Although departing Supreme Court Justice Sandra Day OConnor has been famous for being a frequent swing voter on high-profile cases involving social issues, she may stand out most in the memories of municipal market participants for the blistering dissent she wrote in a landmark 1988 decision that held that Congress was free to tax municipal bonds if it so desired.
OConnors lone defense of the tax-exempt market had been almost forgotten by many in the market until last Friday, when the 75-year-old jurist announced her resignation after 24 years of service on the high court, conditional on her successor being sworn in. President Bush has not yet indicated whom he intends to nominate for the post, but has said he wants the new justice in place when the court begins its new session in October.
In South Carolina v. Baker, OConnor stood alone in defending the constitutionally protected tax-exempt status of municipal bonds that municipal market participants had relied on for almost a century.
In an opinion written by Justice William J. Brennan, the court overturned the 1895 decision, Pollock v. Farmers Loan & Trust Co., which gave constitutional protection to the tax exemption for municipal bonds. When the Pollock case was decided, the doctrine of intergovernmental, or reciprocal, tax immunity a legal theory that the federal government may not tax the debt of states and local governments, and vice versa prevailed.
South Carolina v. Baker came to the court after Congress passed the Tax Equity and Fiscal Responsibility Act of 1982. In the law, section 310(b)(1) removed the federal tax exemption for interest on long-term bonds issued by states and localities unless those bonds were issued in registered form. As Brennan noted in his opinion, federal lawmakers had become concerned about the growing magnitude of tax evasion, and the statute was enacted in an effort to promote compliance with tax laws and thereby boost federal revenue in order to rein in the growing federal deficit.
The court held 7 to 1 that the federal imposition of a bond registration requirement on states did not violate the 10th Amendment because the tax that TEFRA authorized was nondiscriminatory and did not violate the intergovernmental tax immunity doctrine. Section 310 of the law clearly imposes no direct tax on the states, he wrote. The tax is imposed on and collected from bondholders, not states, Brennan wrote.
The First Congress included the 10th Amendment, also known as the Reserved Powers Amendment, in the Bill of Rights to prevent the federal government from exercising powers not specifically provided to it by the Constitution.
But OConnor, a former Senate majority leader in the Arizona Legislature, balked at Brennans reasoning, and sided with the government of the Palmetto State, which had challenged TEFRA.
The court today overrules a precedent that it has honored for nearly 100 years and expresses a willingness to cancel the constitutional immunity that traditionally has shielded the interest paid on state and local bonds from federal taxation, OConnor wrote. TEFRA constituted Congress attempt to regulate the sovereign states by threatening to deprive them of this tax immunity, which would increase their dependence on the national government, she added.
OConnor also accused the court majority of avoiding the issue of whether federal taxation of state and local bond interest actually violated the Constitution. She chided her fellow justices for characterizing the federal tax exemption as a mere aspect of the immunity doctrine, which the majority noted had already been in decline over the preceding century.
Federal taxation of state activities is inherently a threat to state sovereignty If this court is the states sole protector against the threat of crushing taxation, it must take seriously its responsibility to sit in judgment of federal tax initiatives, she wrote.
OConnors strongly worded dissent was a breath of fresh air for the municipal bond industry, which had become accustomed to potential threats emanating from the nations capital at that time, said Christopher Taylor, executive director of the Municipal Securities Rulemaking Board.
There was a hue and cry during the Reagan era for an absolute flat tax, he said.
For example, on March 19, 1986, then-Sen. Bob Packwood, R-Ore., chairman of the Senate Finance Committee, sent shock waves through the market when he introduced legislation that would have made tax-exempt bonds taxable. As news of the proposal spread, municipal bond operations came to a standstill as traders and underwriters canceled deals over fears that the proposed tax would be imposed. Under the plan, which Packwood later abandoned, all tax-exempt interest would have been made subject to a 20% alternative minimum tax over a five-year phase-in period.
There was a great deal of concern among municipal market participants at that time, Taylor said.
Frank Shafroth, director of intergovernmental relations for Arlington County, Va., yesterday said OConnor was a guarantor of federalism on the court in the TEFRA case and others.
He added that OConnors specific expertise in public finance would be missed.
How many judges on the Supreme Court know what arbitrage and rebates are? She did, so this is almost an irreplaceable loss, said Shafroth, who is also an adjunct professor of public budgeting and public policy at George Mason University.
OConnor sided with the majority in McConnell v. Federal Election Commission in 2003, in which the court upheld provisions of a law banning national parties from raising funds through unregulated soft money contributions and like the anti-pay-to-play rule in the muni market strongly supported restricting certain campaign finance practices to avoid even the appearance of political corruption.
Neither the law formally titled the Bipartisan Campaign Reform Act but often called the McCain-Feingold law after sponsors Sen. John McCain, R-Ariz., and Sen. Russ Feingold, D-Wis. nor the high courts majority opinion directly affects the Municipal Securities Rulemaking Boards Rule G-37, but the court decision provided ammunition for G-37 supporters. In 2003, the rule was still coming under heavy fire from some market groups, which had asked the MSRB to loosen the rule.
In the 5-4 majority opinion written by OConnor and Justice John Paul Stevens, the high court said: The question for present purposes is whether large soft-money contributions to national party committees have a corrupting influence or give rise to the appearance of corruption. Both common sense and ample record ... confirm Congress belief that they do.
The justices wrote that the soft money ban did not violate First Amendment free-speech rights and was needed to prevent both corruption and the appearance of it.
Reflecting on the December 2003 decision a year and a half later, MSRBs Taylor said the ruling in the McConnell case upheld the basic thrust of G-37 and goes a long way toward proving the constitutionality of the MSRB regulation. The decision addressed the idea that the perception of a conflict of interest is as significant a problem as the actual conflict of interest, Taylor said.
Constitutional scholars consider OConnor to be a reliable supporter of states rights, but when state authority and property rights came into conflict in a recent eminent domain case, she sided with property owners.
Last month, OConnor was in the minority in Kelo v. New London, Conn., a pivotal case in which the Supreme Court ruled that New London was entitled under a Connecticut law to expropriate private land in order to allow private redevelopment of blighted areas.
The case had been of intense interest to cash-strapped localities that want to condemn land in order to clear the way for redevelopment projects that promise, but do not guarantee, jobs and increased tax revenue. Municipal debt is often used in redevelopment packages so any modification of eminent domain criteria is of interest to the muni market.
In a stinging dissent June 23, OConnor sided with the affected homeowners, writing that the court abandoned a long-held, basic limitation on government power.
Under the banner of economic development, all private property is now vulnerable to being taken and transferred to another private owner, so long as it might be upgraded i.e., given to an owner who will use it in a way that the legislature deems more beneficial to the public in the process, OConnor wrote. The specter of condemnation hangs over all property Nothing is to prevent the state from replacing any Motel 6 with a Ritz-Carlton, any home with a shopping mall, or any farm with a factory.
OConnor also made history in the Kelo case. When the court heard oral arguments Feb. 22, Chief Justice William Rehnquist, who is fighting cancer, and Justice Stevens, who missed a flight to Washington, were both absent, so OConnor became the first woman ever to preside over oral arguments in the Supreme Court.
