ArtVI.C2.1.7.4 Taxation of Federal Employees' Compensation

Article VI, Clause 2:

This Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.

Of a piece with James v. Dravo Contracting Co. was Graves v. New York ex rel. O'Keefe, 1 handed down two years later. Repudiating the theory that a tax on income is legally or economically a tax on its source, the Court held that a state could levy a nondiscriminatory income tax upon the salary of an employee of a government corporation. In the opinion of the Court, Justice Stone intimated that Congress could not validly confer such an immunity upon federal employees. The burden, so far as it can be said to exist or to affect the government in any indirect or incidental way, is one which the Constitution presupposes; and hence it cannot rightly be deemed to be within an implied restriction upon the taxing power of the national and state governments which the Constitution has expressly granted to one and has confirmed to the other. The immunity is not one to be implied from the Constitution, because if allowed it would impose to an inadmissible extent a restriction on the taxing power which the Constitution has reserved to the state governments.2 Chief Justice Hughes concurred in the result without opinion. Justices Butler and McReynolds dissented and Justice Frankfurter wrote a concurring opinion in which he reserved judgment as to whether Congress may, by express legislation, relieve its functionaries from their civic obligations to pay for the benefits of the State governments under which they live.3

That question is academic, Congress’s having consented to state taxation of its employees’ compensation as long as the taxation does not discriminate against the . . . employee, because of the source of the . . . compensation.4 The Court has since held that the nondiscrimination language in the quoted statute, 4 U.S.C. § 111, is “coextensive with the prohibition against discriminatory taxes embodied in the modern constitutional doctrine of intergovernmental tax immunity.” 5

The Supreme Court has on multiple occasions confronted the question of when a state tax is discriminatory within the meaning of § 111 because it violates constitutional “principles of intergovernmental tax immunity.” 6 For example, Davis v. Michigan Department of the Treasury involved a Michigan law that exempted state and local government employees’ retirement benefits from taxation while subjecting federal employees’ retirement benefits to taxation. 7 In evaluating whether the law ran afoul of the nondiscrimination principle, the Court reasoned that “the relevant inquiry is whether the inconsistent tax treatment is directly related to, and justified by, ‘significant differences between the two classes.’” 8 The Court found no “significant differences” between federal and state retirees, rejecting the state’s argument that the differential tax treatment was justified by the relative amount of benefits afforded to retirees in each class. 9 Accordingly, the Court held that the law violated the intergovernmental tax immunity doctrine. 10 The Court reached a similar conclusion in Barker v. Kansas, holding that Kansas could not tax U.S. military retirees’ benefits while simultaneously exempting state and local government retirees’ benefits from the same tax. 11

The Court did, however, uphold a local occupational tax as nondiscriminatory in Jefferson County v. Acker. 12 In that case, two federal judges who adjudicated cases in Jefferson County, Alabama, challenged a county law requiring persons working within the county who were not already subject to a license fee to pay an occupational tax. 13 The Court held that this requirement did not discriminate against federal judges based on “the federal source of their pay.” 14 The Court reasoned that even though federal judges could not qualify for the licensing exemption, their “similarly situated” state counterparts—state court judges—also had to pay the tax, so there was no evidence of discrimination between those classes of employees. 15

The Court’s unanimous 2019 decision in Dawson v. Steager further clarified the scope of the nondiscrimination principle, holding that a violation of § 111 occurs any time a state “treats retired state employees more favorably than retired federal employees and no ‘significant differences between the two classes’ justify the differential treatment.” 16 In that case, West Virginia had “expressly afford[ed] state law enforcement retirees a tax benefit that federal retirees [could not] receive.” 17 The state conceded that there were no “significant differences” between the petitioner’s “former job responsibilities [in the U.S. Marshals Service] and those of the tax-exempt state law enforcement retirees,” which included state police, firefighters, and deputy sheriffs. 18 However, West Virginia argued that the differential tax treatment was permissible because federal law enforcement officials were on the same footing as most state retirees, the state having extended the challenged tax benefit to only a subset of state employees. 19 The Court disagreed, holding that a tax benefit can discriminate against federal employees even when only some state employees qualify for the benefit and other state employees who are similarly situated to the federal employees do not qualify for it. 20 What mattered was not “whether federal retirees are similarly situated to state retirees who don’t receive a tax benefit,” but “whether they are similarly situated to those who do.” 21 And in making the latter determination, the Court clarified, courts should look to how the state itself has defined the “favored class.” 22 In this case, West Virginia “define[d] the favored class” by the retirees’ former occupations rather than other criteria, such as age or differences among types of pension benefits, and so the Court believed it was appropriate to focus on the “comparable duties” of these officials. 23


  1.  306 U.S. 466 (1939), followed in State Comm’n v. Van Cott, 306 U.S. 511 (1939). This case was overruled by implication in Dobbins v. Erie County, 41 U.S. (16 Pet.) 435 (1842), and New York ex rel. Rogers v. Graves, 299 U.S. 401 (1937), which held the income of federal employees to be immune from state taxation.
  2.  306 U.S. at 487.
  3.  306 U.S. at 492.
  4.  4 U.S.C. § 111. The statute, part of the Public Salary Tax Act of 1939, was considered and enacted contemporaneously with the alteration occurring in constitutional law, exemplified by Graves. That is, in Helvering v. Gerhardt, 304 U.S. 405 (1938), the Court had overruled precedents and held that Congress could impose nondiscriminatory taxes on the incomes of most state employees, and the 1939 Act had as its primary purpose the imposition of federal income taxes on the salaries of all state and local government employees. Feeling equity required it, Congress included a provision authorizing nondiscriminatory state taxation of federal employees. Graves came down while the provision was pending in Congress. See Davis v. Michigan Dep’t of Treasury, 489 U.S. 803, 810-14 (1989). For application of the Act to salaries of federal judges, see Jefferson County v. Acker, 527 U.S. 423 (1999) (upholding imposition of a local occupational tax).
  5.  Davis, 489 U.S. at 813; see also Dawson v. Steager, 586 U.S. ___, No. 17-419, slip op. at 2 (2019) (“Section 111 codifies a legal doctrine almost as old as the Nation.”).
  6.  Davis, 489 U.S. at 817; see also id. at 814 (stating that “the scope of the immunity granted or retained by the nondiscrimination clause [in § 111] is to be determined by reference to the constitutional doctrine”).
  7.  Id. at 806.
  8.  Id. at 816 (quoting Phillips Chem. Co. v. Dumas Indep. Sch. Dist., 361 U.S. 376, 383–85 (1960)).
  9.  The Court reasoned that even accepting the state’s argument that federal employees generally received greater retirement benefits than their state counterparts, any difference in amount failed to justify the “blanket exemption” in Michigan’s law. Id. at 817 (reasoning that a “tax exemption truly intended to account for differences in retirement benefits would not discriminate on the basis of the source of those benefits, as Michigan’s statute does; rather, it would discriminate on the basis of the amount of benefits received by individual retirees”).
  10.  Id.
  11.   503 U.S. 594, 598, 605 (1992) (reasoning that although U.S. military retirees remain in the military after retiring from active duty, their retirement benefits are still “deferred pay for past services,” not “current compensation for reduced current services,” and thus “are not significantly different from the benefits paid to Kansas’s state and local government retirees”).
  12.  527 U.S. 423, 443 (1999).
  13.  Id. at 427.
  14.  Id. at 443.
  15.  Id.
  16.  Dawson v. Steager, 586 U.S. ___, No. 17-419, slip op. at 3 (2019) (quoting Davis v. Mich. Dep’t of Treasury, 489 U.S. 803, 814–16 (1989)).
  17.  Id. at 3.
  18.  Id. at 3, 6.
  19.  Id. at 4.
  20.  Id. at 4–7.
  21.  Id. at 7.
  22.  Id. at 6.
  23.  Id. at 6–7.