Income tax and the Supreme Court

The US Supreme Court has made several rulings on the issue of a tax levied directly on the income earned by individuals or corporations. In 1895 the court ruled that an income tax was a direct tax and therefore would need to be apportioned among the states to be constitutional, which effectively blocked it at the federal level. After the ratification of the Sixteenth Amendment in 1913 expressly permitted such a tax, the court refined its interpretation of tax law.

Early Cases

In the Constitutional Convention of 1787, the Framers included two clauses relating to taxation: “all duties, imposts, and excises shall be uniform throughout the United States” and “no capitation, or other direct, tax shall be laid, unless in proportion to the census or enumeration herein before directed to be taken.” The latter clause has led to disputes because the word “direct” was not defined in the Constitution or in the debates at the convention. It is clear, however, that this category of tax was to be apportioned among the states according to their population. Taxes that are not direct are presumably categorized as “duties, imposts, and excises,” which need not be apportioned; rather, they need only be uniform.

The word “direct” was added almost as an afterthought in the midst of a heated debate regarding how the enumeration of enslaved people was to affect the apportionment of representation and taxes. In the course of this debate, Gouverneur Morris of Pennsylvania moved that “taxation shall be in proportion to representation.” Then, realizing that the rule would be inapplicable with regard to indirect taxes on exports, imports, and consumption, he inserted the word “direct,” and the motion passed.

At the time of the convention, there was only one possible source for the distinction between direct and indirect taxes: Adam Smith’s The Wealth of Nations (1776). Smith asserted that the income of individuals ultimately arises from three different sources: rent, profit, and wages, and that every tax must be paid ultimately from one of these three. He goes on to state that on occasion, “the state not knowing how to tax, directly and proportionably, the revenue of its subjects, endeavors to tax it indirectly . . . by taxing the consumable commodities upon which it is laid out.”

Alexander Hamilton, in The Federalist (1788), No. 21, discussing duties on articles of consumption, describes them as falling “under the denomination of indirect taxes,” while “those of the direct kind, which principally relate to land and buildings, may admit of a rule of apportionment.” His use of the word “principally” rather than “solely” implies the possibility of other taxes in this category. Such taxes as a general tax upon income did not exist in his time.

The Supreme Court narrowed Hamilton’s demarcation in Hylton v. United States (1796) when it limited direct taxes to taxes on earnings from land. In addition, it ruled that if the tax could not be apportioned, it was not a direct tax of the kind referred to by the Constitution. In Springer v. United States (1881), the court unanimously upheld the first income tax, established by an 1864 act of Congress as a means of financing the Civil War, ruling that it was an indirect tax, which could therefore be levied without apportionment. Direct taxes, it continued, were only taxes on real estate.

Pollock and the Sixteenth Amendment

In 1894, Congress levied an income tax that provided for a tax of 2 percent on all income above $4,000, a tax that would affect only the richest 1 percent of the population. The tax was challenged in Pollock v. Farmers’ Loan and Trust Co. (1895). The Supreme Court ruled that the tax was a direct tax and thus prohibited by the Constitution. The tax was judged to be a direct tax only because income for the purposes of the tax included earnings from the lease of real estate, but this inclusion caused the court to declare the entire tax unconstitutional. There was a popular outcry against this decision.

When President William H. Taft assumed office in 1909, he urged the passage of a constitutional amendment to allow the government to levy an income tax. In the interim, he proposed a tax on corporate income, carefully described as an excise tax. The Supreme Court approved this tax in Flint v. Stone (1911). The Sixteenth Amendment was then ratified in 1913, ending the debate over the constitutionality of an income tax. The amendment granted Congress the power to “lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Later Cases

While the issue of income tax continued to often generate controversy and debate, over time the federal tax became widely accepted as a key source of revenue for the government, and its constitutionality remained clear under the Sixteenth Amendment. The Supreme Court did continue to hear cases involving income tax law over the decades. Many of these, such as Commissioner v. Glenshaw Glass Co. (1955), dealt with details such as the definition of income.

The Tax Cuts and Jobs Act of 2017 brought fresh attention to certain aspects of income tax law. To partially balance other tax cuts and discourage tax havens, the Republican-backed legislation authorized a tax on shares of profits from American-owned companies operating in other countries, even before investors realize those profits. This provision was challenged by opponents who argued that it violated the Sixteenth Amendment by taxing assets rather than income, and the case attracted additional attention for its potential broader implications on the concept of a wealth tax. The Supreme Court rejected the plaintiffs' argument in Moore v. US (2024), upholding the law as a legitimate tax on foreign income. However, some legal scholars noted that the narrowness of the ruling left a path open for other challenges to federal tax law.

Bibliography

Berson, Susan A. Federal Tax Litigation. New York: Law Journal Press, 2004.

Biskupic, Joan, and Elder Witt. The Supreme Court and the Powers of the American Government. Washington, D.C.: Congressional Quarterly, 1997.

Hamilton, Alexander, James Madison, and John Jay. The Federalist Papers. Reprint. New York: New American Library of World Literature, 1961.

Madison, James. Notes of Debates in the Federal Convention of 1787. New York: W. W. Norton, 1966.

Schwartz, Bernard. Federal and State Powers. Vol. 1 in The Powers of Government. New York: Macmillan, 1963.

Sherman, Mark. "The Supreme Court Upholds a Tax on Foreign Income Over a Challenge Backed by Business Interests." AP, 30 June 2024, apnews.com/article/supreme-court-wealth-tax-5a13417bd5ae41f7d150ac596f7c51d0. Accessed 1 July 2024.

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Yancey, Richard. Confessions of a Tax Collector One Man’s Tour of Duty Inside the IRS. New York: HarpersCollins, 2004.