Laws and rules must be established before they’re enforced. That’s a crucial component of American government.  

A recent filing at North Carolina’s highest court reminds us that legal and regulatory clarity also influence a state’s economic outlook.

In a case called NC Department of Revenue v. FSC II, state tax collectors and a private company dispute tax bills dating back a decade or more. The disagreement involves a former “mill machinery exemption” and its application to equipment that produces asphalt.

Most of us need not ponder the finer points of FSC’s arguments at the state Supreme Court. But we all can benefit from key ideas in an Aug. 2 friend-of-the-court brief from the NC Chamber Legal Institute.

“One fundamental rule-of-law principle requires that binding norms be formulated openly and in advance,” attorney William Nelson wrote. “When rules are ‘fixed and announced beforehand,’ citizens can ‘foresee with fair certainty how the [government] will use its coercive powers in given circumstances’ and ‘plan [their] affairs on the basis of this knowledge.’”

“The importance of this principle to economic growth is obvious,” Nelson added. “Players need to know the rules of the game before they roll the dice. When government agencies can exact penalties for the transgression of secret rules, even the most daring entrepreneurs will be reluctant to commit their capital into the future.”

“Making rules openly and in advance also ensures a measure of political accountability from agencies not subject to direct democratic control,” the brief continued.

Nelson argued that state Revenue Department officials attempted to enforce a “secret rule.” That rule blocked plaintiff FSC from taking a tax exemption.

“[A] taxpayer must satisfy two requirements to come within the mill machinery exemption. The taxpayer must be a ‘manufacturing industry or plant,’ and the items purchased must be ‘mill machinery.’ The Department does not contest that the items FSC purchased are ‘mill machinery’ but denies that FSC is a ‘manufacturing industry or plant,’” Nelson explained.

“The statutes do not define ‘manufacturing industry or plant,’ but this Court has held that a manufacturer is a person who converts raw materials into new products through skill and labor,” his brief continued.

“The Department does not dispute that FSC created a new product out of raw materials using skill and labor. That would seem to make FSC a manufacturer and bring this case to an end,” Nelson wrote. “However, the Department insists that to claim the exemption FSC must satisfy a third requirement not found in the statute: its primary purpose must be selling its manufactured products to third parties.”

“The Record in this case shows that the Department developed this primary purpose requirement internally,” he added. The state Administrative Procedure Act “expressly forbids the enforcement of such an unpromulgated rule.”

Nelson accused the Revenue Department of ignoring the law for adopting new rules.

“In this case, the Department is seeking to do exactly what the APA forbids,” Nelson argued. “It has formulated a ‘policy, guideline, or other interpretive statement,’ (i.e., the primary purpose requirement), which a taxpayer must satisfy to claim the mill machinery exemption. The Department is attempting to enforce this requirement against FSC without having complied with any of its … obligations.”

The “primary purpose requirement” should have been written ahead of time, reviewed by the state Rules Review Commission, and published in the North Carolina Register.

Few of us ever will take a tax exemption for mill machinery. The chamber brief explains why we still should care about this legal fight.

“In a globalized world where hundreds of jurisdictions compete for highly mobile capital, maintaining a dependable legal order is critical to the prosperity of our citizens,” Nelson wrote. “Economic competition is a serious and constant challenge. The hard work of many individuals and public and private institutions over many generations has produced economic and political conditions in North Carolina that are the envy of many jealous competitors.

“But this hard-won success must be defended every day,” he added. “A state agency’s short-sighted disregard of fundamental principles of fairness for the sake of a fleeting victory will not go unnoticed or unremarked upon by our sister states. If the Department is permitted to assess tax against a taxpayer for the violation of a rule it did not, and could not, know, a rule kept secret merely to skirt the mildly irksome requirements of APA rulemaking, North Carolina’s reputation as a safe destination for capital will be seriously impugned, and the people of this State will pay the price.”

Regardless of the outcome of FSC’s case, state leaders should take Nelson’s warning seriously.

Mitch Kokai is senior political analyst for the John Locke Foundation.