In United States v. Doremus, 249 U.S. 86 (1919) the Supreme Court held that a tax law “may not be declared unconstitutional, because its effect may be to accomplish another purpose as well as the raising of revenue.” That other purpose besides raising revenue was found to be absent when, on August 27, 2014, Midwest Gaming & Entertainment, LLC (“Midwest”) obtained a permanent injunction enjoining the imposition and enforcement of Cook County’s Gambling Machine Tax (the “Tax”).1 The Circuit Court of Cook County granted Midwest’s motion for summary judgment, and denied Cook County’s cross-motion for summary judgment, ruling that (1) the Tax improperly interfered with the exclusive jurisdiction for the Illinois Gaming Board (the “IGB”) created by the Illinois Riverboat Gambling Act (the “RGA”); (2) the Tax was an impermissible tax on occupations as prohibited by the Illinois Constitution; (3) the Tax was an illegal license for revenue; and (4) the Tax violated the Illinois Constitution by creating two arbitrary categories of taxpayers: operators of gambling devices and operators of video gaming terminals.
As state and local governments increasingly turn to taxes on gaming, marijuana, and other traditionally regulated products and activities, the Midwest Gaming decision is a timely reminder to taxpayers that many of these “sin taxes” may be vulnerable to challenge, because they do not represent a valid exercise of the police power, and are merely a veiled attempt to raise revenue.
Background On November 9, 2012, the Cook County Board of Commissioners enacted the Gambling Machine Tax Ordinance (Cook County Ordinance 12-O-62), which imposed the Tax, effective June 1, 2013. As enacted, the Gambling Machine Tax Ordinance imposed a $1000 annual tax upon each gambling device and a $200 annual tax upon each video gaming terminal.
Midwest filed the lawsuit alleging the Tax is invalid because (1) the RGA prohibits the imposition of the Tax; (2) the Tax is an impermissible “occupation tax”; (3) the Tax is a prohibited “license for revenue”; and (4) the Tax does not “treat all gambling machines uniformly.”
RGA Provision Barring Taxation by Home Rule Units Midwest argued that the RGA created exclusive jurisdiction for the IGB, and the Tax improperly interfered with that jurisdiction. The RGA provides that licensees “shall not be subject to any . . . occupation tax . . . which is imposed exclusively upon the licensee by the State or any political subdivision thereof”, except as provided in the RGA.2 The county, a “home rule unit” pursuant to Illinois law, argued that the RGA did not preempt the taxing powers of home rule units.3 The court disagreed, stating that the RGA clearly and explicitly prohibited the imposition of a tax, and that the term “home rule unit” was to be included in the phrase “state or any political subdivision thereof.”
The county also argued that the RGA provision expressly preempting additional taxes was not applicable to home rule units because the provision was not passed by the three-fifths supermajority that the Illinois Constitution requires for laws that curtail home rule powers.4 The court disagreed, noting that Article VII, Section 6 of the Illinois Constitution, which includes the three-fifths supermajority requirement, was inapplicable to the RGA, because by its own terms it did not apply to state laws limiting the power of a home rule county to tax activities, like casino gambling – the taxation of which is exclusively exercised and performed by the state.5
The Tax was an Illegal Occupation Tax Midwest also alleged that the Tax was an occupation tax prohibited by the Illinois Constitution. The county argued that the Tax was structured to avoid running afoul of the prohibition on occupation taxes.6 The county further argued that the services provided Midwest and other operators with respect to gambling machines subject to the tax devices was purely incidental and, therefore, the Tax was not a tax on the occupation of operating the gambling machines. The court found that the Tax was a tax on the occupation of operating a gambling business. The court further found that servicing the machine could not be separated from the machine itself. In short, the court held that the Tax was an impermissible tax on the occupation of operating a gambling business, and thus was a tax of the type prohibited by the Illinois Constitution.
The Tax was an Illegal License for Revenue Midwest also alleged that the Tax was a license for revenue – a use of the government’s police power to raise revenue – that was prohibited by the Illinois Constitution.7 The court agreed, finding the Tax bore all the indicia of a license for revenue as it was imposed on holders of gaming licenses and required the registration of machines; required the use and display of an emblem; authorized the county to audit the license holder’s facility, books and records; and penalized the license holder if the requirements were not in compliance.
The Tax Created Two Arbitrary Categories of Taxpayers Plaintiff alleged that the Tax unconstitutionally created two arbitrary categories of taxpayers in violation of the Uniformity Clause of the Illinois Constitution.8 In order to satisfy the Uniformity Clause, a classification must be based on a real and substantial difference between the categories of taxpayers, and must bear some reasonable relationship to the object of the legislation or to public policy.9 The two categories of taxpayers created by the Tax were the operators of gambling devices, subject to a $1,000 tax, versus the operators of video gaming terminals, subject to a $200 tax. Midwest argued that the differentiation between the two categories of taxpayers only served to impose a higher tax burden on operators of gambling devices (mainly casinos), than on operators of video gaming terminals (mainly bars and restaurants). Midwest argued that the differentiation had no relationship to the county’s purported purposes of providing funds to combat crime, health problems and gambling addiction. The county claimed that there is a real and substantial difference between the two classes of operators, because gambling machines tend to be located in casinos, where there were high-limit machines and the main purpose of the patrons was to gamble. In comparison, the county argued that video gaming terminals tended to be located in establishments, like bars and restaurants, where the terminals were merely incidental to the patrons’ primary purpose of for visiting the establishment. The court rejected this argument, because the county had failed to establish a real and substantial difference between video gaming terminals and gambling devices, as it had not established that video gaming terminals were prohibited in casinos, nor that video gaming terminals were only, or predominantly, used at bars and restaurants.
The nationwide spread of gaming as a source of revenue throughout the country is evidence that state and local governments are thirsty for new revenue sources that can be tapped, while avoiding increases in traditional taxes. Thus, while the Midwest Gaming decision impacts a narrow group of companies in Illinois, it serves as a useful reminder to businesses throughout the country that are subject to state or local regulatory or licensing charges. If these charges are not designed to improve or protect the public welfare, then the charges may in fact be taxes, subject to all of the limitations on taxes imposed by the federal and state constitutions, and local law. Although the standard for distinguishing between taxes and regulatory fees may vary from state to state, there is broad support for the proposition that “licensing for revenue” in lieu of adopting a new taxing measure, is an invalid use of state and local police powers.