Simple Liberty  

 

     
   
     

The American Income Tax

Chapter 2

Definitions — Approaching the Camel

Written by Darrell Anderson.

Our Constitution is in actual operation; everything appears to promise that it will last; but in this world nothing is certain but death and taxes.

Benjamin Franklin, 1789

In the American colonies, a war was fought, among other reasons, because of taxation. The taxes levied were involuntary, that is, the colonists had little say in being taxed, or how the revenues were used. History shows that the colonists repeatedly rejected such taxation. The issue was not so much representation, but that of being taxed without consent.[1] Representation was merely a political mechanism through which people were believed to have provided consent. An additional issue was that some of the taxes were levied on necessities, that is, commodities that the colonists could not live without and were forced, by statute, to obtain only from England.[2]

John Adams, eventually the second president of the United States, in October of 1765 wrote an essay in the Boston Gazette that later became known as the Braintree Instructions denouncing the British Stamp Act:[3]

We have always understood it to be a grand and fundamental principle of the [English] constitution that no freeman should be subject to any tax to which he has not given his own consent.

After the Revolutionary War, people wanted little or nothing to do with taxation. Thus, with the nation still in infancy, the Articles of Confederation provided the federal political system no strong taxation powers, which eventually created a revenue shortfall. This shortfall of revenues supposedly impeded Congress’s ability to function effectively. Some people believe that this “inefficiency” is exactly how the process was supposed to operate. Eventually some people in the individual states accepted this alleged shortcoming. For example, read The Federalist Papers Nos. 3–13. However, hardly everybody accepted that there was a “crisis” at hand. Patrick Henry denied as much in his Virginia ratification convention speeches, as did the Anti-Federalist “Centinel” in his newspaper commentaries. This alleged inability to finance certain efforts was agitated through events such as Shays’ Rebellion.[4]

The ratification of the Constitution changed that picture, expanding the national legislators’ power and provided them standing to collect revenues through taxation. The Constitution granted legislators broad taxation powers in the nature of two types of taxes: direct and indirect taxes.

Definitions are critical in this discussion, and without definitions, the debates over various methods of taxation never will be resolved. What are direct and indirect taxes?

From Noah Webster’s 1828 American Dictionary of the English Language:

Direct: Straight; right; as, to pass in a direct line from one body or place to another. It is opposed to crooked, winding, oblique. It is also opposed to refracted; as a direct ray of light . . . Leading or tending to an end, as by a straight line or course; not circuitous. Thus we speak of direct means to effect an object; a direct course; a direct way. Open; not ambiguous or doubtful. Plain; express; not ambiguous; as, he said this in direct words; he made a direct acknowledgment.
Indirect: Not straight or rectilinear; deviating from a direct line or course; circuitous. From New York to England by Bordeaux, is an indirect course.

The word “indirect” is not found in the Constitution. However, the word is implied by the use of the term “direct tax,”[5] found twice in the Constitution with respect to taxation.[6] Within the Constitution, indirect taxes are recognized in the nature of duties, imposts, and excises.[7]

From Noah Webster’s 1828 American Dictionary of the English Language:

Tax: A rate or sum of money assessed on the person or property of a citizen by government, for the use of a nation or state. Taxes, in free governments, are usually laid upon the property of citizens according to their income, or the value of their estates. Tax is a term of general import, including almost every species of imposition on persons or property for supplying the public treasury, as tolls, tribute, subsidy, excise, impost, or customs. But more generally, tax is limited to the sum laid upon polls, lands, houses, horses, cattle, professions and occupations.
Duty: Tax, toll, impost, or customs; excise; any sum of money required by government to be paid on importation, exportation, or consumption of goods.
Impost: Any tax, or tribute imposed by authority; particularly, a duty or tax laid by government on goods imported, and paid or secured by the importer at the time of importation. Imposts are also called customs.
Excise: Cut off. An inland duty or impost, laid on commodities consumed, or on the retail, which is the last stage before consumption . . . But many articles are excised at the manufactories . . . .

What is a direct tax? A common perspective teaches that the cost of a direct tax cannot be passed to another person and the cost of an indirect tax can be passed. Another approach is that direct taxes are compulsory and not voluntary whereas indirect tax are voluntary and can be avoided.[8] Another approach teaches that the difference between a direct tax and an indirect tax is that the subject of a direct tax is people or property,[9] and the subject of an indirect tax is an activity or event.[10] Another viewpoint is that direct taxes are levied on revenues and income (production), and indirect taxes are levied on expenses and consumption.[11] All perspectives appear to be stating something similar, albeit in different words.

Is this confusion something new? At the Constitutional Convention of 1787, Rufus King raised the question as to “the precise meaning of direct taxation” and no one answered.[12] Reading various discussions and debates of that era shows that although there was a general consensus on the meaning of direct tax, there was no overwhelming agreement. Several times the dispute has caused the U.S. Supreme Court justices to struggle to distinguish between direct and indirect taxes.[13] The fact is that nobody yet has answered the question convincingly and probably never will.

Some individuals argue that there are only three possible subjects of a tax:[14]

  1. People.
  2. Property (things).
  3. Specific activities or events.

Although taxes can be classified as such, the only subject of a tax is people. Only people can pay taxes. A tax can be classified as against a thing or for participating in certain activities, or can be measured by the subjective value of those things or activities, but only people can pay those taxes. Similarly, some people like to distinguish taxes on production versus taxes on consumption. Because only people can pay taxes and can pay only from that which they produce, all taxes fundamentally are taxes on production. This is the reality despite any legal artistry with words.

Generally, for many people, nobody can avoid a direct tax, and in theory people can avoid indirect taxes by avoiding (not participating in) the taxable activities. However, that statement again depends greatly upon the definitions of a direct and indirect tax.

Consider, for example, a head tax. Many people probably will agree that such a tax is a direct tax regardless of perspective. That is, such a tax is a tax on people and the tax cannot be passed to other people.

What about a land tax, as is levied today in the nature of the general property tax? Direct or indirect? According to one perspective, the tax is a direct tax because the subject of the tax is property. From another perspective, the nature of the tax is debatable. Why? Consider that homeowners who do not use their home and land commercially probably see the general property tax as a direct tax, and for all intents and purposes are likely correct. For homeowners, the tax cannot be passed to other people. However, any individual who uses landed property commercially, more than likely perceives such taxes as a cost of business and passes the cost to customers embedded in prices of goods and services sold. Many people refer to such taxes as indirect.

A person might object to such reasoning and assert that many homeowners can pass the cost of the property tax. To pay the tax they raise the price of their own skills and knowledge. In effect, they pass the cost to employers and clients. With that observation extend that argument back to head taxes too, because all people will raise the price of their skills and knowledge to pass or recover the cost of the tax.

Further complicate the issue by recognizing that in levying taxes on certain activities, there are only two possible parties who can pay a tax: buyers and sellers. When a tax is levied upon a seller, the cost is immediately passed to buyers. When a buyer pays a tax, either directly or indirectly, the buyer attempts to pass the cost through other methods. The argument does not change when viewed from the perspective of taxing activities. The cost always will be passed to the buyer.

The process of taxation is a never-ending recursive cycle of continuing rising costs and prices. This is true even when ignoring the hidden costs of an unstable currency system, which continually erodes the exchange power of currency. As politicians increase their desire for revenues, more taxes are levied. As people further embrace legal plunder, more taxation shifts wealth from one class of people to another. As sellers pass the cost, buyers raise the cost of their skills and knowledge. As the buyer raises those costs, that effort raises the cost of commodities and products. As prices rise, the cost of skills and knowledge again rises to cover the higher expenses. As prices rise, politicians see the need to raise more revenues and raise taxes. The problem is recursive.

Every individual is both a producer and consumer. Or from another perspective, a buyer and seller. Thus, nobody escapes this maddening recursive game.

Under any tax scheme often an individual can shift the financial burden of any type of tax by passing the cost to another person. Shifting the cost does not remove who is liable for paying the tax, but shifts the burden of who truly foots the bill. The question of liability seems to be a credible element in deciding whether a tax is direct or indirect.

Yet, does passing the cost mean a tax is direct or indirect? Not an easy question to answer; and is any tax truly indirect? After all, eventually somebody has to pay the tax, and to that final individual all taxes are direct. Any individual who pays a tax will try hard to pass the cost to another person, making the tax indirect. Such thinking quickly becomes circular. Discussing whether a tax is direct or indirect can be puzzling and futile.

With that introduction, further confuse this issue by introducing rules to govern the collection of direct and indirect taxes. Imagine trying to understand the rules of baseball without first understanding the general concept of the game.

There are only two federal constitutional rules regulating the taxation powers of legislators. Direct taxes are governed by the rule of apportionment.[15] Although there are various methods to determine proportionality, in the Constitution this apportionment requirement is based upon population among the several states. Indirect taxes are governed by the rule of uniformity.[16]

A federal direct tax was levied in 1798.[17] The tax was levied and collected during the frenzy of the French-American crisis of John Adam’s administration. Adams, despite his intention of negotiating his way out of the crisis,[18] nonetheless asked legislators to raise revenues as a precaution to prepare for possible military action.[19] Congress passed the tax bill only days after the infamous Alien and Sedition Acts were enacted.[20] The subject of the 1798 tax was houses, slaves,[21] and land.[22] Before legislators levied the tax, Oliver Wolcott, Secretary of Treasury, produced a report of all the current subjects of direct taxes within the 14 states.

Similar direct taxes were levied in 1813[23] and 1815,[24] as well as during the War Among the States.[25]

In practice such a tax was straightforward. Assess all property, then divide the sum levied by the total property values. This calculation then determined how much each individual would be levied on a dollar-per-dollar basis. For example, assume that a state was levied $1 million and the total localized property assessments came to $100 million. Each individual then would be levied a tax of $.01 per dollar of assessed value of property. If an individual owned property assessed at a total value of $1,000, the tax would be $10. In the 1798 tax, congressional legislators stipulated assessment rates and then required assessors to adjust the rates only if the total value calculated exceeded the proportioned amount due to Congress. In the subsequent three direct taxes of 1813, 1815, and 1861, congressional legislators allowed assessment rates to be determined locally. However, based upon census population figures, each legislative act stipulated the amount to be paid by each state. The 1813 act stipulated the specific amount to be paid by each county or parish in each state, but the 1815 act instead required establishing local assessment districts.

The Framers knew direct taxation was potentially volatile because such power provided authority to pierce each individual’s life and property. The assessment process invaded the privacy of each and every individual. A war had recently been fought to retain such privacy (writs of assistance and general warrants, for example). The subsequent Bill of Rights acknowledged and attempted to protect that privacy. The new political system arguably was formed upon the foundations of natural rights, law, and self-government. The Framers wanted taxation to provoke as little intrusion as possible.

From the federal level, direct taxation would be imposed only during times of emergency and crisis, such as war or eliminating debt.[26] Whatever other direct taxation that might transpire, the Framers felt such direct taxation should be controlled within the boundaries of each state, where elected and appointed representatives conceivably were more easily held accountable. Unfortunately, despite these cautious efforts, and although restricting some state powers elsewhere in the Constitution, the Framers failed to greatly limit the states’ power of taxation.[27] So much concern did the Framers have for states’ rights that no restrictions were rendered to encourage the same line of thought for state taxation. Therefore, outside the restrictions of due process and equal protection, the federal Constitution is almost powerless to stop taxation schemes contained within the boundaries of any state.

With the memory of war still fresh, the Framers also wanted as little as possible to do with direct taxation, instead opting for indirect taxation. During the constitution ratification debates, Alexander Hamilton wrote:[28]

The ability of a country to pay taxes must always be proportioned, in a great degree, to the quantity of money in circulation, and to the celerity [speed] with which it circulates. Commerce, contributing to both these objects, must of necessity render the payment of taxes easier, and facilitate the requisite supplies to the treasury.

Indirect taxes, although distasteful, were not viewed as dangerous or volatile as direct taxes. Generally, people could more easily avoid indirect taxes. Furthermore, the Framers tried to recognize the foundations of natural rights and property, and as such, property should not be taxed except through specific legislation. Therefore, indirect taxes would be levied upon activities in commerce and also what many people then considered as “luxury items” — nonessentials. Indirect taxation would be a tax on consumption:[29]

It is a signal advantage of taxes on articles of consumption, that they contain in their own nature a security against excess. They prescribe their own limit; which cannot be exceeded without defeating the end proposed, that is, an extension of the revenue. When applied to this object, the saying is as just as it is witty, that, “in political arithmetic, two and two do not always make four.” If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds. This forms a complete barrier against any material oppression of the citizens by taxes of this class, and is itself a natural limitation of the power of imposing them.

Thus, the Framers believed that indirect taxation did not antagonize an individual’s privacy, the right to peaceably enjoy property, or greatly hinder the right to enjoy the fruits of labor. The Framers recognized that consumption taxes were directly related to productivity. The more productive people became the more revenues they would create in general circulation, and conceivably the more they would consume, therefore generating more revenues for the treasury.

The Framers knew what the power of taxation could do. Although discussing a different topic, this concern was nonetheless acknowledged by the Supreme Court justices early in the nation’s history:[30]

That the power to tax involves the power to destroy; that the power to destroy may defeat and render useless the power to create . . . . [emphasis added].

The Framers seemed to have understood the difference between a direct and indirect tax. However, that does not mean there is not confusion about the terms. The important lesson to see is that distinguishing taxes through vague definitions such as Direct Tax and Indirect Tax are exercises in futility. These vague terms have caused much confusion with taxes on income. That is, constitutionally a direct tax must be collected by apportionment, but that does not mean a tax collected by apportionment is correctly labeled a direct tax, or that if a tax is collected without apportionment that such a tax is automatically defined an indirect tax.

Lastly, although the subject of a tax and who is liable can be defined, in a large sense all people will tend to pass the cost of any tax to another individual, regardless of the nature or subject of a tax. The reason is all people desire to provide their needs and wants with as little opposition as possible. Any interference to that effort will be resisted and avoided. So too should vague terms such as Direct and Indirect Taxes be resisted and avoided.

Finis.

Terms of Use

Next: Chapter 3: The First Income Tax — Domesticating the Camel

Table of Contents

Bibliography

Endnotes

[1] Adams, For Good and Evil, p. 294.

[2] Dickinson, Letters from a Farmer in Pennsylvania.

[3] McCullough, John Adams, p. 61.

[4] Rakove, Original Meanings, pp. 33–34.

[5] Hylton v. United States, 3 U.S. (Dallas) 171 (1796).

[6] Article I, § 2, cl. 3; Article I, § 9, cl. 4.

[7] Article 1 § 8, cl. 1.

[8] Wells, “Communism of a Discriminating Income-Tax,” p. 242.

[9] Hylton v. United States, 3 U.S. (Dallas) 171 (1796), Pollock v. Farmers’ Loan and Trust Co., 157 U.S. 429 (1895).

[10] Merchants’ National Bank of Little Rock v. United States, 101 U.S. 1 (1879), Tyler v. United States, 281 U.S. 497 (1930).

[11] Holland, The Law That Always Was, p. 233, citing a report by Albert Gallatin to John Adams, Nov. 12, 1796, “The most generally received opinion, however, is, that by direct taxes in the Constitution, those are meant which are raised on the capital or revenue of the people; by indirect, such as are raised on their expense.”

[12] Rakove, Original Meanings, pp. 179–180.

[13] For example, Hylton v. United States, 3 U.S. (Dallas) 171 (1796), Pacific Insurance Co. v. Soule, 74 U.S. (Wall.) 433 (1868), Veazie Bank v. Fenno, 75 U.S. 533 (1869), Scholey v. Rew 90 U.S. (Wall.) 331 (1874), Springer v. United States, 102 U.S. 586 (1880), Pollock v. Farmers’ Loan and Trust Co., 157 U.S. 429 (1895), Brushaber v. Union Pacific R.R. Co., 240 U.S. 1 (1916), Stanton v. Baltic Mining Co., 240 U.S. 103 (1916).

[14] Skinner, The Biggest “Tax Loophole” of All, pp. 3, 16, 30.

[15] Article I, § 2, cl. 3, Article I, § 9, cl. 3.

[16] Article I, § 8, cl. 1.

[17] Volume 1 Statutes at Large, 5th Congress Session II, Chapter 70, p. 580, enacted July 9, 1798; Chapter 75, p. 597, enacted July 14, 1798.

[18] McCullough, John Adams, pp. 483–484.

[19] Fisher, The Worst Tax?, p. 41.

[20] Volume 1 Statutes at Large, 5th Congress Session II, Chapter 54, p. 566, enacted June 18, 1798, (Repealed Volume 2 Statutes at Large, 7th Congress Session I, Chapter 28, section 5, p. 155, April 14, 1802); Volume 1 Statutes at Large, 5th Congress Session II, Chapter 58, p. 570, enacted June 25, 1798, (Expired June 25, 1800); Volume 1 Statutes at Large, 5th Congress Session II, Chapter 66, p. 577, enacted July 6, 1798, (Expired); Volume 1 Statutes at Large, 5th Congress Session II, Chapter 74, p. 596, enacted July 14, 1798, (Expired).

[21] The infamous three-fifths rule (Article I, Section 2) was a compromise from the Constitutional Convention. Slaves were considered property and to levy a direct tax based upon wealth meant that slave owners would pay more than non-slave owners. But to levy a direct tax based upon population meant slave owners would pay less because slaves were considered property, not citizens. Thus, the compromise to tax slaves as three-fifths an individual. The word “slave” is not used, but by elimination can only fall under the category of “other persons.” Likewise for the other two clauses usually attributed to slavery (Article I, Section 9, Article IV, Section 2). Arguably, because the three-fifths rule was a political compromise and taxation by population was an effort to abolish and discourage slavery, had slavery not existed during that period the apportionment clause might not have been introduced with respect to taxation.

[22] Fisher, The Worst Tax?, p. 41.

[23] Volume 3 Statutes at Large, 13th Congress Session I, Chapter 37, p. 53, enacted August 2, 1813.

[24] Volume 3 Statutes at Large, 13th Congress Session III, Chapter 21, p. 164, enacted January 9, 1815. The 1815 Act was amended in Volume 3 Statutes at Large, 14th Congress Session I, Chapter 24, p. 255, enacted March 5, 1816, reducing the total tax from $6 million to $3 million.

[25] Volume 12 Statutes at Large, 37th Congress Session I, Chapter 45, sections 8 and 13, p. 294, enacted August 5, 1861. The 1861 Act was superceded in Volume 12 Statutes at Large, 37th Congress Session II, Chapter 119, p. 432, enacted July 1, 1862.

[26] Adams, Those Dirty Rotten Taxes, p. 57.

[27] Although the states surrendered power to collect import and export taxes; U.S. Constitution, Article 1 § 10, cl. 2.

[28] The Federalist Papers No. 12.

[29] The Federalist Papers No. 21.

[30] McCulloch v. Maryland, 17 U.S. 316 (1819). The statement was made with respect to state legislators taxing a national bank.