Source: http://taxhistory.org/thp/readings.nsf/ArtWeb/2B34C7FBDA41D9DA8525730800067017?OpenDocument
Timestamp: 2019-04-25 23:47:58+00:00

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Copyright 2006 Alan O. Dixler.
Alan O. Dixler is senior tax counsel at Alpharma Inc., Fort Lee, N.J. He delivered this report to the Committee on Legal History of the Bar Association of the City of New York, of which he is a member.
"Direct tax" appears twice in Article I of the U.S. Constitution. Article I, section 2 provides, in relevant part, that "Representatives and direct Taxes shall be apportioned among the several States . . . according to their respective Numbers." That is part of the infamous three-fifths clause, or "federal ratio," under which slaves were counted as three-fifths of a free person for purposes of determining the size of a state's congressional delegation, the number of members of the Electoral College a state can elect, and the apportionment of federal direct taxes.
Article I, section 9 provides, in relevant part: "No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken." Because of that apportionment requirement, application of "direct tax" as it related to specific taxes has been considered by the Supreme Court in the 18th, 19th, and 20th centuries, and it led to the adoption of the 16th Amendment.
What does the term direct tax, as used in the Constitution, actually mean?1 This report concludes that the Supreme Court's first consideration of the issue, made when four prominent Founders were the participating members of the Court, represents the most historically valid and most sensible treatment.
Justices Samuel Chase, William Paterson, and James Iredell all wrote separate opinions. That did not indicate a fractured Court; the practice of issuing an opinion of the Court had not yet been established. Justice James Wilson contributed a brief comment. Justice William Cushing was unable to attend the argument of the case because of ill health, and he deemed it improper to give an opinion on the merits. Chief Justice Oliver Ellsworth had not been sworn in at a time that would have allowed him to participate. Of the four justices commenting on the merits, two, Paterson and Wilson, had been delegates to the Constitutional Convention in Philadelphia. Justice Iredell had been a delegate to the North Carolina ratification convention. Justice Chase had served on the committee that recommended to the Maryland ratification convention some amendments that anticipated the Bill of Rights. All of those justices therefore can be considered Founders.
The issue before the Supreme Court was whether the passenger carriage tax, which had not been apportioned among the states, was a direct tax. If it were a direct tax, the carriage tax would have been unconstitutional as enacted. The Supreme Court unanimously held that the passenger carriage tax was not a direct tax.
Justice Chase wrote that Congress did not consider the passenger carriage tax a direct tax, and that fact alone would be decisive in a close case. However, Justice Chase did not consider this a close case. Justice Chase said that if a particular tax could not be apportioned without great inequity and injustice, the tax was not a direct tax within the meaning of the Constitution. Justice Chase stated, without ruling as a matter of law, that direct taxes as contemplated by the Constitution were of only two kinds: capitation (mentioned in the constitutional text) and a tax on land. Justice Chase, anticipating Marbury v. Madison4 by seven years, noted that because the carriage tax as enacted was constitutional, it was unnecessary to determine if the Supreme Court had the power to declare that unconstitutional laws enacted by Congress were null and void. However, Justice Chase pledged that if the Court did have such power, he would never use it except in clear cases.
In his opinion, Justice Paterson wrote that the Framers intended that the principal, if not only, direct taxes were capitation and a tax on land. Justice Paterson also speculated that a tax on the immediate produce of land might also be a tax on land, and therefore direct. Justice Paterson, who had been an important delegate to the Philadelphia convention, wrote that the intended object of the requirement to apportion direct taxes was for the protection of the southern states, which had the largest number of slaves and extensive tracts of thinly populated land. (When the Constitution was ratified, North Carolina included the current state of Tennessee, and Virginia included the current states of West Virginia and Kentucky.) In contrast, the majority of states had far fewer slaves and limited territory that was more intensively settled and farmed. Accordingly, a tax of a fixed amount per slave or a fixed amount per acre would fall disproportionately on the southern states. Apportionment by population would prevent that from happening. In contrast, the fact that an apportioned tax on passenger carriages would lead to unjust results convinced Justice Paterson that the tax in question was not a direct tax.
In his opinion, Justice Iredell pointed out that because all direct taxes must be apportioned, the Constitution considered as direct only those taxes that could be apportioned. The carriage tax was not apportionable because apportionment would lead to absurd results. Accordingly, the tax on passenger carriages was not a direct tax. Justice Iredell did not find it necessary or appropriate to propound a general rule, applicable in all cases, on what is or is not a direct tax.
Justice Wilson wrote that he had expressed his judicial opinion that the passenger carriage tax was constitutional when he sat as a circuit court judge when the case at hand was before the Circuit Court of Virginia. Justice Wilson affirmed that his previously stated view -- that the tax was constitutional -- had not changed.
To finance the Civil War, Congress in 1862, 1864, and 1866 enacted revenue acts that taxed the income of insurance companies; taxed amounts insured, renewed, or continued by insurance companies; taxed the gross amounts of premiums received and assessments by insurance companies; and also taxed their dividends and undistributed sums.
The plaintiff insurance company challenged those taxes. One of the plaintiff's lines of attack was that the taxes were direct taxes and, because they were not apportioned among the states, were unconstitutional. The plaintiff argued that any tax that falls on the taxpayer was a direct tax, but a tax whose burden could be shifted to the consumer was an indirect tax. The plaintiff argued that Adam Smith was the leading authority on political economy during the framing of the Constitution and that Smith wrote that a tax on a person's revenue was a direct tax.
Justice Noah Swayne issued the opinion of the Court. On the issue of direct taxation, the Court looked to Hylton for guidance. Justice Swayne noted that the Hylton Court was unanimous. Justice Swayne observed that apportionment would lead to untoward results, which demonstrated that the taxes in question were not direct. Accordingly, the taxes at issue in the case at hand were not direct taxes.
The question before the Supreme Court in this case was the constitutional validity of an act of Congress in 1866 imposing a 10 percent tax on the issuance of circulating bank notes by nationally chartered banks or by state chartered banks. The plaintiff bank was chartered by the state of Maine, and the bank challenged the tax on two grounds. The plaintiff claimed that the tax was a direct tax that had not been apportioned among the states. The plaintiff also claimed that Congress could not tax a franchise that had been granted by one of the states.
Chief Justice Salmon Chase delivered the opinion of the Court. The Court held the tax to be constitutional. The Court held that rather than being a tax on the franchise granted by a state, the tax was on property created or contracts made by the bank. Further, simply because a federal tax may be burdensome, that does not make the tax unconstitutional. Also, Congress may regulate circulating money. Chief Justice Chase also analyzed the meaning of direct tax. He pointed out that Smith's treatise on political economy, while mentioning the difference between direct taxation and indirect taxation, did not bear on the meaning of direct taxes in the text of the Constitution, even though that important treatise had been recently published at the time of the framing of the Constitution. Instead, Chief Justice Chase turned to the historical record.
He pointed out that Congress had enacted taxes that were acknowledged to be direct. Those taxes were enacted in 1798, 1813, 1815, 1816, and 1861. In each instance the sums collected were apportioned among the states. The subjects of those taxes were, variously, lands, improvements, dwelling-houses, and slaves.7 Chief Justice Chase pointed out that Congress never considered taxes on personal property, contracts, or occupations to be direct taxes. He observed that slaves were not an exception because, even though many of the slave states had considered slaves to be real property, slaves were, of course, persons and subject to a capitation, which was direct.
Congress also enacted an income tax to help finance the Civil War. The income tax was reenacted after the Civil War to help pay down the public war debt. Judge Day of the Court of Probate and Insolvency for Barnstable County, Mass., was taxed by the United States on his salary. He sued for a refund.
This case is of relevance to the inquiry as to the meaning of the constitutional term direct tax, not so much for what it does say but for what it does not say. The Court, in an opinion delivered by Justice Samuel Nelson, held that Congress could not tax Judge Day's salary because to do so would in effect impose a tax on the Commonwealth of Massachusetts, and Congress's power does not reach that far.13 What this opinion does not say is that the income tax was a direct tax. Collector v. Day was explicitly overturned in Graves v. New York ex rel. O'Keefe14 in 1939.
This case, like Day, arose from the Civil War income tax. Congress, in the Internal Revenue Act of June 30, 1864, had stipulated that gains and profits of all companies, whether incorporated or partnership, were to be included in the income of any person "entitled" to them, "whether divided or not." The taxpayer argued that he was not "entitled" to a ratable share of corporate earnings that had been retained by the corporation and used by the corporation to acquire business assets and pay down corporate debt. The government argued that the taxpayer, by virtue of his share ownership, was "entitled" to his ratable portion of the profits and would eventually receive them by future dividend or on corporate liquidation. Justice Nathan Clifford, writing for a unanimous Court, sided with the government.
The key point here is that this case was one of simple, statutory interpretation. There was no mention of the tax having been an unapportioned, direct tax. Given the then-recent decision in Pacific Insurance, it is not surprising that the constitutional validity of the tax in question was viewed as obvious.
The tax at issue in this case was a succession tax on real property. The taxpayer claimed that the tax was a direct tax because it applied to real property and was enforceable through liens on the subject real property. Because the tax was not apportioned among the states, the taxpayer asserted that the succession tax was unconstitutional.
Through Springer, the Supreme Court had spoken five times on the issue of the meaning of direct tax. A tax on passenger carriages was determined not to be a direct tax in Hylton. A tax on the income and some business assets and transactions of insurance companies was ruled not to be a direct tax in Pacific Insurance. In Veazie Bank, the Court held that a tax on the issuance of circulating bank notes by federally chartered or state chartered banks was not a direct tax. In Scholey, the Supreme Court held that a tax on succession to real property was not a direct tax. Finally, the Supreme Court specifically held that a general income tax was not a direct tax in Springer.
The Supreme Court held in Day that Congress did not have the power to tax the judicial salary of a state court judge. That was not because the income tax was a direct tax that had not been apportioned, but because the Court viewed an income tax on the recipient of a salary from a state as being, in effect, a tax on the state itself. While Justice Nelson's opinion did not cite Hylton, the idea that a tax on income generated by a particular source is effectively a tax on the source itself is somewhat analogous to a theory expressed in Justice Paterson's opinion in Hylton that a tax on the immediate produce of land might be considered a tax on the land. However, the analogy is very strained. Standing crops, or just harvested crops in raw form, are quite different in their place in the economic chain of events from a salary paid to a public employee. While Justice Paterson mused that a parcel of farmland has no value except to produce a crop, it is a far different thing to conclude that a state exists for the purpose of employing public employees. Further, a tax on land or on standing or just-harvested crops immediately burdens the landowner, while an income tax on a public employee immediately burdens the employee, but not the state.
In Hubbard, the Supreme Court held that a provision of the Civil War income tax was properly construed as imposing a tax on a corporate shareholder with respect to his ratable portion of undistributed corporate profits. The case was one of statutory interpretation. No mention of direct taxation was contained in the Court's opinion or in the reported arguments of counsel, leading to the conclusion that all of the parties involved viewed the constitutionality of the tax as obvious.
In a politically charged atmosphere, Congress in 1894 enacted an income tax. The defendant bank was prepared to pay its income tax, which was based on the bank's income from business operations and also on income from investments in real property, as well as interest on New York City bonds. Also, the defendant bank was going to pay income tax on rental income on real properties that it held in a fiduciary capacity, as a trustee. The plaintiff, Charles Pollock, was a shareholder of the bank, and he sued to enjoin the bank from paying the income tax to the government.
Chief Justice Melville Fuller delivered the opinion of the Court. In his view, the purpose of the inquiry was to find the meaning of direct tax when the Constitution was framed in Philadelphia and ratified by the states.29 Chief Justice Fuller observed that the delegates to the Constitutional Convention in Philadelphia were wise and well read. Therefore, reasoned the chief justice, the published views of the leading political economists of the day provide an insight into the meaning of the term direct tax as it appears in the Constitution.30 That reliance on the published writings of political economists broke with the reasoning of Justice Swayne in Springer.
Chief Justice Fuller acknowledged that Springer was relevant, but he read Springer quite narrowly to properly apply only to a tax on earned income. That is, a tax on personal service income was not a direct tax, but a tax on rental income from real property was not before the Court in Springer. The taxpayer in Springer had income from his professional practice as a lawyer, and the taxpayer also received interest on U.S government bonds, although those facts were not disclosed in the Springer Supreme Court decision.
Chief Justice Fuller's majority opinion went on to hold that a tax on income from real property was the same thing as a tax on real property. Further, Chief Justice Fuller's opinion held that a tax on the income from city of New York bonds was the same thing as a federal tax on a political subdivision of a state. The majority opinion then relied on Day to hold that such interest could not be taxed by the federal government. Thus, a tax on rental income from real property was a direct tax, and a tax on interest income from state bonds was beyond the reach of the federal government. While there is a suggestion that a tax on income from personal property was also a direct tax, there was no holding on that subject.
Justice Edward D. White31 wrote a strong dissenting opinion. He objected to the nature of the suit, which in substance was an attempt to enjoin collection of a tax, rather than an attempt to obtain a refund of a disputed amount. Further, Justice White indicated that he believed the majority opinion departed from a century of precedents holding that only capitations and real property taxes were direct in the constitutional sense. Justice White's opinion pointed out that there was no evidence that the Framers understood the meaning of "direct taxes" as used in the constitutional text to be the meaning ascribed to the term in the leading treatises on political economy of the day.
Chief Justice Fuller wrote for a 5-4 majority. The Court confirmed that a tax on rental income from real property was a direct tax. The Court also ruled that a tax on income generated by personal property was a direct tax. The Court further confirmed that Congress could not tax interest on state bonds because that would be tantamount to a tax on the debtor state. The Court acknowledged that a tax on income from wages, salaries, professional practices, and the like would not be a direct tax. But the Court determined that the 1894 tax legislation was not severable, so the entire 1894 income tax act was unconstitutional.
The foundation of the majority opinion was the theory that a tax on income generated by something was the same thing as a tax on the income-generating source. Accordingly, a tax on rents was the same as a tax on real property (a tax on real property was generally considered to be direct, based on a century of precedent); a tax on interest and dividends was the same thing as a tax on invested capital (the Court also held that a tax on that sort of personal property was a direct tax); and, further, a tax on state bond interest was the same thing as a tax on the debtor state. In that, the Court echoed, to some degree, the theory of Day.
The nontaxability of state bond interest was not controversial. The rest of the majority opinion was highly controversial and gave rise to four dissenting opinions.
Justice John Marshall Harlan's dissenting opinion reviewed the precedents in detail and asserted that the majority was reading the precedents too narrowly. Justice Harlan's dissent pointed out that a tax on rents was not the same thing as a tax on real property because such a tax would not apply to any real property from which no rental income was derived.36 Justice Harlan's dissenting opinion also maintained that there was no precedent for holding that a tax on personal property was a direct tax. Indeed, the carriages taxed in Hylton were personal property. Justice Harlan reasoned that because there was no precedent for concluding that a tax on personal property was a direct tax, there also was no precedent for holding that a tax on income generated by invested personal property was a direct tax. Finally, Justice Harlan thought the 1894 tax act was severable.
This case dealt with a tax enacted to help finance the Spanish- American War of 1898, a stamp tax on memorandums evidencing transactions at a board of trade or exchange. Justice Rufus Peckham authored the Court's opinion; there were no dissenting or concurring opinions.
The Court determined that the tax in question was a tax on the privilege, opportunity, or facility offered at a board of trade or exchange, and as such, was not a tax on property. Accordingly, the tax under examination was not a direct tax.
Only five years after Pollock, the Supreme Court refused to hold that a tax on legacies and distributive shares of personal property, enacted by Congress to help finance the Spanish-American War, was a direct tax. Justice White, who had energetically dissented in both of the Pollock decisions, wrote the majority opinion in Knowlton. The plaintiff executors asserted that the legacies tax was an unapportioned direct tax. The majority opinion in Pollock specifically endorsed Scholey, which held that a tax on successions to real property was not a direct tax. However, the plaintiffs in Knowlton pointed out that the Scholey opinion held the successions tax not to be a direct tax because, among other reasons, a successions tax could not, in principle, be distinguished from an income tax, and in the eyes of the Scholey Court, an income tax clearly was not a direct tax. Nevertheless, Justice White, writing for the Court in Knowlton, upheld the legacies tax. Thus, notwithstanding Pollock, death taxes were not direct taxes.
In 1898, to help finance the war with Spain, Congress enacted a stamp tax requiring that revenue stamps be affixed to any memorandum or contract for the sale of corporate stock in the form of certificates for shares. The plaintiff argued that the tax at issue was a tax on personal property and therefore was a direct tax under Pollock. Because the tax in question had not been apportioned among the states, the plaintiff asserted that the tax was unconstitutional.
This case also involved a tax enacted by Congress to help finance the war with Spain. The tax at issue was a gross receipts tax imposed on refiners of sugar (and on oil refiners too). This case presented the Supreme Court with procedural issues as well as issues of statutory construction. Also, the taxpayer corporation asserted that the tax in question was a direct tax and, accordingly, unconstitutional because it had not been apportioned among the states by population.
In 1909 Congress enacted a tax on corporations. The statute subjected all corporations, joint stock companies, corporation-like associations, and insurance companies doing business in the United States (or in its territories, Alaska, or the District of Columbia) to a "special excise tax" in respect of doing business, in the amount of 1 percent of net income over $5,000. Dividends from other corporations subject to the tax were excluded. Foreign corporate entities were also taxable on income from business done, or capital invested, in the United States, its territories, and so on. This tax was challenged in the Supreme Court as unconstitutional on the theory that it was a direct tax that had not been apportioned among the states by population.
The corporate entity in this case had been in the business of managing and renting space in an office building it owned. Late in 1906, the corporation rented out the entire property under a 130-year lease. The corporate charter was then amended so that the corporation's powers were limited to owning the fee interest in the real property, to receiving and distributing rental payments to the shareholders, and to receiving and distributing to the shareholders the net proceeds arising from any disposition of the real property. Justice Day, writing for a unanimous Court, confirmed that the 1909 corporation tax law validly taxed corporations engaged in the business of managing and renting out real property. However, after the making of the 130-year lease, and amending the articles of incorporation, the corporation in question was no longer engaged in business within the meaning of the 1909 statute. Thus, the corporation in question was not subject to the tax.
Zonne was the last Supreme Court case of relevance to the meaning of direct taxes in the constitutional sense decided before the 16th Amendment was ratified on February 3, 1913. The most important precedents at that time were, of course, the two Pollock decisions. However, the Supreme Court was not expanding the reach of Pollock. Indeed, Pollock was gradually being cut back. Thus, in Nicol, a tax on commodities transactions at a board of trade or exchange was held not to be a direct tax. A legacies tax was held not to be a direct tax in Knowlton. A tax on manufactured tobacco was held not to be a direct tax in Patton. A tax on sales of corporate shares in certificate form was held not be a direct tax in Thomas. A gross receipts tax on sugar refiners and on oil refiners was held not to be a direct tax in Spreckles Sugar Refining Co. Finally, a corporate income tax was held not to be a direct tax in Flint, and that was confirmed in Zonne.
Pollock was the first and, in 1913, the only Supreme Court case to hold that a congressionally enacted tax was an invalid unapportioned direct tax. Interestingly, in the first Pollock decision Chief Justice Fuller remarked that one of the objections to the income tax enacted in 1894 was that it was enacted at a time of "profound peace."55 Only a few years later, that peace was severely shaken when, on the night of February 15, 1898, the battleship Maine exploded while anchored in the harbor at Havana, Cuba. The Maine sank under very suspicious circumstances, and with a great loss of life. By April 25, 1898, America was at war with Spain.56 The taxes at issue in Nicol, Knowlton, Patton, Thomas, and Spreckles Sugar Refining Co. were all enacted to help finance the war with Spain. All were upheld by the Supreme Court. Before Pollock, all of the taxes upheld in the cases before the Supreme Court, from Pacific Insurance through Springer, were taxes that had been enacted to help finance the Civil War or to help retire Civil War debt.
The carriage tax, which had been upheld in Hylton, was, at least in the eyes of Chief Justice Fuller, "enacted in a time of threatened war."57 While there is no constitutional text to support the theory, Chief Justice Fuller apparently believed that Congress's ability to enact a valid tax, not apportioned among the states by population, was greater at times of war, threatened war, or in the aftermath of war.58 The corporate income tax upheld in Flint was not a war tax although the United States had emerged from the war of 1898 as one of the great powers of the world, with new possessions such as the Philippine Islands and Puerto Rico. Of course, by the time Flint was decided Chief Justice Fuller had passed away and Justice White, a dissenter in Pollock, had been promoted to chief justice of the United States.
In two of the post-Pollock decisions, the notion that a tax related to property ownership but not subject to absolute and unavoidable demand because some contingency had to be satisfied before the tax became exigible was used to uphold the tax in question. The tax on the sale of corporate shares in certificate form was upheld for that reason in Thomas, as was the corporate income tax in Flint. Significantly, that theory could have been used to uphold a tax on rental income. The owner of the real property in question would not be subject to tax unless and until the property had been rented out for valuable consideration. Justice Harlan pointed out that objection in his dissent in the second Pollock decision (see note 33, above). The same could be said of a tax on income from personal property. That is, unless and until the personal property in question has started to throw off income, there would be no tax. For that reason, the rule announced in the Pollock decisions -- that a tax on income from property was the same thing as a tax on property -- was eroding.
Chief Justice Fuller's majority opinion in the second Pollock decision held that a tax on personal property was a direct tax. From that the chief justice reasoned that a tax on income from invested capital -- income-generating personal property -- was also a direct tax. However, the tax in question in Patton was upheld. Although a tax on manufactured tobacco was a tax on personal property, the tax at issue was a tax on personal property only of a specified kind. In that light, Hylton too could be viewed as involving a tax on personal property, but only of a specified kind (passenger carriages), and therefore valid. On that theory, it might have been possible to uphold, for example, a tax on annuity contracts. Such a tax would have been a tax on invested capital, but not a tax on invested capital as such, but solely on invested capital of a specified kind.
Starting with Hylton and continuing through Springer, the Supreme Court had relied on a theory that, if apportioning a given tax among the states by population would generate unfair and odd results, the tax in question was not a direct tax. That fairness test was dropped from the Supreme Court analysis in cases after Pollock. In the second Pollock decision, Chief Justice Fuller, writing for the majority, tried to make the case that the income tax could feasibly have been apportioned among the states by population, but that argument was unpersuasive.59 Perhaps the reason that the Supreme Court dropped the fairness test in cases after Pollock was that the fairness test simply could not be squared with Pollock.
The income tax has proved to be a powerful revenue-raising tool for the federal government. The question as to what taxes are direct taxes became far less pressing as a constitutional issue.
XIX. McCoach v. Minehill & Schuylkill H.
This was another dispute that arose under the 1909 tax act. The taxpayer was a British corporation that owned and operated a mine in Colorado from which the taxpayer extracted ores containing gold and other valuable metals. The taxpayer asserted that mining companies operating solely on their own property are not really engaged in business but are merely converting their capital assets from one form to another. Accordingly, under the taxpayer's theory, the 1909 act, as applied to the taxpayer in the case at hand, worked as a tax on capital. As such, the tax was an unapportioned direct tax under Pollock.
The Court opinion, written by Justice Pitney, was unanimous on that issue, holding that mining was doing business within the meaning of the 1909 act. While not praising the Pollock jurisprudence, Justice Pitney's opinion did treat Pollock as limiting Congress's power to tax capital without apportionment among the states by population.64 Thus, while the 16th Amendment had eliminated the application of Pollock to income taxes enacted after ratification, Justice Pitney's opinion treated Pollock as the controlling statement of constitutional law on the issue of a tax on invested capital: A tax on invested capital was a direct tax.
Given that sentiment, expressed the chief justice for a unanimous Court (although Justice James McReynolds took no part in the consideration and decision in the case), it is fair to conclude that Pollock would have been overruled by the Court if there had been no 16th Amendment.
The income tax provisions of the Tariff Act of 1913, taxed "dividends." The government argued that that meant stock dividends as well as cash dividends. The taxpayer in Towne had received a pro rata, common-on-common stock dividend. The distributing corporation had transferred $1.5 million from earned surplus to the capital stock account in respect of the stock dividend. The $1.5 million had been earned before January 1, 1913. Justice Oliver Wendell Holmes Jr. wrote for a unanimous Court (Justice Joseph McKenna concurred in the result but did not write a separate opinion) and held that, as a matter of statutory construction, the stock dividend in question was not income. Although not using the word "realization," Justice Holmes observed that no property had left the corporation and the shareholders had the same proportionate interest in the corporation that they had before the distribution. In observing that income did not necessarily have the same meaning in the 16th Amendment as it did in the statute in question, Justice Holmes made the famous statement, "A word is not a crystal, transparent and unchanged, it is the skin of a living thought and may vary greatly in color and content according to circumstance and the time in which it is used."72 The Towne Court held that a pro rata, common-on-common stock dividend was not income within the meaning of the 1913 statute. Accordingly, Towne was not a constitutional interpretation. Interestingly, the 1870 Hubbard case was not mentioned, perhaps because both Towne and Hubbard were cases of statutory interpretation and very different statutes were involved.
Unlike the Tariff Act of 1913, the Revenue Act of 1916 did specifically tax shareholders on stock dividends (as well as cash dividends). At issue in Eisner was the constitutional validity of taxing a pro rata, common-on-common stock dividend made in 1916. The Court split 5-4, with Justice Pitney writing the majority opinion. The majority ruled that neither the 16th Amendment nor Article I permitted Congress to tax, without apportionment, a pro rata stock dividend or the accumulated profits behind it as income of the shareholder. That is, to be constitutional, an unapportioned tax on income from property must tax only realized income.74 The majority opinion was based on the theory that a tax on a shareholder with respect to any unrealized accretion in value of the shares that shareholder owned was a tax on capital and not on income. Therefore, Justice Pitney observed that Hubbard must be seen as having been overruled by Pollock.75 There were two dissenting opinions, one by Justice Holmes and one by Justice Louis Brandeis. Justice Day concurred with the Holmes dissent, and Justice John Clark concurred with the Brandeis dissent.
The majority opinion in Eisner represented an extension of Pollock beyond the existing case law. Even if it had been stipulated that a tax on a pro rata stock dividend was in fact a tax on invested capital, it still was not inevitably a direct tax. A tax on stock dividends would not have been a tax on invested capital as such, but only on personal property of specified type, as in Patton (tax on manufactured tobacco) or Pacific Insurance (tax on business assets of insurance companies); also, it would not have been a tax that was subject to absolute and unavoidable demand, as required by Thomas and Flint. There would have been no tax payable on the shareholders on account of the undivided profits of the corporation until a stock (or cash) dividend had been distributed. Nevertheless, the majority opinion in the case at hand did not analyze the tax on stock dividends any further than to assert that the tax in question was a tax on capital that it had not been apportioned, and therefore the taxing statute was invalid. Accordingly, Pollock was extended to a case in which the capital taxed was only a particular type, and only under the contingency of a stock dividend.
In the opinion of the Court, authored by Justice Brandeis, the tax was not laid on a state of mind, but on the net income of the corporate taxpayer. As such, the tax at issue was an income tax within the meaning of the 16th Amendment.93 The requisite state of mind was merely a condition precedent to the imposition of the tax on net corporate income.
This case did not deal with the issue of direct taxation. Nevertheless, it is important to the discussion herein because the holding in this case completely negated the theory on which Chief Justice Fuller's majority opinions in the two Pollock decisions rested. The Pollock decisions held that a tax on rental income was tantamount to a tax on real property. Because a tax on real property had been viewed as a direct tax since Hylton, for Chief Justice Fuller a tax on rental income was a direct tax. Additionally, Pollock held that a tax on personal property was a direct tax and went on to reason that a tax on income from invested capital was tantamount to a tax on invested capital. Accordingly, a tax on income from invested capital was a direct tax, in the eyes of Chief Justice Fuller. Moreover, Pollock held that a tax on interest income from bonds issued by a state (or a political subdivision of a state) was equivalent to a tax on the issuing state; accordingly, it was unconstitutional as a matter of intergovernmental immunity. Finally, Pollock had confirmed that taxes on income from personal services, trade, or business operations were not direct taxes, under the authority of Springer, but then had held that the Income Tax Act of 1894 was not severable, so the entire act was unconstitutional. The key to the majority reasoning in Pollock was the theory that a tax on income from a particular source was, in substance, a tax on the source itself. That theory was supported by Day. Graves specifically overruled Day.
With its holding in Graves, the Supreme Court by 1939 had made the 16th Amendment superfluous. While the 16th Amendment permits Congress to impose an income tax without resorting to apportionment, Graves had made the holdings in Pollock concerning the income tax absolutely untenable. That is, a tax on rental income was not the same as a tax on real property, and a tax on interest, dividends, royalties, and the like was not the same as a tax on invested capital.
Justice Wiley Rutledge did not participate in the consideration or in the decision in the case. Justice William O. Douglas contributed a dissenting opinion in which Justice Hugo Black and Justice Frank Murphy joined. The dissenting opinion was rather forthright. In the view of the dissenters, Macomber should have been overruled. For the dissenters, the issue of whether or not to make the receipt of a stock dividend an occasion of taxing the shareholder on the accrual of wealth it represented was within the competence of Congress under the 16th Amendment.103 In the eyes of the dissenters, the 16th Amendment did not require that income must be realized before it was taxed as income.
In 1982 Congress passed legislation that denied federal income tax exemption to interest paid on long-term bonds issued by states (and by their political subdivisions) unless the bonds were issued in registered form. Accordingly, long-term bearer bonds issued by states would no longer yield interest that was exempt from federal income taxation. The legislation was challenged by the state of South Carolina. One of the grounds argued by South Carolina was that such interest could not be taxed by the federal government because of the doctrine of intergovernmental immunity, as held in the first Pollock decision. In Baker the Supreme Court acted in its original jurisdiction. The government had advanced an alternative argument that, because registered bonds remained tax-exempt, the intergovernmental immunity doctrine was not implicated. The special master's report adopted that view.
Justice William Brennan delivered the majority opinion, in which he was joined by Justices Byron White, Marshall, Harry Blackmun, and John Paul Stevens, and, on the issue of intergovernmental immunity under the first Pollock decision, he was also joined by Justice Antonin Scalia. Chief Justice William Rehnquist filed an opinion concurring in the judgment, but it is not clear if he agreed with the majority regarding the first Pollock decision or if he agreed with the government's alternative argument. Justice Sandra Day O'Connor filed a dissenting opinion concerning the first Pollock decision. Justice Anthony Kennedy did not participate.
Justice Brennan's majority opinion expressly overruled the first Pollock decision and held that the federal government had the power under the Constitution to tax interest on state obligations as part of a general income tax. Justice Brennan reasoned that, as had been discussed in Graves, a tax on income was not the same thing as a tax on the source of the income so taxed.105 Thus, after Baker, Pollock had no more continuing vitality regarding federal income taxation.
1. Macomber is incorrect in concluding that the 16th Amendment requires realization. That is the view expressed in Justice Holmes's dissent in Macomber, and in Justice Douglas's dissent in Griffiths. Under that view, realization is a rule of convenience in aid of the administration of the income tax, but it is not a constitutional requirement.
2. Whether or not the 16th Amendment reaches unrealized income, Congress has the power to tax unrealized income in any event. Due to subsequent Supreme Court precedents, Pollock can no longer prevent the taxation (without apportionment) of income from property, even in the absence of the 16th Amendment. That view would find support from Graves and Baker. That is, a tax on income from property is not a tax on property as such. Moreover, in Hubbard unrealized income was taxed in the pre-Pollock era.
3. Pollock has never been overruled concerning its holding that a tax on invested capital is a direct tax. Eisner is correct in holding that a tax on unrealized income is a tax on invested capital. However, not all taxes on invested capital are direct taxes. Under the post-Pollock case of Patton, a tax on manufactured tobacco was held not to be a direct tax, because the tax at issue was not a tax on personal property as such, but rather it was a tax on a specific type of property with a specific intended use. Current nonelective taxes on unrealized income, if viewed as taxes on capital, are not general taxes on capital, but only taxes on capital in specific instances; and they are valid under the theory of Patton.
4. Those are taxes on invested capital; Macomber is right to that extent. However, Pollock is wrong that taxes on invested capital are direct taxes. The only direct taxes are capitations and taxes on land. Hylton is correct in all respects, and it reflects the understanding of the concept of direct taxes current among the justices, all of whom had been involved in the drafting or ratification of the Constitution. Pollock is nothing more than an example of 1890s judicial activism, and as such, Pollock can properly be disregarded in all respects.
The foreign personal holding company regime was challenged as an unapportioned direct tax in Eder v. Commissioner,111 but the Second Circuit (Judges L. Hand, A. Hand, and Frank) upheld the tax on vague and general grounds, without much articulated analysis, in a terse opinion by Judge Frank. Thirty years later, the constitutionality of the subpart F regime was upheld by the Second Circuit (Judges Smith, Mansfield, and Oakes) in Garlock Inc. v. Commissioner.112 Judge Oakes's opinion in Garlock indicated that the taxpayer's constitutional argument, in light of Eder, "borders on the frivolous."113 While the Supreme Court had not directly overruled Macomber on whether there is a realization requirement in the Constitution, to overturn the subpart F regime now would seriously damage United States taxation of multinational businesses and is simply unimaginable. Given the many instances in which, on a nonelective basis, the code imposes a tax on unrealized income,114 it is absolutely clear that Congress does not view realization as a constitutional requirement.
Suppose Congress were to enact a flat, annual tax of a fixed amount, payable by every limited liability business entity engaged in business in at least one state or in the District of Columbia. It is hard to imagine that such a tax would be treated as anything other than an excise on the privilege of limited liability.120 Moreover, even if the second Pollock decision were viewed as good law on the issue of whether a tax on capital is a direct tax, such a corporate "capitation" would not result in a general tax on all invested capital, but merely on property of a very specific type with a specific purpose, and thus should be viewed as other than a direct tax under the reasoning of Patton. Of course, Treasury would have the argument that a tax on capital or any personal property is not a direct tax, on the theory that the second Pollock decision was wrong and the only direct taxes are capitations and taxes on land, as was the law before Pollock.
While untenable for political reasons, a federal net worth tax, not apportioned among the states by population, would surely test the meaning of direct tax. Each of the Justices writing a full opinion in Hylton agreed that if a tax would produce unjust or unfair results if apportioned, it is not a direct tax. Applying the pre- Pollock rule that the only direct taxes are capitations and land taxes, the hypothetical net worth tax should be viewed as not direct. For example, one taxpayer could be completely landless, but could have exactly the same net worth as another taxpayer with substantial real estate holdings. Moreover, the tax liability would not increase as land ownership increased. The reason for that is that the tax base would be the excess, if any, of the fair market value of the taxpayer's assets (of all types) over the total amount of the taxpayer's indebtedness, if any. Apportionment of such a tax would produce unfair results. For example, a taxpayer living in a state with a low per capita net worth, such as Mississippi, would face a higher tax bill than would a taxpayer with the identical net worth, but living in a state with a higher per capita net worth, such as New Jersey. Similarly, the injustice of apportionment is the reason that any tax on personal property, such as the carriage tax in Hylton, would not be a direct tax. The second Pollock decision is simply wrong on that point.121 However, given political reality, a federal net worth tax is as unlikely as a federal capitation.
Four prominent jurists, each of whom had been active in the creation or in the adoption of the Constitution, had ruled in Hylton that the carriage tax was not a direct tax. That ruling is irreconcilable with the view expressed in Pollock that a tax on invested capital would be a direct tax. For example, carriages could represent the invested capital of the owner of a carriage-for- hire business. Hylton, the work product of actual Founders, should be seen as the deciding rule on direct taxes. The apportionment requirement for direct taxes should never hamper public finance.
On August 22, 2006, the U.S. Court of Appeals for the District of Columbia Circuit (Chief Judge Ginsburg and Judges Rogers and Brown) held that taxation, as income, of a tort recovery for emotional injuries was unconstitutional because those recoveries were not income within the meaning of the 16th Amendment. The D.C. Circuit's opinion did not mention the apportionment requirement for direct taxes. Indeed, the opinion did not state that a tax on tort recoveries for emotional injuries was a direct tax. Rather, the opinion seemed to assume that Congress could not impose an income tax at all in the absence of the 16th Amendment.
Prognostication is always treacherous, but it is fairly easy to predict that the Supreme Court will overturn the D.C. Circuit's holding and rule that the recovery in question was, in fact, income within the meaning of the 16th Amendment. It would be most interesting if the Supreme Court were to uphold the tax at issue as not being a direct tax. The theory would be that a federal tax on tort recoveries or settlements of tort cases would not be a direct tax under the Hylton view that only capitations and land taxes are direct taxes in the constitutional sense. A tax on tort recoveries would be neither. Perhaps a future Supreme Court concurring opinion will so state.
1 "'No one answd.,' Madison noted on August 20, when 'King asked what was the precise meaning of direct taxation.'" Rakove, Original Meanings (Knopf 1996), pp. 179, 180, quoting James Madison. Throughout this article, reference will be made to direct taxes, on one hand, and to indirect taxes, or not direct taxes, on the other. Some courts and some commentators have made the verbal distinction as being between direct taxes on one hand, and excises on the other. Also, it should be noted that the notorious federal ratio was eliminated by the 14th Amendment.
2 Hylton v. United States, 3 Dallas (3 U.S.) 171 (1796).
3 The two judges on the circuit court were split, but Hylton confessed to judgment so that the case could be brought to the Supreme Court.
4 Marbury v. Madison, 1 Cranch (5 U.S.) 137 (1803).
5 Pacific Ins. Co. v. Soule, 74 U.S. 433 (7 Wallace) (1868).
6 Veazie Bank v. Fenno, 75 U.S. 533 (8 Wallace) (1869).
7 75 U.S. 533, 542, 543.
8 75 U.S. 533, 543, 544.
9 75 U.S. 533, 544.
10 75 U.S. 533, 544.
11 Chief Justice Chase, a former Treasury secretary, also provided a very interesting history of the efforts to create a national, regularized money supply during the Civil War.
12 Collector v. Day, 78 U.S. 113 (11 Wallace) (1870).
13 78 U.S. 113, 127, 128.
14 Graves v. New York ex rel. O'Keefe, 306 U.S. 466 (1939).
15 Collector v. Hubbard, 79 U.S. 1 (12 Wallace) (1870).
16 Scholey v. Rew, 90 U.S. 331 (23 Wallace) (1874).
17 90 U.S. 331, 347.
18 90 U.S. 331, 347, 348.
19 90 U.S. 331, at footnote 25.
20 Springer v. United States, 102 U.S. 586 (1881).
21 102 U.S. 586, 602. Also, Justice Swayne noted the injustice that would result from the attempt to apportion an income tax, and that lent support to the conclusion that an income tax was not a direct tax. 102 U.S. 586, 600.
22 102 U.S. 586, 596-598.
23 102 U.S. 586, 599-602.
24 102 U.S. 586, 590.
25 102 U.S. 586, 602.
26 This notion appeared in Justice Chase's opinion in Hylton, in Justice Paterson's opinion in Hylton, in Justice Iredell's opinion in Hylton, in Justice Swayne's opinion in Pacific Insurance, and in Justice Swayne's opinion in Springer.
27 Pollock v. Farmers Loan & Trust Co., 158 U.S. 601 (1895), vacating 157 U.S. 429 (1895).
28 157 U.S. 429 (1895).
29 157 U.S. 429, 558.
30 157 U.S. 429, 558, 559.
31 White would become the chief justice of the United States in 1910.
32 158 U.S. 601 (1895), vacating 157 U.S. 429 (1895).
33 158 U.S. 601, 620, 621.
34 158 U.S. 601, 630.
35 158 U.S. 601, 632, 633.
36 158 U.S. 601, 668.
37 158 U.S. 601, 686, 687.
38 158 U.S. 601, 687.
39 158 U.S. 601, 695.
40 158 U.S. 601, 699, 700. It is now considered to be elementary that the economic burden of a tax is shifted, or not shifted, not by the nature of the tax in question but by the relative elasticities of supply and demand. See, e.g., Wessels, Economics, Barron's Educational Series (2000), pp. 520, 521.
41 158 U.S. 601, 702. On the issue of picking and choosing when foreign law is useful for guiding the Court in its decisionmaking, the current controversy over the use of foreign law was anticipated. The current controversy is discussed in Delahanty and Yoo, "Against Foreign Law," 29 Harvard J. of Law & Public Policy 291 (2005).
42 See note 41, supra.
43 Nicol v. Ames, 173 U.S. 509 (1899).
44 Knowlton v. Moore, 178 U.S. 41 (1900).
45 Patton v. Brady, 184 U.S. 606 (1902).
46 184 U.S. 608, 618, 619.
47 Thomas v. United States, 192 U.S. 363 (1904).
48 192 U.S. 363, 370. Chief Justice Fuller did not discuss the problem that a tax on rents, which he had held to be direct in the Pollock cases, was entirely contingent on leasing real property for valuable consideration. If the real property of the taxpayer were not leased out for valuable consideration, there would be no rental income, and accordingly, no tax on rental income would be exigible. Therefore, it would seem that a tax on rents would lack the element of immediate and unavoidable demand.
49 Spreckles Sugar Refining Co. v. McClain, 192 U.S. 397 (1904).
50 192 U.S. 397, 412, 413.
51 Flint v. Stone Tracy Co., 220 U.S. 107 (1911).
52 220 U.S. 107, 145.
53 220 U.S. 107, 151, 152.
54 Zonne v. Minneapolis Syndicate, 220 U.S. 187 (1911).
55 157 U.S. 429, 574.
56 See generally Trask, The War With Spain in 1898 (University of Nebraska Press 1996, originally published by The Free Press, 1981).
57 158 U.S. 601, 623.
58 The federal government does have a special source of revenue in times of international tensions through Congress's power to grant letters of marque and reprisal, under Article I, section 8 of the Constitution. However, by 1895, the year of the Pollock decisions, the days of Jean Lafitte were long gone.
59 158 U.S. 601, 632, 633. The unpersuasiveness of the argument was demonstrated in Justice Harlan's dissenting opinion. 158 U.S. 601, 678, 679. The injustice of apportioning an income was demonstrated in Justice Brown's dissent. 158 U.S. 601, 688, 689. Justice Jackson's dissent also pointed out the injustice of apportionment of the income tax. 158 U.S. 601, 704. For Justice White, such apportionment was simply unthinkable. 158 U.S. 601, 713.
60 McCoach v. Minehill & Schuylkill Haven R.R. Co., 228 U.S. 295 (1913).
61 228 U.S. 295, 306, 307.
62 228 U.S. 295, 312.
63 Stratton's Independence, Ltd. v. Howbert, 231 U.S. 399 (1913).
64 231 U.S. 399, 414.
65 Brushaber v. Union Pacific R.R. Co., 240 U.S. (1916).
66 240 U.S. 1, 13-17.
67 240 U.S. 1, 16.
68 240 U.S. 1, 15.
69 Stanton v. Baltic Mining Co., 240 U.S. 103 (1916).
70 240 U.S. 103, 112, 113.
71 Towne v. Eisner, 245 U.S. 418 (1918).
72 245 U.S. 418, 425.
73 Eisner v. Macomber, 252 U.S. 189 (1920).
74 252 U.S. 189, 219.
75 252 U.S. 189, 218.
76 252 U.S. 189, 219, 220.
77 252 U.S. 189, 220.
78 252 U.S. 189, 215.
79 252 U.S. 189, 228, 229.
80 Bowers v. Kerbaugh-Empire Co., 271 U.S. 170 (1926).
81 271 U.S. 170, 174, 175.
82 Bromley v. McCaughn, 280 U.S. 124 (1929).
83 He would become the chief justice of the United States in 1941.
84 280 U.S. 124, 136, 137.
85 280 U.S. 124, 137.
86 280 U.S. 124, 141, 142.
87 Tyler v. United States, 281 U.S. 497 (1930).
88 281 U.S. 497, 502, 503.
89 281 U.S. 497, 503, 504.
90 Helvering v. National Grocery Co., 304 U.S. 282 (1938).
91 The current version of the accumulated earnings tax is imposed under section 531 of the Internal Revenue Code of 1986.
92 304 U.S. 282, 289.
93 Id. Although not discussed by Justice Brandeis in his opinion, a tax on the net income of a corporation was not a direct tax in any event, according to Flint.
94 Graves v. People of the State of New York, 306 U.S 466 (1939).
95 306 U.S. 466, 486.
96 McCulloch v. Maryland, 4 Wheaton (17 U.S.) 316 (1819).
97 4 Wheaton (17 U.S.) 316, 431.
98 306 U.S. 466, 491, 492.
99 306 U.S. 466, 492, 493.
100 Helvering v. Griffiths, 318 U.S. 371 (1943).
101 318 U.S. 371, 372.
102 318 U.S. 371, 404. As a matter of statutory construction, the Supreme Court held that a pro rata distribution of nonvoting preferred shares to the holders of voting common shares, which had been the only class of outstanding shares before the distribution under review, was not taxable in Strassburger v. Commissioner, aff'd sub nom, Helvering v. Sprouse, 318 U.S. 604 (1943). The Supreme Court also held in Sprouse, as a matter of statutory construction, that when a corporation had both voting and nonvoting common shares outstanding, a pro rata distribution of nonvoting common shares to all existing shareholders was not taxable.
103 318 U.S. 371, 409-411.
104 South Carolina v. Baker, 485 U.S. 505 (1988).
105 485 U.S. 505, 520.
106 485 U.S. 505, 529.
107 485 U.S. 505, 533.
108 Boris Bittker and James Eustice, Federal Income Taxation of Corporations and Shareholders, 7th Ed. (Warren, Gorham & Lamont 2002), at 8-94.
110 American Jobs Creation Act of 2004, section 413(c)(31).
111 Eder v. Commissioner, 138 F.2d 27 (2d Cir. 1943).
112 Garlock Inc. v. Commissioner, 489 F.2d 197 (2d Cir. 1973), cert. denied, 417 U.S. 911 (1974).
113 489 F.2d 197, 202.
114 See note 114 supra, and the accompanying text.
115 Notice 2006-31, Doc 2006-5168, 2006 TNT 52-10.
117 See notes 98 through 103, supra, and the accompanying text.
118 Erik Jensen, "The Apportionment of 'Direct Taxes': Are Consumption Taxes Constitutional?" 97 Colum. L. Rev. 2334, 2405 (1997).
119 97 Colum. L. Rev. 2334, 2414.
120 See generally Flint v. Stone Tracy Co.
121 Bruce Ackerman, "Taxation and the Constitution," 99 Colum. L. Rev. 1, 29 (1999). Calvin Johnson, "Apportionment of Direct Taxes: The Foul-Up in the Core of the Constitution," 7 Wm. & Mary Bill of Rts. J. 1, 37 (1998).
122 See note 73 supra, and the accompanying text.
123 Murphy v. IRS, 460 F.3d 79, Doc 2006- 22626, 2006 TNT 215-20 (D.C. Cir. 2006). See Germain, "Taxing Emotional Injury Recoveries: A Critical Analysis of Murphy v. Internal Revenue Service," available at http://ssrn.com/abstract-942515.

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