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"This potential revenue raiser is the only one that entails a constitutional entanglement with the 10th Amendment," said Michael Cullers, a partner at Squire Patton Boggs. Cullers wrote a March 27 article outlining potential constitutional questions on the firm's
"At minimum, members of Congress should be thinking about that potential outcome and wondering if they should be looking at other sources of revenue to offset the cost of TCJA," Cullers said.
The article comes as municipal market participants remain on edge over potential efforts to trim or eliminate tax-exempt bonds. Cullers is not the only attorney questioning congressional authority to kill tax-exempt state and local government bonds, said Johnny Hutchinson, a partner at Nixon Peabody LLP. Hutchinson phoned Cullers after reading his piece and said other public finance lawyers are pondering the issue.
Cullers' article traces U.S. Supreme Court precedent around the 10th Amendment, which outlines the principle of federalism, in the wake of South Carolina v. Baker. That 1988 decision ruled that the federal government had the right to prohibit states from issuing tax-exempt bearer bonds. But that's not the end of the story, Cullers argued, and court opinions, dissents and interpretations that culminated in Murphy v. National Collegiate Athletic Association may point to a path more favorable to states' rights.
Eliminating the tax exemption on municipal bonds would drive up borrowing costs for states and local governments, which in effect would be an "indirect requisition" of the states, which is prohibited by the 10th Amendment, said Cullers. He said the argument had been "percolating" in his mind for the last few months as the debate over the tax exemption heated up.
"It started to crystallize more when I remembered the Murphy decision," he said, referring to Murphy v. National Collegiate Athletic Association, another 10th Amendment case that led to the 2018 ruling allowing states to launch sports gambling. The case prompted the title of Cullers' blog: "What are the Odds that FanDuelDraftKingsBest365 Can Save Tax-Exempt Bonds?"
The "durable" line of Tenth Amendment precedent "should give one pause before concluding that Congress can completely repeal the ability of state and local governments to issue tax-exempt bonds," Cullers wrote in the blog.
The current SCOTUS makeup, which includes only two new members since the Murphy decision, may also be favorable for states, Cullers said. "I think it's not unlikely that they would hold that a complete prohibition on the issuance of tax-exempt bonds is in effect a requisition of the states," he said.
If Congress did move to eliminate tax-exempt municipal bonds, states would be allowed to bypass the lower courts and bring the issue directly to the nation's top court, Cullers added.
Hutchinson said lawmakers are treating the tax exemption like a simple piggy bank that they can smash open to offset the cost of extending the TCJA.
"But this isn't just a piggy bank — there are serious fundamental constitutional issues that are going to need to get to be worked out," Hutchinson said.
Unlike other potential revenue raisers, the elimination of the tax exemption raises "legal issues that get down to the fundamental bedrock of the way our system of government is set up," he said.
Hutchinson added that he thinks it's likely states would sue if Congress acted.
"There are some big issuers for whom this is a huge issue of cost and a lot of dollars are involved, and even more importantly, some of the smaller issuers could be totally locked out of the market," he said. "I think it's very likely that that kind of an enactment [eliminating the tax exemption] would be significant enough that it would trigger some litigation."
