The Federal System of Taxation divides financial resources between the Federal Government and the States.
The Rules
The United States is different than other countries. The Constitution exists to provide effective government while preserving individual liberty. This is accomplished by a division of authority and separation of powers. Power is divided between the States and Federal Government: Those powers not delegated to Congress are reserved to the States. Power is further divided between the executive, legislative and judicial branches of government. This is done to promote stability and prevent the concentration of political power in the hands of a few.
Seemingly lost to history is the Constitution’s division of financial power. Money is the only real power in this world and preventing the concentration of financial power is just as important as preventing the concentration of political power.
The separation of financial power is accomplished by dividing the power of taxation into direct taxation and indirect taxation, and then dividing these resources between the States and the Federal Government.
Direct taxes must be collected by the rule of apportionment, which means the States pay a tax that is proportional to their population. Indirect taxes must be collected by the rule of uniformity, which means individual citizens pay a tax that is the same for everyone nationwide. In case you missed the subtlety: States pay direct taxes and individuals pay indirect taxes, which will be discussed later. These rules divide the power of taxation between the States and the Federal Government and are found in the Constitution:
It is important to note that the rule of apportionment is the only provision mentioned twice. It’s important and we will soon see why.
Duties, imposts and excises are collected by the rule of uniformity, but direct taxes are collected by the rule of apportionment.
What is a Direct Tax?
The term “direct tax” appears in the Constitution. Therefore, it is a constitutional term, not an economic term and this means that Congress has no power to define it. It must be defined by the Courts because the Federal Government’s taxing authority is affected by its meaning. Senator Cummins explains a similar scenario with the meaning of “commerce,” in the Constitution:
In 1789, I believe, the people of this country gave Congress the power to regulate commerce among the States. It is not within the power of Congress to say what commerce is. “Commerce” may mean a very different thing now as compared with what it meant in 1789. It has broadened with the times; the instrumentalities have changed with the course of years; but Congress cannot make a thing commerce. The court must declare whether a particular regulation is a regulation of commerce and in so declaring it defines for the time being what commerce is.
1913 Congressional Record, Vol L, Part 4, pg. 3844
“Commerce” appears in the Constitution and so Congress cannot define it. “Direct tax” appears in the Constitution and so Congress cannot define it. Additionally, after the Sixteenth Amendment, “income” also appears in the Constitution and so Congress cannot define that either. Congress cannot make a thing commerce. Congress cannot make a thing a direct tax and Congress cannot make a thing income.
David A. Wells, who helped President Lincoln establish a system of internal revenue during the Civil War, wrote an extensive multi-part treatise on taxation in which he describes the Supreme Court’s need to define “direct tax” legally. He said that the Court:
has felt compelled by the language of the Federal Constitution to assign to the term “direct,” as applicable to taxation, a “legal” rather than economic definition
Principles of Taxation, Popular Science Monthly. June 1897
Here again we are reminded that when discussing constitutional taxation, we are dealing with terms like direct tax, income and principal that have “legal” meanings rather economic meanings. In 1880, the Supreme Court provided its legal definition:
Our conclusions are, that direct taxes, within the meaning of the Constitution, are only capitation taxes, as expressed in that instrument, and taxes on real estate
U. S. Supreme Court, Springer v. United States (1880)
In 1880, the constitutional meaning of “direct tax” was limited to capitations and taxes on real estate and the tax structure looked like this:
The Income Tax of 1894
Congress passed its first income tax in 1861 because of the extra revenue needed for the Civil War. In 1880, the decision in Springer cited above decided that the tax on income was an indirect tax: “The duty which the internal revenue acts provided should be assessed, collected and paid upon gains, profits, and income was an excise or duty and not a direct tax, within the meaning of the Constitution.” The tax was allowed to lapse soon after the war ended but was revived in 1894.
It wasn’t long after the new tax was enacted that it was challenged. But this time the Supreme Court, in Pollock v. Farmer’s Loan and Trust (1895), decided that the income tax was a direct tax and must be collected by the rule of apportionment.
The Court said that if the source from which the income is derived must be taxed by apportionment, then the income derived from the source also must be taxed by the rule of apportionment. This was the origin of the “source” argument that was abolished by the Sixteenth Amendment. The Court’s two primary holdings are:
Our conclusions may, therefore, be summed up as follows:
First. We adhere to the opinion already announced, that, taxes on real estate being indisputably direct taxes, taxes on the rents or income of real estate are equally direct taxes.
Second. We are of opinion that taxes on personal property, or on the income of personal property, are likewise direct taxes.
U. S. Supreme Court, Pollock v. Farmer’s Loan and Trust (1895)
Income is derived from capital. Real estate and personal property are the two generic sources of capital from which income is derived. Income is either derived from rents and gains from real estate or it is derived from investing personal property (money) into any type of investment. While capital may take many forms, in the context of income tax, capital in the form of money (personal property) is the focus here. Real estate and money are both forms of property. During the congressional debates on the income tax, Senator Williams noted:
Money is as much property as is anything else, and when a man earns $20,000 in money during a year he has got that much in property
Congressional Record, Vol L, Part 4 pg. 3838
When people get paid for labor, they receive property in the form of money as also noted by Senator Williams:
[S]o that the man whose property consists in dollars which he earns in a year is the least taxed of all men.
Congressional Record, Vol L, Part 4 pg. 3839
The reference to “personal property” in the decision means money. “Invested personal property” means money (capital) invested to produce income, which includes investments of all kinds. One does not invest a house into something so a house is not the kind of personal property to which the decision refers. In the context of income tax, personal property is the capital that is invested to produce income and together with real estate identify the two sources of capital discussed in Pollock. In Pollock, the Court reasoned:
It is evident that the income from realty formed a vital part of the scheme for taxation embodied therein. If that be stricken out, and also the income from all invested personal property, bonds, stocks, investments of all kinds, it is obvious that by far the largest part of the anticipated revenue would be eliminated, and this would leave the burden of the tax to be borne by professions, trades, employments, or vocations, and in that way what was intended as a tax on capital would remain in substance a tax on occupations and labor. We cannot believe that such was the intention of Congress
U. S. Supreme Court, Pollock v. Farmer’s Loan and Trust (1895)
Real estate was already recognized as a direct tax and the Court concluded that the tax on income from real estate was also a direct tax. After Pollock, the definition of “direct tax” was expanded when the Court ruled, “Second. We are of opinion that taxes on personal property, or on the income of personal property, are likewise direct taxes.” In 1895, personal property and income (from real estate and personal property) were all added to the legal definition of “direct tax”:
After Pollock, a tax on investment earnings became a “direct tax” and could not be taxed by Congress unless it went through the rule of apportionment. This angered many because all this idle wealth, as it was described, could not be used to support the government. In his dissent, Justice Harlan stated:
Why do I say that the decision just rendered impairs or menaces the national authority? The reason is so apparent that it need only be stated. In its practical operation, this decision withdraws from national taxation not only all incomes derived from real estate, but tangible personal property, “invested, personal property, bonds, stocks, investments of all kinds,” and the income that may be derived from such property. This results from the fact that, by the decision of the court, all such personal property and all incomes from real estate and personal property, are placed beyond national taxation otherwise than by apportionment among the States on the basis simply of population. No such apportionment can possibly be made without doing gross injustice to the many for the benefit of the favored few in particular States.
U. S. Supreme Court, Pollock v. Farmer’s Loan and Trust (1895)
To reverse this decision, and restore investment earnings to the category of indirect taxes so they can be taxed “without apportionment,” the Sixteenth Amendment was ratified:
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
Sixteenth Amendment, US Constitution
The Sixteenth Amendment applies only to the income, not the capital or personal property from which the income is derived.
- The Supreme Court said, “Hey, the tax on income is a direct tax and must be taxed with apportionment.”
- The Sixteenth Amendment responded, “Oh no it’s not. The tax on income can be collected without apportionment, because it is not a direct tax.”
For those who understand logical reasoning, the Amendment is written using the contrapositive:
- Original Constitutional Proposition: If the tax is direct, the tax is apportioned.
- Contrapositive: If the tax is not apportioned, the tax is not direct
If the Income Tax is collected without apportionment, then the Income Tax is not a direct tax. The Sixteenth Amendment did not change the rules. The tax structure is a logical construct with only two choices: “P” and “not P;” so not one means the other. “Not direct” means “indirect.” “Not indirect” means “direct.” “Without apportionment” means “with uniformity.” If the income tax is collected without apportionment, then it must be collected with uniformity. If the income taxed is collected with uniformity, then the tax must conform to all the rules for uniformity. The tax must be enacted as an indirect tax, meaning a duty, an impost or an excise.
“Without apportionment” can only mean “with uniformity” and therefore, all four of these are logically equivalent statements:
The Sixteenth Amendment reversed the Pollock decision by modifying the constitutional definition of “direct tax” to exclude income. The tax on personal property is still a “direct tax.” After the Sixteenth Amendment and as of 2012, the tax structure looks like this:
In order to be collected by the constitutional rule of uniformity, the tax on income, from both real estate and personal property, must be one of the many excise taxes in the Internal Revenue Code, which is an indirect tax. The Supreme Court unequivocally confirms this analysis in the following two decisions:
The Sixteenth 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, and being placed in the category of direct taxation subject to apportionment by a consideration of the sources from which the income was derived.
U. S. Supreme Court, Stanton v. Baltic Mining Co. (1916)
What is an Excise Tax?
A direct tax is a tax on property, but an excise is a tax on an activity, an event or a privilege. The Supreme Court describes as excise as a tax:
Upon the manufacture, sale or consumption of commodities within the country, upon licenses to pursue certain occupations, and upon corporate privileges
Flint v. Stone Tracey Co., 220 US 107 (1911)
Additionally, the Court describes an excise as:
A tax laid upon the happening of an event, as distinguished from its tangible fruits, is an indirect tax
Tyler v. United States, 281 US 497 (1930)
If the income tax is an excise, then the subject of the tax must be an event, not wages, salaries, tips or commissions, not income, and not gross income, which are tangible fruits in the form of money. The subject of the tax must be an event and not money, which is property.
Because of the Sixteenth Amendment, Congress may, once again, tax income with uniformity (i.e. without apportionment), but the tax must obey the rules for uniformity and be in the form of an indirect tax. The Courts can no longer place a tax on income in the category of direct taxation by considering the source (of capital). The Court provided a complete review and analysis of what is and is not a direct tax in the 2012 Obamacare decision when the Petitioners argued that the penalty was a direct tax that must be apportioned:
That narrow view of what a direct tax might be persisted for a century. In 1880, for example, we explained that “direct taxes,” within the meaning of the Constitution, are only capitation taxes, as expressed in that instrument, and taxes on real estate.” Springer, supra, at 602. In 1895, we expanded our interpretation to include taxes on personal property and income from personal property, in the course of striking down aspects of the federal income tax.Pollock v. Farmers’ Loan & Trust Co., 158 U.S. 601, 618 (1895). That result was overturned by the Sixteenth Amendment, although we continued to consider taxes on personal property to be direct taxes. See Eisner v. Macomber, 252 U.S. 189–219 (1920).
U. S. Supreme Court, National Federation of Independent Businesses v. Sebelius (2012)
The Chief Justice is explaining how the Constitution’s definition of “direct tax” changed over the years. The 16th Amendment merely modifies the Constitution’s definition of “direct tax,” it does not alter the Constitution’s rules for taxation. When analyzing the Obamacare penalty to determine if it qualified as a “direct tax,” the Chief Justice reasoned:
A tax on going without health insurance does not fall within any recognized category of direct tax. It is not a capitation. Capitations are taxes paid by every person, “without regard to property, profession, or any other circumstance.” … The payment is also plainly not a tax on the ownership of land or personal property. The shared responsibility payment is thus not a direct tax that must be apportioned among the several States.
U. S. Supreme Court, National Federation of Independent Businesses v. Sebelius (2012)
Did the reader notice that a tax on “income” is not a recognized category of “direct tax”? After the Sixteenth Amendment, taxes on personal property are still considered “direct taxes,” but taxes on income are not “direct taxes.” As of 2012, the three recognized categories of “direct tax are:” A capitation, a tax on real estate and a tax on personal property (including money). The DC Circuit said much the same thing in Murphy v. IRS:
Only three taxes are definitely known to be direct: (1) a capitation, U.S. Const. art. I, § 9, (2) a tax upon real property, and (3) a tax upon personal property.
DC Court of Appeals, Murphy v. IRS 493 F.3d 170,179 (2007)
The Sixteenth Amendment modified the constitutional definition of “direct tax,” it did not amend the Constitution’s rules for taxation. After the amendment, all direct taxes still require apportionment and all indirect taxes require uniformity. The question has always been, is a tax on income included within the constitutional definition of a “direct tax” or not? In Springer v. United States the Supreme Court said the tax on income is not a “direct tax,” but an excise. In Pollock the Supreme Court reversed itself and concluded that the tax on income is a “direct tax.” The Sixteenth Amendment overruled the Supreme Court and says that the tax on income is not a “direct tax.”
A Non-Apporioned Direct Tax?
According to popular myth, the Sixteenth Amendment allows the income tax to be collected as a non-apportioned direct tax. However, a non-apportioned direct tax would be an UNLIMITED tax subject to neither the rule of apportionment nor the rule of uniformity. A direct tax is not subject to the rule of uniformity by definition. So, a direct tax exempt from apportionment is subject to neither rule and the Supreme Court has already ruled that such a tax cannot exist:
But it clearly results that the proposition and the contentions under it, if acceded to, would cause one provision of the Constitution to destroy another; that is, they would result in bringing the provisions of the Amendment exempting a direct tax from apportionment into irreconcilable conflict with the general requirement that all direct taxes be apportioned. Moreover, the tax authorized by the Amendment, being direct, would not come under the rule of uniformity applicable under the Constitution to other than direct taxes, and thus it would come to pass that the result of the Amendment would be to authorize a particular direct tax not subject either to apportionment or to the rule of geographical uniformity, thus giving power to impose a different tax in one state or states than was levied in another state or states. This result, instead of simplifying the situation and making clear the limitations on the taxing power, which obviously the Amendment must have been intended to accomplish, would create radical and destructive changes in our constitutional system and multiply confusion.
US Supreme Court, Brushaber v. Union Pacific RR Co (1916)
Stanton quoted perviously stated, “The Sixteenth Amendment conferred no new power of taxation.” A non-apportioned direct tax would be a new power of taxation because it could be imposed without limitation and it would allow Congress to impose different tax rates on different States, which is why the Court said it cannot exist. The new tax would create three categories of tax instead of two: Indirect taxes subject to uniformity, direct taxes subject to apportionment and direct taxes subject to neither apportionment nor uniformity. The Constitution does not authorize any unlimited tax:
In Brushaber the Court said a non-apportioned direct tax would create a new direct tax subject to neither uniformity nor apportionment and would destroy the two categories of tax which have existed from the beginning:
Second, that the contention that the Amendment treats a tax on income as a direct tax although it is relieved from apportionment and is necessarily therefore not subject to the rule of uniformity, as such rule only applies to taxes which are not direct, thus destroying the two great classifications which have been recognized and enforced from the beginning, is also wholly without foundation …
U.S. Supreme Court, Brushaber v. Union Pacific R. R. Co (1916)
The income tax cannot be a “direct tax” that is exempt from apportionment because it would create an unlimited third category of tax.
The Subject of the Tax
A tax must have a subject meaning the thing being taxed. A tax imposed on a car means that the car is the subject of the tax. A tax imposed on money means that money is the subject of the tax. The subject of a tax may also be an activity a privilege or an event. One must identify the subject of the tax before it is possible to identify the tax as a “direct tax” or a duty, impost or excise. In our system, the subject of a tax is limited to the items shown below:
The subject of a tax may be a person, property or some kind of event or privilege. Money is property. Money is property and must be taxed as property. A tax on property is a recognized category of direct tax that must be apportioned. This is where the analysis should stop.
However, the analysis does not stop there because Congress wants to tax money, but the apportionment requirement prevents the Federal Government from directly meddling with the property of American citizens. Apportionment is hard and so Congress would rather tax money by the rule of uniformity because it is easy. To tax money by uniformity, Congress must devise a way to tax money without taxing the money, which is to say indirectly. To achieve this objective, Congress applies the four ways to tax money described in Doyle:
Whatever difficulty there may be about a precise and scientific definition of “income,” it imports, as used here, something entirely distinct from principal or capital either as a subject of taxation or as a measure of the tax.
U. S. Supreme Court, Doyle v. Mitchell Bros. (1918)
Income and principal are the two categories of money and each category can be taxed in two different ways: As the subject of the tax or as the measure of the tax. Thus, the four ways to tax money are:
- Income as the subject of the tax: A direct tax on money that requires apportionment.
- Income as the measure of the tax: An indirect tax on money that requires uniformity.
- Principal as the subject of the tax: A direct tax on money that requires apportionment.
- Principal as the measure of the tax: An indirect tax on money that requires uniformity.
Introducing “the measure of the tax.” The measure of the tax is a legal invention to evade the apportionment requirement for taxing money. The Supreme Court has recognized the distinction when money is used as the subject of the tax (direct tax) and when money is used as the measure of the tax (indirect tax). If money is the subject of the tax, the tax falls on property and is a direct tax that requires apportionment. If money is the measure of the tax, then something else is used as the subject of the tax and the tax is an indirect tax that requires uniformity.
In order to get around the apportionment requirement for taxing money, Congress has invented the idea of taxing privilege as the subject of the tax and using money as the measure of the tax in order to determine how much privilege one must pay for. Congress must target the money by taxing something else, which is what indirect means. Taxing privilege is the mechanism by which an indirect tax on money is constitutional.
If a person has $100,000 in income and Congress imposes a tax on the $100,000, meaning on the money itself, then it is a tax on property and must be apportioned.
However, if Congress says the $100,000 was acquired by a privilege and taxes the privilege and uses the money as the measure of the tax to determine how much the privilege will cost, it is an indirect tax that can be collected by uniformity. How can a privilege be taxed? What does that even mean? The only way to tax a privilege, activity or an event is to assign it a dollar value. And this is why the “measure of the tax” was invented by American lawyers:
The money is the real target of the tax, but the money is being targeted indirectly in stead of directly. Congress targets the money by taxing something else, which is what indirect means. The amount of tax that a person pays is exactly the same. This is just legal mumbo-jumbo to get around the apportionment requirement for taxing money. However, now it is necessary to split hairs to determine which money can be taxed as a privilege and which money cannot.
Without privilege, money can only be taxed as property, by the rule of apportionment. Not all money can be taxed as a privilege (all income can, but all capital cannot). The Courts have accepted this innovation as illustrated by these examples:
Congress, in exercising the right to tax a legitimate subject of taxation as a franchise or privilege, was not debarred by the Constitution from measuring the taxation by the total income, although derived in part from property which, considered by itself, was not taxable.
U. S. Supreme Court, Stratton’s Independence v. Howbert (1913)
They are based on two principles: 1. An inheritance tax is not one on property, but one on the succession. 2. The right to take property by devise or descent is the creature of the law, and not a natural right – a privilege, and therefore the authority which confers it may impose conditions upon it.
U. S. Supreme Court, Knowlton v. Moore (1900)
It is this distinctive privilege which is the subject of taxation, not the mere buying or selling or handling of goods.
While a direct tax may be void if it reaches nontaxable property, the measure of an excise tax on privilege may be the income from all property, although part of it may be from that which is nontaxable.
But this argument confuses the measure of the tax upon the privilege with direct taxation of the state or thing taxed.
U. S. Supreme Court, Flint v. Stone Tracy Co. (1911)
These authorities establish that Congress taxes privileges and that the mumbo-jumbo has become venerated legal precedent. This fact may be a surprise to some. The tax on income uses privilege as the subject of the tax and income as the measure of the tax and this is how a tax on income is imposed indirectly using the rule of uniformity.
After the Sixteenth Amendment, a tax on income is collected “without apportionment,” which means it must be collected with uniformity. Therefore, a tax on income must conform to the Constitution’s rule for uniformity and must be a duty, an impost or an excise or, in other words, an indirect tax. Knowlton v. Moore (178 US 41, 1900) confirms that uniformity is imposed “only on duties, imposts and excises” – not direct taxes:
Thus, the qualification of uniformity is imposed not upon all taxes which the Constitution authorizes, but only on duties, imposts and excises.
In order for the tax on income to conform to the Constitution’s rule for uniformity, it must be enacted as an indirect tax and thus, money cannot be the subject of the tax. A privilege, an activity or an event must be the subject of the tax because it provides the indirection that is needed for the tax to qualify for the rule of uniformity. Congress targets the money by taxing privilege. This explains why income must be the measure of the tax, and not the subject of the tax. This concept further explained by former legislative draftsman for Treasury Department, F. Morse Hubbard in the 1943 Congressional Record:
So the amendment made it possible to bring investment income within the scope of a general income-tax law, but did not change the character of the tax. It is still fundamentally an excise or duty with respect to the privilege of carrying on any activity or owning any property which produces income.
The income tax is, therefore, not a tax on income as such. It is an excise tax with respect to certain activities and privileges which is measured by reference to the income which they produce. The income is not the subject of the tax: it is the basis for determining the amount of tax.
1943 Congressional Record Vol 89, Part 2 pg. 2580
The admission that “The income tax is, therefore, not a tax on income as such,” is evidence that a word game is being played. Mr. Hubbard means that the income tax does not tax money. If the income tax doesn’t tax income, then what does it tax? It taxes “privilege” and uses income as the measure of the tax and this is being done specifically to evade the apportionment requirement for taxing money.
Congress may tax incomes either with apportionment of without apportionment at its own discretion, it simply must follow the rules for each tax. An income tax collected with apportionment is a direct tax; an income tax collected without apportionment is an indirect tax. The Sixteenth Amendment did not strip from Congress the power to tax income by apportionment if it chooses. The Amendment says, “Congress shall have power to lay and collect taxes on incomes…without apportionment” and like any power granted to Congress, it may choose to exercise that power or choose not to exercise it. Congress is not required to tax income without apportionment.
To exercise the Authority of the Sixteenth Amendment and tax income “without apportionment,” Congress must tax the privileges and activities that produce income and not the money. From its inception in 1861, the Income Tax has never been conceived as a tax on the money itself. The tax is on the privileges or activities that produce income, which allows it to be taxed by uniformity and not apportionment. The activities that produce income are investment activities. The activities that produce capital are employment activities. United States is the only country in the world where this legal legerdemain is required to tax property because the apportionment requirement is designed to protect a citizen’s property from direct federal taxation.
Understanding Our Federal System of Taxation
Money is the only real power in this world. If the Constitution was written to divide power to protect against tyranny and oppression, then dividing financial power is just as important as dividing political power. Understanding this division of financial power may have been forever lost to history had it not been preserved in Pollock v. Farmers’ Loan & Trust Co. (158 U.S. 601 & 618, 1895):
In distributing the power of taxation, the Constitution retained to the State the absolute power of direct taxation, but granted to the Federal government the power of the same taxation upon condition that, in its exercise, such taxes should be apportioned among the several States according to number, and this was done in order to protect to the States, who were surrendering to the Federal government so many sources of income, the power of direct taxation, which was their principal remaining resource.
From this powerful summary found in the syllabus, we learn that the power of taxation is divided to fairly allocate financial resources, and that apportionment exists to discourage the Federal Government from encroaching on the States’ constitutionally protected source of revenue. Direct taxes are the States’ principal financial resource, and all revenue derived from direct taxes belongs to the States unless apportioned for federal use. The States surrendered numerous sources of revenue to the Federal Government when ratifying the Constitution, so the absolute power of direct taxation is meant to compensate them and ensure they have a sufficient financial resource to fund their constitutional obligations. The following excerpt from Chief Justice Fuller’s opinion in Pollock is quoted at length to provide authoritative evidence that, in the opinion of The Court, the Founders and the Constitution intentionally divided financial resources between the States and Federal Government, and that apportionment exists specifically to enforce the separation of financial power.
The reasons for the clauses of the Constitution in respect of direct taxation are not far to seek. The States, respectively, possessed plenary powers of taxation. They could tax the property of their citizens in such manner and to such extent as they saw fit; they had unrestricted powers to impose duties or imposts on imports from abroad, and excises on manufactures, consumable commodities, or otherwise. They gave up the great sources of revenue derived from commerce; they retained the concurrent power of levying excises, and duties if covering anything other than excises; but, in respect of them, the range of taxation was narrowed by the power granted over interstate commerce, and by the danger of being put at disadvantage in dealing with excises on manufactures. They retained the power of direct taxation, and to that they looked as their chief resource; but, even in respect of that, they granted the concurrent power, and if the tax were placed by both governments on the same subject, the claim of the United States had preference. Therefore, they did not grant the power of direct taxation without regard to their own condition and resources as States; but they granted the power of apportioned direct taxation, a power just as efficacious to serve the needs of the general government, but securing to the States the opportunity to pay the amount apportioned, and to recoup from their own citizens in the most feasible way, and in harmony with their systems of local self-government.
The founders anticipated that the expenditures of the States, their counties, cities, and towns, would chiefly be met by direct taxation on accumulated property, while they expected that those of the Federal government would be, for the most part, met by indirect taxes. And in order that the power of direct taxation by the general government should not be exercised, except on necessity … the qualified grant was made.
U. S. Supreme Court, Pollock v. Farmer’s Loan and Trust (1895)
While the States possess the absolute power of direct taxation, the Federal Government’s power of direct taxation is “qualified” meaning that it must go through the rule of apportionment. The reason that the Federal Government must go through the rule of apportionment to enact direct taxes is that apportionment is difficult by design and this difficulty acts as a barrier to “protect to the States … the power of direct taxation.”
In the Obamacare decision quoted preivously, one will not find a more lucid or concise summary of the constitutional meaning of “direct taxes.” First, they included only capitation taxes and taxes on real estate. Pollock expanded that interpretation to include “taxes on personal property and income from personal property,” but that expanded interpretation was overturned by the Sixteenth Amendment. Therefore, while taxes on personal property are still considered “direct taxes,” after the Sixteenth Amendment, taxes on income are not “direct taxes.” The three recognized categories of “direct tax” are: A capitation, a tax on real estate, and a tax on personal property (including money), and these categories are sources of revenue the Constitution reserves to the States.
The tax structure is adjusted and summarized in the chart below, which shows the division of the taxing power between the Federal and State Governments and also how apportionment separates financial resources.
Those who understand American government may admire how beautifully the Founders incorporated federalism into the tax structure. This chart shows that when collecting federal revenue, Congress must use the rule of uniformity when it enacts duties, imposts and excises, but if Congress wishes to impose a direct tax, and intrude on the States’ primary source of revenue, it must go through the rule of apportionment. “Gross income” includes all financial gains taxed by the rule of uniformity where privilege is the subject of the tax and money (capital and income) is the measure of the tax. Without the element of privilege, money must be taxed as property by the rule of apportionment.
Apportionment is important, which is why the Constitution mentions it twice. It serves two purposes: “Protect to the States … the power of direct taxation,” and prevent the Federal Government from laying its hands directly on a citizens property. If a person’s property is to be taxed, then the State Governments are the authorities to tax it because the citizens have more control and influence over their State Governments than over the Federal Government. If the people don’t like the way the State taxes their property, they can correct the error in the next election. The people of one particular State would have little recourse if the Federal Government taxed their property in a manner that they opposed.
This explains why, when Congress enacts a direct tax, the State Governments are the taxpayers, and “pay the amount apportioned” and then “recoup from their own citizens” (see Pollock) the amount of the federal tax. The State decides how to touch its citizen’s property, not the Feds. Individuals do not pay a direct tax to the United States because that is not how the federal system is designed to operate. In “Federalist 39,” James Madison concluded that our federal system is neither wholly national nor wholly federal, but a combination of both, explaining the difference this way:
The difference between a federal and national government, as it relates to the operation of the government, is supposed to consist in this, that in the former the powers operate on the political bodies composing the Confederacy, in their political capacities; in the latter, on the individual citizens composing the nation, in their individual capacities.
James Madison, Federalist #39
The federal and national principles of government are manifest in the tax structure. The rule of uniformity has the effect of stripping away the State boundaries to collect indirect taxes on citizens composing the nation, in their individual capacities, as if the country is one consolidated republic. In contrast, direct taxes are apportioned and collected from each of the States in their political capacities. The rule of uniformity promotes the national principle while the rule of apportionment promotes the federal principle, and so it could be said that indirect taxes are collected nationally while direct taxes are collected federally. In harmony with Madison’s conclusion, Congress’ power of taxation is partly national and partly federal. This means that individual citizens pay indirect taxes, while the State Governments pay direct taxes. Justice Paterson, in Hylton v. United States (3 U.S. 3 Dall. 171 171, 1796), observed:
Apportionment is an operation on states, and involves valuations and assessments which are arbitrary, and should not be resorted to but in case of necessity. Uniformity is an instant operation on individuals without the intervention of assessments or any regard to states, and is at once easy, certain, and efficacious
Hylton v. United States (1796)
Using simple logic, it is easy to conclude that:
- Direct taxes are apportioned and operate on States – the State Government is the taxpayer.
- Indirect taxes are uniform and operate on individuals – the individual citizen is the taxpayer.
The Constitution does not permit these rules to be altered or rearranged for the sake of convenience. The Constitution does not authorize a uniform direct tax or an apportioned indirect tax, and neither Congress nor the IRS can invent a new tax. Therefore, direct taxes do not operate on individuals and indirect taxes do not operate on States. It is commonly, but wrongly, asserted that the Sixteenth Amendment allows a non-apportioned direct tax upon income, as shown on the IRS website:
Numerous courts have both implicitly and explicitly recognized that the Sixteenth Amendment authorizes a non-apportioned direct income tax on United States citizens and that the federal tax laws are valid as applied
IRS Website: Truth About Frivolous Arguments
First, this statement contradicts the Brushaber ruling, but neither the IRS nor the lower courts care much about that. Second, citizens do not pay a direct tax to the United States. Finally, if a tax is non-apportioned and direct, at the same time, then which constitutional rule would apply and upon whom or what would it operate?
Chief Justice Roberts provided contemporary analysis to support the premise that the States pay direct taxes in NFIB, where he explains Article 1 Section 9
That clause provides: “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” This requirement means that any “direct Tax” must be apportioned so that each State pays in proportion to its population.
U. S. Supreme Court, National Federation of Independent Businesses v. Sebelius (2012)
The Chief Justice explains that when Congress imposes any “direct tax” (no exceptions), “each State pays in proportion to its population,” from which it can be concluded that the individual does not pay a “direct tax.” When Congress enacts a “direct tax,” the State Governments write the checks to pay it. Therefore, not only is the power of taxation divided between the States and the Federal Government, but who pays the tax is also divided. In our federal system of taxation, “direct taxes” are collected federally, not nationally, and are paid by the States, not by individuals.
This division of the taxing power does not exist in any other country in the world. When Great Britain, or any other country, imposes a direct tax or an indirect tax, there is no legal argument about rules and limitations because the individual citizen always pay the tax. This is also true for each State Government, when the State of Georgia enacts a direct or an indirect tax, Georgia citizens pay the tax.
In the United States, the relationship is different because the American citizen must financially support two sovereign governments. Individuals pay both direct and indirect taxes to their State Government, but they only pay indirect taxes to the Federal Government. The State Government pays a “direct tax” to the Federal Government and this is how the Constitution protects a citizen’s property from being confiscated by the Swamp. The Constitution distributes the power of taxation as shown below:
(PS: This is one of the reasons that the Senate was elected by the State Legislatures – the State is a taxpayer: No taxation without representation!)
The Constitution divides the power of taxation. Both the States and The United States collect direct and indirect taxes, but they are collected by different means. The States collect both direct and indirect taxes from the individual taxpayers in the State. The States collect a direct tax in the economic sense as defined by economists like Adam Smith. The United States collects an indirect tax nationally from individuals, but it collects a “direct tax” federally from the State Governments. The United States collects a “direct tax” in the constitutional sense as defined by The U. S. Supreme Court, not economists. As shown in the graphic, if Congress does not exercise the apportionment option, then all revenue derived from direct taxes remains with the States, “and this was done in order to protect to the States…the power of direct taxation.” There is no constitutional provision for the individual citizen to pay a direct tax to the United States – ever. Below is an example of a “direct tax” enacted in 1813, as as can be seen, the STATE pays:
A “direct tax” enacted by Congress is a tax upon the State Governments and it will always specify how much each State Government must pay and is therefore, very easy to identify. If a tax enacted by Congress does not specify how much each State must pay, then the tax must be imposed as an indirect tax (a duty, an impost or an excise), must identify the privilege or activity that is being taxed and must be paid by the individual citizen.
If the system was designed as shown below, it is easy to see how the individual taxpayer would be financially crushed in between two sovereign governments vying for the same tax revenue:
The Constitution divides financial power as surely as it divides political power. The tax on income is an indirect tax and serves as a primary source of revenue for the Federal Government. However, a direct tax on capital is a source of revenue the Constitution reserves to the States and requires apportionment. Direct taxes are, in the simplest terms, taxes on property and the Federal Government cannot tax property unless it goes through the rule of apportionment because taxing property is a source of revenue the Constitution reserves to the States.
Federal Jurisdiction
Congress administers federal territory as if it were its own state. We don’t often use the term “federal state,” but that is exactly how it operates. The Constitution gives Congress the power to exercise exclusive legislation in its own territory, which includes DC, any purchased property and all federal territories. Article 1 Section 8 states that Congress has power:
To exercise exclusive Legislation in all Cases whatsoever, over such District (not exceeding ten Miles square) as may, by Cession of particular States, and the Acceptance of Congress, become the Seat of the Government of the United States, and to exercise like Authority over all Places purchased by the Consent of the Legislature of the State in which the Same shall be, for the Erection of Forts, Magazines, Arsenals, dock-Yards, and other needful Buildings
U. S. Constitution, Article I Section 8
This makes the federal government sovereign unto itself inside its own territory and this gives Congress the exclusive power to tax inside federal territory as well. Congress has the same sovereign power to tax everything in its own territory in the same way that Great Britain has the power to tax everything inside its own territory, which is the same sovereign power to tax the State of Texas has inside its own territory. The Courts have recognized the separate jurisdictions created by our federal system of government:
All subjects over which the sovereign power of a state extends, are objects of taxation; but those over which it does not extend are, upon the soundest principles, exempt from taxation. This proposition may almost be pronounced self-evident.
The sovereignty of a state extends to everything which exists by its own authority, or is introduced by its permission.
Supreme Court, McCulloch v. Maryland (1819)
And it also affirmed that state territory is sovereign and outside Congress’ authority to interfere:
Yet every State has a sphere of action where the authority of the national government may not intrude. Within that domain the State is as if the union were not. Such are the checks and balances in our complicated but wise system of State and national polity.
Supreme Court, Farrington v. Tennessee (1877)
This creates two different jurisdictions, with two different tax rules. Inside federal territory, Congress is sovereign and Congress makes the tax rules. People who live and work inside federal territory pay all federal taxes. Outside federal territory, Congress must follow either the rule of apportionment, which people do not pay, or Congress must follow the rule of uniformity, which only applies to duties, imposts and excises. This means, that if you live and work outside federal territory, you only pay duties, imposts and excises to the federal government. The Constitution does not permit you to pay any other kind of tax. Any person who pays a tax other than a duty, impost or an excise to the federal government has made a voluntary contribution to Uncle Sam’s Charity Fund. Congress has no power to make any person pay any other kind of tax. If you do not know what an duty, impost or excise is, you have better learn because it is the only kind of tax that you are required to pay.
The fact individuals only pay excises is hard-wired into the system by the Constitution and nothing in the Tax Code can change that. The Tax Code does not say that individuals only pay excise taxes. Don’t search there because you wont find it in the Tax Code. The Supreme Court and the Constitution say that individuals only pay excises and nothing in the Tax Code can override that constitutional requirement. Inside federal territory Congress may tax EVERY INDIVIDUAL without restriction by its own sovereign authority. Outside federal territory, Congress may only impose duties, imposts and excises on individuals; Congress has no power to impose any other kind of tax.
If the whole Tax Code were re-written from scratch starting with a blank piece of paper, it is understood, before pen is put to paper, that people outside federal territory only pay excises. That is a constitutional design requirement before word one is written. Nothing written in the Tax Code can change that requirement. The hardware determines where the electrons flow and the software cannot override the hardware design. The Constitution creates the hardware design and has already determined where the money flows and has determined which taxes you pay and which taxes you do not. Nothing in the software, nothing in the Tax Code, can violate or alter this design requirement. The two million words in the Tax Code and all of the thousands of statutes, paragraphs and subparagraphs are fluff, and bluff and distraction. A person is looking for is an excise that applies him and nothing more.
Where does Congress have the exclusive authority to legislate and where does Congress have the sovereign power to tax everything on its own authority? The answer is in the graphic below:
The red areas are the “federal state” – though we generally do not use that term. Call it what you will – a nation, a state, a country, any political science term that means separate autonomous political entity. Here The Federal Government is sovereign unto itself. The red areas designate where Congress has the sovereign power to tax on its own authority. In the red areas Congress makes the tax rules; in the white areas the Constitution makes the tax rules and requires that Congress tax either by the rule of apportionment, which people do not pay, or the rule of uniformity, which only applies to duties, imposts and excises. OUTSIDE FEDERAL TERRITORY, PEOPLE ONLY PAY DUTIES, IMPOSTS AND EXCISES.
The United States Is Different
As stated at the beginning, The United States is different. The United States does not have an unrestricted national power of taxation like Great Britain. The Federal Government’s power of taxation is partly national and partly federal. Great Britain is not constrained by troublesome rules when it taxes a citizen’s property nor must it invent ridiculous constructs like taxing privilege. The United States has rules that other countries do not.
While debating the income tax in 1913, the Senators took note of the difference between Great Britain’s national power of taxation as compared to the United States’ more limited power of taxation. Senator Cummins noted:
[T]hat the authority of the Congress of the United States with regard to this subject is not unlimited. Our power is not like the power which Great Britain exercises over the subject. It is not like the power which the several States exercise over the subject. It is a power granted in article 16 of the Constitution and I will read it
1913 Congressional Record Vol L, Part 4 pg. 3843
The Senator continued:
Great Britain might employ such words as these in modification or explanation or enlargement of the word “income,” because Great Britain has no constitutional restriction upon her Parliament. A. State might use these words with perfect propriety, because a State has a right to include whatever she likes within the meaning of the word “income”; but the Congress has no right to employ them, because the Congress can not affect the meaning of the word “income” by any legislation whatsoever.
1913 Congressional Record, Vol L, Part 4 pg. 3844
The taxing powers of Great Britain and the State of Georgia are almost identical: Both of these authorities collect direct and indirect taxes from their individual taxpayers. They possess what may be described as a national power of taxation within their respective jurisdictions. Their power of taxation is not divided. The rules that govern the United States’ power of taxation establish a taxing authority that is partly national and partly federal because the individual taxpayer pays the indirect tax, while the State Government pays the direct tax.
Unlike Great Britain or the State of Georgia, Congress does not collect all taxes from the people. The State Governments pay the direct taxes and the people only pay the indirect taxes. The rules and bizarre constructs like taxing privilege or using money as the measure of the tax may make one think that our national scheme of taxation is way too complicated. It is not. The system exists to divide financial resources between the States and the Federal Government and to protect citizens’ property from being confiscated from Washington D. C. where they have little direct influence. The bizarre constructs are the government’s effort to defeat the rules.
In Springer v. United States, Justice Swayne observed:
The question, what is a direct tax, is one exclusively in American jurisprudence.
U.S. Supreme Court, Springer v. United States (1880)
This question is exclusively in American jurisprudence because it is not a legal question in other country because they don’t have rules dividing their power of taxation. In America, a “direct tax,” within the meaning of the Constitution, has a legal definition and it is a tax on property paid by the State Governments. In the rest of the world, a direct tax is merely an economic idea with no legal significance whatsoever.
AfterPollock v. Farmer’s Loan and Trust nullified the 1894 income tax, British observers took note of the differences between the American and British powers of taxation. David A. Wells, recorded the observation in his treatise on taxation:
But the most important and vital issue involved in the income tax enacted 1894 (August 18th) was that it designedly provided for discriminating taxation, and this fact may be best demonstrated and brought to popular comprehension in the following manner: In a recent interview (1885) with a leading British parliamentary authority, the conversation turned on the new and unprecedented discriminating rates in the legacy and succession taxes imposed by the present British Parliament, and the opinion of the writer was asked respecting them. He returned, offhand, the answer that he could only discuss them from a British point of view, for, under the Constitution of the United States, such taxes could not be levied by the Federal Government, contemporaneously, and how promptly foreign authorities recognize the truth of this position is shown by the following extract from an editorial in the London Times on the phase of the income statute then before the United States Supreme Court: “Were we,” it said, “under the United States Constitution, Sir William Harcourt’s budget would have been declared unconstitutional. Populist leaders in America must envy us the freedom of dealing with other people’s property, enjoyed in this motherland of liberty.” This conversation led to a historical investigation, and the recognition of what seemed to be a fact little or not before noted, that the United States is the only nation that now exists or ever has existed which, through constitutional or other provisions, has, or has had, any limitations on its Government in respect to the general exercise or extent of the power of taxation.
David A. Wells, Principles of Taxation Vol 28, July 1898
Populist leaders in Britain chided their American counterparts because they could take another person’s property much easier than the U. S. Constitution allows. Unlike any other nation in the world, the United States has rules on how its taxes must be imposed. These rules mostly focus on how property, including one’s money, can be taxed. Understanding these rules is essential to maintaining our political and financial liberty.
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Summary
- Congress can collect two types of taxes: taxes that are apportioned (direct) and taxes that are uniform (indirect).
- “Direct taxes” are taxes on property.
- Excise taxes are taxes on the happening of an event, an activity or a privilege
- There are three recognized categories of “direct tax:” A capitation, a tax on real estate and a tax on personal property (including money).
- “Direct taxes” are sources of revenue the Constitution reserves to the States.
- State Governments pay “direct taxes” to the United States, while individual citizens pay indirect taxes – duties, imposts and excises – to the United States.
- If the Tax Code does not impose an excise on any of your economic activities, then you cannot be the taxpayer and you are not subject to the tax.