Historical Perspectives on the Federal Income Tax
"If there has been one thing which seems to have been decided by the courts it is that a tax on income is not a tax on the source of the income. A tax on a man’s salary from whatever source derived is a tax on that man and on his income, not a tax on the source from which he derives his income" …(Congressional Record, October 7, 1942, page 7910, Senator Lee of Oklahoma)
What is the meaning of the term "source" in the above statements, and what is it that the court supposedly decided? The answer to those questions changed our tax system, without a Constitutional amendment. Legal interpretations often change our perspective of what we believe the Constitution means. Through a progression of court interpretations, rendered over a period of time, it seems that the Constitution itself does change. Perhaps it does. Another factor is that when Congress passes a Revenue Bill the courts assume it is constitutional, and Congress relied upon that "presumption of constitutionality" during the late 1930's. What happened and why is the point of this section.
The 16th Amendment was proposed and ratified for the distinct purpose of clarifying the "intent" of Congress, not to change or alter the then existing Constitution (Congressional Record 1909-10). Congress has always possessed the authority to tax "income", the question was; did they have the authority to tax the "source" of the "income", through a tax upon such "income". In other words, did Congress have the authority, through the then existing Constitution, to tax the people (labor) or the ownership of property by other than a "Capitation or other direct, Tax? The Court, in the Pollock Cases, answered no! The 16th Amendment was a direct result of that answer, but was its purpose to change the Constitution or clarify the "intent" of Congress? Its purpose was to clarify. The Amendment did not change or alter the existing Constitution; that is, it did not delete, remove or alter the existing wording governing taxation. Its purpose was to confine the "Income Tax" to that of an indirect excise tax in compliance with the existing Constitution. They accomplished it by excluding the "source" (labor or property) from taxation, thereby removing the requirement of apportionment.
I started with the opening quotation because it epitomizes the confusion over the "intent" of the 16th Amendment. I think everyone one can agree that the purpose of the Amendment was to exclude from taxation the "source" of income, but it is obvious that there is question as to the meaning of "source". The second sentence presents a paradox, for it seems true, but is entirely false. The purpose of the Amendment was to prevent the "Income Tax" from becoming a tax upon the ownership of property, by confining the operation of the tax to the "income" derived from property. The same principle must also be true with people, that is, the income derived from "labor". The tax is not levied upon "that man", as a "capitation Tax"; but upon "that man's" income, as an indirect excise tax. There is a distinct difference between the two types of taxes.
What is the meaning of the term "source", and "why" would the Amendment seek to protect it from taxation? The Constitution was written by the people, in order to secure a more perfect Union. The purpose being to protect the people from their government, while at the same time providing the government with the power and authority to protect the people. Included was the authority to levy "Taxes". In order to protect the people from excessive or arbitrary taxation requirements were placed within that Constitution. Article 1, Section 9, clause 4 reads: "No capitation, or other direct, Tax shall be laid ..."; the purpose was to protect the people, and or the ownership of their property, from arbitrary and abusive taxation. Article 1, Section 8, reads in part: "... but all duties, imposts and excises shall be uniform throughout the United States.", the purpose being to protect both the people and the States from arbitrary and abusive taxation by the federal government. The 16th Amendment changed neither one of those requirements. Its purpose was to confine the "Income Tax" to a "indirect" levy upon "income" by excluding the "source" (labor or property), and the expenses incurred, from taxation.
Read the second sentence and determine the "source" of the man's income; is it the man (his own labor), or is it his employer? According to that statement, "source" is in reference to "whomever" the man works for. This is perhaps the biggest switch ever made, because it change the meaning of the 16th Amendment. By transferring the meaning of "source" to the employer (or where the money came from), the tax falls with a crushing blow upon the man (labor) who earned it. Look at it another way: When real estate is rented or leased the renter or lessor is not the source of the person's "income", the property is. The same is true with all forms of "business", i.e. the manufacturing and sale of merchandise or commodities, financial operations or professional services. In these cases it is not the consumer that is the source of the "person's" income, if it were then "income" would be equal to the gross receipts, or the amount the consumer paid. That has never been true, so why would that concept be true with the "wages" of the employee (labor for hire)? "Income" is derived from transactions, it is the operation of someone doing something, producing something or selling something for which they received "gain". The term "from whatever source derived" can only be in reference to people (labor) or their property, it has nothing to do with where, or from whom, the money (receipts) came from. Did the court really switch the meaning of the term "source", or did Congress through their interpretation of the court's decision? The cases dealing with the question are in relation to the sovereign immunity of state, local and federal governments, not employer-employee relationships.
The definition of "income", as recognized by the courts and codified by Title 26 U.S.C, has always been "The gain derived from capital, from labor or from both combined" (accessions to wealth clearly realized). Note that this definition makes no reference to consumers, purchasers or employers. The tax is based upon the results of personal choices, that is, it is based upon what we chose to do and how we choose to do it. John R. Lackey, a Legislative Attorney with the Library of Congress, explains this concept in his update of the research report "Frequently Asked Questions Concerning The Federal Income Tax" (C.R.S. Report for Congress 92-303A (1992)).
"An excise tax is a tax levied on the manufacture, sale, or consumption of a commodity or any of the various taxes on privileges often assessed in the form of a license or fee. In other words, it is a tax on doing something to property or on the privilege of holding some property or doing some act, not a tax on the property itself. A sales tax is a clear example of an excise tax. The tax is not on the property directly, but rather it is a tax on the transaction.
When a court refers to an income tax as being in the nature of an excise, it is merely stating that the tax is not on the property itself, but rather it is a fee for the privilege of receiving gain from the property. The tax is based upon the amount of the gain, not the value of the property."
The "Income Tax" is a personal tax, that is, it is assessed against the "income" of the person earning it. However, the "Income Tax" is not a "capitation or other direct, tax" measured by the person's income. The two "Taxes" are entirely different. The first is levied in consequence of our actions, our voluntary dealings in activities for "gain", and therefore, is an indirect excise tax. The second is levied as a consequence of being a citizen, that is, it is a forced extraction owed by every citizen in order to pay the cost of government. The difference between the two is determined by the "intent" of Congress and the method they chose to levy the tax. A tax levied upon the "source" must be apportioned and a tax levied upon anything else must be uniform; that was the "intent" declared by the 16th Amendment. There is only one "income tax" and that tax applies equally to both "property" and "labor". If the tax upon the "gain" from property is a fee for the privilege of receiving that "gain", then the tax upon the employee's wages must also be a fee for the privilege of receiving those wages (that is, if those "wages" are in fact "income" under the 16th Amendment).
So why is it that "salaries, wages, and compensation for services", are classified as "income"? If the "source" is the person's labor and the "compensation" the payment for that labor, then would not an excise tax upon that "compensation" be an excise tax upon the "source" (labor)? Of course it would, the same way an excise tax upon the sales price (gross receipts) of real property would in reality be a direct tax upon that property. However, that is not the case in "business, trades, professions and employment's", their compensation is paid out of the gross income, or gain, derived from their "business" pursuits, not out of the gross receipts. In other words the tax is an excise, levied upon the privilege of receiving gain and measured by the amount of that gain.
This definition of "income" worked well for real estate, invested personal property, it even worked for "business, trades and professions" however, its application is a bit more confusing when it comes to personal labor apart from "business", i.e. "employees". This is where history provides all of the answers. The following is a review of historical documentation, as it was recorded by court cases such as "Pollock", "Brushaber", the Davis Cases of 1937, Graves, Gerhardt and many more. It also includes the statements made by Congressmen and Senators cited from in the Congressional Record. This documentation explains the transition of the "Income Tax" from an indirect excise tax, levied upon the "privilege of receiving gain", to a capitation tax, levied upon the privilege of receiving "wages" in exchange for labor.
The Pollock Cases in 1895, established the principle upon which the
16th Amendment was adopted. It was there contended that the
Income Tax, levied under the Act of 1894, was unconstitutional because
of its intention to tax "property" directly. The Court in viewing
this matter set forth 5 points upon which they based their review of the
case and subsequently rendered their decision. They are 157 U.S.
427 @ 573-574:
(1) That the distinction between direct and indirect taxation was well understood by the framers of the Constitution and those who adopted it.
(2) That under the state system of taxation all taxes on real estate or personal property or the rents or income thereof were regarded as direct taxes.
(3) That the rules of apportionment and uniformity were adopted in view of that distinction and those systems.
(4) That whether the tax on carriages was direct or indirect was disputed, but the tax was sustained as a tax on use and an excise.
(5) That the original expectation was that the power of direct taxation would be exercised only in extraordinary exigencies, and down to August 15, 1894, this expectation has been realized. The Act of that date was passed in a time of profound peace, and if we assume that no special exigency called for unusual legislation, and that this mode of taxation is to become an ordinary and usual means of supply, that fact furnishes an additional reason for circumspection and care in disposing of the case."
The "Pollock Cases" contain perhaps the most complete history of our State and federal tax systems, as such they provide the basis for understanding the progression of the federal income tax. Keep in mind that the Constitution granted Congress a restricted power of taxation, i.e. a complete authority with specific methods of accomplishment. The States, on the other hand, did not have any restrictions other than those imposed by their own Constitutions. The only restrictions the Constitution placed upon Congress were that of apportionment, uniformity and an exclusion of taxation on exports. The rule of apportionment applied to "capitation, and other direct, taxes" and the rule of uniformity applied to all other forms of taxation.
The early taxes are best explained by a quote taken from the first Pollock Case, 157 US 427. It appears in the briefs filed by Clarence A. Seward, the attorney for the appellants.
"Prior to the adoption of the Constitution, the States of Vermont, Massachusetts, Connecticut, Pennsylvania, Delaware, New Jersey, Virginia and South Carolina, assessed their citizens upon their profits from their professions, trades and employments, and collected a tax thereon for the benefit of the states and the general government. In addition to these taxes upon income, nearly all the states imposed poll taxes, taxes on lands, on cattle of all kinds, and various kinds of personal property."
Note the reference "assessed their citizens upon their profits (income) from their professions, trades and employments" and ask the question; did the employee (labor for hire) acquire profits (income) from their employment? The obvious answer is no.
In an exchange of comments between Mr. Edmunds and the Justices, Justice Harlan asked this question:
"Have you formulated in your own mind any general rule by which we are to determine whether a tax is direct or indirect?
Mr. Edmunds answered:
"But my definition is--and I believe it to be generally found to be universally true--that a direct tax is a tax upon every kind of property and upon every kind of person in respect of himself, or in respect of his property, either in existence or acquired, or to be acquired, and not in respect to his voluntary calling, pursuit, or acts, as importing goods which he may import or not import as he pleases, not in respect of his being a trader or manufacture, etc., in all of which cases he is taxed as a consequence of his free choice of business and in all of which the burden is in some degree moved on--but in respect of things that belong to the existence of property as an entity--a state of physical being."
Justice Shiras then asked: "Have you any definition of the word "excise"?
To which Mr. Edmunds answered: "Yes sir; … always bringing in the idea, the ruling idea, that indirect taxes are levied upon consumption as it is called, always takes the thing in movement--transactions among men, in respect to which they are the masters of their own conduct, and, therefore, are not regulated as to how much tax they all pay, according to the kind of business they choose to carry on, …"
Attorney General Olney, when addressing the court, made this observation in regards to the "income tax" under question:
"A second reason for the income tax was the desire to equalize in some degree the burdens of taxation. The prior taxes, customs, duties and internal revenue alike, being laid on consumption, they bore more heavily on the poor and what is sometimes called the lower middle class of the population.
A flagrant injustice to the poorer class of contributors unless compensated by the existence of other taxes from which, as from the present income tax, they are altogether exempt."
That's a pretty clear statement that "employees" (labor for hire) were not subject to the income tax of 1894. To further that principle the court in the second case 158 US 601 @ 635 makes this clear determination about "business" and "profits":
"We have considered the Act only in respect of the tax on income derived from real estate, and from invested personal property, and have not commented on so much of it as bears on gains or profits from business, privileges, or employments, in view of the instances in which taxation on business, privileges, or employments, has assumed the guise of an excise tax and been sustained as such."
They went on to say:
"… 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."
Did the court reverse their decision, and did they really mean to include the employee (labor for hire), or were their comments restricted to only such labor that was taxable by the existing excise tax? The court went on to further clarify that statement by saying:
"We do not mean to say that an Act laying by apportionment a direct tax on all real estate and personal property, or the income thereof, might not also lay excise taxes on business, privileges, employments, and vocations."
Did the 16th Amendment convert the existing excise tax levied upon business, privileges and employments, measured by gains and profits (income), into a "capitation, or other direct, tax"? Of course not, it did however classify the income tax as an excise tax by removing the requirement of apportionment, without changing the existing Constitutional meaning of "capitation, or other direct, taxes".
The knowledge gained from the Pollock Cases is this; the tax levied
upon the income (gain and profits) derived from business pursuits, i.e.
trades, profession, occupations, vocations and employments were assessed
upon the "privilege" of doing business for profit and measured by the amount
of profit (income) derived. These "taxes" were incurred by choice. There
is no reference made to the "employee" except by Attorney Olney, in which
case he said the poor and lower middle class (included employees) were
altogether exempt. Another important fact is that the "personal exemption",
allowed as a credit against the "net-income" subject to tax, was more than
double the amount paid as "wages" to employees (labor for hire) (see the
dissenting opinions of Justices Brown and Harlan concerning the purpose
of the personal exemption). In other words: Whether by direct exclusion
from the tax or by exemption through the "personal exemption", the "employee's"
(labor for hire) liability for either an excise tax or an income tax upon
their "wages" is not addressed by these cases.
The 16th Amendment was ratified in 1913 and the first "Income Tax" levied under it was in October of that year. In a synopsis of that Revenue Act, prepared by the person responsible for writing the Act, the following facts are presented from the Congressional Record, Volume 50 pages 5679-80:
"The Treasury regulations soon to be prepared will make clear to every taxpayer the requirements of the law and its application to income derived from the various kinds of business."
"The statutory exemption of $3,000 is allowed for personal living and family expenses:"
"Income Tax--Personal/ incomes covered: 'All net incomes from property owned and from every business, trade, or profession carried on in the United States by persons (aliens or citizen) residing elsewhere."
"Net-income includes: 'All gains, profits, and income derived from salaries, wages, or compensation for personal services of any kind and however paid."
Would the employee's wages be classified as "net-income", as opposed to the compensation (or wages) earned by business, trades and professions, which are paid out of the "net-income" of their "business"? Was the employee (labor for hire) classified as being in business, in 1913? Did the employee (labor for hire) even earn as much as $3,000 from "wages" in 1913? The answers are no, No and NO.
The Congressional Record provides an outstanding review of the federal
income tax system, how it works and what it was intended to operate upon.
Yet, there is nothing in those records which would even suggest that the
employee's (labor for hire) wages were subject to the excise tax on business
or the "Income Tax", before or immediately after 1913.
The authority most cited by the Internal Revenue Service, concerning the application of "Individual Income Taxes", is Chief Justice White and the 1915 case of Brushaber v. Union Pacific RR 240 U.S. 1. Justice White was a member of the Supreme Court at the time of the Pollock decision and participated in that ruling. We must acknowledge his expertise on the subject of income taxation and the effects of the 16th Amendment. He said, in speaking of the effects of the Pollock decision and the amendment:
"...it did not in any way dispute the all-embracing taxing
authority possessed by Congress, including necessarily therein the power
to impose income taxes if only they conformed to the constitutional regulations
which were applicable to them. Moreover, in addition, the conclusion
reached in the Pollock Case did not in any degree involve holding that
income taxes generally 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 unless and until it was concluded that to enforce it would
amount to accomplishing the result which the requirement as to apportionment
of direct taxation was adopted to prevent, in which case the duty would
arise to disregard form and consider substance alone, and hence subject
the tax to the regulation as to apportionment which otherwise as an excise
would not apply to it. Nothing could serve to make this clearer than
to recall that in the Pollock Case, in so far as the law taxed incomes
from other classes of property than real estate and invested personal property,
that is, incomes from "professions, trades, employments, or vocations"
(158 U.S. 637), its validity was recognized; indeed, it was expressly declared
that no dispute was made upon the subject, and attention was called to
the fact that taxes on such income had been sustained as excise taxes in
The above statement has been taken out of context to support the conclusion
that employees (labor for hire) were included in the decision render by
the court in 1895 (by their reference to "labor"). That conclusion, as
has been shown, is not supported by the facts. In order for the "Income
Tax" to apply to the "wages" of the employee (labor for hire) under the
"Brushaber" decision, the employee would have to have been included in
the above statement. Again the same principles of the "Pollock Cases" apply.
The income tax was levied upon "net-income", in fact, the filing requirement
was based upon net-income not gross income or gross receipts. The allowance
for the "personal exemption" was more than double the "wages" paid to employees
(labor for hire), thereby exempting them from even filing a tax return.
Here again there is no evidence or documentation that the employee's "wages"
were even considered to be "income", taxable by either the excise tax upon
"the privilege of doing business" or the income tax upon "privilege of
receiving gain". Is it by "interpretation" that the employee is included
or is it accomplished through misinterpretation of the court's decision?
The "Income Tax" levied from 1913 through 1953 was entirely based upon "net-income", a report of gross income was not even requested until the Revenue Act of 1940. The first Congressional Act, requiring the employee (labor for hire) to contribute a "tax" directly from their wages, was in 1935 under the Social Security Act. This "Act" took effect in 1936 and the first court challenge followed soon after. The challenge however was not instituted by an "employee", why would they? Their "contribution" was matched by a tax imposed upon their employer, and they received it all, including interest, when they retired.
The Social Security Act was implemented under Title 42 of the United States Code, not under Title 26, and therefore was not considered to be an "Income Tax" based upon the employee's wages. This is the first "tax" levied upon gross receipts, i.e. the total "wages" of the employee, it is also the first "excise tax" levied upon the employee (labor for hire). During the court cases of 1937, known as the "Davis Cases", the court was asked to rule upon the validity of the tax as it applied to the employee. However, the person making the request did not have standing with the court as an "employee" and therefore the court denied the request. The person asking the question was the Commissioner of Internal Revenue, Mr. Helvering, the case; Helvering v. Davis 301 US 619. The other cases involved are; Steward Machine Co. v. Davis 301 US 548 and Carmichael v. Southern Coal and Coke 301 US 495. These cases, as well as an explanation of the Social Security Act, are on line @ (http://www.ssa.gov/history/court.html). The interesting fact is that where all three cases were decided the same day, they were not recorded in the order they were decided. The Carmichael Case was actually decided last. This case does not deal with the federal tax, but is regarding the Alabama Unemployment Compensation Act, which is predicated upon the federal Social Security Act. There are two sections of this case worth quoting. Keep in mind that this case deals with State taxing authority not federal authority and the two authorities are not the same.
"Taxes, which are but means of distributing the burden of the cost of government, are commonly levied upon property or its use, but they may likewise be laid on the exercise of personal rights and privileges. As has been pointed out by the opinion in the Chas. C. Steward Machine Co. Case, such levies, including taxes on the exercise of the right to employ or to be employed, were know in England and the Colonies before the adoption of the Constitution, and must be taken to be embraced within the wide range of choice of subjects of taxation, which was an attribute of the sovereign power of the states at the time of the adoption of the Constitution, and which was reserved to them by that instrument. As the present levy has all the indicia of a tax, and is of a type traditional in history of Anglo-American legislation, it is within the state taxing power, and is immaterial whether it is called an excise or by another name.
The question presented by Mr. Helvering was; does this same power of taxation apply to the federal government? That is, is the form of the tax, whether that of an excise or some other name, immaterial (see question (2) 301 US 639) in relation to the employee and a tax levied upon their "wages"? Read the Steward Machine Case, it involves the unemployment taxes levied under the Social Security Act. The unemployment tax was levied only upon the payrolls of the employer, it was not levied upon the wages received by the employee. It is the interpretation of this court decision that became the basis of future Revenue Acts and court decisions.
All of the previous Revenue Acts levied excise taxes upon the "privilege of doing business for profit", this one levied an excise tax upon the "privilege of using employees", to enhance that profit. This was a new concept in taxation and the court was called upon to rationalize the reasoning behind it. In order to do that the court made several analogies, which were easily taken out of context. The first is on page 580-581 of 301 US 548 it reads:
"We learn that employment for lawful gain is a "natural" or "inherent" or "inalienable" right and not a "privilege" at all. But natural rights, so called, are as much subject to taxation as rights of less importance [footnote 6]. An excise is not limited to vocations or activities that may be prohibited altogether. It is not limited to those that are the outcome of franchise. It extends to vocations or activities pursued as a common right. What the individual does in the operation of a business is amenable to taxation just as much as what he owns, at all events if the classification is not tyrannical or arbitrary. "Business is as legitimate an object of the taxing power as property"
Footnote 6 is a reference to John MacArthur Maguire's "Taxing the Exercise of Natural Rights" published in 1934 (Harvard Legal Essays). This essay is a review of the state's taxing authority and how it was utilized from 1789 to 1934. This document is well worth reading. In his essay he makes a clear distinction between the "inalienable" right of labor and the "natural right" to labor or employ others to labor. The court above did not misinterpret this essay. If you read the decision in respect to the parties involved and the question asked it is in full compliance. Note that the court limited their scope to the operation of "business".
The second analogy (page 581), when read out of context, is a real stinger. The implication is that the court threw employees into their decision regarding employers.
"Employment is a business relation, if not itself a business. It is a relation without which business could seldom be carried on effectively. The power to tax the activities and relations that constitute a calling considered as a unit is the power to tax any of them. The whole includes the parts."
On the surface that sounds like the court is referring to the employees hired by their employers. But does it? Keep in mind that this case only involves employers. When read in context with the case at hand this is a very logical statement. The court is referring to the employer-employee relationship and the ability of the employer to enhance his "business" by hiring employees. To reason any differently would suggest that the court stepped out of bounds and rendered a decision upon a question not properly at issue; something the court is not inclined to do as evidence by the Helvering Case 601 US 619.
The other section deals with the "separability clause under Section 19 of the Alabama Act. Alabama required contributions to the Unemployment Fund from both the employer and the employee, the same principle as the federal Social Security Retirement Fund. This statement made by the court parallels the question presented by Helvering.
"Tax On Employees. Appellees extend their attack on the statute from the tax imposed on them as employers to the tax imposed on employees. But they cannot object to a tax which they are not asked to pay, at least if it is separable, as we think it is, from the tax they must pay. The statute contains the usual separability clause. Section 19. The taxation of employees is not prerequisite to enjoyment of the benefits of the Social Security Act. The collection and expenditure of the tax on employers do not depend upon taxing the employees, and we find nothing in the language of the statute or its application to suggest that the tax on employees is so essential to the operation of the statute as to restrict the effect of the separability clause.
Section 1103 of the Federal Social Security Act (1935) also contains a separability clause, yet there is no identifiable record of the Act ever being challenge by an employee. Did the court in the Steward Machine Case, without the employee being represented, render a decision which reversed 146 years of history; or because of the court's silence in the matter, has it been assumed they did? This is the first "tax" to be levied upon the employee by the federal government, and yet it has never been challenged. It is also the first "tax" levied upon gross receipts, yet that has never been challenged. As I said, the federal "Income Tax" was based strictly upon "net-income" not gross receipts, and it applied to the operation of "business" as an excise tax upon privilege.
District Judge Tieber, in writing the Opinion of the Court for the case United States v. Morris 125 F 322 (1903), summed up the previous 116 years of judicial history regarding the value of the "inalienable rights" contained within the phrase "Life, Liberty and the Pursuit of happiness":
"can there be any doubt that the right to purchase, lease and cultivate lands or to perform honest labor for wages with which to support himself and family, is among these rights thus declared to be "inherent and inalienable?"…That the right to lease land and accept employment as a laborer for hire are fundamental rights, inherent in every free citizen is indisputable."
The right to labor, as an employee (master and servant relationship), is the fundamental right guaranteed to every citizen by the Constitution. It is a right every bit as strong as the right to own property, possibly even more so. As such, like capital (property) it is not taxable by the levy of an excise tax. Did the court in 1937 overrule this opinion? No! The employee (labor for hire) was not involved in those Cases and the question was not addressed (not at issue before the court)
The Revenue Act of 1939 is perhaps the most complex of all the revenue statutes. This is where the change from an excise tax upon the operation of business, measured by income, to a capitation tax on labor, measured by wages, begins.
The first step was to include the revenue generated under the Social Security Act, Title 42, into the Internal Revenue Code, Title 26. The reason was to simplify the collection of the various revenue measures by placing them under one Code. The "employment taxes", Social Security and unemployment, were separated from the income tax under Chapter 9, and its inclusion did not impose the income tax upon employee's wages even though the "personal exemption" was now about equal with those wages.
The second step was the "Public Salaries Tax Act (H.R. 3790), a unilateral agreement to the taxation of public office holders, whether that of federal or state public office. This is the departure from the previous "income taxes" and is the direct result of previous court interpretations. The opening quotation is the basis upon which this Act was adopted
This is what was supposed to happen under the Public Salaries Tax Act of 1939.
Congressional Record-House, February 9, 1939, page 1301, Congressman
Boehne of Indiana:
"It is my understanding that by the passage of this bill only about 6 percent of all State and local employees will fall into the category of Federal income-tax payers….
…"Because a person has been appointed or elected to a public office is no reason why he should be placed in a preferred class…
…If we can bring every public officeholder to realize this by taxing his own salary to the limit of the law, such employees will insist that a proper balance between income and expenditure be maintained at all costs."
This goes back to the original State taxes and the reference to "posts of profit" (see 158 US 601 and the briefs filed by Mr. Choate and Mr. Guthrie). The implication was that elected and appointed public officers were paid "salaries" which were well above the average "wages" paid to labor for hire (employees). This difference was then considered to be in relation to "places of profit"; they were also places of privilege.
This is how they made it happen and is well worth reading in the Congressional Record. The "party politics" of today do not hold a candle to the politics of the Roosevelt era.
Congressional Record-House, February 9, 1939, page 1315, Congressman
Jenkins of Ohio:
"It prevents the Treasury Department from going back 2 or 3 years and levying a tax on school teachers and policemen and thousands of others in your State. If they have a right to collect that tax 2 or 3 years back without any law why have they not the right to levy it forward now without this law? [Applause] Who can explain that to me? I repeat, if they have a right to go back and tax schoolteachers and the policemen and the firemen of your community, they must do it by some virtue of some law, by some semblance of a law. If they can collect 1937 tax legally then they can collect 1940 tax legally. Of course, sometimes they do not pay much attention to the law down there, but they must act on some semblance of law."
I think we would call this coercion today. Did Congress really have the authority to tax the paycheck of State and federal employees (labor for hire)?
This is what actually happened and is the reason the federal income tax is applied to the "wages" of employees (labor for hire) today.
Congressional Record-House, February 9, 1939, page 1311, Congressman
Robison of Kentucky:
"It is urged that many of these officials and employees of the State, district, county, and city governments would not be required to pay an income tax after allowing exemptions. If this policy should be once adopted, then the policy that has been urged for some time would be brought into action; that is, to greatly reduce the exemptions, so that all of our State, district, county and city employees, including teachers, nurses, and others, might be required to pay an income tax to the Federal Government."
Under the Revenue Bill of 1940 (H.R. 10039) the requirement for filing tax returns was changed from the basis of net-income to "gross income", in order to verify the expenses deducted in the tax return. The "personal exemption" was also reduced to below the average wage paid to employees (labor for hire). The tax however, continued to be levied upon net-income and few if any employees (labor for hire) actually paid an "income tax" to the federal government.
The Revenue Bill of 1942 (H.R. 7378) implemented the Victory Tax, which for the first time included an income tax withholding provision based on the "wages" of employees. The Act itself was not part of the "normal" income tax system and in fact was designed under the same pretense as the Social Security Act. In other words, the tax collected from the employee was to be partially returned after the war. It was collected as a "forced savings", not as an "income tax". The purpose of the tax was to reduce the amount of borrowing by providing a constant revenue flow through the Treasury. It was also implemented to reduce inflation caused by increased wages and short supplies caused by the war effort. The statement below expresses the reasoning Congress used for the implementation of the Victory Tax Act.
Congressional Record-Senate, Volume 88, October 8, 1942, page 7946.
Exhibit C, Opinion of Assistant Attorney General Samuel O. Clark, Jr.,
addressed to Randolph E. Paul.
"We are, of course, no longer concerned with the power of the Federal Government to tax the income of State officers and employees. The decision of the Supreme Court in Graves v. New York, ex rel. O’Keefe (306 U.S. 466) (1939) and the enactment of the Public Salary Tax Act of 1939, have removed that problem from the field of controversy. …
The theory, which once won a qualified approval, that a tax on income is legally or economically a tax on its source, is no longer tenable."
The "Individual Income Tax Bill" of 1944 completed the transition. Under this Act the Victory Tax was repealed and the "withholding" provision moved to the "employment tax" section, thereby including the "wages" earned by employees within the normal income system. The earned income tax credit was also repealed and the standard deduction implemented in its place. The "personal exemption" was now well below the average wages earned by labor for hire.
This brings us full circle with the opening quotation and summary. By
shifting the meaning of "source" away from the person responsible for earning
the income, the tax would comply with the wording of the Amendment. Problem;
that was not the question the court was asked to decide. The question
presented to the court was: Is a tax levied upon the salary of Government
employees a tax upon the person receiving it, or a tax upon the Government
paying the salary? The "theory", was that the tax was actually placed
upon the Government and therefore invalid, because of the increased salaries
they would be forced to pay. These decisions only clarified that
such taxes were not upon the Government.
There appears to be three main cases which were relied upon by Congress to support the transition, or transfer, of the term "source" from the person earning the salary to the entity paying it. All three cases deal with the issue of sovereignty and the "burden placed upon the government"
The first case is Helvering v. Gerhardt 304 US 405 in 1938. The question presented to the court was:
"The question for decision is whether the imposition of a federal income tax for the calendar years 1932 and 1933 on salaries received by respondents, as employees of the Port of New York Authority, places an unconstitutional burden on the States of New York and New Jersey."
The respondents were respectively: "a construction engineer and two assistant general managers, employed by the Authority at annual salaries ranging between $8,000 and $15,000." Employee "wages" at the time averaged less than $1500 per year, classifying the respondents as being in "positions of profit". The said (304 US 405 @420-421):
"With these controlling principles in mind we turn to their application
in the circumstance of the present case. The challenged taxes laid
under section 22, Revenue Act of 1932, c. 209, 47 Stat. 169, 178, 26 U.S.C.A.
22, are upon the net income of respondents, derived from their employment
in common occupations not shown to be different in their methods or duties
from those of similar employees in private occupations…. A nondiscriminatory
tax laid on their net income, in common with that of all other members
of the community.
(421)…. When immunity is claimed from a tax laid on private persons, it must clearly appear that the burden upon the state function is actual and substantial, not conjectural…The extent to which salaries in business or professions whose standards of compensation are otherwise fixed by competitive conditions may be effected by the immunity of state employees from income tax is to a high degree conjectural."
The comparison the court uses is between like occupations, both in respect to duties, authority and compensation. The comparison to "business or profession" has no relationship to common labor for hire.
The second case, O'Malley v. Woodrough 307 US 277 (1939), concerns itself with the compensation of federal judges:
"Is the provision of Section 22 of the Revenue Act of 1932, 47 Stat. 169, 178, reenacted by Section 22(a) of the Revenue Act of 1936, 49 Stat. 1648, 1657, 26U.S.C.A. 22(a), constitutional insofar as it included in the "gross income", on the basis of which taxes were to be paid, the compensation of judges of courts of the United States taking office after June 6, 1932.
The Judges salary was $12,500 per year, 10 times the average employee's wage. Congress, in anticipation of including the judges salaries within the income tax raised their salaries in 1932 (Congressional Record).
The third case Graves v. New York 306 US 466 (1939) deals with issue of a state income tax levied upon an employee of a federal corporation. This is the opposite issue of the Gerhardt Case. The question presented was:
"We are asked to decide whether the imposition by the State of New York of an income tax on the salary of an employee of the Home Owner's Corporation places an unconstitutional burden upon the federal government."
According to the Court record this decision only applied to the question of whether or not the State income tax, imposed upon the employee, was in effect an unconstitutional burden upon the Federal Government. The respondent was an attorney, receiving a salary of $2,400 per year, from the Home Owner’s Loan Corporation.
This case has no application to the question of whether or not the "employee’s compensation was taxable or not by the Federal Income Tax.
The "Public Salary Tax Act of 1939" was basically supported by
these three cases, yet none of them deals with the "labor for hire" employee.
The Act itself is a unilateral agreement, issued by the Federal Government,
allowing for income taxation of "officers and employees" of both State
and Federal Government agencies and instrumentality's. This reference
to "Officers and employees" is directed at those who are elected or appointed,
or those who because of the position derive "profit" from their compensation.
The Act itself has no power or authority to make the "wages" earned by
employees (labor for hire) taxable by an income tax.
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