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The American Income Tax

Chapter 9

An Indirect Tax — The Camel Barks

Written by Darrell Anderson.

Twas brillig, and the slithy toves
Did gyre and gimble in the wabe;
All mimsy were the borogoves,
And the mome raths outgrabe.

Jabberwocky, from Through the Looking-Glass, by Lewis Carroll

Despite this background and climate, the confusion with this tax continued. No sooner had the 16th Amendment and 1913 revenue act become law, than people began challenging the tax act. A primary challenge was the 1913 act enacted a direct tax without following the new constitutional rule. Many people read the 16th Amendment to mean that incomes were to be taxed without implementing the rule of apportionment, although the tax remained a direct tax. Others thought differently.

The exasperating aspect to the question of the nature of the income tax is that court judges are routinely confused and provide different answers. In 1990, attorney Jeffrey Dickstein, long associated with trying to encourage tax reform, published a book titled Judicial Tyranny and examined almost every applicable court case since the 16th Amendment was allegedly ratified discussing the time-worn argument that “wages are income.” He showed that no such argument can be sustained from the then existing case law. Nothing has changed in the past two decades because in the more recent cases judges merely cite these old flawed cases. In 1999, attorney Larry Becraft, similarly engaged in pursuing meaningful social and tax reform, published a treatise examining the confusion among the various levels of the court system.[1] He found that there was utterly no consistency in deciding the nature of the income tax.

Some of this confusion is real, some is suspect, and some circumstantially indicates a willingness to uphold fraud.[2] Why is such a seemingly straightforward question continually evaded? Part of the reason is that the proper questions have never been asked of court judges and when some people have come close to asking proper questions, have failed to provide proper foundations. Consider that in the hotly contested Pollock decision, the question was not properly raised and the justices declined to decide whether a tax on wages and salaries was a direct tax. Part of the reason for this ambiguity, as seen in Springer, is misinterpretations of previous rulings. Part of the reason is that once the monster grew out of control, no judge had the courage to rule against the system.

Today then, the entire issue is so discombobulated within the legal and political system, that the question is essentially impossible to answer. The questions are good questions, but no judge or politician wants to answer any time soon. If by some strange chance somebody in fact did ask the right questions, there can be little doubt that in this stage of the game the Supreme Court justices would beat around the bush and that a petition for a writ of certiorari would be denied.[3] This question is a classic hot potato.

This same confusion exists at the highest court. The 1880 Springer case decided that the war time income taxes were indirect taxes. The 1895 Pollock Court decided that certain taxes on income were direct taxes and implied that income taxes on wages and salaries also were direct.

In the 1916 Brushaber v. Union Pacific R.R. Co. case,[4] the Supreme Court justices decided that taxes on income are indirect taxes in the nature of an excise, stating stated that:[5]

Moreover, in addition, the conclusion reached in the Pollock Case did not in any degree involve holding that income taxes generically and necessarily came within the class of direct taxes on property, but, on the contrary, recognized the fact that taxation on income was in its nature an excise entitled to be enforced as such . . . .

Of course, the Pollock justices said no such thing. In the 1916 Stanton v. Baltic Mining Co. case,[6] the justices said:[7]

But, aside from the obvious error of the proposition, intrinsically considered, it manifestly disregards the fact that by the previous ruling [Brushaber] it was settled that the provisions of the 16th Amendment conferred no new power of taxation, but simply prohibited the previous complete and plenary power of income taxation possessed by Congress from the beginning from being taken out of the category of indirect taxation to which it inherently belonged . . . .

Only two years later, in William E. Peck and Co. v. Lowe,[8] the Court justices stated:[9]

The Sixteenth Amendment, although referred to in argument, has no real bearing and may be put out of view. As pointed out in recent decisions, it does not extend the taxing power to new or excepted subjects, but merely removes all occasion, which otherwise might exist, for an apportionment among the states of taxes laid on income, whether it be derived from one source or another.

Notice the statement includes no mention of moving taxes on income to the class of indirect taxes or excises. Notice that the words “in recent decisions” are used. Was the Court justices covering its tracks, or did those previous decisions declare something else?

Two years later in Eisner v. Macomber,[10] the justices stated:[11]

As repeatedly held, this did not extend the taxing power to new subjects, but merely removed the necessity which otherwise might exist for an apportionment among the states of taxes laid on income.

The justices decided that the tax imposed on stock dividends:[12]

. . . from every point of view we are brought irresistibly to the conclusion that neither under the Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a true stock dividend made lawfully and in good faith, or the accumulated profits behind it, as income of the stockholder.

The specific issue at bar was whether stock dividends were taxable as income. The Supreme Court justices spent considerable time in their opinion defining how to recognize income, indicating that they understood the 16th Amendment to be exempting the specific property of incomes from the rule of apportionment. Otherwise the rule of apportionment applied. They decided that, fundamentally, if capital or labor were not involved with producing a gain that the gain was not income. A stock dividend therefore was not income. The justices wrote that the 16th Amendment merely removed the requirement of apportionment from taxing incomes. Nowhere did the justices say anything about income taxes being indirect taxes in the nature of an excise nor did they imply as much.

Pollock, William E. Peck and Co., and Eisner are in conflict with Springer, Brushaber, and Stanton. This is the top court of the land. Interestingly, Edward Douglass White, appointed to the Supreme Court on March 12, 1894, wrote a dissenting opinion in Pollock; was appointed Chief Justice on December 19, 1910; wrote the majority opinion in Brushaber and Stanton; and affirmed the opinions in William E. Peck and Co. and Eisner. Apparently even White could not decide the nature of the tax. White died while in office on May 19, 1921.

Many people scratch their heads because indirect taxes are not taxes on property, but taxes on activities and consumption. Indirect taxes are voluntary in the sense that a person can avoid paying the tax by avoiding the activity or commodity. Direct taxes are paid directly by the taxpayer with no intermediary. Direct taxes cannot be avoided and are compulsory. Direct taxes are taxes on property, revenues and production. Historically incomes have been considered personal property, regardless of the source that generated the income. With an indirect tax, income cannot be the subject of the tax, but can only serve as a yardstick to determine the tax owed for having participated in a taxable activity.

At this point many people might conclude that if the rule of apportionment no longer applied that through the process of elimination the rule of uniformity must apply and that the tax is an indirect tax. However, because the Amendment states nothing about moving the property class of incomes into the class of indirect taxation, the Amendment allowed taxes on income to be collected without the rule of uniformity.[13] In other words, with respect to the specific property of income only, taxes could be collected without any rules or restraints at all. Thus, the 16th Amendment truly emphasized the adage that the power to tax is the power to destroy. Under the 16th Amendment wealth redistribution would be as easy as cutting butter with a hot knife. That legislators immediately taxed anything that could arguably be labeled as income is evident in the 1913 revenue act. Legislators tried to tax “excess” wages and salaries. Such a tax was a direct tax regardless of the method used to collect the tax.

Those two monumental 1916 Supreme Court decisions seemed to put an end to the debate about the nature of the income tax and the 16th Amendment.[14] The Supreme Court justices declared that all taxation on incomes were indirect taxes in the nature of an excise.[15] For several decades revenue collectors correctly ignored these decisions and maintained the idea that the tax was a direct tax not subject to apportionment. Legislators ignored these decisions because they continued to tax “excess” wages and salaries.

The Supreme Court justices seems to have understood what was at stake, but nonetheless made the wrong turn in trying to resolve this dilemma. When the Supreme Court justices stated that the Amendment “conferred no new power” they did not mean the Amendment was meaningless. The Court justices did not declare that the Amendment overturned the Pollock decision, which essentially stated that a tax on income was a tax on the source. According to the Supreme Court justices, the Amendment would only attempt to segregate incomes from sources. That is, a constitutional amendment would preclude courts from having to look for the rule of apportionment when taxes were levied on the specific property of income. In Stanton the justices stated the 16th Amendment was needed to remedy the issues raised by the Pollock decision.

The Court justices were stating the only thing the 16th Amendment did was to provide clarification to alleviate the confusion caused by the questions presented in Pollock. The Court justices declared that the 16th Amendment did not truly amend the Constitution, but only clarified how taxes on incomes were to be collected.

The Court justices then proceeded to perform some significant legal acrobatics. The Brushaber decision is one of the most difficult cases to read and understand. Justice White, who delivered the majority opinion, used long, run-on sentences that contribute to this challenge.

Frank Brushaber was the appellant in the case and the original plaintiff at the district court level. He had purchased stock issued by the Union Pacific Railroad Company. He sued Union Pacific Railroad to recover the taxes imposed on the dividends realized from stock ownership. The Supreme Court justices decided to uphold the tax as an excise tax. The case was the first test of the 16th Amendment and the resulting tax act of 1913.

The Court justices incorrectly stated that a direct tax on incomes not being subject to the rule of apportionment would have created internal inconsistency within the Constitution. To interpret the 16th Amendment as legislators originally intended would lead to confusion and calamity with the overall design of the Constitution.

The Court justices stated that one part of the Constitution could not call for direct taxation by the rule of apportionment and then another section stating that direct taxes could be collected without apportionment. Such reasoning is nonsense and this is exactly what legislators had intended to do, but only with respect to the specific property of incomes. An amendment, by nature and design, modifies an original document. If the Court justices were correct that such an inconsistency could not exist, rather that twistify an explanation to fit some ruse, they instead should have read the legislative record of the day as well as published academic and scholarly commentaries.

There is little doubt that the intention of the 16th Amendment was to create a new method of collecting taxes with respect to the specific property of income. Legislators specifically wanted to tax incomes. Legislators understood incomes to be property. They could not tax incomes under the then-current Constitution because of the rule of apportionment. The 1916 Supreme Court justices ignored that record and by doing so, painted themselves into a corner. Instead the Court justices opined that, by the process of elimination if the rule of apportionment is negated then the tax must be an indirect tax.

This thinking is rooted all the way back to the flawed dicta of Hylton. Recall that in Hylton the Supreme Court justices thought that if a tax could not be collected pursuant to the rule of apportionment then the tax must necessarily be pigeon-holed an indirect tax. But such thinking was not the intent of the Framers of the Constitution. They purposely made direct taxation difficult. Difficult, but not impossible. But recalling the Hylton dicta helps understand the several decision made by the Supreme Court justices after Pollock. In those subsequent cases the justices found the tax to be an indirect tax in the nature of an excise. Unfortunately, in Brushaber and Stanton, et. al., rather than render a correct decision based upon legislative intent, the justices continued down this path of avoiding the direct vs. indirect tax debate by classifying the new income tax as an excise.

To perform this acrobatic feat, the Court justices declared that the 16th Amendment did allow taxes on income to be exempt from apportionment, but through faulty logic argued that taxes on income were indirect taxes in the nature of an excise. Essentially, without explicitly doing as much, the Court justices were declaring that the Pollock decision was incorrect, that Pollock had inadvertently moved taxes from the class of indirect taxation to direct taxation. Thus, in Brushaber, the Court justices was stating that the 16th Amendment only overcame the Pollock rule, and did not say that they were overruling Pollock.[16] Yet, history indicates that taxes on income were direct taxes, as carefully explained and exhausted in Pollock.

Can such logic hold water? No, such logic is faulty. Such logic is similar to the following:

  1. Fluffy is a cat.
  2. Fluffy has brown fur.
  3. All cats have brown fur.

The first two statements are factual statements, but the third statement is conjecture that is not necessarily true. Consider a similar set of statements regarding the issue of taxes on incomes, as seen by the Brushaber and Stanton court.

  1. Direct taxes are subject to the rule of apportionment.
  2. The 16th Amendment allowed a direct tax on incomes to be collected without the rule of apportionment.
  3. Taxes on income are indirect taxes.

Do you recognize the flaw? The first two statements are factual, the third is conjecture. Although the Supreme Court justices stated otherwise, the 16th Amendment did not move taxes on incomes from the class of direct taxes into the class of indirect taxes, but merely exempted from the rule of apportionment the species of property known as income. That is exactly what legislators wanted to do. A straightforward reading of the Amendment affirms that intent as well as legislative history and scholarly commentaries of that period.

Legislators wanted to tax incomes. What is income? This question is not easy to answer and early proponents of the income tax recognized the challenge. Edwin R. A. Seligman, one of the primary scholars of the day addressing the income tax, posed the question publicly:[17]

At the very outset we are confronted by the question what income really means.

There are three traditional ideas about the concept of income.[18]

  1. Income is the realized gain separate from the capital or labor that derives or creates the gain.
  2. Income is the net gain or increase in wealth between two points of time.
  3. Income is the gain that has been converted into a useable and consumable form.

Historical study shows that within the intent of the 16th Amendment, income is profit or unearned gain, that the three words income, profit, and gain are synonymous.[19] The Supreme Court justices addressed the definition of income in several cases. The most notable examination of the term is found in Eisner v. Macomber, where the justices stated:

Income may be defined as the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. [Emphasis added.]

Justice Mahlon Pitney added that “legislators cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised.”[20] Pitney’s comment was a clue that for many years the term income was a question of law rather than a question of fact.[21] That is, disputes about what is or is not income were expected to be resolved judicially rather than administratively. For several decades this is exactly how most such disputes were resolved.

Further examples of the meaning of the term income are found in Stratton’s Independence v. Howbert,[22] Towne v. Eisner,[23] Doyle v. Mitchell Bros. Co.,[24] Southern Pacific Co. v. Lowe.[25] The Supreme Court justices seemed tired of explaining this definition in their final explanation in Merchants’ Loan and Trust Co. v. Smietanka.[26]

However, in all of these referenced cases, the Supreme Court justices only addressed the issue from within the limited scope of corporate profits or unearned gains. More importantly, these examinations are limited to the issues at bar. That is, income is not only corporate gain, but corporate gain is always income.[27] The reason is that inspecting court cases discussing the definition of income reveals that those discussions always revolve around business or trust profits and unearned gains. Although the Supreme Court justices definition is broad and applies easily to non-business gains, the Supreme Court justices never have addressed whether the issue of revenues can be defined as income when received directly as wages and salaries, nor whether such exchanges are gain. Those questions never have been asked or answered.[28]

Only a handful of times have the Supreme Court justices come close to discussing whether wages and salaries are income and even then, they did not address whether they meant income in the nature of profits and gains or income in the nature of gross receipts. A relatively recent case was in the dissenting opinion of Cheek v. United States.[29] At issue in that case was the handling of jury instructions in a tax dispute such that the defendant could show a good faith belief and reasonable cause to negate any “willfulness” elements in the charges for failing to file a tax return.

The justices also touched upon the subject in Central Illinois Public Service Co. v. United States.[30] At issue in that case was whether lunch expenses of employees on non-overnight company travel were considered income for the purposes of taxation.

Another case was Commissioner v. Kowalski.[31] At issue in that case was whether cash meal allowances for state police troopers were considered income for the purposes of taxation.

The oldest case in which the topic was discussed was only in a tightly narrow application: the salaries of federal judges in Evans v. Gore and Miles v. Graham.[32] Those cases did not directly address whether wages and salaries were taxable, but only whether a federal judge’s salary may be diminished while in office, pursuant to Article III, Section 1, clause 1 of the Constitution.

In none of these cases was the issue raised of whether wages and salaries are income. Every other case involving income has moved within the limited realm of corporate or trust activities or passive investments. So few cases discussing income outside those boundaries is rather remarkable considering the 8 decades that have elapsed since the alleged ratification of the 16th Amendment. One would think that after nearly 80 years that the question would have been directly asked at least once, but this is not the case.

Some people have noticed that Justice White did not write that the income tax was actually an excise tax, but only in the nature of an excise and entitled to be enforced as such.[33] If that observation is correct, then there might be some reconciliation with the Pollock justices noticing that taxes on employments and vocations often were levied under the guise of an excise. Does this theory mean that bureaucrats can collect the tax under the illusion of an excise unless and until challenged that the tax is a direct tax? But what would that establish if, as history indicates, that the original intent of the 16th Amendment was to impose a direct tax on incomes but merely without being subject to the rule of apportionment? That would only return us to the ancient question of “What is income with respect to the 16th Amendment?” The Supreme Court justices and lower level court judges struggled with this simple question for several decades.[34]

Finis.

Terms of Use

Next: Chapter 10: Direct and Indirect — Will The Real Camel Please Rise

Table of Contents

Bibliography

Endnotes

[1] Becraft, Uncertainty Of The Federal Income Tax Laws, published Sept. 1, 1999.

[2] Stang, Tax Scam, pp. 80–93.

[3] The Supreme Court justices do not hear cases automatically on appeal. Instead people must petition and ask the Court justices to issue a writ to review the records of the lower courts. A rather convenient system for people to deny justice.

[4] 240 U.S. 1 (1916).

[5] 240 U.S. 1 (1916), at pages 16–17.

[6] 240 U.S. 103 (1916).

[7] 240 U.S. 103 (1916), at page 112.

[8] 247 U.S. 165 (1918).

[9] 247 U.S. 165 (1918), at pages 172–173.

[10] 252 U.S. 189 (1920).

[11] 252 U.S. 189 (1920), at page 206.

[12] 252 U.S. 189 (1920), at page 219.

[13] Holland, The Law That Always Was, p. 177.

[14] Although these two cases are always cited in the income tax debate, there actually were five cases involved, all with the same result: the income tax in an indirect tax in the nature of an excise. Tyee Realty Co. v. Anderson and Thorne v. Anderson were decided the same day, 240 U.S. 115 (1916); as well as Dodge v. Osborn, 240 U.S. 118 (1916).

[15] In neither case did the justices address findings of fact or appealable errors of the lower courts. Read the introductory sentences carefully to realize that the cases were a result of direct appeal only to address constitutional issues. Otherwise the cases had been dismissed for failing to state a cause of action upon which the lower courts could grant relief.

[16] Holland, The Law That Always Was, p. 192.

[17] Crane, “The Income Tax and the Burden of Perfection,” p. 182, citing Edwin R. A. Seligman, Introduction to the Federal Income Tax: A Series of Lectures Delivered at Columbia University in December 1920.

[18] Dodge, “The Story of Glenshaw Glass: Toward a Modern Concept of Gross Income,” Tax Stories, pp. 32–35. The first definition was promoted by Edwin R. A. Seligman, the second by Robert Haig and Thomas S. Adams, the third by Irving Fisher.

[19] Stang, Tax Scam, pp. 56–70.

[20] 252 U.S. 189 (1920), at page 206.

[21] Crane, “The Income Tax and the Burden of Perfection,” p. 179.

[22] 231 U.S. 399 (1913).

[23] 245 U.S. 418 (1918).

[24] 247 U.S. 179 (1918).

[25] 247 U.S. 330 (1918).

[26] 255 U.S. 509 (1921).

[27] Merchants’ Loan and Trust Co. v. Smietanka, 255 U.S. 509 (1921), was about income derived from a trust, not a corporation. Yet, notice that a trust is nonetheless a legal fiction at law, not an individual human being.

[28] Dickstein, Judicial Tyranny, p. 50.

[29] 498 U.S. 192 (1991).

[30] 435 U.S. 21 (1978).

[31] 434 U.S. 77 (1977).

[32] 253 U.S. 245 (1920), 268 U.S. 501 (1925). Those cases eventually were overturned in O’Malley v. Woodrough, 307 U.S. 277 (1939), in part because of the Public Salary Tax Act of 1939.

[33] Benson and Beckman, The Law That Never Was, Vol. II, pp. 20–21.

[34] Caron, Tax Stories, p. 3.