Chapter 6

"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration."

Thus far we have dealt only with such limitations upon the federal taxing power as are expressly imposed by the Constitution. As has been seen, the only express limitations are that direct taxes shall be apportioned among the states, that indirect taxes shall be uniform, and that exports shall not be taxed at all. There are, however, certain other limitations which we proceed to notice briefly.

The Constitution provides[1] that the compensation of federal judges "shall not be diminished during their continuance in office." There is a similar provision as to the compensation of the President.[2] No attempt seems to have been made to tax the compensation of federal judges prior to 1862. A statute of that year subjected the salaries of all civil officers of the United States to an income tax and was construed by the revenue officers as including the compensation of the President and the judges. Chief Justice Taney, the head of the judiciary, wrote the Secretary of the Treasury a letter[3] protesting against the tax as a virtual diminution of judicial compensation in violation of the constitutional provision. No heed was paid to the protest at the time but some years later, upon the strength of an opinion by Attorney General Hoar, the tax on the compensation of the President and the judges was discontinued and the amounts theretofore collected were refunded. There the matter rested until after the Income Tax Amendment, when Congress again sought to impose a tax upon the income of the President and the judges. A federal judge of a Kentucky district contested the tax and the question came up before the Supreme Court for final decision. On behalf of the revenue department it was urged that a general income tax, operating alike on all classes, did not involve any violation of the constitutional provision. It was also contended that such a tax was expressly authorized by the Sixteenth Amendment giving Congress power to tax incomes "from whatever source derived." The Court in an exhaustive opinion[4] overruled both these contentions and held the tax to be a violation of the Constitution.

[Footnote 1: Art. 3, Sec. 1.]

[Footnote 2: Art. 2, Sec. 1, Clause 6.]

[Footnote 3: See 157 U.S., 701.]

[Footnote 4: _Evans v. Gore_, 253 U.S., 245.]

It has often been asserted that a limitation of the federal taxing power is found in the "due process" clause of the Fifth Amendment of the Constitution, providing that no person shall "be deprived of life, liberty, or property without due process of law." This amendment relates to the powers of the General Government. A similar limitation on the powers of the states is found in the Fourteenth Amendment. Taxing laws have frequently been attacked in the courts on the ground that, by reason of some inequality or injustice in their provisions, the taxpayer was deprived of his property without due process of law. In cases involving state laws such objections have sometimes been sustained.[1] There seems, however, to have been no case in which a federal taxing law was declared invalid on this ground, and the Supreme Court has recently remarked that it is "well settled that such clause (viz., the due process clause of the Fifth Amendment) is not a limitation upon the taxing power conferred upon Congress by the Constitution."[2] Nevertheless, it is believed that if a federal tax were clearly imposed for other than a public use, or were imposed on tangible property lying outside the national jurisdiction, or were so arbitrary and without basis for classification as to amount to confiscation, relief might be obtained under the due process clause of the Fifth Amendment.

[Footnote 1: See, e.g., _Union Tank Line Co. v. Wright_, 249 U.S., 275.]

[Footnote 2: _Brushaber v. Union Pacific R.R._, 240 U.S., 24.]

By far the most important and interesting of the implied limitations of the federal taxing power remains to be noticed. That is the limitation which prohibits the National Government from burdening by taxation the property or revenues or obligations of a state, or the emoluments of a state official, or anything connected with the exercise by a state of one of its governmental functions. In other words, while the National Government may tax income from bonds issued by England or France or their cities, it is powerless to tax the income from bonds of Rhode Island or the smallest of its towns.

This implied limitation, nowhere categorically expressed but enunciated in a series of decisions of the Supreme Court, has not always met with acquiescence from the executive and legislative branches of the Government. In fact, Congress is now engaged in an effort to do away with it, at least in so far as concerns the right to tax the income from state and municipal bonds. To-day, however, it still stands as one of the most striking and unique characteristics of our governmental system. It will be discussed more at length in the next chapter.

IX

CAN CONGRESS TAX THE INCOME FROM STATE AND MUNICIPAL BONDS?

That is a question which is agitating a good many people just now. Congress from time to time has seemed disposed to try it, in spite of misgivings as to the constitutionality of such legislation.[1] A recent Revenue Bill contained provisions taxing the income of future issues of such obligations, and a motion for the elimination of those provisions was defeated in the House 132 to 61. Meanwhile, protests were pouring in from state and municipal officers assailing the justice and expediency of such a tax.

[Footnote 1: See, e.g., H. Report No. 767, 65th Cong., 2d Sess., accompanying House Revenue Bill of 1918 as reported by Mr. Kitchin from the Committee on Ways and Means, page 89.]

It is not the purpose of this chapter to discuss the questions of justice and expediency (as to which there is much to be said on both sides) but rather to deal with the strictly legal aspects of the matter and indicate briefly why such a tax cannot be laid without a change in our fundamental law.

Let it be said at the outset that no express provision of the United States Constitution forbids. On the contrary, that instrument confers on Congress the power to lay taxes without any restriction or limitation save that exports shall not be taxed, that duties, imposts, and excises shall be uniform throughout the United States, and that direct taxes must be apportioned among the states in proportion to population. The obstacle lies rather in an implied limitation inherent in our dual system of government and formulated in decisions of the Supreme Court.

The founders of this republic established a form of government wherein the states, though subordinate to the Federal Government in all matters within its jurisdiction, nevertheless remained distinct bodies politic, each one supreme in its own sphere. In the famous phrase of Salmon P. Chase, pronouncing judgment as Chief Justice of the Supreme Court[1]:

The Constitution in all its provisions looks to an indestructible Union, composed of indestructible states.

[Footnote 1: _Texas v. White_, 7 Wall., 700, 725.]

In a later case[1] another eminent justice (Samuel Nelson of New York) put the matter thus:

The General Government, and the states, although both exist within the same territorial limits, are separate and distinct sovereignties, acting separately and independently of each other, within their respective spheres. The former, in its appropriate sphere, is supreme; but the states within the limits of their powers not granted, or, in the language of the 10th Amendment, "reserved", are as independent of the General Government as that government within its sphere is independent of the states.

[Footnote 1: _The Collector v. Day_, 11 Wall., 113, 124.]

It follows that the two governments, national and state, must each exercise its powers so as not to interfere with the free and full exercise by the other of its powers. To do otherwise would be contrary to the fundamental compact embodied in the Constitution--in other words, it would be _unconstitutional_.

This proposition was affirmed at an early day by Chief Justice John Marshall in the great case of _McCulloch vs. The State of Maryland_,[1] which involved the attempt of a state to tax the operations of a national bank. That case is one of the landmarks of American constitutional law. While it did not expressly decide that the Federal Government could not tax a state instrumentality but only the converse, i.e., that a state could not tax an instrumentality of the nation, the Court has held in many subsequent decisions that the proposition enunciated by the great Chief Justice works both ways. For example, it has declared that a state cannot tax the obligations of the United States because such a tax operates upon the power of the Federal Government to borrow money[2] and conversely, that Congress cannot tax the obligations of a state for the same reason;[3] that a state cannot tax the emoluments of an official of the United States[4] and conversely, that the United States cannot tax the salary of a state official;[5] that a state cannot impose a tax on the property or revenues of the United States[6] and conversely, that Congress cannot tax the property or revenues of a state or a municipality thereof.[7]

[Footnote 1: 4 Wheaton, 316.]

[Footnote 2: _Weston v. City of Charleston_, 2 Pet., 449.]

[Footnote 3: _Mercantile Bank v. New York_, 121 U.S., 138, 162.]

[Footnote 4: _Dobbins v. Commissioner of Erie County_, 16 Pet., 435.]

[Footnote 5: _Collector v. Day_, 11 Wall., 113.]

[Footnote 6: _Van Brocklin v. Tennessee_, 117 U.S., 151.]

[Footnote 7: _United States v. Railroad Co._, 17 Wall., 322.]

The Supreme Court has said (and many times reiterated in substance) that the National Government "cannot exercise its power of taxation so as to destroy the state governments, or embarrass their lawful action."[1] One of the most distinguished writers on American Constitutional law (Thomas M. Cooley, Chief Justice of the Supreme Court of Michigan and afterward Chairman of the federal Interstate Commerce Commission) has said:

There is nothing in the Constitution which can be made to admit of any interference by Congress with the secure existence of any state authority within its lawful bounds. And any such interference by the indirect means of taxation is quite as much beyond the power of the national legislature as if the interference were direct and extreme.[2]

[Footnote 1: _Railroad Co. v. Peniston_, 18 Wall., 5, 30.]

[Footnote 2: _Cooley's Constitutional Limitations_, 7th Ed., 684.]

The question as to the right of Congress to levy an income tax on municipal securities came up squarely in the famous Income Tax Cases[1] involving the constitutionality of the Income Tax Law of 1804. While the Supreme Court was sharply divided as to the constitutionality of other features of the law, it was unanimous as to the lack of authority in the United States to tax the interest on municipal bonds.

[Footnote 1: _Pollock v. Farmers Loan & Trust Co._, 157 U.S., 429; same case on rehearing, 158 U.S., 601.]

The decision in those cases is the law to-day (except in so far as it has been changed by the recent Sixteenth Amendment) with one possible limitation. It has been held that state agencies and instrumentalities, in order to be exempt from national taxation, must be of a strictly governmental character; the exemption does not extend to agencies and instrumentalities used by the state in carrying on an ordinary private business. This was decided in the South Carolina Dispensary case.[1] The State of South Carolina had taken over the business of selling liquor and the case involved a federal tax upon such business. The Court, while reaffirming the general doctrine, nevertheless upheld the tax on the ground that the business was not of a strictly governmental character. This decision suggests the possibility that if an attempt were made to tax state and municipal bonds the Court might draw a distinction based on the purpose for which the bonds were issued, and hold that only such as were issued for strictly governmental purposes were exempt.

[Footnote 1: _South Carolina v. United States_, 199 U.S., 437, decided in 1905.]

It remains to consider the effect of the Sixteenth Amendment.

After the Supreme Court had held the Income Tax Law of 1894 unconstitutional on the ground that it was a direct tax and had not been apportioned among the states in proportion to population the Sixteenth Amendment to the Constitution was proposed and ratified. This amendment provides that

the Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.

When the amendment was submitted to the states for approval some lawyers apprehended that the words "incomes from whatever source derived" might open the door to the taxation by the Government of income from state and municipal bonds. Charles E. Hughes, then Governor of New York, sent a special message to the Legislature opposing ratification of the amendment on this ground.

Other lawyers, notably Senator Elihu Root, took a different view of the scope of the amendment, holding that it would not enlarge the taxing power but merely remove the obstacle found by the Supreme Court to the Income Tax Law of 1894, i.e., the necessity of apportionment among the states in proportion to population. This latter view has now been confirmed by the Supreme Court. In a case involving a tax on income from exports the Court said:[1]

The Sixteenth Amendment ... does not extend the taxing power to new or excepted subjects, but merely removes all occasion, which otherwise might exist, for an apportionment among the states of taxes laid on income, whether it be derived from one source or another....

[Footnote 1: _Peck v. Lowe_, 247 U.S., 165.]

In a case decided a little earlier[1] the Court, speaking through Chief Justice White, had said:

By the previous ruling (i.e., in _Brushaber v. Union Pacific Railway Co._, 240 U.S., 1) it was settled that the provisions of the Sixteenth Amendment conferred no new power of taxation....

[Footnote 1: _Stanton v. Baltic Mining Co._, 240 U.S., 103, 112.]

From what has been said it will be evident that the doctrine of exemption of state and municipal bonds from federal taxation is firmly embedded in our law and has not been affected by the Sixteenth Amendment.

Whether it is a doctrine suited to present-day conditions is a question outside the scope of this paper.

The fear of federal encroachment, so strong in the minds of the makers of our Constitution, has become little more than a tradition. To many it doubtless will seem that any rule of law which operates to prevent the nation, in the great exigency of war, from taxing a portion of the property of its citizens is pernicious and should be changed.

If this be the view of a sufficient number the change can and will be made. Lawyers think, however, that it will have to be done by the orderly method of constitutional amendment, not by passing taxing statutes which a reluctant Court will be obliged to declare unconstitutional.

Just now the tide of popular sentiment is setting strongly toward such a change. It was advocated in a recent Presidential message.[1] The immunity enjoyed by state bond issues is coming to be regarded less as a safeguard of state rights than as a means whereby the rich escape federal income surtaxes. One is tempted to predict that the next formal amendment of the Constitution will deal with this subject. If so, another inroad will have been made by the General Government on the failing powers of the states.

[Footnote 1: Message of President Harding to Congress, December 6, 1921.]

X

IS THE FEDERAL CORPORATION TAX CONSTITUTIONAL?[1]

[Footnote 1: Since this chapter was first published in 1909 as an article in the _Outlook_ magazine the specific question propounded in its title has been settled by the Supreme Court (_Flint v. Stone Tracy Co._, 220 U.S., 107). The paper is here reproduced, however, in the belief that its discussion of the principles of our dual system of Government is as pertinent now as it was before.]

The most noteworthy enactment of the sixty-first Congress from a legal point of view, to say nothing of its economic and political significance, was the Corporation Tax Act. That Act, forming §38 of the Tariff Law, provides--

That every corporation ... organized for profit and having a capital stock represented by shares ... shall be subject to pay annually a special excise tax with respect to the carrying on or doing business by such corporation ... equivalent to one per centum upon the entire net income over and above five thousand dollars received by it from all sources, etc.

The act goes on to require the corporations to make periodical reports concerning their business and affairs, and confers on the Commissioner of Internal Revenue a visitorial power to examine and compel further returns.

The genesis of the act is interesting. The growing demand for more efficient regulation of the corporations, so pronounced during President Roosevelt's Administration, had foreshadowed such legislation. It remained, however, for President Taft to take the initiative and mould the shape which the legislation was to take.

In the course of the Senate debate on the new Tariff Act it had become apparent that an influential party in Congress, backed by strong sympathy outside, was bent upon passing a general income tax act. The previous Income Tax Law had been pronounced unconstitutional by the Supreme Court as violating the provision of the Constitution that all direct taxes must be apportioned among the states in proportion to population.[1] That decision, however, had been reached by a bare majority of five to four. It had overruled previous decisions and overturned doctrines that had been acquiesced in almost from the foundation of the Government. A strong party was in favor of enacting another income tax law and bringing the question again before the Court in the hope that the Court as then constituted might be induced to overrule or materially modify the doctrine of the Pollock case. The President and his advisers viewed such a proposal with disfavor. To their minds the proper way to establish the right of Congress to levy an income tax was by an amendment to the Constitution, not by an assault upon the Supreme Court. Accordingly on June 16, 1909, the President transmitted a message to Congress[2] recommending a constitutional amendment, and proposing, in order to meet the present need for more revenue, an excise tax on corporations. The proposal, coupled as it was with a suggestion that such an act might be made to serve for purposes of federal supervision and control as well as revenue, met with favor and was enacted into law.

[Footnote 1: _Pollock vs. Farmers' Loan & Trust Co._, 157 U.S., 429.]

[Footnote 2: _Congressional Record_, June 16, 1909, p. 3450.]

President Taft, himself an eminent constitutional lawyer, in his message recommending the law expressed full confidence in its constitutionality. The same view was taken by able lawyers who surrounded him in the capacity of advisers. The act is understood to have been drafted by Mr. Wickersham, the Attorney General, and vouched for by Senator Elihu Root and others of scarcely less authority in the domain of constitutional law.

Against opinions from such sources one takes the field with diffidence. I venture, however, to outline briefly some reasons for doubting the constitutionality of the act.

At the outset it is essential to determine the exact nature of the tax. Obviously it is not a tax upon income _as income_. If it were, it would be obnoxious to the decision in the Pollock case as imposing a direct tax without apportionment among the states. The language of the act, as well as the declarations of its sponsors, clearly indicate that it is intended, not as a direct tax on property, but as an excise tax on privilege. The phraseology of the act itself is--"A special excise tax with respect to the carrying on or doing business by such corporation," etc. Undoubtedly Congress has power to impose an excise tax upon occupation or business. This was expressly decided, in the case of the businesses of refining petroleum and refining sugar, by the Spreckels case,[1] referred to in President Taft's message. The message says:

The decision of the Supreme Court in the case of Spreckels Sugar Refining Company against McClain (192 U.S., 397) seems clearly to establish the principle that such a tax as this is an excise tax upon privilege and not a direct tax on property, and is within the federal power without apportionment according to population.

[Footnote 1: _Spreckels Sugar Refining Co. vs. McClain_, 192 U.S., 397.]

What, then, is the privilege with respect to which the tax is imposed? Is it, like the tax involved in the Spreckels case, the privilege of doing the various kinds of business (manufacturing, mercantile, and the rest) in which the corporations subject to the operation of the law are engaged? Obviously not. No kind or kinds of business are specified in the act. The tax falls not only on corporations doing every conceivable kind of business, but also on the corporation that does no specific business whatever--the corporation which, in the language of an eminent judge, is merely "an incorporated gentleman of leisure."[1] Moreover, if the tax were merely upon the privilege of doing business, it would seem to be obnoxious to the cardinal principle of just taxation that taxes should be uniform. In other words, if the privilege of doing a business--say conducting a department store--were the thing taxed and the only thing taxed, the rule of uniformity would seem to require that a corporation and a copartnership conducting similar stores on opposite corners of the street should both be taxed. Nothing inconsistent with this view will be found in the Spreckels case. The party to that suit was, to be sure, a corporation, but the act under which the tax was imposed applied to individuals, firms, and corporations alike.

[Footnote 1: Vann, J., in _People ex rel. vs. Roberts_, 154 N.Y., 1.]

It must be concluded, therefore, that the tax is not upon the privilege of doing the businesses in which the various corporations in the land are engaged, but is rather a _tax upon the privilege of doing business in a corporate capacity_, or, in other words, upon the exercise of the corporate franchise. That this is so appears very clearly from the message of President Taft. He says:

This is an excise tax upon the privilege of doing business as an artificial entity and of freedom from a general partnership liability enjoyed by those who own the stock.

Assuming, then, that this is the real nature of the tax, is it constitutional?