451 U.S. 648 (1981)

WESTERN & SOUTHERN LIFE INSURANCE CO.
v.
STATE BOARD OF EQUALIZATION OF CALIFORNIA.

No. 79-1423.

Supreme Court of United States.

Argued January 12, 1981. Decided May 26, 1981. APPEAL FROM THE COURT OF APPEAL OF CALIFORNIA, SECOND APPELLATE DISTRICT.

*649 Alan R. Vogeler argued the cause and filed briefs for appellant.

Timothy G. Laddish, Deputy Attorney General of California, argued the cause for appellee. With him on the brief was George Deukmejian, Attorney General.^[*]

Briefs of amici curiae urging affirmance were filed by Robert K. Corbin, Attorney General of Arizona, Edwin P. Lee, and Bronson C. La Follette, Attorney General of Wisconsin, for the State of Arizona et al.; by William M. Leech, Jr., Attorney General, Jimmy G. Creecy, Deputy Attorney General, and Kate Eyler, Assistant Attorney General, for the State of Tennessee; and by Matthew J. Zinn for the American Insurance Association et al.

JUSTICE BRENNAN delivered the opinion of the Court.

California imposes two insurance taxes on insurance companies doing business in the State. A premiums tax, set at a fixed percentage of premiums paid on insurance policies issued *650 in the State, is imposed on both foreign and domestic insurance companies and a "retaliatory" tax, set in response to the insurance tax laws of the insurer's home State, is imposed on some foreign insurance companies. This case presents the question of the constitutionality of retaliatory taxes assessed by the State of California against appellant Western & Southern Life Insurance Co., an Ohio corporation, and paid under protest for the years 1965 through 1971.

I

Section 685 of the California Insurance Code imposes a retaliatory tax on out-of-state insurers doing business in California, when the insurer's State of incorporation imposes higher taxes on California insurers doing business in that State than California would otherwise impose on that State's insurers doing business in California.^[1] In computing the retaliatory *651 tax owed by a given out-of-state insurer, California subtracts the California taxes otherwise due from the total taxes that would be imposed on a hypothetical similar California company doing business in the out-of-state insurer's State of incorporation. If the other State's taxes on the hypothetical California insurer would be greater than California's taxes on the other State's insurer, a retaliatory tax in the amount of the difference is imposed. If the other State's taxes on the hypothetical California insurer would be less than or equal to California's taxes, however, California exacts no retaliatory tax from the other State's insurer.

Western & Southern, an Ohio corporation headquartered in Ohio, has engaged in the business of insurance in California since 1955. During the years in question, the company paid a total of $977,853.57 to the State in retaliatory taxes. After unsuccessfully filing claims for refunds with appellee Board of Equalization, Western & Southern initiated this refund suit in Superior Court, arguing that California's retaliatory tax violates the Commerce and Equal Protection Clauses of the United States Constitution.^[2]

*652 The Superior Court tried the case on stipulated facts without a jury, and ruled that the retaliatory tax is unconstitutional. It ordered a full refund of retaliatory taxes paid, plus interest and costs. App. 78-79. The California Court of Appeal reversed, upholding the retaliatory tax. 99 Cal. App. 3d 410, 159 Cal. Rptr. 539. The California Supreme Court denied Western & Southern's petition for hearing. App. 89. Western & Southern filed a notice of appeal in this Court, and we noted probable jurisdiction. 449 U. S. 817 (1980). We affirm.

II

The Commerce Clause provides that "The Congress shall have Power . . . To regulate Commerce . . . among the several States." U. S. Const., Art. I, § 8, cl. 3. In terms, the Clause is a grant of authority to Congress, not an explicit limitation on the power of the States. In a long line of cases stretching back to the early days of the Republic, however, this Court has recognized that the Commerce Clause contains an implied limitation on the power of the States to interfere with or impose burdens on interstate commerce.^[3] Even in the absence of congressional action, the courts may decide whether state regulations challenged under the Commerce Clause impermissibly burden interstate commerce. See, e. g., Minnesota v. Clover Leaf Creamery Co., 449 U. S. 456 (1981); Philadelphia v. New Jersey, 437 U. S. 617 (1978).

Our decisions do not, however, limit the authority of Congress to regulate commerce among the several States as it sees fit. In the exercise of this plenary authority, Congress may "confe[r] upon the States an ability to restrict the flow of interstate commerce that they would not otherwise enjoy." Lewis v. BT Investment Managers, Inc., 447 U. S. 27, 44 (1980); see H. P. Hood & Sons, Inc. v. Du Mond, 336 U. S. 525, 542-543 (1949). If Congress ordains that the States *653 may freely regulate an aspect of interstate commerce, any action taken by a State within the scope of the congressional authorization is rendered invulnerable to Commerce Clause challenge.

Congress removed all Commerce Clause limitations on the authority of the States to regulate and tax the business of insurance when it passed the McCarran-Ferguson Act, 59 Stat. 33, 15 U. S. C. § 1011 et seq., as this Court acknowledged in State Board of Insurance v. Todd Shipyards Corp., 370 U. S. 451, 452 (1962). See also Group Life & Health Ins. Co. v. Royal Drug Co., 440 U. S. 205, 219, n. 18 (1979); Wilburn Boat Co. v. Firemen's Fund Ins. Co., 348 U. S. 310, 319 (1955). Nevertheless, Western & Southern, joined by the Solicitor General as amicus curiae, argues that the McCarran-Ferguson Act does not permit "anti-competitive state taxation that discriminates against out-of-state insurers." Brief for Appellant 28; Brief for United States as Amicus Curiae 16. We find no such limitation in the language or history of the Act.

Section 1 of the Act, 59 Stat. 33, 15 U. S. C. § 1011, contains a declaration of policy:

"Congress declares that the continued regulation and taxation by the several States of the business of insurance is in the public interest, and that silence on the part of the Congress shall not be construed to impose any barrier to the regulation or taxation of such business by the several States."

Section 2 (a), 59 Stat. 33, 15 U. S. C. § 1012 (a), declares: "The business of insurance . . . shall be subject to the laws of the several States which relate to the regulation or taxation of such business." The unequivocal language of the Act suggests no exceptions.

The McCarran-Ferguson Act was passed in the wake of United States v. South-Eastern Underwriters Assn., 322 U. S. 533 (1944), which held that insurance is "commerce" within the meaning of the Commerce Clause. Prior to South-Eastern *654 Underwriters, insurance was not considered to be commerce within the meaning of the Commerce Clause, New York Life Ins. Co. v. Deer Lodge County, 231 U. S. 495 (1913); Paul v. Virginia, 8 Wall. 168 (1869), and thus "negative implication from the commerce clause was held not to place any limitation upon state power over the [insurance] business." Prudential Ins. Co. v. Benjamin, 328 U. S. 408, 414 (1946) (emphasis added). Believing that the business of insurance is "a local matter, to be subject to and regulated by the laws of the several States," H. R. Rep. No. 143, 79th Cong., 1st Sess., 2 (1945), Congress explicitly intended the McCarran-Ferguson Act to restore state taxing and regulatory powers over the insurance business to their pre-South-Eastern Underwriters scope. H. R. Rep. No. 143, supra, at 3; see SEC v. National Securities, Inc., 393 U. S. 453, 459 (1969); Maryland Casualty Co. v. Cushing, 347 U. S. 409, 412-413 (1954).

The Court has squarely rejected the argument that discriminatory state insurance taxes may be challenged under the Commerce Clause despite the McCarran-Ferguson Act. Prudential Ins. Co. v. Benjamin, supra; Prudential Ins. Co. v. Hobbs, 328 U. S. 822 (1946) (per curiam). In Benjamin, the Court considered a South Carolina insurance premiums tax imposed solely on foreign insurance companies. The Court found it unnecessary to decide whether the tax "would be valid in the dormancy of Congress' power," 328 U. S., at 427, or whether the tax "would be discriminatory in the sense of an exaction forbidden by the commerce clause," id., at 428. Expressly assuming that the tax would be discriminatory, id., at 429, the Court held that enactment of the McCarran-Ferguson Act "put the full weight of [Congress'] power behind existing and future state legislation to sustain it from any attack under the commerce clause to whatever extent this may be done with the force of that power behind it, subject only to the exceptions expressly provided for." Id., at 431. In Hobbs, this Court sustained against a Commerce Clause challenge a Kansas retaliatory insurance tax indistinguishable *655 from California's.^[4] The Kansas Supreme Court, upholding the retaliatory tax, had held that the McCarran-Ferguson Act "left the matter of regulation and taxation of insurance companies to the states." In re Insurance Tax Cases, 160 Kan. 300, 313, 161 P. 2d 726, 735 (1945). This Court summarily affirmed, citing Benjamin and its companion case, Robertson v. California, 328 U. S. 440 (1946). Prudential Ins. Co. v. Hobbs, supra, at 822.^[5]

We must therefore reject Western & Southern's Commerce Clause challenge to the California retaliatory tax: the McCarran-Ferguson Act removes entirely any Commerce Clause restriction upon California's power to tax the insurance business.

III

Ordinarily, there are three provisions of the Constitution under which a taxpayer may challenge an allegedly discriminatory state tax:^[6] the Commerce Clause, see, e. g., Complete *656 Auto Transit, Inc. v. Brady, 430 U. S. 274 (1977); the Privileges and Immunities Clause of Art. IV, § 2, see, e. g., Toomer v. Witsell, 334 U. S. 385 (1948); and the Equal Protection Clause, see, e. g., Wheeling Steel Corp. v. Glander, 337 U. S. 562 (1949).^[7] This case assumes an unusual posture, however, because the Commerce Clause is inapplicable to the business of insurance, see Part II, supra, and the Privileges and Immunities Clause is inapplicable to corporations, see Hemphill v. Orloff, 277 U. S. 537, 548-550 (1928). Only the Equal Protection Clause remains as a possible ground for invalidation of the California tax.^[8]

The Fourteenth Amendment forbids the States to "deny to any person within [their] jurisdiction the equal protection *657 of the laws," but does not prevent the States from making reasonable classifications among such persons. See Lehnhausen v. Lake Shore Auto Parts Co., 410 U. S. 356, 359-360 (1973); Allied Stores of Ohio v. Bowers, 358 U. S. 522, 526-527 (1959). Thus, California's retaliatory insurance tax should be sustained if we find that its classification is rationally related to achievement of a legitimate state purpose.

But as appellee points out, state tax provisions directed against out-of-state parties have not always been subjected to such scrutiny. Rather, a line of Supreme Court cases most recently exemplified by Lincoln National Life Ins. Co. v. Read, 325 U. S. 673 (1945), holds that a State may impose a tax on out-of-state corporations for the "privilege" of doing business in the State, without any requirement of a rational basis. Since the California courts have defined the retaliatory tax as a "privilege" tax, Western & Southern Life Ins. Co. v. State Board of Equalization, 4 Cal. App. 3d 21, 35, 84 Cal. Rptr. 88, 97-98 (1970), application of the reasoning of these cases would require us to sustain the tax without further inquiry into its rational basis. We must therefore decide first whether California's retaliatory tax is subject to such further inquiry.

Some past decisions of this Court have held that a State may exclude a foreign corporation from doing business or acquiring or holding property within its borders. E. g., Asbury Hospital v. Cass County, 326 U. S. 207, 211 (1945); Bank of Augusta v. Earle, 13 Pet. 519, 588-589, 592 (1839). From this principle has arisen the theory that a State may attach such conditions as it chooses upon the grant of the privilege to do business within the State. Paul v. Virginia, 8 Wall., at 181. While this theory would suggest that a State may exact any condition, no matter how onerous or otherwise unconstitutional, from a foreign corporation desiring to do business within it, this Court has also held that a State may not impose unconstitutional conditions on the grant of a privilege. *658 E. g., Sherbert v. Verner, 374 U. S. 398, 404 (1963); Wieman v. Updegraff, 344 U. S. 183, 192 (1952); Frost & Frost Trucking Co. v. Railroad Comm'n, 271 U. S. 583, 592-593 (1926).

These two principles are in obvious tension. If a State cannot impose unconstitutional conditions on the grant of a privilege, then its right to withhold the privilege is less than absolute. But if the State's right to withhold the privilege is absolute, then no one has the right to challenge the terms under which the State chooses to exercise that right. In view of this tension, it is not surprising that the Court's attempt to accommodate both principles has produced results that seem inconsistent or illogical. Compare Doyle v. Continental Ins. Co., 94 U. S. 535 (1877), with Insurance Co. v. Morse, 20 Wall. 445 (1874); and compare Lincoln National Life Ins. Co. v. Read, supra, with Hanover Fire Ins. Co. v. Harding, 272 U. S. 494 (1926).

The doctrine that a State may impose taxes and conditions at its unfettered discretion on foreign corporations, in return for granting the "privilege" of doing business within the State, originated in Paul v. Virginia, supra, a case decided only 15 months after the effective date of the Fourteenth Amendment. A Virginia statute required foreign insurance companies to purchase and file a specified amount of bonds as security for the protection of persons insured. No such requirement was imposed on domestic insurers. Several New York insurance companies refused to comply, and their agent was accordingly denied a license to engage in the insurance business in Virginia. The agent was prosecuted for selling insurance without a license; he defended on the ground that the statute was unconstitutional under the Privileges and Immunities Clause of Art. IV, § 2, and the Commerce Clause.^[9]

*659 This Court sustained the Virginia statute. Viewing corporations as recipients of "special privileges," 8 Wall., at 181, and believing that "it might be of the highest public interest that the number of corporations in the State should be limited," id., at 182, the Court held that a State's assent to the creation of a domestic corporation or the entry of a foreign corporation "may be granted upon such terms and conditions as those States may think proper to impose." Id., at 181.^[10] Under this view, there was no need for the Court to consider whether the statute was arbitrary, irrational, or discriminatory.

"[The States] may exclude the foreign corporation entirely; they may restrict its business to particular localities, or they may exact such security for the performance of its contracts with their citizens as in their judgment will best promote the public interest. The whole matter rests in their discretion." Ibid.

In two important respects, the legal underpinnings of Paul v. Virginia were soon eroded. First, the advent of laws of general incorporation, which swept the country in the late 19th century, see Louis K. Liggett Co. v. Lee, 288 U. S. 517, 557-564 (1933) (Brandeis, J., dissenting), altered the very nature of the corporation. Such laws, stimulated largely by "the desire for equality and the dread of special privilege[s]," id., at 549, n. 4, permitted persons to form corporations freely, subject only to generally applicable requirements and limitations. Incorporation lost its status as a special privilege. See *660 Henderson 68.^[11] Second, the Fourteenth Amendment, ratified in 1868, introduced the constitutional requirement of equal protection, prohibiting the States from acting arbitrarily or treating similarly situated persons differently, even with respect to privileges formerly dispensed at the State's discretion. The combination of general incorporation laws and equal protection necessarily undermined the doctrine of Paul v. Virginia. If the right to incorporate or to do business within a State ceases to be a privilege to be dispensed by the State as it sees fit, and becomes a right generally available to all on equal terms, then the argument for special exactions as "privilege taxes" is destroyed.

The Court was slow to recognize the consequences of these developments. In Philadelphia Fire Assn. v. New York, 119 U. S. 110 (1886), the first relevant decision governed by the Fourteenth Amendment, the Court unhesitatingly applied the doctrine of Paul v. Virginia to sustain a New York retaliatory insurance tax against an equal protection challenge. The Court held that a corporation is not a "person within [the State's] jurisdiction," 119 U. S., at 116, for purposes of the Equal Protection Clause unless it is in compliance with the conditions placed upon its entry into the State, and that a corporation assents to all state laws in effect at the time of its entry. Id., at 119.^[12]

"The State, having the power to exclude entirely, has *661 the power to change the conditions of admission at any time, for the future, and to impose as a condition the payment of a new tax, or a further tax, as a license fee. If it imposes such license fee as a prerequisite for the future, the foreign corporation, until it pays such license fee, is not admitted within the State or within its jurisdiction. It is outside, at the threshold, seeking admission, with consent not yet given. . . . By going into the State of New York in 1872, [the Philadelphia Fire Association] assented to such prerequisite as a condition of its admission within the jurisdiction of New York." Id., at 119-120.

Justice Harlan dissented. Acknowledging that a State may prescribe certain conditions upon the entry of a foreign corporation, he insisted "that it is the settled doctrine of this court, that the terms and conditions so prescribed must not be repugnant to the Constitution of the United States, or inconsistent with any right granted or secured by that instrument." Id., at 125. "Can it be," he asked, "that a corporation is estopped to claim the benefit of the constitutional provision securing to it the equal protection of the laws simply because it voluntarily entered and remained in a State which has enacted a statute denying such protection to it and to like corporations from the same State?" Id., at 127.

Although dicta in several cases supported Justice Harlan's view that a State may not impose conditions repugnant to the Constitution upon the grant of a privilege, see, e. g., Ducat v. Chicago, 10 Wall. 410, 415 (1871); Doyle v. Continental *662 Ins. Co., 94 U. S., at 540, the Court continued to reject constitutional claims by corporations challenging conditions to entry. E. g., New York v. Roberts, 171 U. S. 658, 665-666 (1898); Horn Silver Mining Co. v. New York, 143 U. S. 305, 312-315 (1892); Pembina Consol. Silver Mining & Milling Co. v. Pennsylvania, 125 U. S. 181, 184-185 (1888). Nonetheless, the first quarter of this century saw "an almost complete disintegration" of the doctrine of Paul v. Virginia. Henderson 111. The change became evident in the October Term 1909, when the Court decided four cases in conflict with the principle that the States possess unlimited power to condition the entry of foreign corporations.^[13] The most significant of these decisions for our purposes is Southern R. Co. v. Greene, 216 U. S. 400 (1910), which expressly rejected the contention "that the imposition of special taxes upon foreign corporations for the privilege of doing business within the State is sufficient to justify such different taxation." Id., at 417.^[14]

*663 The plaintiff, Southern Railway, had been admitted to do business in Alabama and had invested in permanent facilities in the State. At that time, franchise taxes imposed on domestic corporations were equal to privilege taxes imposed on foreign corporations. Later, Alabama imposed an additional privilege tax on foreign corporations, which Southern Railway challenged on equal protection grounds. The Court held that classifications among corporations for purposes of taxation are constitutional under the Equal Protection Clause only if they bear a "reasonable and just relation" to the purpose for which they are imposed. Ibid. Noting that there were domestic corporations in Alabama whose business was indistinguishable from that of Southern Railway, the Court stated that "[i]t would be a fanciful distinction to say that there is any real difference in the burden imposed because the one is taxed for the privilege of a foreign corporation to do business in the State and [the] other for the right to be a corporation." Id., at 417-418. The Court held that "to tax the foreign corporation for carrying on business under the circumstances shown, by a different and much more onerous rule than is used in taxing domestic corporations for the same privilege, is a denial of the equal protection of the laws." Id., at 418.^[15]

*664 In Hanover Fire Ins. Co. v. Harding, 272 U. S. 494 (1926), the Court extended the protections of Southern Railway against discriminatory taxation to corporations holding short-term licenses, and to those without substantial permanent property in the State.^[16] 272 U. S., at 508, 509, 514-515. With respect to the general tax burden on business, "the foreign corporation stands equal, and is to be classified with domestic corporations of the same kind." Id., at 511.^[17]

After Hanover Fire Ins. Co., little was left of the doctrine of Paul v. Virginia and Philadelphia Fire Assn. v. New York, 119 U. S. 110 (1886). It was replaced by a new doctrine:

"It is not necessary to challenge the proposition that, as a general rule, the state, having power to deny a privilege altogether, may grant it upon such conditions as it sees fit to impose. But the power of the state in that respect is not unlimited; and one of the limitations is that it may not impose conditions which require the relinquishment of constitutional rights. If the state may compel the surrender of one constitutional right as a condition of its favor, it may, in like manner, compel a surrender of all. It is inconceivable that guaranties embedded in the Constitution of the United States may *665 thus be manipulated out of existence." Frost & Frost Trucking Co. v. Railroad Comm'n, 271 U. S., at 593-594.

See also Power Manufacturing Co. v. Saunders, 274 U. S. 490, 497 (1927).

The decision in Lincoln National Life Ins. Co. v. Read, 325 U. S. 673 (1945), thus stands as a surprising throwback to the doctrine of Paul v. Virginia and Philadelphia Fire Assn. v. New York. There, the Court seemed to adopt precisely the argument that was rejected in Hanover Fire Ins. Co.: "that a State may discriminate against foreign corporations by admitting them under more onerous conditions than it exacts from domestic companies . . . ." 325 U. S., at 677; cf. 272 U. S., at 507.^[18] The Court stated that the argument that a State may not impose unconstitutional conditions to entry "proves too much." 325 U. S., at 677. "If it were adopted," the Court said, "then the long-established rule that a State may discriminate against foreign corporations by admitting them under more onerous conditions than it exacts from domestic companies would go into the discard." Ibid.^[19] So long as a tax is "levied upon the privilege of entering the State and engaging in business there," it may not be challenged under the Equal Protection Clause, even though it may impose a burden greater and more discriminatory than was imposed at the date of the corporation's entry into the State. Id., at 678.

The holding in Lincoln National has been implicitly rejected *666 in at least three subsequent cases. In Wheeling Steel Corp. v. Glander, 337 U. S. 562 (1949), the Court struck down a provision of Ohio's ad valorem tax law that subjected certain intangible property of non-Ohio corporations to a tax not applied to identical property of Ohio corporations. The Court concluded that the provision violated the Equal Protection Clause on the ground that the inequality of treatment was "not because of the slightest difference in Ohio's relation to the decisive transaction, but solely because of the different residence of the owner." Id., at 572.^[20] The decision in Wheeling Steel was not directly in conflict with that in Lincoln National, because the Ohio courts had held the tax in Wheeling Steel an "ad valorem property tax, . . . and in no sense a franchise, privilege, occupation, or income tax." 337 U. S., at 572. However, the Wheeling Steel decision rejected the principle of Lincoln National: the opinion declared that a State's power to exclude out-of-state corporations is limited by the Constitution; the State may not "exac[t] surrender of rights derived from the Constitution of the United States." 337 U. S., at 571 (citing Hanover Fire Ins. Co. v. Harding, supra, at 507).

In Allied Stores of Ohio, Inc. v. Bowers, U. S. 522 (1959), this Court sustained an Ohio statute exempting non-residents from an ad valorem tax on certain property held in a storage warehouse, but not exempting Ohio residents from the tax. Without alluding to any possibility that legislative classifications based on State of incorporation should be subject to a different standard from other classifications, the Court held that state tax laws "must proceed upon a rational *667 basis and may not resort to a classification that is palpably arbitrary." Id., at 527.^[21]

Finally, in WHYY, Inc. v. Glassboro, 393 U. S. 117 (1968), this Court struck down a New Jersey statute exempting nonprofit corporations incorporated in New Jersey from tax, but denying a similar exemption to nonprofit corporations incorporated in other States. Disregarding Lincoln National, the Court stated the applicable principle of law as follows:

"This Court has consistently held that while a State may impose conditions on the entry of foreign corporations to do business in the State, once it has permitted them to enter, `the adopted corporations are entitled to equal protection with the state's own corporate progeny, at least to the extent that their property is entitled to an equally favorable ad valorem tax basis.' Wheeling Steel Corp. v. Glander, 337 U. S. 562, 571-572. See Reserve Life Ins. Co. v. Bowers, 380 U. S. 258; Hanover Fire Ins. Co. v. Harding, 272 U. S. 494; Southern R. Co. v. Greene, 216 U. S. 400." 393 U. S., at 119-120.

In view of the decisions of this Court both before and after Lincoln National, it is difficult to view that decision as other than an anachronism. We consider it now established that, whatever the extent of a State's authority to exclude foreign corporations from doing business within its boundaries, that *668 authority does not justify imposition of more onerous taxes or other burdens on foreign corporations than those imposed on domestic corporations, unless the discrimination between foreign and domestic corporations bears a rational relation to a legitimate state purpose. As we held in Power Manufacturing Co. v. Saunders, 274 U. S., at 493-494:

"No doubt there are . . . subjects as to which foreign corporations may be classified separately from both individuals and domestic corporations and dealt with differently. But there are other subjects as to which such a course is not admissible, the distinguishing principle being that classification must rest on differences pertinent to the subject in respect of which the classification is made."

IV

In determining whether a challenged classification is rationally related to achievement of a legitimate state purpose, we must answer two questions: (1) Does the challenged legislation have a legitimate purpose? and (2) Was it reasonable for the lawmakers to believe that use of the challenged classification would promote that purpose? See Minnesota v. Clover Leaf Creamery Co., 449 U. S., at 461-463;