WASHINGTON -- The Supreme Court on Monday voted 7-2 to uphold the tax exemption states and localities give to in-state municipal bonds.
The ruling overturns a Kentucky appeals court holding that had said the practice violates the Constitution because it discriminates against out-of-state bonds. The outcome means the opinion will require no changes to the way the market for public municipal bonds operates.
Justice David Souter wrote the main opinion for the court. Seven justices supported the outcome of the case but they splintered over some of the reasoning. These differences of opinion are likely the reason the court took six months to rule.
"Kentucky's tax exemption favors a traditional government function without any differential treatment favoring local entities over substantially similar out-of-state interests," Mr. Souter wrote. "This type of law does not discriminate against interstate commerce."
The lawsuit began in 2003 when two Louisville residents, George and Catherine Davis, filed a class-action lawsuit against Kentucky, arguing it was wrong for the state to tax interest on their out-of-state bond investments while exempting in-state bond interest.
A trial judge ruled against them. But the Kentucky Court of Appeals reversed, ruling the state interest exemption violated the U.S. Constitution because the same break isn't extended to out-of-state bond products. The Kentucky Supreme Court in 2006 let the lower court ruling stand.
More than 40 states exempt interest on in-state municipal bonds from income taxes, creating what is a tremendous nationwide market for bond products carved up by state boundaries. According to the Bond Buyer/Thomson Financial 2007 Yearbook, state and local government bonds are increasingly popular, with $891 billion issued in 2005 and 2006 alone.
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