January 1998
 

Taxing Times in Indian Country

by David J. Bodney


Historically, the State of Arizona has not been known for its abiding interest in the economic vitality of the Indian tribes whose governments coexist within the state’s geographic boundaries.

Over the past century, the state has shown little enthusiasm for providing essential governmental services to the tribes. Little wonder — no state or local government is constitutionally obliged to fend for its tribal counterparts, and until the recent advent of Indian gaming, few tribes have generated sufficient on-reservation income to attract even the taxman’s attention.1

Now all that has changed. Over the past several years, the Arizona Department of Revenue has litigated aggressively against the tribes to collect taxes on the sale of products and services by businesses on reservation lands.The state’s sudden interest in taxing sales and rentals in Indian country — in imposing a "transaction privilege" tax on them — has produced a series of Ninth Circuit opinions that merit close examination if only to bear witness to the rapid erosion of a key attribute of tribal sovereignty — freedom from state taxation.

A Tale of Three Tribes

In each of the last three years, the Ninth Circuit Court of Appeals has decided a different case involving Arizona’s attempts to tax the generation of wealth on tribal lands.2 Each case involved a different tribe, and each time the Ninth Circuit rejected the tribe’s argument that the taxes were prohibited by the Indian preemption doctrine, and ruled in favor of the state’s taxing authority. Not coincidentally, each of the three tribes involved in these decisions had recently begun to generate tangible income from gaming activities, or otherwise had showed signs of economic vitality.

Unfortunately, the Ninth Circuit has exhibited little discipline or consistency in its various formulations of the Indian preemption doctrine in tax cases. And its latest ruling on point — a two-to-one decision upholding the state’s right to tax hotel rooms at a tribally owned hotel-casino — eviscerates "[t]raditional notions of Indian sovereignty and the federal goal of promoting tribal self-government..."3

The Salt River Case

The Ninth Circuit’s undoing of the Indian preemption doctrine began in 1995 with a case whose facts arguably invited a tax-friendly outcome. In Salt River Pima-Maricopa Indian Community v. State of Arizona, the Court of Appeals affirmed District Judge McNamee’s decision in favor of the state’s collection of taxes on sales and rentals by non-Indian businesses to non-Indian customers at the Scottsdale Pavilions shopping mall. 4 As the court noted, though Scottsdale Pavilions is located on land within the community’s reservation, the property belongs not to the community itself, but rather "is held in trust by the United States for individual allottees and is leased...to a non-Indian developer, Vestar Development Company."5

The Ninth Circuit opened its opinion in Salt River with a recognition that the Indian preemption doctrine is "broader" than traditional preemption notions. 6 "That is, in the Indian law context, state law is preempted not only by an explicit congressional statement — the traditional preemption standard — but also if the balance of federal, state and tribal interests tips in favor of preemption."7 Beginning its analysis, the Court of Appeals repeated the three major factors identified by the Supreme Court for consideration when determining whether a state tax borne by non-Indians is preempted: (1) the extent of federal regulation involved, (2) the respective regulatory and revenue-raising interests of the tribe and state, and (3) the amount of tribal and state services provided to the taxed party.8

Not illogically, the Ninth Circuit viewed the tax at issue in Salt River through the lens of the so-called "smoke shop" cases.9 At its highest formulation, the smoke shop logic led the U.S. Supreme Court in 1980 to conclude that the sale of cigarettes by a tribe to non-Indians was not preempted because the state’s taxes were "reasonably designed to prevent the tribes from marketing their tax exemption to non-members who do not receive significant tribal services and who would otherwise purchase their cigarettes outside the reservations."10

Applying the smoke shop rationale to the facts in Salt River, the Ninth Circuit found that the balance had tipped "unmistakably" in favor of taxation, especially since "the goods and services sold are non-Indian, and the legal incidence of Arizona’s taxes falls on non-Indians."11 Indeed, recognizing that more than 99 percent of the goods sold at the Scottsdale Pavilions were produced off-reservation, the Court of Appeals rejected the community’s attempt to distinguish the smoke shop cases, and dryly observed that "[t]he mall earns its profits simply by importing non-Indian products onto the reservation for resale to non-Indians."12

Gila River I and II

The following year, the Ninth Circuit announced that Salt River "controlled" its thinking in another Indian tax case that had shown earlier promise for preserving the preemption doctrine’s integrity.13 In Gila River Indian Community v. Waddell ("Gila River II"), the Court of Appeals in 1996 affirmed District Judge Strand’s entry of summary judgment in favor of the state, and rejected the tribe’s request for declaratory and injunctive relief from the imposition of a tax on the sale of tickets and concessionary items on the reservation.14 Initially, the case arose four years earlier in the context of the district court’s dismissal of the tribe’s lawsuit for failure to state a claim.15 Known as Gila River I, the lawsuit involved the community’s contention that the state’s attempt to impose a transaction privilege tax on the sale of concert tickets at Compton Terrace and cultural activities at Firebird Lake — both occurring on the Gila River Indian Reservation — was preempted by federal law or prohibited by the doctrine of tribal self-government.16

In Gila River I, the Ninth Circuit announced in 1992 its reliance on a "narrowly tailored" test for Indian tax cases — that is, where strong federal and tribal interests exist, the state may avoid the preemption of its taxing authority "only if its taxes are ‘narrowly tailored’ to funding the services it provides in connection with the activities taking place on tribal land." 17 Importantly, the appellate record in Gila River I was "devoid" of any proof of a direct connection between the state’s tax and its services to the tribe.18 Consequently, the Court of Appeals in Gila River I concluded that the tribe had stated a "cognizable claim" of preemption, and therefore reversed the district court’s decision and remanded the case for further proceedings.19

Those further proceedings, however, resulted in the entry of summary judgment against the tribe, and again the community appealed to the Ninth Circuit. As in Salt River, the Gila River II court made short shrift of the tribe’s preemption argument. Recognizing that less than five percent of the visitors to Compton Terrace and Firebird Lake were tribal members, and that the programs, souvenirs and concession items sold were printed, manufactured or made outside the reservation, the Ninth Circuit concluded that the Arizona sales tax would not interfere with the use and development of reservation property.20 As the court emphasized, "[h]ere, the state tax is imposed on receipts from non-Indian off-reservation residents who pay to see performers and racers who are also from off-reservation."21

Despite the Ninth Circuit’s endorsement of a "narrowly tailored" test in Gila River I, the Court of Appeals in Gila River II rejected even a "direct connection" requirement as "meritless."22 Invoking the Supreme Court’s Cotton Petroleum decision — a 1989 case involving New Mexico’s tax on oil extraction on Indian lands — the Ninth Circuit ignored its rationale in Gila River I completely, and jettisoned even a "proportionality" requirement as creating "nightmarish administrative burdens" for the state.23 Content to note that the state provided law enforcement and traffic control services for the tribe, the Ninth Circuit deemed such involvement a sufficient "interest" to justify taxing the beneficiaries of such services.24

The Yavapai-Prescott Decision

If Salt River and Gila River II had shown the court’s versatility in using conflicting analytical approaches to deliver a stinging one-two combination, then in 1997 the Ninth Circuit delivered the knockout punch. In Yavapai-Prescott Indian Tribe v. Scott, the appellate court effectively eliminated any distinction between the special concerns of Indian preemption and the doctrine’s more general application in federal law.25 In a majority opinion by Circuit Judge Noonan, the court interpreted the so-called "judge-created law" of Indian preemption to permit its conclusion that the state’s interest in taxation was simply "superior" to the federal and tribal interests at stake.26 Judge Noonan characterized the "narrowly tailored" test as "elusive," and dispensed with its application.27

The Yavapai-Prescott case involved the state’s attempts to impose a transaction privilege tax on the rooms rented, and food and beverages served, at the Prescott Convention Center (PCC) — the state’s only hotel-casino.28 Owned by the tribe and situated on the reservation’s most prominent lands, the hotel was built with the proceeds of a $1.12 million grant in 1983 from the United States Department of Housing and Urban Development specifically issued to facilitate the tribe’s economic development.29 While the tribe leased the hotel to a non-Indian developer, it retained a 30 percent ownership interest in the hotel (and its proceeds, if sold).30 Since 1992, the tribe subleased hotel space from PCC to operate (and self-manage) a gaming facility known as Bucky’s.31

Despite formidable federal interests in the tribe’s economic development, and the district court’s entry of summary judgment in favor of the tribe, the Ninth Circuit reversed and found for the state and its taxing authority. Oddly enough, the majority began its opinion by listing 18 facts from Gila River I and Salt River that "weighed in favor of preemption," and only four factors that weighed in favor of the state.32 It then continued its "analysis" section by enumerating eight "facts" that favored preemption in Yavapai-Prescott, and six "[f]actors weighing against preemption."33 Without elaboration, Judge Noonan concluded that the six factors eclipsed the eight facts.

The majority saw no difference between the food and beverage sales at the hotel and the sale in Salt River of goods that were produced 99 percent off-reservation. That the goods at the hotel in Yavapai-Prescott were meals prepared on-reservation was deemed "irrelevant."34

The majority acknowledged "[a] closer case," however, when it analyzed the state’s attempts to tax the tribe’s hotel rooms.35 Still, it ruled in the state’s favor even as to the nightly renting of prime real estate at a tribal hotel-casino. In large measure, the court based its conclusion on the tribe’s supposed failure to prove specifically "how much of the [hotel’s] value arises from the tribe’s contribution."36

That argument — like the rest of the majority’s anomalous opinion — was forcibly countered by Circuit Judge Pregerson in dissent. Relying on the Cabazon decisions, the dissenting opinion reasoned that the tribe’s interest in the hotel and casino were "one and the same because the hotel and casino are closely interrelated."37 Hence, the tribe had "demonstrated a strong interest in the hotel’s operations through its concerted and sustained efforts to develop and manage its resources — the commercial value of its land."38 The majority’s creation of a duty on the tribe to provide specific, exact-dollar proof of its value-added would create "a nearly insurmountable burden on the Tribe."39

Judge Pregerson’s dissent merits note not only for its analytical clarity but for its historical perspective as well. In 1995, Judge Pregerson was one of the three circuit judges who unanimously decided Salt River in favor of the state. Two years later, seeing how the Ninth Circuit had used Salt River to ignore "compelling evidence" in favor of preemption in Yavapai-Prescott, Judge Pregerson’s dissent carefully dissected the majority’s opinion and found it flatly "wrong" in concluding that federal law does not preempt Arizona’s transaction privilege tax.40

Long ago, the Supreme Court recognized that the power to tax is the power to destroy.41 That adage takes on new meaning against the backdrop of this discordant trio of Ninth Circuit cases interpreting the Indian preemption doctrine. If tribes must now compete with the state for scant tax dollars generated by on-reservation business activities, then the road to economic self-sufficiency for Arizona’s tribes just got that much rougher. Indeed, if tribes are now subject to State taxes but not entitled to the benefits afforded other taxpayers through state services, the road leads only uphill. Based on the recent evidence, it seems that only the Tribes’ ability to generate gaming revenues or related business income is enough to get the state thinking about tribal economics — but then only so far as taxing them goes.

David J. Bodney is the deputy managing partner of the Phoenix office of Steptoe & Johnson LLP, where he practices constitutional law. He serves as general counsel to the Yavapai-Prescott Indian Tribe.

ENDNOTES:
1. As a matter of constitutional law, Chief Justice John Marshall long ago established the parameters of federalism as applied to the country’s "domestic dependent nations" in Cherokee Nation v. Georgia, 30 U.S. (5 Pet.) 1 (1831). In the Supreme Court’s next term following the Cherokee Nation case, Chief Justice Marshall issued an opinion reversing Georgia’s conviction of non-Indians residing in Cherokee territory for failure to obtain licenses from the state, and concluded that such state laws would "have no force" in Indian country. Worcester v. Georgia, 31 U.S. (6 Pet.) 515, 561 (1832). With the court’s holding in Worcester, Marshall built "the foundation of jurisdictional law excluding the states from power over Indian affairs..." W. Canby, Jr., American Indian Law 16 (1988). See generally Williams v. Lee, 358 U.S. 217 (1959).
2. Yavapai-Prescott Indian Tribe v. Scott, Slip op. No. 96-16416 (9th Cir. June 30, 1997); Gila River Indian Community v. Waddell ("Gila River II"), 91 F.3d 1232 (9th Cir. 1996); Salt River Pima-Maricopa Indian Community v. State of Arizona, 50 F.3d 734 (9th Cir. 1995).
3. Yavapai-Prescott Indian Tribe, Slip op. at 7554 (per Pregerson, dissenting). Indeed, the recent trilogy of Ninth Circuit opinions on the Indian preemption doctrine represents a radical departure from the court’s holdings on point in the 1980s. See Hoopa Tribe v. Nivens, 881 F.2d 657 (9th Cir. 1989); Crow Tribe of Indians v. Montana, 819 F.2d 900 (9th Cir. 1987) (a case in which the "narrowly tailored" test was ultimately affirmed by the U. S. Supreme Court).
4. Salt River Pima-Maricopa Indian Community v. State of Arizona, 50 F.3d 734 9th Cir. 1995).
5. Salt River, 50 F.3d at 735.
6. Salt River, 50 F.3d at 736.
7. Id. (citing In re Blue Lake Forest Prods. Inc., 30 F.3d 1138, 1142 (9th Cir. 1994) [citing Gila River Indian Community v. Waddell ("Gila River II"), 967 F.2d 1404, 1407-08 (9th Cir. 1992)].
8. Id. (citing Felix S. Cohen, Handbook on American Indian law, 413 (1982) [(citing Central Machinery Co. v. Arizona State Tax Comm’n, 448 U.S. 160, 163-66, 100 S.Ct. 2592, 2994-97, 65 L.Ed.2d 684 (1980); White Mountain, 448 U.S. at 141-45, 100 S.Ct. at 2582-85; Colville, 447 U.S. at 160-63, 100 S.Ct. at 2084-86)].
9. Salt River, 50 F.3d at 737. See, e.g., Washington v. Confederated Tribes of the Colville Indian Reservation, 447 U.S. 134 (1980); Chemeneuvi Indian Tribe v. California State Board of Equalization, 800 F.2d 1446 (9th Cir. 1986).
10. Washington v. Confederated Tribes of the Colville Indian Reservation, 447 U.S. at 157 (cited in Salt River, 50 F.3d at 737) (emphasis supplied).
11. Salt River, 50 F.3d at 737, 739.
12. Id., at 738.
13. Gila River II, 91 F.3d at 1236.
14. Gila River II, 91 F.3d 1232 (9th Cir. 1996).
15. Gila River I, 967 F.2d 1404 (9th Cir. 1992).
16. Id.
17. Gila River I, at 1412 (citing Crow Tribe of Indians v. Montana, 819 F.2d 895, 900-02 (9th Cir. 1987)).
18. Gila River I, at 1412. Presumably, a "direct connection" requirement entails even less proof from the state than a "narrowly tailored" test, but the state had met neither standard in Gila I.
19. Id., at 1412-13.
20. Gila River II, 91 F.3d at 1235, 1237.
21. Id., at 1237.
22. Id., at 1239.
23. Id. (citing Cotton Petroleum, 490 U.S. 163, 185, n.15 (1989)).
24. Gila River II, 91 F.3d at 1239.
25. Yavapai-Prescott Indian Tribe v. Scott, Slip op. No. 96-16416 (9th Cir. June 30, 1997).
26. Id., at 7540.
27. Id., at 7548.
28. PCC is now known as the Prescott Resort and Conference Center.
29. Id., at 7541, 7553.
30. Id.
31. Id., at 7542.
32. Id., at 7544-46.
33. Id., at 7548-50.
34. Id., at 7550.
35. Id.
36. Id., at 7551.
37. Id., at 7555-56 (citing California v. Cabazon Band of Mission Indians, 480 U.S. 202 (1987), and Cabazon Bank of Mission Indians v. Wilson, 37 F.3d 430 (9th Cir. 1994)).
38. Id., at 7556-57.
39. Id., at 7556, n. 2.
40. Id., at 7554-7561.
41. McCulloch v. Maryland, 17 U.S. 316 (1819). Interestingly, as Professor Charles L. Black, Jr. recently noted, the problem with the Maryland law in McCulloch was not that it directly violated a federal statute; rather, "what it did was to interfere with the functioning of a system created by national law." C. Black, A New Birth of Freedom 54 (1997) (emphasis in original). By that most basic formulation, the majority’s conclusion in Yavapai-Prescott that the state’s interests were "superior" to the federal-tribal interests at stake in the case was flawed in all but its allegiance to "states’ rights" as preeminent philosophical doctrine.