Tax Incentives For Burning Local Coal

Tax Incentives For Burning Local Coal

February 01, 2001

State tax credits to electricity generators for burning local coal may be unconstitutional because they favor in-state coal producers to out-of-state ones.

Other state tax or regulatory schemes that discriminate against out-of-state businesses - for example, higher disposal fees on solid waste from other states or a requirement that utilities use a minimum amount of in-state coal - may also be unconstitutional for the same reason.

State Tax Credits

At least seven states currently give tax credits for burning in-state coal: Arizona, Kentucky, Maryland, Ohio, Oklahoma, Virginia and West Virginia. Alabama and Utah are considering similar incentives. Washington’s incentive - a sales tax exemption for generators that use 70% or more in-state coal - was dropped after a lawsuit by coal companies in Wyoming and Montana.

Under these schemes, the states usually give tax credits to generators to offset their overall tax liabilities if they burn coal produced in-state rather than coal purchased from out-of-state producers. The amount of the credit ranges from $1 to $3 per ton of in-state coal burned. Other forms of incentives also exist. For instance, Arizona gives tax credits in an amount equal to 30% of the sales tax paid on the purchase of the in-state coal. In Kentucky, the credit is available only for Kentucky coal burned in excess of a base amount. These credits are nonrefundable.

US Constitution

The commerce clause of the US Constitution grants Congress the power to “regulate commerce . . . among the several States . . . .”

From this clause, the courts have drawn both a positive and a negative implication. Positively, the clause means Congress has the power to enact laws governing interstate commerce and such laws trump conflicting state laws. Negatively, the clause means a state may not enact laws designed to benefit in-state economic interests by burdening out-of-state entities. If a state law affecting interstate commerce benefits in-state entities at the expense of the out-of-state competitors, that law violates the negative implication of the commerce clause and may be unconstitutional.

A state law can affect interstate commerce in at least two ways. It may discriminate overtly against out-of-state entities by giving economic benefits only to in-state entities or imposing economic burdens only on out-of-state entities. Alternatively, the burden on out-of-state entities may simply be a side effect of trying to carry out another objective.

In Philadelphia v. New Jersey, the US Supreme Court said, “where simple economic protectionism is effected by state legislation, a virtually per se rule of invalidity has been erected.” In that case, a New Jersey statute prohibiting importation of most solid or liquid waste originating outside New Jersey was held unconstitutional.

In subsequent cases, the Supreme Court struck down all but one state law that conferred benefits only on in-state entities or imposed burdens only on out-of-state entities. For instance, the Supreme Court struck down an Oregon statute that imposed an additional fee on solid waste generated out-of-state and brought into Oregon for disposal. It struck down a North Carolina intangibles tax on corporate stock owned by its residents, whose amount was reduced in proportion to the level of business activity the corporation was engaged in business in North Carolina. It struck down a New York local ordinance requiring that all solid waste generated in that locality be processed by a local recycling plant.

Only once has a state law that discriminated on its face been upheld. In Maine v. Taylor, the Supreme Court examined a Maine statute that prohibited any importation of live baitfish into Maine. Maine argued such a measure was necessary because it needed to protect Maine’s wild fish from being placed at risk by certain parasites prevalent in out-of-state baitfish, but not common to wild fish in Maine. Maine also argued non-native species inadvertently included in shipments of live baitfish could disturb Maine’s aquatic ecology significantly. The Supreme Court upheld Maine’s legislation, explaining the interests Maine attempted to protect were legitimate and there was no physical alternative to the total ban that would protect Maine’s interests.

Even if a state law does not discriminate against out-of-state entities on its face, it may burden out-of-state entities as a side effect of trying to do something else. Such laws are more likely to be upheld. However, the state must show the harm done to interstate commerce is outweighed by the larger goal the statute is trying to serve.

In Pike v. Bruce Church, Inc., the Supreme Court said “where the statute regulates even-handedly to effectuate a legitimate local public interest, and its effects on interstate commerce are only incidental, it will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits.” In that case, the Supreme Court struck down an Arizona law that prohibited Arizona producers of cantaloupes from exporting the cantaloupes to out-of-state entities unless their packaging complied with Arizona regulations. The Supreme Court explained the benefit to Arizona — preserving the reputation of Arizona growers by prohibiting deceptive packaging — was not important enough to justify the effective requirement that certain Arizona producers build and operate packaging plants in Arizona to comply with state regulations.

Implications

Because most state tax credits for burning in-state coal discriminate overtly against out-of-state coal producers, they are almost certainly unconstitutional.

The Supreme Court has struck down similar measures as unconstitutional. For instance, in Wyoming v. Oklahoma, the Supreme Court struck down an Oklahoma statute that required coal-fired electric utilities to burn a mixture containing at least 10% Oklahoma-mined coal. This law unconstitutionally “reserve[d] a segment of the Oklahoma coal market for Oklahoma-mined coal, to the exclusion of coal mined in other States. Such a preference for coal from domestic sources cannot be characterized as anything other than protectionist and discriminatory, for the [Oklahoma statute] purports to exclude coal mined in other States solely on its origin.”

State tax or regulatory measures that deal with solid waste disposal or other types of state level taxes may also be problematic. So long as they impose a greater economic burden on out-of-state entities than they do on in-state entities, those measures are susceptible to constitutional challenges.