In Davis v. Department of Revenue, 193 S.W.3d 557 (2006), the Kentucky Court of Appeals agreed with the taxpayers’ argument that Kentucky’s income tax statutes, which assess income taxes on interest earned on out-of-state municipal bonds but exempt interest on in-state municipal bonds, violate the Commerce Clause of the U.S. Constitution, Art. I, § 8, cl. 3. The state court said such discrimination is unconstitutional “economic protectionism” that is “designed to benefit in-state economic interests by burdening out-of-state competitors.”
Kentucky, in its writ of certiorari to the U.S. Supreme Court, based its argument, in part, on the decision by the Ohio Court of Appeals in Sharper v. Tracy , 647 N.E.2d 550 (1994), which said the Commerce Clause was not intended to apply to acts of one sovereign state trying to gain an advantage over another sovereign state. Tax laws in 38 states give such favorable treatment to in-state municipal bonds.