State Investment Tax Credits, the Commerce Clause, and Cuno v. DaimlerChrysler

CRS Report for Congress
State Investment Tax Credits, the Commerce
Clause, and DaimlerChrysler v. Cuno
Erika Lunder
Legislative Attorney
American Law Division
Summary
In 2005, the Sixth Circuit Court of Appeals held in Cuno v. DaimlerChrsyler that
Ohio’s investment tax credit violated the Commerce Clause of the U.S. Constitution.
The case received significant attention because most states have similar credits. In
2006, the Supreme Court held that the Cuno plaintiffs lacked standing to challenge the
credit in federal court. Because the Supreme Court based its decision on the issue of
standing, it did not address whether the credit violated the Commerce Clause.
Introduced prior to the Supreme Court’s decision, the Economic Development Act of
2005 (H.R. 2471 and S. 1066) would authorize states to offer tax incentives similar to
Ohio’s investment tax credit.
Like most states, Ohio provides various tax incentives to encourage businesses to
locate or expand operations in the state. In 1998, DaimlerChrysler agreed to construct a
new assembly plant in Ohio in exchange for various benefits, which were valued at $280
million. One benefit the company was qualified to receive because of the plant
construction was Ohio’s investment tax credit. This credit was a non-refundable credit
against the state’s corporate franchise tax for taxpayers who purchased new¹
manufacturing machinery and equipment and installed it in the state. Taxpayers from
Ohio and Michigan then brought suit against DaimlerChrysler, Ohio, and several other
defendants, alleging, among other things, that the investment tax credit violated the
Commerce Clause of the U.S. Constitution.² As discussed below, the U.S. district court
held that the credit was constitutional, whereas the Sixth Circuit Court of Appeals held
the opposite. In 2006, the Supreme Court ordered the case be dismissed because the
plaintiffs lacked standing to bring suit in federal court.

¹ Ohio Rev. Code Ann. § 5733.33. In 2005, Ohio significantly reformed its corporate tax system
and has eliminated the credit for taxable years ending on or after July 1, 2005.
² The plaintiffs’ other claims included an allegation that a property tax exemption provided to
DaimlerChrysler by an Ohio municipality and authorized under Ohio law violated the Commerce
Clause. Both the U.S. district court and Sixth Circuit Court of Appeals held that the property tax
exemption did not violate the Commerce Clause, and the issue will not be discussed in this report.
Congressional Research Service ˜ The Library of Congress

Commerce Clause
The Commerce Clause grants Congress the power to regulate interstate commerce.
Congress’s authority to regulate interstate commerce has been described as plenary and
limited only by other constitutional provisions.³ On the flip side of the issue, the Supreme
Court has long held that the states may not unduly burden interstate commerce in the
absence of federal regulation. This restriction is founded in what is referred to as the
dormant Commerce Clause. A state tax provision does not violate the dormant
Commerce Clause if four qualifications are met: (1) the activity taxed has a substantial
nexus with the state, (2) the tax is fairly apportioned to reflect the degree of activity that
occurs within the state, (3) the tax does not discriminate against interstate commerce, and
(4) the tax is fairly related to benefits provided by the state.⁴
In the Cuno case, the only issue with respect to the Commerce Clause was whether
the tax incentive was discriminatory. There is no simple definition of the term
“discriminatory.” Instead, the Supreme Court has provided general principles, which are
then applied to the specific tax at issue. For example, the Court has declared that a
“fundamental principle” of the Commerce Clause is that states may not “impose a tax
which discriminates against interstate commerce . . . by providing a direct commercial
advantage to local business.”⁵ Another general rule is that a state may use its tax system
to encourage intrastate commerce and may compete with other states for interstate
commerce so long as the state does not “discriminatorily tax the products manufactured
or the business operations performed in any other [s]tate.”⁶
The Supreme Court has not addressed whether an investment tax credit similar to the
one at issue in Cuno is discriminatory. Thus, the district court and court of appeals were
left to look at the general principles found in the Court’s decisions and analogize the Ohio
credit to the tax credits in the prior cases. As shown by the opposite outcomes of the two
lower courts (discussed below), it is possible to come to different conclusions about the
meaning of the Supreme Court’s prior cases. The decisions by the district court and court
of appeals broadly represent two viewpoints of the Court’s jurisprudence.⁷ The district
court’s decision represents the idea that the purpose of the Commerce Clause is to prevent
economic protectionism by the states (i.e., to prevent states from helping in-state
businesses by penalizing out-of-state businesses). The court of appeals’ decision
represents the view that the Clause’s purpose is to encourage free trade by limiting the
state’s ability to use its taxing power to coerce taxpayers into conducting business in that
state. As seen in the two opinions, there is support in the Supreme Court’s prior decisions
for both interpretations. The Supreme Court, in holding that the plaintiffs lacked standing

³ See e.g., Prudential Insurance Co. v. Benjamin, 328 U.S. 408, 434 (1946).
⁴ See Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977).
⁵ Boston Stock Exchange v. State Tax Comm’n, 429 U.S. 318, 329 (1977).
⁶ Id. at 336-37.
⁷ See e.g., Peter D. Enrich, Saving the States From Themselves: Commerce Clause Constraints
on State Tax Incentives for Business, 110 H^ARV.L.R^EV. 377 (1996); Clayton P. Gillette,
Business Incentives, Interstate Competition, and the Commerce Clause, 82 M^IN^N.L.R^EV. 447
(1997); testimony from a hearing on the Cuno case held by subcommittees of the House Judiciary
Committee on May 24, 2005, available at [http://judiciary.house.gov/Oversight.aspx?ID=164].

to bring suit in federal court, did not address whether the tax credit violated the
Commerce Clause.
Cuno v. DaimlerChrysler
District Court. The U.S. district court, in granting the defendants’ motion to
dismiss the case for failure to state a claim, held that the investment tax credit did not⁸
violate the Commerce Clause. The court began by describing what it believed were the
two types of state taxation schemes the Supreme Court had found to be discriminatory.⁹
The first was that states could not tax goods imported from other states without imposing
a tax on in-state goods, and the court found this was not an issue with the Ohio credit.
The second was that a state’s tax could not be based on the proportion of a business’s
activities carried on in that state to the amount carried on in other states. The court¹⁰
described the tax scheme in Westinghouse Electric Co. v. Tully as the “paradigmatic
example” of what was not allowed under this second rule.¹¹ In Westinghouse, the
Supreme Court held that a New York corporate tax credit that lowered the effective tax
rate on a company’s income as its subsidiary’s exports from New York increased relative
to those from other states was discriminatory. The district court in Cuno noted that the
New York and Ohio credits were similar in that an increase in New York activity
increased the New York credit and an increase in Ohio activity increased the Ohio credit.
However, the court distinguished between the two cases: although an increase in activity
conducted outside New York decreased the New York credit, an increase in activity
conducted outside Ohio did not decrease the Ohio credit. Based on this distinction, the¹²
court held the Ohio credit was not discriminatory.
Sixth Circuit Court of Appeals. The plaintiffs appealed the district court’s
decision. The U.S. Court of Appeals for the Sixth Circuit held that the investment tax¹³
credit violated the Commerce Clause and reversed this part of the lower court’s decision.
The court began by rejecting the defendants’ argument, accepted by the district court, that
prior Supreme Court opinions had held that only two types of taxes were unacceptable:
those that functioned as tariffs and those that determined the taxpayer’s effective tax rate
using both in-state and out-of-state activities. The court characterized this view as
“primarily concerned with preventing economic protectionism,” and the court rejected it
because it “rests on the distinction between laws that benefit in-state activity and laws that
burden out-of-state activity.”¹⁴ The court described this distinction as “tenuous” because
the Supreme Court had stated that “virtually every discriminatory statute . . . can be

⁸ Cuno v. DaimlerChrysler, 154 F. Supp. 2d 1196 (N.D. Ohio 2001).
⁹ Id. at 1203.
¹⁰ 466 U.S. 388 (1984).
¹¹ Cuno, 154 F. Supp. 2d at 1203.
¹² Id.
¹³ Cuno v. DaimlerChrsyler, 386 F.3d 738 (6^th Cir. 2004).
¹⁴ Id. at 745.

viewed as conferring a benefit on one party and a detriment on the other, in either an
absolute or relative sense.”¹⁵
Instead, the court of appeals compared the Ohio tax incentives with state tax schemes
that the Supreme Court had found to be discriminatory because they involved a state using
its taxing power to encourage investment in the state at the expense of investment in other
states. The court looked at three cases:
^!Boston Stock Exchange v. State Tax Commission, 429 U.S. 318 (1977),
where the Court invalidated part of a New York securities transfer tax.
New York imposed a tax on a transfer of securities if a taxable event
occurred in the state. Since New York was the only state that taxed
securities transfers, the tax placed New York brokers at a disadvantage.
The state created incentives to encourage New York sales: if a sale
occurred in New York, then nonresidents were taxed at a lower rate and
both residents and nonresidents could not be taxed above a certain
amount. The court of appeals quoted the Supreme Court as finding that
the incentives “foreclosed tax-neutral decisions” and that New York was
improperly using “its power to tax an in-state operation as a means of
requiring [other] business operations to be performed in the home state,”
which was “wholly inconsistent with the free trade purpose of the
Commerce Clause.”¹⁶
^!Maryland v. Louisiana, 451 U.S. 725 (1981), where the Supreme Court
invalidated a Louisiana severance tax credit that favored in-state natural
gas producers. The appeals court quoted the Supreme Court as finding
that since the credit “favored those who both own [offshore] gas and
engage in Louisiana production” and that the “obvious economic effect
of this Severance Tax Credit [was] to encourage natural gas owners
involved in the production of [offshore] gas to invest in mineral
exploration and development within Louisiana rather than to invest in
further [offshore] development or in production in other States,” the
credit “unquestionably discriminated against interstate commerce in favor
of local interests.”¹⁷
^!Westinghouse Electric Corp. v. Tully, which was discussed above in the
section on the district court’s opinion and was distinguished by that
court. The court of appeals quoted the Supreme Court as stating that the
tax scheme “penalized increases in the [export] shipping activities in
other states,” which meant it placed “a discriminatory burden on
commerce to its sister States.”¹⁸

¹⁵ Id.
¹⁶ Id. at 744.
¹⁷ Id.
¹⁸ Id. at 744-45.

The court of appeals found the Ohio credit to be analogous to these other tax
incentives in that the credit, by reducing a business’s pre-existing franchise tax liability,
coerced businesses into making in-state investments.¹⁹ A business with activities in Ohio
would be subject to the state’s franchise tax regardless of whether the business made an
investment in new property eligible for the tax credit. The business could, however,
reduce its existing franchise tax liability by making new investments that would qualify
for the tax credit. On the other hand, if the business chose to make the new investments
outside of Ohio, it could not reduce its Ohio franchise tax liability. This meant, in the
court’s view, that Ohio was using its power to tax to coerce businesses subject to the Ohio
franchise tax to expand in Ohio rather than in another state.²⁰ As a result, it held the credit
was discriminatory.
Supreme Court. Ohio and the other defendants appealed the decision as it related
to the investment tax credit to the U.S. Supreme Court. In 2006, the Court held that the
plaintiffs did not have standing to bring the case in federal court and vacated and
remanded that part of the court of appeals’ opinion for dismissal.²¹ The issue of standing²²
had not been addressed by the court of appeals. It was briefly an issue before the district
court after the defendants asked for the case, which the plaintiffs had initially brought in
state court, to be removed to federal court. The plaintiffs used their potential lack of
standing as one reason why the suit should not be removed, but the district court, in
approving the removal, stated that the plaintiffs had standing to challenge the tax credit
under the “municipal taxpayer standing” rule. That rule derives from a Supreme Court²³
case, Massachusetts v. Mellon, in which the Court indicated that a municipal resident
could have standing to challenge the illegal spending of money by a municipality because
of the special relationship that arose between the resident and municipality due to the
later’s corporate status. The district court apparently felt that the Cuno plaintiffs had
standing to challenge the state investment tax credit because they had standing to
challenge the other benefits provided to DaimlerChrysler, specifically a property tax
exemption provided by an Ohio municipality as authorized under Ohio law.
Before the Supreme Court, the Cuno plaintiffs claimed they had standing due to their
status as Ohio taxpayers who were injured because the credit reduced the funds available
in the Ohio fisc to be used for lawful purposes and therefore imposed a disproportionate
burden on them. The Supreme Court, in rejecting their claim, began by noting that
standing is an integral part of the “case or controversy” requirement in Article III of the
U.S. Constitution and requires plaintiffs show a “personal injury fairly traceable to the
defendant’s allegedly unlawful conduct and likely to be redressed by the requested

¹⁹ Id. at 743-45.
²⁰ Id. at 743.
²¹ DaimlerChrysler v. Cuno, No. 04-1704 and 04-1724, 2006 U.S. Lexis 3956 (2006).
²² The issue of standing was brought up by the State of Ohio when it asked for en banc review
of the panel’s decision. See The State of Ohio’s Petition for Rehearing, at 9-10, Cuno, 386 F.3d

738. The court denied the motion to review the case en banc. Cuno, 2005 U.S. App. LEXIS^th

1750 (6 Cir. 2005).

²³ 262 U.S. 447, 486-87 (1923).

relief.”²⁴ The Court noted that federal taxpayers generally do not have standing solely
because of their taxpayer status to challenge an expenditure of federal funds.²⁵ This is
because such taxpayers’ injuries are (1) not particularized to those plaintiffs, but rather
common to the general taxpaying public, and (2) hypothetical because whether they will
occur or be redressed depends on future actions by a legislative body. The Court
concluded that the same reasons for denying standing to federal taxpayers applied to deny
standing to state taxpayers, including the plaintiffs in Cuno.²⁶
The Court also rejected the plaintiffs’ contention that there should be an exception
to the general rule disallowing taxpayer standing for Commerce Clause challenges,
similar to the exception that exists for Establishment Clause challenges.²⁷ The Court
distinguished between the two situations, noting that the injury in taxpayer suits alleging
violation of the Establishment Clause was the taxing and spending itself and that the
injury could be redressed by enjoining the taxing and spending activity without requiring
further legislative action.²⁸ The Court also reasoned that allowing an exception for
Commerce Clause suits would lead to the creation of exceptions for any constitutional
provision that implicates a government’s taxing and spending powers, and thus be
inconsistent with the general rule that disallows taxpayer standing. Finally, the Court
rejected the argument that the plaintiffs had standing to challenge the investment tax
credit under the theory of supplemental jurisdiction (which would have allowed them to
challenge the investment tax credit because they had standing as municipal taxpayers to
challenge the property tax exemption provided to DaimlerChrysler by an Ohio
municipality), stating that the plaintiffs must have standing for each claim presented.²⁹
Legislation introduced in the 109^th Congress
The Economic Development Act of 2005 (H.R. 2471 and S. 1066) would give states
the authority to offer incentives like the investment tax credit struck down by the Sixth
Circuit in Cuno. The act would generally allow the states to provide discriminatory tax
incentives that are for an economic development purpose, including any legally permitted
activity for attracting, retaining, or expanding business activity, jobs, or investment in a
state. Some incentives would not be allowed, including those that depend on state of
incorporation or domicile, require the recipient to acquire or use services or property
produced in the state, are reduced as a direct result of an increase in out-of-state activity,
result in a loss of a compensating tax system, require reciprocal tax benefits from another
jurisdiction, or reduce a tax not imposed on apportioned interstate activities. The act
would apply to all qualifying tax incentives, regardless of their date of enactment.

²⁴ Cuno, 2006 U.S. Lexis 3956 at 18, quoting Allen v. Wright, 468 U.S. 737, 751 (1984).
²⁵ Id. at 21-23.
²⁶ Id. at 24-26.
²⁷ Flast v. Cohen, 392 U.S. 83 (1968).
²⁸ Cuno, 2006 U.S. Lexis 3956 at 27-30.
²⁹ Id. at 35-38.