A Sordid Tax Tale

One topic in An American Revolution is the Sixteenth Amendment of the U.S. Constitution. The story questions the constitutionality of the Sixteenth Amendment. This is the amendment that allows the government to lay an income tax, among others. It's legality has been challenged many times since it was ratified in 1913. The circumstances of ratification, however, leave an open question. The amendment reads:

The Congress shall have 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.

So what's the problem? The architects of the Constitution recorded a different view. First, this is what Article I Section 8 says:

The Congress shall have the power to lay and collect Taxes, Duties, Imposts, and Excises, To pay the Debts and provide for the common Defence and General Welfare of the United States; but all Duties, Imposts, and Excises shall be Uniform among the United States.

Income tax has the distinction of being legally described as an excise tax. An excise tax, by definition, is a tax on the manufacture and distribution of certain non-essential consumer goods. Fuel tax, for example, is an excise tax. When we work for a company or person, even as an independent contractor, we provide a service and earn a wage for performance. A percentage is set aside for taxes either by withholding or quarterly estimates, and the money ends up in the Federal Reserve. How a tax on income came to be an excise tax is a somewhat sordid story told by stacks of case law. Nevertheless, by definition a paycheck is a manufactured non-essential consumer good. A legal explanation was recorded by the Third Circuit Court of Appeals in Penn Mutual Indemnity Co. v. Commissioner, 277 F.2d 16, 60-1 U.S. Tax Case 1959-1960.

It could well be argued that the tax involved here is an "excise tax" based upon the receipt of money by the taxpayer. It certainly is not a tax on property and it certainly is not a capitation tax; therefore, it need not be apportioned. We do not think it profitable, however, to make the label as precise as that required under the Food and Drug Act. Congress has the power to impose taxes generally, and if the particular imposition does not run afoul of any constitutional restrictions then the tax is lawful, call it what you will.

The term capitation tax needs clarification, it will come up again. A capitation tax is like a head tax, it is a direct tax apportioned uniformly in accordance with the census. Income tax, on the other hand is a percentage of money received.

The next part of the puzzle is Article I, Section 9 of the Constitution.

No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.

The Sixteenth seems to contradict the intentions of Sections 8 and 9, because it says that Congress can lay taxes without regard for apportionment. And, this is where things slide off the plate into a bucket of one hundred years of case law, including the Penn Mutual case. Its ironic, starting with two rather simple propositions from Article I, Section 8 and Section 9, the volume of case law is inestimable. The architects of the Constitution explicitly set taxation in relation to representation with these two propositions. Except, the income tax is considered an excise tax, which by definition is an indirect tax and has no relationship with representation.

Once upon a time in 1861 the Union needed money for the Civil War and Congress passed the Revenue Act of 1861. It was a flat tax on incomes over $800.00 per year. Next they passed the Revenue Act of 1862. It was a graduated tax on incomes over $600.00 per year and had a 1866 sundown. In the 1890's, the Socialist Labor Party, Democrats, and Populists, three political parties of the day, all proposed income tax strategies. Then everything ran into Pollock v. Farmers' Loan & Trust Co.,157 U.S. 429 (1895)
Before the Pollock case, all income taxes were considered excise taxes and were required to be imposed with geographical uniformity. You see now why the Revenue Act of 1861 and 1862 were percentage based and imposed across the Union. Excise taxes are not required to be apportioned among the States. Only direct taxes are required to be apportioned.

The Court in the Pollock case decided that certain taxes, for instance income from real property, were indeed direct taxes and had to be apportioned. Ownership played a key role in the Court's decision. Ownership is circumstantial but necessary. The tax was on the income of the property. Now the source of income is relevant - wage versus property. From this point forward a personal income income tax, i.e., a tax on wages, is considered indirect and is required to be imposed with geographic uniformity. It was this way from 1895 until 1913.

In the presidential race of 1912, three candidates advocated an income tax: Democrat Woodrow Wilson, Progressive Theodore Roosevelt, and Republican William Howard Taft. Ironically, Taft had started the process in 1909 by proposing a constitutional amendment and 2% tax on the income of corporations. A month later Congress sent a proposal to the state legislatures. Opponents balked at the phrase from whatever source derived. Congress essentially has unlimited power to tax nearly anything they want. It can tax any sort of income as long as its applied with geographic uniformity.

The ratification process of the Sixteenth ended under Woodrow Wilson, February 3, 1913. On hearing that Delaware would be the thirty-sixth state to ratify the amendment, Philander Knox, the Secretary of State, announced the good news. Except, it wasn't really news yet. Delaware merely acknowledged that it would ratify, it hadn't done the deed yet. On hearing the news, New Mexico and two other states ratified the amendment on February 3 and February 4. A clear case of premature ratification. It was followed shortly by the Revenue Act of 1913 which re-instituted the a federal income tax. The only thing remaining is in which bank the new tax revenue would be deposited.

The Federal Reserve Act was passed in December, 1913. History is satisfied to say that the reason was to prevent panics on banks by being a bank's bank. There had been several panics for impetus, especially the 1907 panic. Before 1913, the country's relationship with central banking ran in fits and starts. The first and second attempts at centralized banking in the 18th century failed due to alarming foreign influence and fictitious credit. The idea of a private bank peaked again in the late 19th and early 20th century. It had staunch support from progressive democrats, who called for a decentralized reserve system out of the reach of industrial bankers. Since that time the role and responsibilities of the Fed have grown.

The Fed today has five parts: A board of governors appointed by the president of the U.S., an open market committee, twelve privately owned banks, several investing subscriber banks, and expert committees as needed. Even today, the Fed, created to prohibit panics, still controls the national economy and is a last resort lender providing liquid assets (money) to public banks on a short term basis. One of these loans was the famous AIG debacle of 2008. As the only central bank it controls the nation's currency, and manages government securities. In the role of controlling the flow of currency, it buys paper and coin money from the U.S. Treasury at a low cost, about 4 cents per paper bill.

As the federal bank your tax money flows into the Federal Reserve. The government borrows against projected tax revenues, this becomes the national debt. The national deficit is a budget shortfall that will, most likely, turn into national debt. The money is distributed among the subscriber banks who act to loan money to each other and the banks we citizens use.

After all this, does it seem to you there might be a fly in the ointment? Remember the board of governors? Remember why the Federal Reserve was commissioned? The democrats wanted a decentralized reserve system out of the reach of bankers and avoiding alarming foreign influence and fictitious credit. We have a foundational private banking system created to be independent of corruption, advised by people it was created to avoid, Wall Street bankers. We have foreign governments with huge investments in U.S. banks taking loans from the Federal Reserve. We have a tax system the founding architects wanted to avoid: a direct non-apportioned excise tax that sounds suspiciously like a capitation or head tax. Makes one wonder.