The American Income Tax
Defining Income — The Camel’s Nose
Written by Darrell Anderson.
All taxation is an evil, but heavy taxes, indiscriminately levied on everything, in utter disregard of scientific principles and of the lessons of experience, are one of the greatest curses that can afflict a people.
Politicians originally promoted the 16th Amendment as a means of restoring legislative powers that had been quashed by Pollock. Because income was considered personal property and any tax on person or property was considered a direct tax, consistent with the Framers intents the income tax was promoted as an emergency tax, not a peacetime tax. Senator Norris Brown of Nebraska, one of the foremost legislative proponents and amendment authorities in 1910, wrote:
This is not an argument in favor of an income-tax law. It is an argument in favor of an income-tax amendment to the Constitution, which lays no tax, promises to lay none, but simply and solely restores to the people a power many times sustained but finally denied by the courts. The exercise of the power can not become an issue until the power is restored.
Yet, no sooner had the 16th Amendment been adopted, than congressional legislators began drafting a new peacetime revenue act to include taxing incomes.
Reading the legislative history for that act is interesting, because despite the history of the 16th Amendment and the Corporate Excise Tax of 1909, legislators did not know how to tax incomes of individual humans. Unlike organized business activities, such people seldom maintained a bookkeeping system that would easily identify profits or gains. Additionally, such people were not actively pursuing profits or gains, but merely trying to sustain their lives and families. Seeking profit or gain was not their primary goal or purpose.
Taxing large businesses and corporations was straightforward because people owning or managing those enterprises maintained bookkeeping practices to easily determine the amount of profit or gain. Similarly, identifying gain with certain forms of passive unearned income, such as stock dividends or interest, was straightforward. Fundamentally, this was all that legislators and the common person of the day wanted to tax under any income tax. Identifying profit or gain with the small-scale proprietor, artisan, or independent worker was a significant challenge but not a primary goal. The common worker was not motivated in taxing such people anyway.
While drafting this first modern income tax, a challenge quickly appeared and that was multiple meaning of the word income.
Gain vs. Receipts
In reviewing the 1862 revenue act, imposing an income tax duty, the legislative history reveals how legislators understood the term income. In the Congressional Globe, of the 37th Congress, second session, Congressman Thaddeus Stevens of Pennsylvania, House Ways and Means Chair, said:
. . . The words “gain” and “income” mean the same thing. They are equivalent terms. They mean the net profits. You cannot have any gains until you pay the expenses. What it costs to produce is to be deducted, and then there will be left only the net profits.
Along with the state history of imposing an income (faculty) tax, a picture emerges that income is and was synonymous with profits and gains. Reading the revenue acts of 1862 and subsequent acts through 1894 shows that the three words were always used concurrently to convey the same idea.
A challenge occurred when reading those texts outside the limited and narrow application of the tax laws. The term income not only meant net income in the nature of profits and gains with respect to business and certain passive receipts, but was used by many people in a popular sense to mean “everything that comes in” or gross receipts. This generic meaning went at least as far back as those early faculty taxes. The common person referred to wages and salaries as income, although not in the unearned sense. Consider the words of Kentucky Governor Augustus E. Willson in 1911:
The poor man does not regard his wages or salary as “an income.”
Nevertheless, notice this dual meaning from many years earlier. From Noah Webster’s 1828 American Dictionary of the English Language:
Income: That gain which proceeds from labor, business or property of any kind; the produce of a farm; the rent of houses; the proceeds of professional business; the profits of commerce or of occupation; the interest of money or stock in funds. Income is often used synonymously with revenue, but income is more generally applied to the gain of private persons, and revenue to that of a sovereign or of a state.
Salary: The recompense or consideration stipulated to be paid to a person for services, usually a fixed sum to be paid by the year, as to governors, magistrates, settled clergymen, instructors of seminaries, or other officers, civil or ecclesiastical. When wages are stated or stipulated by the month, week or day we do not call the compensation salary, but pay or wages; as in the case of military men and workers.
Wages: Hire; reward; that which is paid or stipulated for services, but chiefly for services by manual labor, or for military and naval services. We speak of servant’s wages, a worker’s wages, or soldiers wages; but we never apply the word to the rewards given to men in office, which are called fees or salary. The word is however sometimes applied to the compensation given to representatives in the legislature.
Such confusion was not limited to the common worker. In a Senate discussion on August 26, 1913, between Mississippi Senator John Sharp Williams and Iowa Senator Albert B. Cummins, Senator Cummins displayed his own confusion about the meaning of the term. Cummins presumed the meaning to be gross receipts and Williams had to remedy this incorrect meaning. Two days later Senator Sherman of Illinois distinguished between the income derived from fixed investments and that derived from personal earning capacity.
Senator Cummins seemed to have grasped his own previous error and stated for the record that the term income possessed a limited legal meaning. Cummins then noted that the 16th Amendment restricted legislators from taxing all property without the rule of apportionment and only allowed taxing the property of incomes in such a manner:
Mr. Sterling: If the definition of the word “income,” as given in a standard dictionary, the words “gains and profits” are also given as synonymous with the term “income” would there be anything wrong in the use of those words in the section to which the Senator refers?
Mr. Cummins: I do not think there would be, although they would be wholly unnecessary.
Senator Chilton piped in to add the following:
. . . it is provided that the “income derived from salaries, wages” and so forth, shall be included. It has to be income before it can be taxed, no matter how it is derived. We could say that only income from salaries or income from property or income from interest should be taxed. We have simply mentioned certain things: but they must be income before they can be taxed. We use the very language of the Constitution.
In other words, there must be an element of gain before something can be called income. Income, in the constitutional sense, means profits and gains — net income. Every revenue act from 1913 to 1953 imposed a tax on net income. Senator Williams emphasized the point:
Mr. President, the object of this bill is to tax a man’s net income; that is to say, what he has at the end of the year after deducting from his receipts his expenditures or losses. It is not to reform men’s moral characters; that is not the object of the bill at all. The tax is not levied for the purpose of restraining people from betting on horse races or upon “futures” but the law is framed for the purpose of making a man pay upon his net income, his actual profit during the year. The tax does not care where he got it from, so far as the tax is concerned, although the law may very properly care in another way. [emphasis added.]
This distinction might seem quaint or charming today, but in the early formative years of the modern income tax this distinction was significant. So significant that the debate was brought before the Supreme Court justices. In 1918 the justices heard three pivotal cases in which they distinguished this concept of income in the nature of profits and gains versus income in the nature of gross receipts. In Doyle v. Mitchell Brothers Company, Hays, Collector, v. Gauley Mountain Coal Company, and Southern Pacific Company v. Lowe, the Supreme Court justices rejected the argument that a mere conversion of assets created income in the nature of profits and gains. Gross receipts was not the key element in determining the existence of profits and gains. Determining the nature of a gain required more.
Another language issue introduced more confusion. The word on is used in many ways. The word means “in regard to, in reference to, or with respect to.” The word also is used to reference the object in which some form of payment is due. This meaning, however, should reveal to many people that within the 16th Amendment, incomes are not the subject of any tax, but only the means through which an income tax is measured or calculated. Yet, legislators seemed to ignore the meaning of the word on.
Along with the dual meaning of the word income, the infamous and awkward clause “from whatever source derived” opened the door to much mischief. Previously in taxation, legislators were required to explicitly identify the source or activity that was being taxed. Without that explicit legislative effort and statutory result, no taxes were due.
Among the first concerns of this infamous clause were state legislators who believed that the clause would allow taxation of state financial instruments, particularly state and local bonds. Taxing such instruments likely would impede and discourage investment, which would necessarily impede and discourage state and local development and progress. Early fears were that the clause would cause state legislators to live at the mercy of federal taxing powers and such power would cross the line of immunity between national and state legislators. At that time, state legislators could not tax national instruments or vice-versa. This was the legal holding passed through the years from McCulloch v. Maryland, and the infamous message of John Marshall “That the power to tax involves the power to destroy . . . .” This was one of the significant issues conveyed to state legislators in New York Governor Charles Evans Hughes’ message on January 5th 1910. The primary concern of many people was that infamous clause of “from whatever source derived.” Many people during that time foresaw the bottomless pit such words would create. Idaho Senator William Borah, a significant contributor to getting the Amendment ratified, responded that the phrase was merely a technical redundancy. “There is no kind of property, ‘no income from whatever source derived,’ which will be subject to taxation after the adoption of the amendment which is not at the present time subject to taxation with apportionment.” Significantly perhaps, six years later Hughes would sit on the Supreme Court and contribute to the unanimous decision upholding the income tax laws of 1913 and the 16th Amendment.
That specific concern addressed by Hughes never developed, but the infamous clause remained in the proposed amendment and did create a bottomless pit. Legal experts and scholars of the day argued that the Amendment was worded poorly and easy to misunderstand. Those words would nevertheless cause havoc in the oncoming years. With this infamous clause legislators and administrative agents were provided a bottomless pit to search and determine whether income in the nature of profits and gains existed. Legislators and revenue agents could ignore the source and look only for potential or alleged profits and gains. Although various Supreme Court decisions somewhat impeded that effort, as well as the simple fact that a majority of Americans had annual wages and salaries less than the statutory exemption ceiling, the bottomless pit soon became available with several significant legislative efforts during World War II as well as a quiet but significant Supreme Court decision in 1955. The Supreme Court justices would use the infamous clause to forever quash the debate of what is and what is not taxable.
 U.S. Senate Document No. 705, 1910, p. 6.
 Congressional Globe, 37th Congress Session II, April 3, 1862, p. 1531.
 Hart, Constitutional Income, p. 71, citing the New York Times, p. 13, February 26, 1911.
 Congressional Record, 63rd Congress Session I, pp. 3843–3844, August 26, 1913.
 Congressional Record, 63rd Congress Session I, p. 3845, August 28, 1913.
 Congressional Record, 63rd Congress Session I, p. 3845, August 28, 1913.
 Congressional Record, 63rd Congress Session I, p. 3849, August 28, 1913.
 247 U.S. 179 (1918).
 247 U.S. 189 (1918).
 247 U.S. 330 (1918).
 Buenker, “The Ratification of the Income Tax Amendment,” p. 190.
 17 U.S. (4 Wheaton) 316 (1819).
 State of New York, Senate, Special Message from the Governor Submitting to the Legislature Certified Copy of a Resolution of Congress Entitled “Joint Resolution Proposing an Amendment to the Constitution of the United States,” January 5, 1910.
 Congressional Record, 61st Congress Session II, pp. 1694–1695, February 19, 1910.
 Brushaber v. Union Pacific R.R. Co., 240 U.S. 1 (1916).
 Hart, Constitutional Income, pp. 185–186.
 Commissioner v. Glenshaw Glass Company, 348 U.S. 426 (1955).