The Yale Law Journal


From the Court’s Docket: DaimlerChrysler Corp. v. Cuno and the European Experience

01 Sep 2006

Nearly every state uses tax incentives to attract local investment. Do such incentives discriminate against interstate commerce in violation of the dormant Commerce Clause? The Supreme Court now confronts this question in DaimlerChrysler Corp. v. Cuno (oral arguments on March 1). If the Court takes an expansive view of what constitutes discrimination against interstate commerce, its decision could reshape the state tax policy landscape. Europe has already moved in this direction, and the problems with its doctrine should make the Court hesitant to travel the same path.

The European Court of Justice (ECJ) has interpreted the freedoms guaranteed by the European Union’s governing treaties to prohibit member state tax policies that discriminate against commerce involving another member state. In scores of cases, the ECJ has invalidated tax provisions that favor domestic products over other EU products, domestic producers over other EU producers, and domestic production over production elsewhere in the EU. On the first two of these dimensions, the ECJ’s approach generally accords with prevailing international practice: Under international trade and tax treaties, countries agree not to discriminate against foreign products and foreign producers. Such treaties, however, still permit a country to favor domestic production over foreign production by its own taxpayers. The U.S. federal government, for example, can (and does) offer tax credits or depreciation allowances designed to stimulate domestic investment despite its international trade and tax treaty obligations.

Although Europe’s robust view of discrimination may appear innocuous, it suffers from at least two serious flaws. First, the ECJ has significantly constrained the fiscal autonomy of EU member states by making what are quintessentially legislative judgments. The ECJ’s preoccupation with nondiscrimination has pushed considerations of economic efficiency, fairness, and administrability to the margins. As a result, the ECJ has deprived EU member states of their ability to weigh important policy tradeoffs.

Second, attempting to root out tax discrimination in all its forms is ultimately a quest for an unattainable goal. Consider two basic principles of nondiscrimination: (1) all investment income should be taxed equally by the investor’s home jurisdiction, whether the investment is domestic or foreign; and (2) all investments within a jurisdiction should be taxed equally, whether the investor is domestic or foreign. Achieving both of these principles simultaneously is impossible as long as each jurisdiction retains the ability to establish its own tax bases and rates.

To date, the Supreme Court’s nondiscrimination doctrine is not as far-reaching as Europe’s. Moorman Manufacturing Co. v. Bair is a leading example of the Court’s reluctance to intervene in state tax policy choices. The Court in Moorman upheld Iowa’s policy for allocating corporate income solely on the basis of sales, despite claims that the state’s apportionment formula effectively subsidized Iowa manufacturers who sold goods outside the state. Invalidating the tax would have required the Court to find that Iowa’s apportionment formula deviated from a baseline formula that also included property and wages. Even though most states used a three-part formula, the Court refused to set a default baseline because that would have entailed “extensive judicial lawmaking” and would have encroached upon state policy prerogatives.

The Supreme Court may avoid the discrimination question in Cuno by reversing the Sixth Circuit Court of Appeals on standing grounds. If it does reach the merits, the Court should refuse to extend its nondiscrimination doctrine along European lines. Cuno involves an Ohio investment tax credit that was intended to lure DaimlerChrysler into expanding its production facilities in the state. The Sixth Circuit held that the tax credit impermissibly discriminated against out-of-state production. In fact, the Ohio investment credit is simply a less expensive way to do what the Moorman Court permitted: Rather than using an apportionment formula that avoids taxing all business assets located in the state, Ohio targeted only new investments. Furthermore, the Court has made it clear that it will permit states to use direct subsidies to encourage in-state production, so barring investment tax credits does little more than reduce the states’ policy discretion to select the means they will use to achieve an authorized end.

If the Court does decide that investment tax credits violate the dormant Commerce Clause, the issue will simply shift to Congress. Several bills have already been introduced that would explicitly permit the sort of credits that the Sixth Circuit struck down. The question at issue in Cuno is fundamentally one of policy, and the Court would do well to avoid stepping into the conundrum that exists under the ECJ’s decisions.

Read the full-length print version of Michael J. Graetz and Alvin C. Warren, Jr.'s forthcoming piece, Income Tax Discrimination and the Political and Economic Integration of Europe, in The Yale Law Journal.

Preferred Citation: Michael J. Graetz, Alvin C. Warren, Jr., & Robert Yablon, From the Court's Docket: DaimlerChrysler Corp. v. Cuno and the European Experience, Yale L.J. (The Pocket Part), Mar. 2006,