Chapter 7

Unquestionably Congress may tax corporations organized under federal laws upon their franchises; any sovereignty may tax the creatures of its creation for the privilege of exercising their franchises; but how about corporations chartered by the states and doing purely an intrastate business? A state confers on John Doe and his associates the privilege or franchise of doing business in a corporate capacity. Can Congress impose a tax on the exercise of that privilege or franchise? The power to tax involves the power to destroy.[1] If Congress can impose a tax of one per cent., it can impose a tax of ten per cent. or fifty per cent., and thus impair or destroy altogether the value of corporate charters for business purposes. Does Congress possess such a power? The Constitution puts no express limitation on the right of Congress to levy excises except that they shall be "uniform throughout the United States." But there are certain implied limitations inherent in our dual system of government. The sovereignty and independence of the separate states within their spheres are as complete as are the sovereignty and independence of the General Government within its sphere.[2] Neither may interfere with or encroach upon the other.

[Footnote 1: _McCulloch vs. Maryland_, 4 Wheat., 316.]

[Footnote 2: _The Collector vs. Day_, 11 Wall., 113, 124.]

The right to grant corporate charters for ordinary business purposes is an attribute of sovereignty belonging to the states, not to the General Government. The United States is a government of enumerated powers. The Constitution nowhere expressly confers upon Congress the right to grant corporate charters, and it is well settled that this right exists only in the limited class of cases where the granting of charters becomes incidental to some power expressly conferred on Congress, e.g., the power to establish a uniform currency, or the power to regulate interstate commerce. On the other hand, the right of the separate states to grant charters of incorporation is unquestionable. By the Tenth Amendment of the Constitution it is expressly provided: "The powers not delegated to the United States by the Constitution nor prohibited by it to the states are reserved to the states respectively or to the people." The Supreme Court long ago said: "A state may grant acts of incorporation for the attainment of those objects which are essential to the interests of society. _This power is incident to sovereignty._"[1]

[Footnote 1: _Briscoe v. Bank of Kentucky_, 11 Peters, 257, 317.]

The power to grant the franchise of corporate capacity being therefore inherent in the sovereignty of the states, will not a tax imposed by Congress upon the exercise of the franchise constitute an interference with the power? If so the tax is unconstitutional.

The Supreme Court has repeatedly held, that the National Government "cannot exercise its power of taxation so as to destroy the state governments or embarrass their lawful action."[1] In the case of _California vs. Central Pacific R.R. Co._[2] the question was whether franchises granted to the Central Pacific Railroad Company by the United States were legitimate subjects of taxation by the State of California. The Supreme Court, in language frequently quoted in subsequent cases, discusses the nature and origin of franchises, concluding that a franchise is "a right, privilege, or power of public concern" existing and exercised by legislative authority. After enumerating various kinds of franchises, the Court remarks: "No persons can make themselves a body corporate and politic without legislative authority. Corporate capacity is a franchise." The Court continues:

In view of this description of the nature of a franchise, how can it be possible that a franchise granted by Congress can be subject to taxation by a state without the consent of Congress? Taxation is a burden and may be laid so heavily as to destroy the thing taxed or render it valueless. As Chief Justice Marshall said in _McCulloch v. Maryland_, "The power to tax involves the power to destroy."... It seems to us almost absurd to contend that a power given to a person or corporation by the United States may be subjected to taxation by a state. The power conferred emanates from and is a portion of the power of the government that confers it. To tax it is not only derogatory to the dignity but subversive of the powers of the government, and repugnant to its paramount sovereignty.

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

[Footnote 2: 127 U.S., 1.]

It is true that the Court was here discussing the right of a state to tax franchises granted by the United States, and not the converse of that question. The reasoning of the Court would seem, however, to apply with equal force to the right of the United States to tax a franchise granted by a state acting within the scope of its sovereign authority.

Patent rights and copyrights are special privileges or franchises granted by the sovereign or government, and under the United States Constitution the right to grant patents and copyrights is expressly conferred on Congress. It has been held repeatedly that patent rights and copyrights are not taxable by the states[1]. As said by the New York Court of Appeals in a case involving the power of the state to tax copyrights:[2]

To concede a right to tax them would be to concede a power to impede or burden the operation of the laws enacted by Congress to carry into execution a power vested in the National Government by the Constitution.

[Footnote 1: _People ex rel. Edison, &c., Co., v. Assessors_, 156 N.Y., 417; _People ex rel. v. Roberts_, 159 N.Y., 70; _In Re Sheffield_, 64 Fed. Rep., 833; _Commonwealth v. Westinghouse, &c., Co._, 151 Pa., 265.]

[Footnote 2: 159 N.Y., p. 75.]

Apparently the same rule would be applicable were the granting of patent rights, like the granting of ordinary corporate franchises, a prerogative reserved under our system of government to the states instead of being expressly conferred on the United States. By parity of reasoning, the Federal Government in that case would have no power to tax them.

It is familiar law, reiterated over and over again by the Supreme Court, that Congress cannot tax the means or instrumentalities employed by the states in exercising their powers and functions, any more than a state can tax the instrumentalities similarly employed by the General Government. Thus, it has been held that Congress cannot tax a municipal corporation (being a portion of the sovereign power of the state) upon its municipal revenues[1]; that Congress cannot impose a tax upon the salary of a judicial officer of a state[2]; that Congress cannot tax a bond given in pursuance of a state law to secure a liquor license.[3]

[Footnote 1: _United States vs. Railroad Co._, 17 Wall., 322.]

[Footnote 2: _Collector v. Day_, 11 Wall., 113.]

[Footnote 3: _Ambrosini v. United States_, 185 U.S., 1.]

In the light of these decisions it is not apparent how Congress can tax the franchises of those state corporations (and they are many and important) which perform some public or quasi-public function. A state, to carry out its purposes of internal improvement, charters an intrastate railway or ferry company with power to charge tolls and exercise the right of eminent domain. Is not the grant of corporate existence and privileges to such a corporation one of the means or instrumentalities employed by the state for carrying out its legitimate functions, and is not a tax by the Federal Government upon the exercise by such a corporation of its corporate powers an interference with such means or instrumentalities?

In any discussion of the right of Congress to tax the agencies of or franchises granted by a state, the distinction must be borne in mind between a tax upon _property_ acquired by means of the franchise from the state and a tax upon the exercise of the franchise itself. The former tax may be perfectly valid where the latter would be unconstitutional. Thus, the Supreme Court has upheld a tax by a state upon the real and personal property (as distinct from the franchises) of a railway company chartered by Congress for private gain, while conceding that the state could not tax the franchises, because to do so would be a direct obstruction to federal powers.[1]

[Footnote 1: _Union Pacific Railroad Company vs. Peniston_, 18 Wall., 5.]

It remains to notice briefly one or two Supreme Court decisions which are relied upon by the sponsors of the new tax law. Reference has already been made to the decision in the Spreckels case[1] which upheld the validity of the tax imposed by the War Revenue Act of 1898 upon the gross receipts of corporations engaged in the businesses of refining petroleum and refining sugar. The Court held the tax to be an excise tax "in respect of the carrying on or doing the business of refining sugar," and such it obviously was. It was not a tax upon the privilege or franchise of doing business in a corporate capacity, like the tax now under debate. On the contrary, the act expressly applied to "every person, firm, corporation, or company carrying on or doing the business of refining sugar...." The case, therefore, has no bearing on the point we are discussing. Had the act applied only to corporations, a different question would have been involved.

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

The case of _Veazie Bank vs. Fenno_,[1] upholding the statute which taxed out of existence the circulation of the state banks, has frequently been cited as an authority sustaining the right of Congress to levy a tax upon a franchise or privilege granted by a state. It is true that in that case the eminent counsel for the bank (Messrs. Reverdy Johnson and Caleb Cushing) argued unsuccessfully "that the act imposing the tax impaired a franchise granted by the state, and that Congress had no power to pass any law which could do that;"[2] and that two justices dissented on that ground. The conclusive answer to this argument, was, however, that the power of the states to grant the particular right or privilege in question was subordinate to powers expressly conferred on Congress by the Constitution; that Congress was given power under the Constitution to provide a currency for the whole country, and the act in question was legislation appropriate to that end. The case does not hold that Congress has any general power to tax franchises or privileges granted by a state.

[Footnote 1: 8 Wall., 533.]

[Footnote 2: See 8 Wall., p. 535.]

The scope of this chapter does not admit of further reference to the decisions. It is strongly urged, however, that none of them, rightly construed, will be found to sustain the right of the General Government to impose a tax upon the exercise of franchises granted by a state in the exercise of its independent sovereignty, and that such a decision would mark a new departure in our jurisprudence.

In the debates in Congress over the bill many good lawyers appear to have assumed, somewhat too hastily, that the tax in question was an excise tax on business or occupation like that involved in the Spreckels case, and that the only constitutional question, therefore, was one of classification under the provision of the Constitution that excises shall be uniform throughout the United States. No less eminent a constitutional lawyer than Senator Bailey of Texas, in a colloquy with the junior Senator from New York, put the matter thus:[1]

Mr. Root: May I ask the Senator from Texas if I am right in inferring from the statement which he has just made that he does not seriously question the constitutional power of the Congress to impose this tax on corporations?

Mr. Bailey: Mr. President, I answer the Senator frankly that I do not.... I think the rule was and is that Congress can levy any tax it pleases except an export tax. Of course a direct tax must be apportioned and an indirect tax must be uniform. But the uniformity rule simply requires that wherever the subject of taxation is found, the tax shall operate equally upon it.

I believe that Congress can tax all red-headed men engaged in a given line of business if it pleases.... I have no doubt if the tax fell upon every red-headed man in Massachusetts the same as in Mississippi or Texas and all other states, the law imposing such a tax would be perfectly valid.

[Footnote 1: _Congressional Record_ for July 6, 1909, pp. 4251 to 4252.]

The difficulty with this reasoning is that it overlooks the fact that the privilege of being red-headed is not a franchise granted by a sovereign state. From the viewpoint of constitutional law it may well be that Congress can tax a privilege conferred by the gods where it would be powerless to tax a franchise granted by the Legislature of New Jersey.

XI

THE CORPORATION TAX DECISION

The immediate consequences of the decision of the United States Supreme Court[1] affirming the constitutionality of the federal corporation tax are so slight that its profound significance is likely to be overlooked. Until it was merged with the general income tax the exaction was not burdensome and proved easy of collection. The thing upon which it fell--the privilege of doing business in a corporate capacity--is an abstraction which makes little appeal to the sympathies or the moral sense. The public, more concerned with present conditions than with the passing of a theory, is indifferent.

[Footnote 1: _Flint v. Stone Tracy Co._, 220 U.S., 107]

Thus it has sometimes been with the turning points in the affairs of nations. They came quietly and without observation, and it remained for the historians to mark the actual parting of the ways.

The Supreme Court holds, and in its opinion reiterates many times, that the tax is upon the _privilege of doing business in a corporate capacity_.

Right here is the crux of the matter. Corporate capacity is not a right granted by the National Government. It is something which Congress can neither give nor take away. In the division of powers which marked the creation of our dual government the power to confer corporate capacity was reserved to the states. The decision, therefore, comes to this: Congress can by taxation burden the exercise of a privilege which only a state can grant. And the power to tax, it must be remembered, involves the power to destroy. This seems a long step from the theory of the men who founded the Republic.

Nearly fifty years ago the Supreme Court stated the theory as follows:

The states are, and they must ever be, co-existent with the National Government. Neither may destroy the other. Hence the Federal Constitution must receive a practical construction. Its limitations and its implied prohibitions must not be extended so far as to destroy the necessary powers of the States, or prevent their efficient exercise.[1]

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

The court buttresses its decision by the argument _ex necessitate_--that to hold otherwise would open the way for men to withdraw their business activities from the reach of federal taxation and thus cripple the National Government. The Court says:

The inquiry in this connection is: How far do the implied limitations upon the taxing power of the United States over objects which would otherwise be legitimate subjects of federal taxation, withdraw them from the reach of the Federal Government in raising revenue, because they are pursued under franchises which are the creation of the states?... Let it be supposed that a group of individuals, as partners, were carrying on a business upon which Congress concluded to lay an excise tax. If it be true that the forming of a state corporation would defeat this purpose, by taking the necessary steps required by the state law to create a corporation and carrying on the business under rights granted by a state statute, the federal tax would become invalid and that source of national revenue be destroyed, except as to the business in the hands of individuals or partnerships. It cannot be supposed that it was intended that it should be within the power of individuals acting under state authority thus to impair and limit the exertion of authority which may be essential to national existence.

This argument will not bear scrutiny. It apparently loses sight of the vital distinction between a tax on the mere doing of business and a tax on the privilege of doing that business in a corporate capacity. These are two very different things. The right of Congress to tax the doing of business was not disputed. It had been expressly upheld in the well-known case of _Spreckels Sugar Refining Co. v. McClain_,[1] which involved a tax on the business of refining sugar, whether done by a corporation or by individuals. The tax under consideration, however, goes further and fastens upon something new--something which in the case of individuals or partnerships has no existence at all--which comes into being only by the exercise of the sovereign power of a state. The opponents of the tax, far from attempting to narrow the existing field of federal taxation, were in fact resisting an encroachment by Congress on an entirely new field, created by, and theretofore reserved exclusively to, the separate states. It was conceded that Congress could tax a business when done by individuals and could tax the same business when done by a corporation. The inquiry was: Does the act of a state in clothing the individuals with corporate capacity create a new subject matter for taxation by the General Government? That was the real question before the Court, and the decision answers it in the affirmative.

[Footnote 1: 192 U.S., 397.]

Other illustrations of the same apparent confusion of thought are to be found in the opinion. For example, it is said (citing various cases involving a tax on business where the party taxed was a corporation):

We think it is the result of the cases heretofore decided in this Court, that such _business activities_, though exercised because of state-created franchises, are not beyond the taxing power of the United States.

Here again the Court seems to lose sight of the distinction between a tax on "business activities" and a tax on the privilege of conducting such activities in a corporate capacity.

It is futile, however, to quarrel with the logic of the opinion. The question is closed and the Court, by affirming the judgments appealed from, has committed itself to the theory that the Federal Government may, by taxation, burden the exercise of a privilege which only a state can confer. With the expediency of that theory as applied to present-day political conditions we are not now concerned. The object of this chapter is to point out that the decision marks a distinct departure from the earlier doctrine that the two sovereignties, federal and state, are upon an equality within their respective spheres.

In view of the centralizing forces which are tending to transform these sovereign states into mere political subdivisions of a nation, the decision is of great significance. Moreover, in a very practical way it touches the right of each state under the compact evidenced by the Federal Constitution to manage its internal affairs free from compulsion or interference by the other states. To illustrate: In some parts of the country the anti-corporation feeling runs high. Many men if given their way would tax the larger corporations out of existence. Under this decision the way is open whenever a majority can be secured in Congress. An increase in the tax rate is all that would be necessary. Make the rate ten per cent. or twenty per cent. instead of one per cent. and the thing is accomplished.

New York may deem it good policy to encourage the carrying on of industry in a corporate form. Texas may take a different view and conclude that the solution of the trust problem lies in suppressing certain classes of corporations altogether. Under this decision it lies within the power of Texas and her associates if sufficiently numerous to impose their view on New York and make it impossible for her domestic industries to be carried on profitably in a corporate form. And yet the possibility of impressing the will of one state or group of states upon another state with respect to her internal affairs is the very thing which the founders of the republic sought most carefully to avoid. Had it been understood in 1787 that the grant of taxing powers to the General Government involved such a curtailment of state independence, few states, in all probability, would have been ready to ratify the Constitution.

XII

THE FEDERAL GOVERNMENT AND THE TRUSTS

The curbing of monopolies and combinations in restraint of trade was no part of the functions of the Federal Government as planned by the framers of the Constitution. To their minds such matters, under the dual system of government which they were establishing, belonged to the states. The Constitution was designed to limit the National Government to functions absolutely needed for the national welfare. All other powers were "reserved to the states respectively or to the people."

As time went on, however, and industries expanded it was seen that the power of no single state was adequate to control concerns operating in many states at the same time. The need of action by the General Government became manifest. Power in Congress to legislate on the subject, albeit somewhat indirectly, was found in the Commerce Clause of the Constitution, and in the year 1890 the Sherman Anti-Trust Act was enacted.

Few statutes have aroused more discussion or been the subject of more perplexity and misunderstanding. President Taft's remark, made after the decisions of the Supreme Court in the Standard Oil and Tobacco Trust cases,[1] that "the business community now knows or ought to know where it stands," was received with incredulity approaching derision. Yet from a lawyer's point of view (and it must be borne in mind that the President was a lawyer and is now Chief Justice of the Court) the statement cannot be controverted. The decisions in the Standard Oil and Tobacco cases did in fact dispel whatever uncertainty remained as to what the Sherman Act means.

[Footnote 1: _Standard Oil Co. v. United States_, 221 U.S., 1.

_United States v. American Tobacco Co._, id., 106.]

The Sherman Act[1] declares unlawful every contract, combination, or conspiracy in restraint of interstate trade, and every attempt to monopolize interstate trade. The legal uncertainties that have arisen in its enforcement have not been with respect to the meaning of the terms "restraint of trade" and "monopoly," although the popular impression is to the contrary. In 1890, when the statute was passed, contracts in restraint of trade and monopolies were already unlawful at common law, and these terms, by a long series of decisions both here and in England, had been defined as definitely as the nature of the subject matter permitted. While incapable (like the term "fraud") of precise definition covering all forms which the ingenuity of man might devise, nevertheless their meaning and scope were well within the understanding of any man of reasonable intelligence. Whatever legal uncertainties have arisen have been chiefly owing to two questions: first, What is _interstate_ trade within the meaning of the act? and second, Did the act enlarge the common-law rule as to what restraints were unlawful?

[Footnote 1: "An Act to protect trade and commerce against unlawful restraints and monopolies," approved July 2, 1890.]