A unanimous three-judge panel of the US Court of Appeals for the District of Columbia Circuit ruled that the president – and not lawmakers – had sole authority to say who controls the historic holy city claimed by Israelis and Palestinians.
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In the US government, the president "exclusively holds the power to determine whether to recognize a foreign sovereign," wrote Judge Karen Henderson for the panel.
Since the founding of Israel in 1948, US presidents have declined to state a position on the status of Jerusalem, leaving it as one of the thorniest issues to be resolved in possible future peace talks.
The State Department, which issues passports and reports to the president, has declined to enforce the law passed by Congress in 2002, saying it violated the separation of executive and legislative powers laid out in the US Constitution.
When President George W. Bush signed the law, he said that if construed as mandatory rather than advisory, it would "impermissibly interfere" with the president's authority to speak for the country in international affairs.
Ari and Naomi Zivotofsky, whose son Menachem was born in Jerusalem and is a US citizen, filed a lawsuit in 2003 demanding that the government enforce the law.
The issue reached the US Supreme Court last year on the preliminary question of whether it was so political that it did not belong in the courts. The high court ruled 8-1 that the case could proceed, setting up Tuesday's ruling.
Nathan Lewin, a lawyer for the Zivotofskys, said he was preparing a statement.
An estimated 50,000 American citizens were born in Jerusalem and could have used the law, if it were enforced, to list Israel as their birthplace.
While Israel calls Jerusalem its eternal and indivisible capital, few other countries accept that status. Most, including the United States, maintain their embassies to Israel in Tel Aviv.
Palestinians want east Jerusalem, captured by Israel in 1967, as capital of the state they aim to establish in the West Bank and Gaza Strip, alongside Israel.
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