The Search for Tax Justice is a Tax Notes State series examining the inequities inherent in state and federal taxes.
In this installment, Mark J. Cowan, a professor in the Department of Accountancy at Boise State University in Idaho, discusses the use of compacts to fairly resolve disputes between tribes and states over the taxation of nonmembers doing business in Indian Country.
Copyright 2021 Mark J. Cowan.
All rights reserved.
Many factors hinder the search for tax justice in Indian Country. Among these are a unique, complex, uncertain, sometimes archaic, and often formalistic legal landscape that frequently spawns litigation; overlapping state and tribal jurisdictions with no formal coordination procedure between the sovereign governments involved; and, in many cases, long-standing mistrust or even enmity between the states and the tribes with reservations located within their borders. These factors breed many issues of tax justice.1 I focus here on one: the taxation of those who engage in business or transactions in Indian Country but are not members of the tribe governing the reservation. Taxation of nonmembers is often an area of contention between tribes and states, but also one in which there is a clear, if not easy, path forward: the use of intergovernmental agreements, also known as compacts.
Along with the federal government and the state governments, federally recognized Indian tribes are considered sovereign entities.2 Under the Indian commerce clause of the U.S. Constitution, the federal government has exclusive power over Indian tribes.3 States may only exercise authority on tribal lands within their borders if federal law allows. Thus, tribes and states are bound together geographically, but not politically. From the outside, tribes may appear to operate much like local governments such as cities, towns, or counties. But local governments do not have sovereignty. They only have the power (including taxing power) that has been delegated to them by the true sovereign — the state in which they are located.4 The state has ultimate responsibility for local affairs, even though in practice it may allow significant autonomy and power to reside at the local level. Any state versus local dispute can ultimately be resolved using state power. Unlike local governments, tribes have inherent sovereignty over local affairs and do not owe their power to the state in which they are located.5 States and tribes, as close neighbors, must work together on local issues. Yet neither has significant authority over the other. State and tribal disputes over local matters — like taxes — can only be resolved by agreement or by the intervention of the federal government.
Tribal and State Taxation of Nonmembers In Indian Country
At the outset, it is important to define the terms “member” and “nonmember.” An individual is a member of a tribe if he is listed on the membership roll of the tribe controlling the reservation on which he resides or does business. All others, including non-Indians and members of other Indian tribes, are considered nonmembers.6 As sovereign governments, tribes have the power to impose taxes on their members and on nonmembers doing business in their jurisdiction.7 States are prohibited from taxing tribes and tribal members directly regarding their on-reservation activities unless the taxation has been allowed by federal law.8 Absent federal preemption, however, a state may impose nondiscriminatory taxes on nonmembers doing business on Indian reservations located within the state’s borders.9
The ability of states to impose taxes in Indian Country turns on the legal incidence of the tax.10 If the legal incidence is on the tribe or tribal members, taxation is prohibited.11 If the legal incidence is on a nonmember, taxation is generally allowed — even if the economic incidence of the tax falls on the tribe or tribal members.12
Problems of Overlapping Taxing Jurisdiction
The tax landscape described above, in which both states and tribes have the power to tax the same nonmember transactions in Indian Country and in which the state’s ability to tax is based on the formalistic notion of legal incidence, creates the opportunity for tax systems that are unfair to either the state or the tribal government. Two overarching issues are implicated. First is the tax policy norm of horizontal equity — the principle that taxpayers in the same position should pay the same tax.13 A tax landscape certainly seems unfair if a product is taxed differently on versus off the reservation. Second, even if horizontal equity issues can be resolved, there is the issue of which government is entitled to the revenue from taxes on nonmembers.
Horizontal Equity — Potential Unfairness to States
Although legal incidence is easier to determine than economic incidence, the legal incidence is not always clear.14 If the state (perhaps inadvertently) places the legal incidence on a tribe or tribal member, the tax will be ineffective. This would allow the tribe to either capture the revenue from the tax by imposing its own tax or market a tax exemption to nonmembers. For example, on-reservation gas stations might sell gas at a lower price than nearby off-reservation gas stations because of the tax advantage.
Sometimes, a state tax validly applies on the reservation, but the state is limited in its ability to enforce collection. This was the case in many states with cigarette taxes. Tribes and tribal members would use their exemption from state taxes to improperly sell cigarettes to nonmembers free of state tax locally or over the internet.15
Horizontal Equity — Potential Unfairness to Tribes
Using legal incidence as the touchstone of taxation is formalistic, allowing states to effectively tax tribes and tribal members by calibrating their tax statutes to place the legal incidence of a tax on nonmembers.16 This reality often puts states in a superior position to tribes when it comes to taxing nonmembers — and it can lead to double taxation. A tribe may impose a sales tax, for example, on on-reservation sales. A state may impose its own sales tax on on-reservation sales — provided the legal incidence is placed on the nonmember customer and not the tribal retailer. The possibility of double taxation can have a chilling effect on nonmember investment in Indian Country, stifling economic development. For example, a nonmember company extracting oil on an Indian reservation may be subject to both state and tribal severance taxes.17 If that same company had been operating outside Indian Country, only the state tax would apply. All else being equal, the nonmember company would likely choose to operate on non-Indian land before exploiting the resources in Indian Country. The tribe, of course, could forgo its own tax to avoid the double tax problem, but that would deny the tribe a revenue stream.18
Which Government Gets the Revenue?
Horizontal equity in Indian Country is, in theory, easy to identify and uniform in result across all states and tribes — just make sure that the tax on and off the reservation is the same. Even if the horizontal equity issues are addressed, the issue of which government should be entitled to the revenue from the tax on nonmember activity in Indian Country would remain. And the resolution of that issue is not always easy to identify or uniform in result across all states and tribes. Both tribes and states need to finance their operations, and both provide services (roads, schools, a court system, and so forth) that benefit nonmembers operating in Indian Country. Fairness would dictate that the government providing the services should get the revenue. Here there is great variety. There are 574 federally recognized tribes in the United States, each with its own culture, traditions, history, government, economic status, and relationship with the state in which it is located.19 Each state and tribe’s relationship is unique, with the state providing some services and the tribe providing others. A revenue allocation that is fair in one state and tribal context may be unfair in another.
In many cases, both the tribe and the state have valid claims to tax revenue from nonmember activity taking place on Indian reservations. Implicitly acknowledging this, the Supreme Court has largely refused to prioritize one government’s assertion of tax jurisdiction over the other’s, often allowing both the state tax and tribal tax to stand.
Toward More Fairness
Absent a revision in the Supreme Court’s views on state and tribal tax matters, there are two primary ways that state and tribal tax conflicts could effectively be resolved: congressional intervention or the use of state and tribal compacts. Congress could use its plenary power over the tribes and its power over state taxes that implicate interstate commerce to develop a scheme to reconcile tribal and state claims to taxation of nonmembers in Indian Country. But even if Congress wanted to address this issue, it is unlikely it would be able to develop one set of rules that would fairly reconcile competing state and tribal claims to tax revenue in every case. Given the diversity of state and tribal relations, a national “one size fits all” rule is unlikely to yield satisfactory results in all cases. Thus, if Congress were to act, it should do so by providing a general framework that would facilitate making compacts and allow states and tribes significant discretion to address unique local issues.
As an alternative to congressional action, states and tribes can try to put aside their differences and negotiate tax compacts to avoid double taxation, provide certainty, and allocate tax revenue between the two governments. There are over 200 state and tribal tax compacts.20
The provisions of tax compacts can vary greatly. Often, however, the tribe will agree to collect a tax on the reservation that equals the state tax charged off the reservation. This will prevent the reservation from becoming a tax haven and eliminate the specter of double taxation. The state and the tribe will then agree on how they will divide the revenue collected via the on-reservation tax.
Compacts are advantageous to both parties and the business community because they provide certainty in an otherwise confusing area of the law. With a compact, the state and the tribe are assured of a predictable revenue stream and the business community is assured that it will not be treated more harshly on the reservation than off it.
Stories From Two States
In negotiating compacts, the experience of two states, Idaho and Washington, is instructive. The former took a reactive approach — choosing to fight tribes that asserted their tax authority via litigation and legislation for years before finally agreeing to a compact. The latter took a proactive approach — embracing a compact from the start to ensure that the state and the tribes would avoid any disputes in a new industry.
Idaho and Fuel Taxes
For more than six years, Idaho and the tribes located in the state fought over which government had the right to collect fuel taxes on Indian land. The dispute was contentious, involving litigation in the state and federal courts, multiple interventions by the Legislature, and posturing by both sides in the press. Ultimately, the state and the tribes were able to negotiate compacts to resolve the issues. Under the fuel tax compacts, the tribes agreed to continue to collect a tribal fuel tax equal to the state’s tax. Should the state tax increase in the future, the tribes would increase their taxes by the same amount. This mechanism maintains a level playing field between on-reservation and off-reservation sales of gasoline. While the tribes will retain the revenue they collect from the tribal fuel taxes, they agreed to use the funds to pay for road construction and maintenance. While the state forgoes the revenue from its fuel tax in Indian Country, presumably the tribes’ commitment to dedicate the tax revenue to roadwork relieves the state of some maintenance work it would otherwise need to pay for.21 While Idaho and the tribes ultimately came to an agreement, it is unfortunate that it took years of contentious disputes to arrive at the negotiating table.
Washington and Cannabis Taxes
Events in Washington show an alternative path. Shortly after legalizing the recreational use of cannabis, Washington passed legislation authorizing the governor to negotiate cannabis compacts with Indian tribes located in the state and setting standard terms for such compacts.22 In 2015 Washington entered into the nation’s first state and tribal cannabis compact with the Squamish Tribe.23 Under the compact, sales of cannabis on the reservation are not subject to state taxation.24 But the tribe must impose a tax equal to at least 100 percent of the state tax on sales of cannabis on the reservation.25 If the state requests, the tribe must hire an auditor to verify compliance.26 Any tax proceeds must be used by the tribe for essential government services, which were broadly defined.27
Compacts are not perfect. Both the state and the tribe must cede some sovereignty when entering a compact. In particular, tribes give up some control over the tax rate. In Idaho and Washington, for example, the tribes agreed to impose (at least) the same taxes as the state. Thus, the tribes must follow the lead of the state as it tweaks its tax system. Perhaps that is a small price to pay to ensure fairness and certainty.
Tax compacts between states and tribes will not always lead to perfect justice, but they have the potential to resolve issues in a fair manner while providing much-needed certainty to those doing business in Indian Country. That does not mean negotiating compacts is always easy, feasible, or perfect. Still, when searching for tax justice in Indian Country, you are more likely to find it in the conference room than in the courtroom.
It is important to remember that taxation is but one area of possible contention between tribes and states. Tax disputes often exist in the context of years of tribal and state distrust and enmity created by a variety of nontax issues. Making a good-faith effort to resolve tax issues via government-to-government compacts will not magically change enmity to amity, but it could allow states and tribes to develop more trust and find some tax justice — and that, one would hope, could lead to more trust and justice in other areas as well.
1 For a thorough analysis and critique of the tax law in Indian Country, see Richard D. Pomp, “The Unfulfilled Promise of the Indian Commerce Clause and State Taxation,” 63 Tax Law. 897 (2010).
2 Upon arriving in America, the European powers implicitly acknowledged tribal sovereignty by dealing with the tribes as they would other foreign governments and leaving the tribes to govern their own internal affairs. William C. Canby Jr., American Indian Law in a Nutshell 76 (5th ed. 2009); see also Cohen’s Handbook of Federal Indian Law, section 4.01 (2012) [hereinafter Cohen’s Handbook].
3 Under the Indian commerce clause, one of Congress’s enumerated powers is to “regulate Commerce . . . with the Indian Tribes.” U.S. Const. Art. I, section 8, cl. 3. The U.S. Supreme Court has interpreted this clause as vesting in the federal government exclusive power over the Native American tribes. See Cherokee Nation v. Georgia, 30 U.S. 1, 19 (1831).
4 Michael A. Pagano, “Local Governments and Taxing Espresso,” State Tax Notes, Oct. 27, 2003, p. 303 (indicating that local governments, “as creatures of their states, exercise fiscal authority differently depending on what the state allows”).
5 See Canby, supra note 2, at 71: “A tribe is quite unlike a city or other subdivision of a state. When a question arises as to the power of a city to enact a particular regulation, there must be some showing that the state has conferred such power on the city; the state, not the city, is the sovereign body from which power must flow. A tribe, on the other hand, is its own source of power . . . the tribe is sovereign.” Id.
6 See, e.g., Washington v. Confederated Tribes of Colville Indian Reservation, 447 U.S. 134, 161 (1980) (noting that members of tribes other than the tribe governing the reservation “stand on the same footing as non-Indians resident on the reservation”).
7 E.g., Merrion v. Jicarilla Apache Tribe, 455 U.S. 130 (1982) (holding a tribe may impose, based on its inherent sovereign governmental powers, a severance tax on nonmember lessees extracting oil and gas from the reservation); Confederated Tribes of Colville Indian Reservation, 447 U.S. 134 (upholding a tribal cigarette tax on nonmembers purchasing cigarettes on the reservation).
8 E.g., Oklahoma Tax Commission v. Chickasaw Nation, 515 U.S. 450, 453 (1995) (striking down a state fuel excise tax assessed on fuel sold by tribally owned stores and stating that a state tax will not stand if the legal incidence is directly on the tribe or a tribal member operating entirely on the reservation); and Montana v. Blackfeet Tribe of Indians, 471 U.S. 759 (1985) (striking down a state tax on royalties the Blackfeet tribe received from nonmember lessees of oil and gas properties on the reservation); Confederated Tribes of Colville Indian Reservation, 447 U.S. 134 (striking down a state motor vehicle privilege tax assessed on tribal members); Bryan v. Itasca County, 426 U.S. 373 (1976) (striking down a state personal property tax on a mobile home owned by a tribal member because it was not explicitly authorized by federal law); Moe v. Confederated Salish and Kootenai Tribes of the Flathead Reservation, 425 U.S. 463 (1976) (striking down state cigarette and motor vehicle taxes when the legal incidence of the tax fell on a tribal member); McClanahan v. State Tax Commission of Arizona, 411 U.S. 164, 165 (1973) (ruling that Arizona may not impose its personal income tax on a tribal member working exclusively on the reservation).
States may, however, generally tax tribal members and tribes on their off-reservation activities. See, e.g., Chickasaw Nation, 515 U.S. 450, 462-64 (upholding a state income tax on tribal members who worked for an Indian tribe, but who lived off the reservation); and Mescalero Apache Tribe v. Jones, 411 U.S. 145 (1973) (allowing the state of New Mexico to impose a gross receipts tax on a tribal ski resort operated outside the tribe’s reservation).
9 E.g., Confederated Tribes of Colville Indian Reservation, 447 U.S. 134, 156-59 (upholding a state cigarette tax on nonmembers, even when the tribe imposed its own tax on such sales); Confederated Salish and Kootenai Tribes, 425 U.S. 463, 483 (1976) (also upholding a state cigarette tax on nonmembers purchasing cigarettes on the reservation because the legal incidence of the tax fell upon the nonmember purchasers).
10 The legal incidence is usually clear: it is the party the tax statute specifies as being responsible for paying the tax to the government. If the tax is not paid, the government will attempt to collect it from the party with the legal incidence. In doing so, the government may impose penalties on that party and, if necessary, seize that party’s assets to satisfy the tax bill.
11 See supra note 8.
12 Because the ability to transfer the tax burden turns on market conditions, the law of supply and demand (including elasticity), contractual arrangements, and other factors, economic incidence can be difficult to measure.
13 Applying traditional horizontal equity principles in this context is challenging, because there are multiple governments involved and no coordination mechanism among them.
14 See generally Mark J. Cowan, “Anatomy of a State/Tribal Tax Dispute: Legal Formalism, Shifting Incidence, Potatoes, and the Idaho Motor Fuel Tax,” 8 J. of Legal Tax Research 1 (2010) (discussing cases in which a court disagreed with a state over whether the legal incidence of a state tax fell on a tribe or tribal member).
15 See, e.g., Red Earth LLC v. United States, 657 F.3d 138 (2d Cir. 2013) (reviewing constitutional challenges to the Prevent All Cigarette Trafficking Act of 2009).
16 See Chickasaw Nation, 515 U.S. 450, 460 (noting that “if a State is unable to enforce a tax because the legal incidence of the impost is on Indians or Indian tribes, the State generally is free to amend its law to shift the tax’s legal incidence”).
17 See e.g., Cotton Petroleum Corp. v. New Mexico, 490 U.S. 163 (1989) (upholding both state and tribal severance taxes on the production of oil and gas on reservation land by nonmembers).
18 Whether this is fair might turn on whether it is the tribe that owns the business selling the taxed product. See Pomp, supra note 1, at 1220 (questioning “whether double taxation should be viewed as even existing when a tribe is simultaneously the taxing sovereign and the vendor of the taxed good,” because in that case, the label “tax” is just a formality with “no independent economic significance”).
20 Cohen’s Handbook, supra note 2, at section 8.05.
21 For more detail on the Idaho fuel tax issue, see Cowan, supra note 14.
22 Wash. Rev. Code section 43.06.490 (2019). For more on issues related to the taxation of cannabis in Indian Country, see Mark J. Cowan, “Taxing Cannabis on the Reservation,” 57 Am. Bus. L.J. 865 (2020).
23 Marijuana Compact Between the Suquamish Tribe and the State of Washington (Sept. 15, 2015). Washington and other tribes later entered similar compacts. E.g., Marijuana Compact Between the State of Washington and the Puyallup Tribe of Indians (2015).
24 Suquamish Compact, supra note 23, at section V.F.1.
25 Id. at section V.F.2.
26 Id. at section V.F.2.b.
27 Id. at section V.F.2.a. Essential government services include, for example, “administration, public facilities, fire, police, health, education, elder care, social services, sewer, water, environmental and land use, transportation, utility services, community development, and economic development.” Id. at section IV.D.