California Decides to Go It Alone on Taxes

A court decision could undermine interstate agreements.

Photographer: Getty Images

Things that Americans routinely do across state borders are made possible by interstate contracts known as compacts: driving your car in another state; adopting a child from another state; working as a nurse in another state without having to get a new license; buying insurance from a company based in another state. The compacts let states get things done without the federal government. They cover state boundaries, education, flood control, health, transportation, water apportionment, and treatment of prisoners, among other issues. There are almost 200 of these agreements, some more than a century old. “Interstate compacts are the most powerful, durable, and adaptive tools for ensuring cooperative action among the states,” the nonprofit Council of State Governments says on its website.

Suddenly, though, the legal standing of the compacts is under a cloud. On Dec. 31 the California Supreme Court issued a ruling weakening one of the most important interstate compacts, a 49-year-old agreement known as the Multistate Tax Compact (MTC). The ruling, some experts say, might embolden plaintiffs who no longer want to abide by the terms of other compacts to challenge those, too. “It creates uncertainty,” says Rick Masters, a lawyer in Louisville, who is special counsel to the National Center for Interstate Compacts, a unit of the Council of State Governments.

The original MTC said member states should tax corporate income on the basis of three equally weighted factors: how many employees a company has in the state, how much property it owns in the state, and the value of in-state sales. But over the years, more than half the states, including California, drifted away from those terms with impunity. Instead, they adopted tax formulas that benefit in-state companies at the expense of out-of-state ones.

In 2005, Gillette, the razor maker owned by Procter & Gamble, sued California tax authorities, arguing that it should be taxed according to the original MTC tax formula, which was better for it as a non-California-based company. Unfortunately for Gillette, which is in Boston, the Multistate Tax Commission didn’t stand up for its own compact. Instead, the commission’s lawyers agreed with California in a friend-of-the-court brief, arguing that the compact’s taxation formula was nonbinding and didn’t supersede state law. “It was never a compact in the traditional sense of ‘compact,’ ” says Elliott Dubin, the commission’s director of policy research. (The commission tweaked its formula in 2014 to reflect states’ practices.)

The impact of the California ruling remains unclear. Challenges against other compacts haven’t yet emerged since the Dec. 31 decision. The Multistate Tax Compact has been known to be squishy for years. Other compacts are considerably stronger. The Interstate Insurance Product Regulation Compact, for instance, is clearly written as a binding legal contract, so the California Supreme Court’s decision is irrelevant to it, argues Karen Schutter, executive director of the Washington-based commission that oversees the insurance accord.

On Jan. 25, Gillette’s lead lawyer, Amy Silverstein, said through an aide that the company is planning to ask the U.S. Supreme Court to review the California ruling. For now, the only compacts that everyone agrees are safe from challenge are the ones to which Congress has explicitly given consent—for example, those covering nuclear waste disposal, oil and gas, and water rights. Congressionally approved compacts have the force of federal law, which trumps state law. One solution, then, to the problem of weak interstate agreements like MTC would seem to be for states to ask Congress to put its stamp of approval on all interstate compacts. Falling back on Washington might injure their pride, but it would keep legal uncertainty from gumming up the works.

The bottom line: A California decision to weaken an interstate tax agreement may put similar compacts between states at risk.

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