-state companies harder than those of in-state companies. On its face a violation of the interstate-commerce clause, the tax eventually fell prey to exactly such a challenge in court. North Carolina was compelled to refund hundreds of millions of dollars in revenues collected under the illegal tax. Now, DirectTV and Dish are hoping for a similar verdict, though the amount to be refunded would be far smaller.
I don’t pretend to know how this will turn out. I find the satellite industry’s argument persuasive, but I don’t know how courts have previously treated local franchise taxes on utilities using the public right-of-way. If they are treated as merely levies for general revenue, like property or sales tax are, then the state may have a good defense. But if they are considered exceptional, levied as a charge for use of public property and for related services rendered, then the lawsuit would likely succeed on constitutional grounds.
If the second is true, and North Carolina once again finds itself losing a major tax case, it might be worth rethinking the process of legislating tax changes. Do state lawmakers get adequate legal advice from knowledgeable and independent sources? And who should pay the subsequent and exorbitant legal bills when they don’t?
Hood is president of the John Locke Foundation and publisher of Carolina Journal.