Gillis v. Yount

748 S.W.2d 357, 100 Oil & Gas Rep. 645, 1988 Ky. LEXIS 13, 1988 WL 17258

• Court: Kentucky Supreme Court
• Decided: March 3, 1988
• Docket: 87-SC-286-DG, 87-SC-288-DG
• Status: Published

Opinions

LEIBSON, Justice.

These cases challenge the constitutionality of KRS 132.020(5), which classifies un-mined coal separately from other real property and then taxes it “at the rate of one-tenth of one cent ($.001) per one hundred dollars ($100) of assessed value.” All other real property is taxed “for state purposes” under KRS 132.020(1) at “thirty-one and one-half cents (31 Vat) upon each one hundred dollars ($100) of value.”

The cases are consolidated. In the first case Yount and others similarly situated, a class of real property owners, claim that the statute is unconstitutional because the General Assembly has arbitrarily classified one type of real property separately from other real property. In the second case Moore and others similarly situated, a class of automobile owners, claim that the 1 mil (“$.001”) rate is unconstitutional because it is an exemption and not a tax.

The Franklin Circuit Court, after trial on the merits, entered judgment (1) rejecting the claim that the separate classification for unmined coal was constitutionally impermissible, and (2) upholding the claim that the tax rate “bestows on unmined coal a de facto exemption from property taxation,” and thus “is unconstitutional under Sections 3 and 174 of the Constitution.”

On appeal the Court of Appeals ruled in favor of the claims of both plaintiffs, agreeing with the trial court that this one mil rate for unmined coal was in fact an unconstitutional exemption, and then further holding that the separate classification of unmined coal was arbitrary and therefore unconstitutional under Section 171 of our Constitution which requires that “[t]axes ... shall be uniform upon all property of the same class subject to taxation within the territorial limits of the authority levying the tax.”¹

A majority of our Court has decided that the classification issue is the threshold issue on discretionary review. Having decided that KRS 132.020(5) is an arbitrary classification in violation of Section 171 of the Kentucky Constitution, as quoted above, the Court has elected not to consider whether the $.001 ad valorem levy upon unmined coal is an unconstitutional tax rate.

Both sides agree that Kentucky law classifies ownership of unmined coal as an interest in real estate. As stated in Williams’ Adm’r v. Union Bank and Trust Co., 283 Ky. 644, 143 S.W.2d 297, 300 (1940): “[i]t has long been the law of this State that minerals in place are real estate_” And as stated in Commonwealth v. Elkhorn-Piney Coal Min. Co., 241 Ky. 245, 43 S.W.2d 684, 686 (1931):

“[T]he rights created by a coal lease ... constitute real estate for the purposes of taxation under our present statutes.”

From 1792, when Kentucky’s first property tax was levied, until the 1970’s, coal was taxed only insofar as it was included in the value of the surface property. Then in the 1970’s, the General Assembly enacted a new type of tax, the severance tax, first applicable only to coal and then extended to “the physical removal of [any] natural resource from the earth or waters of this State by any means” with certain exemptions and exceptions which are not relevant to this case. KRS Chapters 143 and 143A.

The new tax is an excise tax “upon the privilege of severing and processing coal” and not a property tax. Circle “C” Coal Co., Inc. v. Com., Ky.App., 628 S.W.2d 883, 885 (1982). Coal was the first mineral, and is perhaps the major one, subject to this new excise tax, the severance tax, but it is certainly not the only one. “Rock, stone, limestone, shale, gravel, sand, clay, natural gas, and natural gas liquids,” are all classified as a “natural resource” (KRS 143A.010) and taxed at the same rate (KRS 143A.020), which is 4V2%. Under KRS 137.-120 a similar tax is imposed upon “all crude petroleum produced in this state.”

However, for purposes of ad valorem taxation unmined coal alone has been separately classified from other real estate. In 1976, the General Assembly classified coal separately from other real estate for the first time (1976 Kentucky Acts, Chapter 84, Section 7), and in 1978 the General Assembly followed this up with the new rate of one cent per thousand (one mil) enacted in KRS 132.020(5). The connection between classifying unmined coal separately from other interests in real property subject to ad valorem tax and then imposing the new one mil rate for such property is abundantly clear from review of the legislative history of the one mil rate.

The framers of the 1891 Kentucky Constitution, to protect the people, enacted significant constitutional limitations upon the powers of the General Assembly to impose state property taxes and create exemptions. 2 Debates Constitutional Convention 1890, 2372-2423 (1890). The primary source of tax revenue at the time was property taxes, and this is where the problems with unfairness were perceived, so these constitutional limitations, covered principally in Kentucky Constitutions Sections 170-175, deal only with the power to tax property, or ad valorem taxes. They require inter alia, that taxes “shall be uniform upon all property of the same class,” (Section 171), that “all property, not exempted from taxation by this Constitution, shall be assessed ... at its fair cash value” (Section 172), and that “all property ... shall be taxed in proportion to its value, unless exempted by this Constitution; and ... shall pay the same rate of taxation” (Section 174). The constitutional exemptions are specified in Section 170, which states that “all laws exempting or omitting property from taxation other than the property above mentioned shall be void.” It is almost impossible to see how the constitutional mandate on state property taxes could have been expressed in clearer or more positive terms.

The one mil rate (one cent per thousand) was devised as a method to avoid these constitutional restrictions. See Joint Submission, Kentucky Department of Kevenue, Annual Report HS-88 (1975-76). The movant, Gary Gillis, Secretary of the Revenue Cabinet, candidly conceded that the legislative purpose behind a one mil rate is to create a de facto exemption, although arguing that this is constitutionally permissible. The only way to effect such a purpose, a de facto exemption, with reference to unmined coal was to first classify it separately from other real property, and to then designate one mil as the applicable rate. The statutes of 1976 and 1978 were enacted as a plan to effect this purpose.

The need to enact a one mil rate when the General Assembly wished to favor a certain type of property with a de facto tax exemption resulted from the decision of our Court in Russman v. Luckett, Ky., 391 S.W.2d 694 (1965). Russman is the bellwether case on the subject of constitutional limitations on property taxes. It was a taxpayers’ suit attacking the assessment procedures then in place by which “real estate and tangible personal property in Kentucky [were] assessed for tax purposes at varying percentages substantially less than 100 percent of fair cash value.” 391 S.W.2d at 695. Our Constitution, Section 172, specifies that “[a]ll property, not exempted from taxation by this Constitution, shall be assessed for taxation at its fair cash value.” Nevertheless, over a period of 75 years the practice had evolved of “substituting the test of ‘uniformity’ in place of ‘fair cash value’.” In Russman, our Court delivered to the executive branch and the legislature the message that in the area of property taxes, when called upon to do so, our Court was prepared to enforce the Constitutional mandate. We stated that there is “no authority which would recognize an implied repeal of a constitutional provision because of its continued violation by public officials. The suggestion is appalling.” Id. at 697.

As admitted by the Revenue Cabinet, primarily in reaction to Russman the concept of a one mil tax rate developed to avoid the tax burden for certain types of property which did not enjoy constitutional exemption but which were perceived by the General Assembly as needing de facto exemption in the public interest. Because unmined coal was taxed as an interest in real estate, in order to favor unmined coal with this de facto exemption it was necessary to employ a two-stage procedure, first classifying it separately from other real estate, and then assigning to it the 1 mil rate. The question is, of course, whether this procedure is legitimate tax avoidance or unconstitutional tax evasion; does the method instituted to avoid the constitutional limitations in Section 172 impale upon the constitutional limitations in Sections 171 and 174? In answering that question there are several arguments in the present case that track similar arguments in Russ-man, and that are fully answered by the Russman opinion.

Movants argue that the 1891 Constitution is “outmoded,” that the stated purpose for and definition of taxation as stated in Section 171, raising revenue “to defray the estimated expenses of the Commonwealth,” fails to take account of the present need to use taxation to promote economic development, and therefore the judiciary should aid and abet the General Assembly in structuring taxation free from constitutional restraints. The Revenue Cabinet’s Brief claims:

“The politics and issues of Kentucky in 1890 are as foreign to this generation as the intrigues of ancient Rome. The revenue provisions of the Constitution shackled the hand of the legislature to keep it from embracing the corrupt and polluting grasp of wealthy corporations. Today there is no need to tighten those shackles to prevent the legislature from extending a benevolent hand to ... others [presumably the owners of unmined coal] who honor their debt to the Commonwealth in ways worthy of legislative consideration.”

The record is not convincing that circumstances today are so different that constitutional restrictions on the power of the General Assembly with regard to property taxes are no longer viable. With special interests and pressure groups seemingly better organized, better financed and more powerful than ever before, we can hardly take judicial notice that the General Assembly should be free from constitutional restraint to manipulate the tax structure to extend “a benevolent hand” to those “who honor their debt to the Commonwealth in ways worthy of legislative consideration.” The proponents of the special tax treatment for unmined coal in KRS 132.020(5) have yet to provide any hard information in the record or in briefs as to how this statute benefits anyone but the coal owners. The best that has been offered is an argument that it is part of an overall scheme for taxing the coal industry in which the severance tax paid by coal producers “more than makes up” for any potential loss of revenue.

Even if we were inclined to accept as fact that the people of Kentucky no longer need protection from the “corrupt and polluting grasp of wealthy corporations” (or the power of today’s special interest groups), we are not free to strike the constitutional mandate. We have no power to ignore the plain meaning of the Constitution when we believe it expedient to do so. As stated in Russman:

we are dealing with our fundamental law. It is not outdated, or obsolete, or contrary to any policy we know of.... This law today is just as vital and enforceable as it was the day it was written into the Constitution.” 391 S.W.2d at 697.

Where constitutional change is needed, the process is not by legislative enactment and judicial acquiescence, but by constitutional amendment. In Fannin v. Williams, Ky., 655 S.W.2d 480 (1983), we were faced with powerful arguments that the constitution should be circumvented in the public interest. Nevertheless, we recognized that it was our judicial duty to declare unconstitutional a statute supplying textbooks to children in the state’s nonpublic schools.

“The people of Kentucky specified by the language of the Constitution ... that the type of expenditure authorized by the statute in question should be unconstitutional. If the people of Kentucky wish to change their position in this matter, it is their right to do so.

... If the legislature thinks the people of Kentucky want this change, they should place the matter on the ballot.

... We cannot sell the people of Kentucky a mule and call it a horse, even if we believe the public needs a mule.” Id. at 484.

The movants argue that judicial intervention in matters of taxation usurps the legislative function. The judiciary intervenes only when called upon by the litigants to settle a case in controversy. But when so called upon it is part of the exercise of this function to enforce constitutional restrictions on legislative power. The judiciary cannot abdicate its responsibility by deferring to the legislature. As stated by Mr. Justice Roberts in United States v. Butler, 297 U.S. 1, 62-63, 56 S.Ct. 312, 317-18, 80 L.Ed. 477 (1936), in reviewing the judiciary’s “responsibility to render judgment in accordance with the principles established for the governance of all three branches of the Government”:

“It is sometimes said that the court assumes a power to overrule or control the action of the people’s representatives. This is a misconception. The Constitution is the supreme law of the land ordained and established by the people. All legislation must conform to the principles it lays down.' When an act of Congress [or in our present case the General Assembly] is appropriately challenged in the courts as not conforming to the constitutional mandate the judicial branch of the Government has only one duty, — to lay the article of the Constitution which is invoked beside the statute which is challenged and to decide whether the latter squares with the former.”

The opinion continues:

“This court neither approves nor condemns any legislative policy. Its delicate and difficult office is to ascertain and declare whether the legislation is in accordance with, or in contravention of, the provisions of the Constitution; and, having done that, its duty ends.”

In Russman, in language expressing the same concept, our Court stated:

“In the performance of our duty we are not, by this decision, in any sense changing the law of taxation, or the tax structure, or increasing the tax burden. We are simply declaring and enforcing the law [i.e., the Constitution], and the law is made by the people.” 391 S.W.2d at 700.

The original 1891 proviso in Section 171 of the Kentucky Constitution specified that all state property taxes shall be “uniform upon all classes of property.” In 1915 by Constitutional Amendment this was changed to specify “uniform upon all property of the same class.” We took up the effect of this Amendment in Martin v. High Splint Coal Co., 268 Ky. 11, 103 S.W.2d 711, 712-13 (1937). The legislation at issue in Martin attempted to exempt all real property from taxation, and then to separately classify “minerals” so as to permit continued taxation of mineral estates, and coal in particular. The situation was the reverse of the present case but the principles at issue were essentially the same. We held the statutory scheme unconstitutional. We stated:

“[T]he question is not whether it is competent for a Legislature to either classify or exempt property from taxation where there are no constitutional provisions prohibiting either classification or exemption.” Id. 103 S.W.2d at 712-13. [Emphasis original.]

In Martin, we explained the effect of the 1915 Amendment to Section 171. The 1915 Amendment to Section 171 did not alter the fundamental constitutional injunction that all property must be taxed. Martin v. High Splint Coal Co., supra; Cumberland Pipeline Co. v. Commonwealth, 258 Ky. 90, 79 S.W.2d 366 (1935). Nor did it authorize the General Assembly to separately classify except by distinctions related to the particular characteristics of the property relevant to the purposes of taxation, and not artificial distinctions to accommodate the economic situations of a particular industry, unrelated to taxation.

According to its legislative history, the 1915 Amendment did not generate from a perceived need to favor certain classes of property in the process of taxation. On the contrary, the perceived need was to remedy “an unfair proportion of the burden of government [being] borne by visible property [real property and other tangibles], which cannot escape taxation, and wholesale evasion by such forms of property as are easily hidden [intangibles].” Report of the Special Tax Commission, 1909, pp. 3-4. The Report states:

“The answer is found in the experience of other States which have proved that under a reasonable tax rate [for intangibles] many millions of dollars of property, previously withheld from assessment, have been listed for taxation. For the most part, men seem to prefer to deal squarely in the matter of listing their property if they can do so without suffering what they consider unnecessary confiscation.” Id., p. 26.

It is difficult to understand the logical underpinnings of the movants’ argument that this special tax classification for un-mined coal, and this special tax treatment favoring those who own unmined coal (the one mil rate), benefits economic development. The record shows that vast amounts of Kentucky’s unmined coal reserves are owned by different interests than those who mine it, process it and distribute it. Those persons and corporations engaged in the production and sale of coal, generating jobs and dollars, would seemingly have a much stronger claim on the General Assembly for protective legislation than those harboring it in its natural state. The economic development arguments presented by the Revenue Cabinet and the Kentucky Coal Association, Inc. are tenuous and speculative. As we stated in the case of Tablet v. Wallace, Ky., 704 S.W.2d 179, 187 (1986):

“The only apparent basis for the present legislation is that a special class ... lobbied for a statute.... There is no social or economic basis presented to justify a special class, only their own self-interest. Other groups similarly situated do not share in their legislative windfall. Their subjective reasons will not withstand public policy analysis.” Id. at 187.

We conclude here, as we did in Tablet, that “imaginative reasons that could exist, without anything of a positive nature to suggest that they did exist, do not suffice.” Id.

Nevertheless, if we were to assume that such arguments are valid for reasons that cannot be satisfactorily explained, the critical point in this case remains that the constitutionality of the one mil tax on un-mined coal does not turn on whether the General Assembly perceived that this favorable tax treatment served a public purpose, but on whether the tax classification is constitutionally permissible within the limiting language of Section 171. Thus, as stated in United States v. Butler, quoted supra, our "duty” is “to lay the article of the Constitution which is evoked beside the statute which is challenged and decide whether the latter squares with the former.” 297 U.S. at 63, 56 S.Ct. at 318.

Under Section 171 the stated purpose for taxation is to raise revenue which, “with other resources, shall be sufficient to defray the estimated expenses of the Commonwealth for each fiscal year.” As we stated in Atlantic Coastline R. Co. v. Commonwealth, 302 Ky. 36, 193 S.W.2d 749, 752 (1946):

“It is always to be borne in mind that the taxing statutes are framed to produce revenue.”

And in Gray v. Methodist Episcopal Church, 272 Ky. 646, 114 S.W.2d 1141, 1143 (1938), a levy classifies as a tax if “for purposes of raising revenue.” The 1915 Amendment does not change any of the other clauses of the Constitution restricting state property taxes; it simply permits the General Assembly to tax different classes of property separately. All property must still be taxed, and this must be a bona fide tax, i.e., one which has for its purpose raising revenue rather than exempting property from taxation.

From the historical material that has been presented to us (e.g., statements of some individuals contained in the Report of the Special Tax Commission, 1915, Chapter 4) it appears that many advocated for broader constitutional amendment, eliminating all constitutional restrictions on state property taxes. But it is clear from the limited nature of the amendment that was finally proposed and adopted, and the subsequent rejection of more expansive amendments, such as the proposed 1932 Amendment “to provide by law that real estate and/or tangible personal property may be exempted from taxation for state purposes {See 1932 Acts Ch. 141 rejected by an overwhelming majority),” that our people have never yet favored permitting any further inroads into the constitutional limitations on state property taxes. The cases and materials available to us refute this contention. Cases advocated by the movants in urging us to a different course, such as Delta Airlines, Inc. v. Commonwealth, Revenue Cabinet, Ky., 689 S.W.2d 14 (1985), are inapposite because the taxes involved are not state property taxes, and thus not subject to the constitutional restrictions on state property taxes.

Quite obviously the 1891 version of the constitutional mandate in Section 171, that all classes of property shall be taxed the same, was changed by the 1915 Amendment. The question is, of course, what is the nature and effect of the change wrought by the 1915 Amendment. That the intended effect was limited is evident from the fact that only one change was made in state property taxes.

We are aware that & further change was made giving the General Assembly more power over “local taxation,” to wit:

“The General Assembly shall have power to divide property into classes and to determine what class or classes of property shall be subject to local taxation.” [Emphasis added].

But this grant of additional power in local taxation simply reenforces the conscious decision to make only one change in the restrictions on state property taxes, that change being to permit property of one “class” to be taxed at a different rate than property of another.

So the question is what was accomplished by this one change in the constitutional structure limiting state property taxes? What does the Constitution mean by “classes” for purposes of ad valorem taxes? The answer rests in the general principle that constitutional provisions permitting classification always carry with them the limitation that the classification scheme must be reasonable, not arbitrary, and this in turn requires classification on the basis of “an appreciable relevancy to the subject matter of the legislation.” Bd. of Educ. of Jefferson Co. v. Bd. of Educ., Ky., 472 S.W.2d 496, 498 (1971).

The subject matter in Bd. of Educ. of Jefferson Co. v. Bd. of Educ. of Louisville was the constitutional limits on classification effected by Sections 59 and 60 which forbid special and local legislation. But viewed as a problem in constitutional interpretation, the issue is essentially the same as the classification problem presented by Section 171. We stated the rule thusly:

“[T]he General Assembly may indulge in class legislation if the classification is made to depend upon natural, real or substantial distinctions, inhering in the subject matter, such as suggest the necessity for or propriety of independent legislation in regard to the class specified. A classification based upon purely artificial, arbitrary or fictitious conditions is unreasonable and will not be permitted.” 472 S.W.2d at 498.

The present problem does not turn on whether real property is a super class which cannot be subdivided for purposes of taxation, although that argument has been presented. We need only decide whether a separate tax classification for unmined coal treating it differently from all other interests in real estate, including other interests with similar characteristics such as oil and gas in its natural state, is a classification that is, or is not, related to the constitutionally permissible classification for tax purposes. If it is “[a] classification based upon purely artificial, arbitrary or fictitious conditions [it] is unreasonable and will not be permitted.” Bd. of Educ. of Jefferson Co., as quoted supra. For instance, the General Assembly could not classify state real property for taxation according to size or location rather than value because this would be arbitrary classification. Differences of a nature which permit classification for one governmental function are not transferable to permit classification for a different function. In this case the function is taxation. The classification serves no legitimate purpose to promote the governmental function directly involved.

The kind of differences that justify separate classification for purposes of state property taxation are the kind of difference that was the motivation behind the constitutional amendment, justifying separate classification of real estate and intangible property taxes. See Report of the Special Tax Commission, 1909, supra. See also, Kentucky Finance Co. v. McCord, Ky., 290 S.W.2d 481 (1956), recognizing that the Constitutional Amendment permits the General Assembly to classify intangible personalty separately from real estate and assign a different tax rate.

There is no difference between unmined coal and other unmined minerals for purposes of taxation unless it be in movants’ claim that the economic importance of the coal industry to our state, standing alone, is sufficient to justify separate classification. But this argument is fatally flawed for two reasons:

1) Assuming that coal has a special economic importance qualitatively different from any other interest in real estate, this special classification and rate for unmined coal does not promote the coal industry but only one element in the industry, the coal owners. Indeed, the moral justification advanced for excusing coal owners from taxation is that the coal producers will make up the difference for the coal industry through the severance tax. But coal owners and coal producers are often two different taxpayers, so this reasoning does not withstand scrutiny. However, even if it did the severance tax (as an excise tax) would be unrelated to constitutional restrictions on state property taxes.

2) If the difference between unmined coal and other unmined minerals is the difference in the economic importance that the coal industry assigns to itself by reason of its size, size alone does not constitute a reason for classification unless that size produces other qualitative differences related to the purpose of the classification. Bd. of Educ. of Jefferson Co. v. Bd. of Educ. of Louisville, quoted supra.

On this point movants rely on language of the court in Delta Airlines Inc. v. Comm. Revenue Cabinet, supra. The Delta Airlines case involved an assessment for sales and use taxes against airlines of fuel and food purchases in Kentucky. The airlines claimed that the tax was discriminatory because other transportation industries, notably trucks and other motor common carriers, received different and more favorable tax treatment from the General Assembly on their fuel purchases in Kentucky. We stated:

“This Court has determined that economic factors are valid considerations which the legislature may take into account in developing a legitimate tax classification. ...

The different tax treatment for airlines, truck lines, barge lines, bus lines and railroad lines can be justified by their different competitive environment and their different significance to the overall state economy_” 689 S.W.2d at 18.

But these are excise taxes not subject to the constitutional restrictions on state property taxes in Section 171. Making tax distinctions for purposes of promoting some perceived state economic advantage rather than for purposes related to raising revenue is permissible in taxes other than property taxes because other kinds of taxes do not involve the same constitutional restrictions. Excise taxes may be varied from one type of taxpayer to another to promote competitive conditions or some perceived state economic advantage; classification may be structured to serve some purpose other than taxation. But the tax scheme for state property taxes expressed in the 1891 Constitution and unchanged by the 1915 Amendment, was exactly the opposite, i.e., taxation is permitted for the limited purpose of raising revenue and shall not be subject to manipulation to promote any taxpayer’s (or group of taxpayers’) economic advantage regardless of whether the General Assembly should perceive that some other public benefit may be derived by doing so.

A case similar in principle is City of Corbin v. Louisville & N.R. Co., 233 Ky. 709, 26 S.W.2d 539 (1930). In that case the governmental entity, the City of Corbin, agreed to a contract with the railroad, and enacted an ordinance, providing reimbursement of a tax assessment in exchange for permission to utilize a portion of the railroad’s property in constructing a sewer system. We held the ordinance and contract unconstitutional, stating “the railroad secured ... a right or privilege denied to other property owners similarly situ-ated_ The ordinance was for the benefit of one taxpayer.” Id. 26 S.W.2d at 540. Here the statute is for the benefit of one group of taxpayers, those owning an interest in unmined coal, who cannot be distinguished from other taxpayers for any reason related to the purpose for property taxes stated in Section 171 of the Constitution, which is raising revenue “to defray the estimated expenses of the Commonwealth.”

The judgment of the trial court holding the statute in question, KRS 132.020(5), is unconstitutional, and the decision of the Court of Appeals affirming this holding, are affirmed.

STEPHENS, C.J., and LAMBERT, VANCE and WINTERSHEIMER, JJ., concur. LEIBSON, J., concurs in this opinion, and also files a separate concurring opinion.

WINTERSHEIMER, J., concurs by separate opinion in which LEIBSON, J., joins.

STEPHENSON, J., dissents by separate opinion in which GANT, J., joins.

1 . The Court of Appeals held that another issue presented, the propriety of awarding attorneys’ fees, was not preserved for appellate review because the appellants did not designate the attorneys as parties to the appeal. We have not considered this issue on discretionary review.