## Facts

- Congress enacted the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), altering federal income tax treatment of interest on state and local bonds.
- TEFRA generally preserved tax-exempt treatment for bond interest only if new bonds were issued in registered form and met federal registration requirements.
- If state or local bonds were issued in bearer (unregistered) form, interest paid to bondholders would be subject to federal income tax.
- South Carolina alleged the law effectively forced States to abandon bearer bonds by increasing borrowing costs if they continued issuing them.
- South Carolina sued the Secretary of the Treasury, seeking a declaration that TEFRA’s requirements were unconstitutional; lower federal courts upheld the statute.

## Issues

1. Whether conditioning federal tax exemption for state-bond interest on issuance in registered form violates the Tenth Amendment or state sovereignty principles.
2. Whether TEFRA violates intergovernmental tax immunity by burdening state borrowing through taxation of interest on certain state bonds.
3. Whether other constitutional provisions (including structural theories such as the Guarantee Clause) bar Congress from imposing these conditions.

## Decision

- The Supreme Court upheld TEFRA and rejected South Carolina’s constitutional challenge.
- The Court characterized the law as regulating federal tax consequences for bondholders, not commanding States to issue bonds in a particular form.
- The Court held Congress acted within its taxing power and that the political process provides the primary protection for state interests in this setting.
- The Court found no intergovernmental tax-immunity violation because the tax applied to private bondholders’ income in a nondiscriminatory manner.
- The Court rejected additional structural and Guarantee Clause arguments.

## Legal Principles

- Congress may condition a federal tax exemption on compliance with federal requirements when acting within its enumerated taxing power.
- A federal law does not violate the Tenth Amendment merely because it creates financial incentives that influence state choices, absent a direct command to the States.
- Intergovernmental tax immunity generally permits nondiscriminatory federal taxes that fall on private parties, even if they indirectly affect States.
- States have no constitutional entitlement to permanent federal tax-exempt status for interest on their bonds; Congress may modify or withdraw tax preferences.
- Under the post-*Garcia* approach, generally applicable federal measures within enumerated powers are ordinarily evaluated through political accountability rather than a judicial “traditional governmental functions” test.

## Conclusion

The Court held that TEFRA’s registered-bond condition for federal tax-exempt interest is a valid exercise of Congress’s taxing power that regulates bondholders’ tax liability, does not commandeer States, and does not violate intergovernmental tax immunity or other asserted structural limits.


South Carolina v. Baker, 485 U.S. 505 (1988)