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The Tax Injunction Act requires federal courts to determine whether the state levy under consideration is a tax or a fee, which in turn will determine whether the court has jurisdiction to proceed. The Supreme Court, which has never addressed the issue, now has before it the opportunity to lay the matter to rest in Hegar.

The Difference Between a Tax and a Fee

The TIA was passed in 1937, yet federal courts continue to wrestle with the threshold jurisdictional question of whether a disputed state exaction is a tax or a fee.

The Court has visited the TIA issue many times, including in holdings that the TIA bars federal court jurisdiction when the state has afforded taxpayers a “plain, speedy and efficient remedy”; over state tax suits in which the plaintiff seeks damages under section 1983; and in suits for declaratory relief in state tax cases.

However, the Court has never provided guidance on the characteristics of a state exaction that render it a tax or a fee.

Lacking direction, it’s not surprising that federal circuit courts have been left floundering on the question. The circuits appear to have embraced the concept articulated in San Juan Cellular that taxes and fees lie on a spectrum, with the paradigmatic tax at one end and the paradigmatic fee at the other.

The concept may be clear, but the murkiness lies in alchemizing it into a workable formula that distinguishes between the two, especially for state levies that carry the characteristics of a tax and a fee.

Fees are regulatory measures that are intended to raise revenue but may also act as a deterrent to engaging in a particular activity deemed undesirable. The revenue from such fees is usually deposited into a special fund, the moneys used to counteract the negative externalities that result from the activity. Yet taxes can do the same.

The classic example is the tobacco tax. The tax raises revenue while aiming to discourage tobacco use; like fees, tobacco tax revenues are usually deposited into a special fund and are used to defray the costs of addressing the societal harms resulting from tobacco use. Levies like these, falling somewhere between the two paradigmatic points, are the problems the circuits have had to address.

All have devised a solution; unfortunately, they’re not the same solution. For example, the Ninth Circuit has fashioned a three-factor test to distinguish taxes from fees, making inquiry into: (1) the entity that levies the charge; (2) the parties upon whom the charge is levied; and (3) the manner in which the revenue is ultimately used.

The Second, Third, Seventh, and Tenth circuits look to the primary purpose of the charge — that is, whether its primary purpose is to raise revenue; if so, the measure is deemed to be a tax. Other solutions look to whether the levy raises money for public use without providing the payors a corresponding benefit, and whether the money is not used to defray administrative costs.

Thus, the different tests used by the appellate courts mean that the resolution of the tax-vs.-fee question could depend on the circuit in which the suit was brought.

Hegar: Tax or Fee?

Texas imposes a sexually oriented business fee (SOBF), a $5-per-customer charge payable by adult entertainment venues featuring nude dancing and serving alcohol. The fees are deposited into a special fund dedicated to programs for the prevention of sexual assault.

At the outset of its opinion, the appellate court noted that its precedent has established a three-part framework for distinguishing whether a state or local exaction should be classified as a tax or a fee.

First, if the levy “sustains the essential flow of revenue to the government,” it is a tax; if the levy “is linked to some regulatory scheme,” it is a fee. Second, if the levy “is imposed by a state or municipal legislature,” it is a tax; if “imposed by an agency upon those it regulates,” it is a fee. Third, if the levy “is designed to provide a benefit for the entire community,” it is a tax; if the levy “is designed to raise money to help defray an agency’s regulatory expenses,” it is a fee.

The Fifth Circuit had no difficulty in finding that the SOBF was a fee. Although it acknowledged that the levy was created by the Legislature rather than an agency, which pushes it closer to a tax, the appellate court did not find this fact to be dispositive.

It pointed out that the Legislature labeled the imposition a fee, and while conceding that the label a Legislature uses to designate an exaction is also not dispositive of its nature, “the statutory text actually chosen by the Legislature is the best yardstick of the Legislature’s intent.”

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In addition, the levy was imposed on a narrow class of persons: The proprietors of adult entertainment venues that serve alcohol. Such proprietors could escape the levy simply by refraining from serving alcohol, and moreover, most of the public at large is not affected by the levy.

Finally, the appellate court concluded that the exaction was regulatory in nature because it deliberately raises the costs for businesses that provide the type of entertainment targeted by the SOBF, and the revenue is designated for a specific program, not for the general fund.

Supreme Court: It’s Your Move

Assuming the Court grants Texas’s petition, it has a few options to resolve the tax-vs.-fee debate. It could analyze the various tests developed by the circuits and pick the one it deems to work best. Or it could distill the various tests to their essence and craft a new one.

In researching this article, I discovered a third course the Court might take to simplify matters by focusing on the exaction’s legislative label. That solution isn’t as absurd as it sounds, given that the Court did that very thing in NFIB, when it was called on to decide whether the individual mandate imposed on persons who chose not to purchase health insurance under the Affordable Care Act was a tax — and therefore subject to the restrictions of the Anti-Injunction Act — or a penalty.

Although the AIA was at issue in NFIB, the Court in Hibbs found both statutes evinced Congress’s intent that they serve the same purpose: to respond to the federal and state governments’ “need to assess and collect tax as expeditiously as possible with a minimum of pre-enforcement judicial interference” and that “the legal right to the disputed sums be determined in a suit for refund.” Thus, there is no reason the NFIB Court’s reasoning and holding should not equally apply to suits involving the TIA.

In determining whether the individual mandate was a tax or a penalty, the NFIB Court said the fact that Congress chose to call it a penalty is significant because elsewhere the ACA makes specific reference to taxes. When Congress chooses to use different terms in separate parts of the same statute, the Court explained, “it is generally presumed that Congress acts intentionally.”

It is true that Congress cannot constitutionally expand its power by labeling, for example, a severe financial penalty as a tax to escape the constraints of the double jeopardy clause. However, the Court said, the AIA and the ACA are both congressional enactments, and how they relate to one another is up to Congress.

The best way to discern congressional intent, the Court explained, is by looking to the statutory text. For support, the Court pointed to IRC section 6671(a), which states that wherever the term “tax” appears in title 26, it also refers to the penalties and liabilities provided by IRC subchapter 68B. Yet the individual mandate does not appear in subchapter 68B, the Court said, and no other ACA provision provides that references to “taxes” in title 26 also apply to the individual mandate.

Further, that the ACA directs the Treasury secretary to assess and collect the penalty in the same manner as it assesses and collects taxes does not implicate the AIA, the Court said, explaining that the provision merely gives the secretary the same authority and guidance she must assess and collect other taxes as specified elsewhere in the IRC.

In sum, Congress meant the individual mandate to be a penalty and not a tax because it said the mandate was a penalty, no matter that it appears in the IRC and is administered by the IRS.

Should the Court follow NFIB, the concern is that state and local lawmakers will simply label every exaction a tax or, to apply the label to nontraditional categories, perhaps by enacting a “tax” on protest rallies to get around the TIA.

These concerns are well founded. However, such abuses will inevitably be blunted by federal and state constitutional limitations. In addition, the political consequences to lawmakers for enacting new taxes cannot be ignored. American voters are notoriously tax averse; that is, they harbor “a dislike of taxes per se that goes above and beyond any associated costs.”

In a 2005 study, researchers found that in general, subjects reacted less favorably to levies that were called taxes than to those that were called payments or fees, even though the economics for both were the same. Levies that were already paid for through taxes, such as fire and education, were favorably viewed. However, user fees were preferred for services for which no taxes were in place.

Even more striking, a 2011 study found that subjects were willing to wait longer in line to purchase a store item that promised a 9% tax discount than a 9% nontax, “customer rewards” discount. The same study further showed that subjects were willing to travel 30 minutes to a store in a different jurisdiction to receive an 8% tax-related discount than they were to travel 30 minutes to the same store to receive a 9% discount unrelated to tax.

These studies suggest that state and local government lawmakers would face a political backlash not only for imposing new taxes, but also for statutorily relabeling fees as taxes.

Conclusion

Distinguishing taxes and fees for purposes of the TIA is a question that has bedeviled the lower federal courts for decades, resulting in inconsistent methodologies for distinguishing one from the other.

The Supreme Court, however, has never addressed the issue. A case pending before the Court has the potential to resolve the question.

Should the Court grant the certiorari petition, single test would surely be welcome to the federal jurists who constantly struggle with this important jurisdictional issue.

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