As most other states do, the Commonwealth of Kentucky taxes its residents' income. Kentucky law establishes that interest on bonds issued by Kentucky and its political subdivisions is exempt from Kentucky's income tax, whereas interest on bonds issued by other states and their political subdivisions is taxable. The tax exemption for Kentucky bonds helps make those bonds attractive to in-state purchasers even if they carry somewhat lower rates of interest than other states' bonds or those issued by private companies. Most other states have differential tax schemes that resemble Kentucky's. Kentucky residents George and Catherine Davis paid state income tax on interest from out-of-state municipal bonds, and then sued the Department of Revenue of Kentucky in an effort to obtain a refund. The Davises contended that Kentucky's differential taxation of municipal bond interest impermissibly discriminates against interstate commerce in violation of the U.S. Constitution's Commerce Clause. Were the Davises correct?
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