Chapter IV: Section 2: of the amendment that "the Congress and the several States (2)

One of the chief defects, perhaps the most vital defect of all, in the Confederation which carried through the Revolutionary War and preceded the Union, was its inability to raise revenue directly by taxation. The Confederation was obliged to call upon the several states to furnish their respective contributions or quotas, and requisitions upon the states encountered delays and sometimes were ignored altogether. There were no effective means of compulsion.

With these facts before them the founders of the Union determined that the new government should not be wrecked upon this rock at any rate, and therefore insisted, against great opposition, in conferring upon it powers of taxation which were practically unlimited in their reach. The Constitution was made to provide that[1]

the Congress shall have power to lay and collect taxes,
duties, imposts and excises, to pay the debts and provide for
the common defense and general welfare of the United States.

[Footnote 1: Const., Art. I, Sec. 8, Clause 1.]

The only tax which Congress was expressly forbidden to lay was a tax on exports.[1] It was, however, provided that indirect taxes (duties, imposts, and excises) should be uniform throughout the United States,[2] and that direct taxes should be apportioned among the states according to population.[3] The last mentioned provision was a concession to the fears of the wealthier states lest their citizens be taxed unduly for the benefit of the poorer states, and represented one of the great compromises by which the ratification of the Constitution as a whole was secured.

[Footnote 1: Const., Art. I, Sec. 9, Clause 5.]

[Footnote 2: Id., Art. I, Sec. 8, Clause 1.]

[Footnote 3: Id., Art. I, Sec. 2, Clause 3. Sec. 9, Clause 4.]

The Constitution nowhere specified just what taxes were to be deemed "direct" (Madison in his notes of the Constitutional Convention records: "Mr. King asked what was the precise meaning of direct taxation? No one answd.")[1] or what kind of uniformity was intended by the provision that indirect taxes should be uniform, and more than a century was to elapse before either of these fundamental questions was finally settled. The answer to the latter question (that the term "uniform" refers purely to a geographical uniformity and is synonymous with the expression "to operate generally throughout the United States") was given by the Supreme Court in the year 1900 in the celebrated case of _Knowlton v. Moore_,[2] and met with general approval. The answer to the question of what constitutes a direct tax within the meaning of the Constitution, given by the Supreme Court in 1895 in the Income Tax cases,[3] met with a different reception. The decision upset long-settled ideas, disarranged the federal taxing system, aroused popular resentment, and ultimately led to the enactment of the Sixteenth Amendment.

[Footnote 1: Farrand, "Records of the Federal Convention," Vol. II, p. 350.]

[Footnote 2: 178 U.S., 41.]

[Footnote 3: _Pollock v. Farmers Loan & Trust Co._, 157 U.S., 429.]

The question had arisen early in the life of the Republic in the case of _Hylton v. United States_, decided in 1796.[1] This litigation involved the validity of a tax on carriages which had been imposed by Congress without apportionment among the states. Alexander Hamilton argued the case before the Supreme Court in support of the tax. The Court adopted his view and sustained the tax, holding that it was a tax on consumption and therefore a species of excise or duty. The Justices who wrote opinions expressed doubt whether anything but poll taxes and taxes on land were "direct" within the meaning of the Constitution. That point, however, was not necessarily involved and was not decided, though later generations came to assume that it had been decided.

[Footnote 1: 3 Dallas, 171.]

The tax on carriages was soon repealed and many years elapsed before the question came up again. After the Civil War broke out, however, the need of revenue became acute and various statutes taxing income without apportionment among the states were enacted by Congress. These met with general acquiescence. It was felt that they were emergency measures necessitated by the war, and they were in fact abandoned as soon as practicable after the war. A well-known lawyer, however (William M. Springer of Illinois), did not acquiesce and refused to pay his income tax, on the ground that it was a direct tax not levied in accordance with the Constitution. In the action brought to test the question[1] it appeared that the income on which Mr. Springer had been taxed was derived in part from the practice of his profession as an attorney. To this extent it was clearly an excise or duty, i.e., an indirect tax. As it was incumbent upon Mr. Springer, by reason of the form of the action, to demonstrate that the tax was void _in toto_ the Court could not do otherwise than decide against him. In rendering its decision, however, the Court took occasion to discuss the question as to what were direct taxes within the meaning of the Constitution, and expressed the view that the term included only capitation or poll taxes, and taxes on real estate. There the matter rested until the year 1894 when Congress enacted another income tax law. This time the argument from necessity was lacking. The country was in a state of profound peace. Opposition to the tax among the moneyed interests was widespread. Test suits were brought and after most elaborate and exhaustive argument and reargument the Hylton and Springer cases were distinguished and the act was held unconstitutional.[2] The decision was by a closely divided Court (five to four), the majority finally holding that "direct taxes" within the meaning of the Constitution included taxes on personal property and the income of personal property, as well as taxes on real estate and the rents or income of real estate. This conclusion was fatal to the act. It was conceded that the tax, in so far as it affected income derived from a business or profession, was an indirect tax and therefore valid without apportionment among the states, but the provisions for taxing the income of real and personal property were held to be an essential part of the taxing scheme invalidating the whole statute.

[Footnote 1: _Springer v. United States_, 102 U.S., 586.]

[Footnote 2: _Pollock v. Farmers Loan & Trust Co._, 157 U.S., 429; same case on rehearing, 158 U.S., 601.]

This momentous decision was almost as unpopular with Congress and the general public as the decision in _Chisholm v. Georgia_ had been a hundred years earlier. Many legislators were in favor of enacting another income tax law forthwith and endeavoring to coerce the Court, through the force of legislative and popular opinion, to overrule its decision. Calmer counsels prevailed, however, and plans were initiated to get over the difficulty by a constitutional amendment. Meanwhile, steps were taken to eke out the national revenue by various excise taxes, notably the so-called Federal Corporation Tax. This novel tax, which was thought by many to involve a very serious encroachment by the Federal Government on the powers of the states, will be discussed more at length in later chapters.[1]

[Footnote 1: See Chapters X and XI, infra.]

The constitutional amendment as proposed by Congress and ratified by the states provided:

"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."

Thus far we have dealt only with such limitations upon the federal taxing power as are expressly imposed by the Constitution. As has been seen, the only express limitations are that direct taxes shall be apportioned among the states, that indirect taxes shall be uniform, and that exports shall not be taxed at all. There are, however, certain other limitations which we proceed to notice briefly.

The Constitution provides[1] that the compensation of federal judges "shall not be diminished during their continuance in office." There is a similar provision as to the compensation of the President.[2] No attempt seems to have been made to tax the compensation of federal judges prior to 1862. A statute of that year subjected the salaries of all civil officers of the United States to an income tax and was construed by the revenue officers as including the compensation of the President and the judges. Chief Justice Taney, the head of the judiciary, wrote the Secretary of the Treasury a letter[3] protesting against the tax as a virtual diminution of judicial compensation in violation of the constitutional provision. No heed was paid to the protest at the time but some years later, upon the strength of an opinion by Attorney General Hoar, the tax on the compensation of the President and the judges was discontinued and the amounts theretofore collected were refunded. There the matter rested until after the Income Tax Amendment, when Congress again sought to impose a tax upon the income of the President and the judges. A federal judge of a Kentucky district contested the tax and the question came up before the Supreme Court for final decision. On behalf of the revenue department it was urged that a general income tax, operating alike on all classes, did not involve any violation of the constitutional provision. It was also contended that such a tax was expressly authorized by the Sixteenth Amendment giving Congress power to tax incomes "from whatever source derived." The Court in an exhaustive opinion[4] overruled both these contentions and held the tax to be a violation of the Constitution.

[Footnote 1: Art. 3, Sec. 1.]

[Footnote 2: Art. 2, Sec. 1, Clause 6.]

[Footnote 3: See 157 U.S., 701.]

[Footnote 4: _Evans v. Gore_, 253 U.S., 245.]

It has often been asserted that a limitation of the federal taxing power is found in the "due process" clause of the Fifth Amendment of the Constitution, providing that no person shall "be deprived of life, liberty, or property without due process of law." This amendment relates to the powers of the General Government. A similar limitation on the powers of the states is found in the Fourteenth Amendment. Taxing laws have frequently been attacked in the courts on the ground that, by reason of some inequality or injustice in their provisions, the taxpayer was deprived of his property without due process of law. In cases involving state laws such objections have sometimes been sustained.[1] There seems, however, to have been no case in which a federal taxing law was declared invalid on this ground, and the Supreme Court has recently remarked that it is "well settled that such clause (viz., the due process clause of the Fifth Amendment) is not a limitation upon the taxing power conferred upon Congress by the Constitution."[2] Nevertheless, it is believed that if a federal tax were clearly imposed for other than a public use, or were imposed on tangible property lying outside the national jurisdiction, or were so arbitrary and without basis for classification as to amount to confiscation, relief might be obtained under the due process clause of the Fifth Amendment.

[Footnote 1: See, e.g., _Union Tank Line Co. v. Wright_, 249 U.S., 275.]

[Footnote 2: _Brushaber v. Union Pacific R.R._, 240 U.S., 24.]

By far the most important and interesting of the implied limitations of the federal taxing power remains to be noticed. That is the limitation which prohibits the National Government from burdening by taxation the property or revenues or obligations of a state, or the emoluments of a state official, or anything connected with the exercise by a state of one of its governmental functions. In other words, while the National Government may tax income from bonds issued by England or France or their cities, it is powerless to tax the income from bonds of Rhode Island or the smallest of its towns.

This implied limitation, nowhere categorically expressed but enunciated in a series of decisions of the Supreme Court, has not always met with acquiescence from the executive and legislative branches of the Government. In fact, Congress is now engaged in an effort to do away with it, at least in so far as concerns the right to tax the income from state and municipal bonds. To-day, however, it still stands as one of the most striking and unique characteristics of our governmental system. It will be discussed more at length in the next chapter.

IX

CAN CONGRESS TAX THE INCOME FROM STATE AND MUNICIPAL BONDS?

That is a question which is agitating a good many people just now. Congress from time to time has seemed disposed to try it, in spite of misgivings as to the constitutionality of such legislation.[1] A recent Revenue Bill contained provisions taxing the income of future issues of such obligations, and a motion for the elimination of those provisions was defeated in the House 132 to 61. Meanwhile, protests were pouring in from state and municipal officers assailing the justice and expediency of such a tax.

[Footnote 1: See, e.g., H. Report No. 767, 65th Cong., 2d Sess., accompanying House Revenue Bill of 1918 as reported by Mr. Kitchin from the Committee on Ways and Means, page 89.]

It is not the purpose of this chapter to discuss the questions of justice and expediency (as to which there is much to be said on both sides) but rather to deal with the strictly legal aspects of the matter and indicate briefly why such a tax cannot be laid without a change in our fundamental law.

Let it be said at the outset that no express provision of the United States Constitution forbids. On the contrary, that instrument confers on Congress the power to lay taxes without any restriction or limitation save that exports shall not be taxed, that duties, imposts, and excises shall be uniform throughout the United States, and that direct taxes must be apportioned among the states in proportion to population. The obstacle lies rather in an implied limitation inherent in our dual system of government and formulated in decisions of the Supreme Court.

The founders of this republic established a form of government wherein the states, though subordinate to the Federal Government in all matters within its jurisdiction, nevertheless remained distinct bodies politic, each one supreme in its own sphere. In the famous phrase of Salmon P. Chase, pronouncing judgment as Chief Justice of the Supreme Court[1]:

The Constitution in all its provisions looks to an
indestructible Union, composed of indestructible states.

[Footnote 1: _Texas v. White_, 7 Wall., 700, 725.]

In a later case[1] another eminent justice (Samuel Nelson of New York) put the matter thus:

The General Government, and the states, although both exist
within the same territorial limits, are separate and distinct
sovereignties, acting separately and independently of each
other, within their respective spheres. The former, in its
appropriate sphere, is supreme; but the states within the
limits of their powers not granted, or, in the language of the
10th Amendment, "reserved", are as independent of the General
Government as that government within its sphere is independent
of the states.

[Footnote 1: _The Collector v. Day_, 11 Wall., 113, 124.]

It follows that the two governments, national and state, must each exercise its powers so as not to interfere with the free and full exercise by the other of its powers. To do otherwise would be contrary to the fundamental compact embodied in the Constitution--in other words, it would be _unconstitutional_.

This proposition was affirmed at an early day by Chief Justice John Marshall in the great case of _McCulloch vs. The State of Maryland_,[1] which involved the attempt of a state to tax the operations of a national bank. That case is one of the landmarks of American constitutional law. While it did not expressly decide that the Federal Government could not tax a state instrumentality but only the converse, i.e., that a state could not tax an instrumentality of the nation, the Court has held in many subsequent decisions that the proposition enunciated by the great Chief Justice works both ways. For example, it has declared that a state cannot tax the obligations of the United States because such a tax operates upon the power of the Federal Government to borrow money[2] and conversely, that Congress cannot tax the obligations of a state for the same reason;[3] that a state cannot tax the emoluments of an official of the United States[4] and conversely, that the United States cannot tax the salary of a state official;[5] that a state cannot impose a tax on the property or revenues of the United States[6] and conversely, that Congress cannot tax the property or revenues of a state or a municipality thereof.[7]

[Footnote 1: 4 Wheaton, 316.]

[Footnote 2: _Weston v. City of Charleston_, 2 Pet., 449.]

[Footnote 3: _Mercantile Bank v. New York_, 121 U.S., 138, 162.]

[Footnote 4: _Dobbins v. Commissioner of Erie County_, 16 Pet., 435.]

[Footnote 5: _Collector v. Day_, 11 Wall., 113.]

[Footnote 6: _Van Brocklin v. Tennessee_, 117 U.S., 151.]

[Footnote 7: _United States v. Railroad Co._, 17 Wall., 322.]

The Supreme Court has said (and many times reiterated in substance) that the National Government "cannot exercise its power of taxation so as to destroy the state governments, or embarrass their lawful action."[1] One of the most distinguished writers on American Constitutional law (Thomas M. Cooley, Chief Justice of the Supreme Court of Michigan and afterward Chairman of the federal Interstate Commerce Commission) has said:

There is nothing in the Constitution which can be made to
admit of any interference by Congress with the secure
existence of any state authority within its lawful bounds. And
any such interference by the indirect means of taxation is
quite as much beyond the power of the national legislature as
if the interference were direct and extreme.[2]

[Footnote 1: _Railroad Co. v. Peniston_, 18 Wall., 5, 30.]

[Footnote 2: _Cooley's Constitutional Limitations_, 7th Ed., 684.]

The question as to the right of Congress to levy an income tax on municipal securities came up squarely in the famous Income Tax Cases[1] involving the constitutionality of the Income Tax Law of 1804. While the Supreme Court was sharply divided as to the constitutionality of other features of the law, it was unanimous as to the lack of authority in the United States to tax the interest on municipal bonds.

[Footnote 1: _Pollock v. Farmers Loan & Trust Co._, 157 U.S., 429; same case on rehearing, 158 U.S., 601.]

The decision in those cases is the law to-day (except in so far as it has been changed by the recent Sixteenth Amendment) with one possible limitation. It has been held that state agencies and instrumentalities, in order to be exempt from national taxation, must be of a strictly governmental character; the exemption does not extend to agencies and instrumentalities used by the state in carrying on an ordinary private business. This was decided in the South Carolina Dispensary case.[1] The State of South Carolina had taken over the business of selling liquor and the case involved a federal tax upon such business. The Court, while reaffirming the general doctrine, nevertheless upheld the tax on the ground that the business was not of a strictly governmental character. This decision suggests the possibility that if an attempt were made to tax state and municipal bonds the Court might draw a distinction based on the purpose for which the bonds were issued, and hold that only such as were issued for strictly governmental purposes were exempt.

[Footnote 1: _South Carolina v. United States_, 199 U.S., 437, decided in 1905.]

It remains to consider the effect of the Sixteenth Amendment.

After the Supreme Court had held the Income Tax Law of 1894 unconstitutional on the ground that it was a direct tax and had not been apportioned among the states in proportion to population the Sixteenth Amendment to the Constitution was proposed and ratified. This amendment provides that

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.

When the amendment was submitted to the states for approval some lawyers apprehended that the words "incomes from whatever source derived" might open the door to the taxation by the Government of income from state and municipal bonds. Charles E. Hughes, then Governor of New York, sent a special message to the Legislature opposing ratification of the amendment on this ground.

Other lawyers, notably Senator Elihu Root, took a different view of the scope of the amendment, holding that it would not enlarge the taxing power but merely remove the obstacle found by the Supreme Court to the Income Tax Law of 1894, i.e., the necessity of apportionment among the states in proportion to population. This latter view has now been confirmed by the Supreme Court. In a case involving a tax on income from exports the Court said:[1]

The Sixteenth Amendment ... does not extend the taxing power
to new or excepted subjects, but merely removes all occasion,
which otherwise might exist, for an apportionment among the
states of taxes laid on income, whether it be derived from one
source or another....

[Footnote 1: _Peck v. Lowe_, 247 U.S., 165.]

In a case decided a little earlier[1] the Court, speaking through Chief Justice White, had said:

By the previous ruling (i.e., in _Brushaber v. Union Pacific
Railway Co._, 240 U.S., 1) it was settled that the provisions
of the Sixteenth Amendment conferred no new power of
taxation....

[Footnote 1: _Stanton v. Baltic Mining Co._, 240 U.S., 103, 112.]

From what has been said it will be evident that the doctrine of exemption of state and municipal bonds from federal taxation is firmly embedded in our law and has not been affected by the Sixteenth Amendment.

Whether it is a doctrine suited to present-day conditions is a question outside the scope of this paper.

The fear of federal encroachment, so strong in the minds of the makers of our Constitution, has become little more than a tradition. To many it doubtless will seem that any rule of law which operates to prevent the nation, in the great exigency of war, from taxing a portion of the property of its citizens is pernicious and should be changed.

If this be the view of a sufficient number the change can and will be made. Lawyers think, however, that it will have to be done by the orderly method of constitutional amendment, not by passing taxing statutes which a reluctant Court will be obliged to declare unconstitutional.

Just now the tide of popular sentiment is setting strongly toward such a change. It was advocated in a recent Presidential message.[1] The immunity enjoyed by state bond issues is coming to be regarded less as a safeguard of state rights than as a means whereby the rich escape federal income surtaxes. One is tempted to predict that the next formal amendment of the Constitution will deal with this subject. If so, another inroad will have been made by the General Government on the failing powers of the states.

[Footnote 1: Message of President Harding to Congress, December 6, 1921.]

X

IS THE FEDERAL CORPORATION TAX CONSTITUTIONAL?[1]

[Footnote 1: Since this chapter was first published in 1909 as an article in the _Outlook_ magazine the specific question propounded in its title has been settled by the Supreme Court (_Flint v. Stone Tracy Co._, 220 U.S., 107). The paper is here reproduced, however, in the belief that its discussion of the principles of our dual system of Government is as pertinent now as it was before.]

The most noteworthy enactment of the sixty-first Congress from a legal point of view, to say nothing of its economic and political significance, was the Corporation Tax Act. That Act, forming §38 of the Tariff Law, provides--

That every corporation ... organized for profit and having a
capital stock represented by shares ... shall be subject to
pay annually a special excise tax with respect to the carrying
on or doing business by such corporation ... equivalent to one
per centum upon the entire net income over and above five
thousand dollars received by it from all sources, etc.

The act goes on to require the corporations to make periodical reports concerning their business and affairs, and confers on the Commissioner of Internal Revenue a visitorial power to examine and compel further returns.

The genesis of the act is interesting. The growing demand for more efficient regulation of the corporations, so pronounced during President Roosevelt's Administration, had foreshadowed such legislation. It remained, however, for President Taft to take the initiative and mould the shape which the legislation was to take.

In the course of the Senate debate on the new Tariff Act it had become apparent that an influential party in Congress, backed by strong sympathy outside, was bent upon passing a general income tax act. The previous Income Tax Law had been pronounced unconstitutional by the Supreme Court as violating the provision of the Constitution that all direct taxes must be apportioned among the states in proportion to population.[1] That decision, however, had been reached by a bare majority of five to four. It had overruled previous decisions and overturned doctrines that had been acquiesced in almost from the foundation of the Government. A strong party was in favor of enacting another income tax law and bringing the question again before the Court in the hope that the Court as then constituted might be induced to overrule or materially modify the doctrine of the Pollock case. The President and his advisers viewed such a proposal with disfavor. To their minds the proper way to establish the right of Congress to levy an income tax was by an amendment to the Constitution, not by an assault upon the Supreme Court. Accordingly on June 16, 1909, the President transmitted a message to Congress[2] recommending a constitutional amendment, and proposing, in order to meet the present need for more revenue, an excise tax on corporations. The proposal, coupled as it was with a suggestion that such an act might be made to serve for purposes of federal supervision and control as well as revenue, met with favor and was enacted into law.

[Footnote 1: _Pollock vs. Farmers' Loan & Trust Co._, 157 U.S., 429.]

[Footnote 2: _Congressional Record_, June 16, 1909, p. 3450.]

President Taft, himself an eminent constitutional lawyer, in his message recommending the law expressed full confidence in its constitutionality. The same view was taken by able lawyers who surrounded him in the capacity of advisers. The act is understood to have been drafted by Mr. Wickersham, the Attorney General, and vouched for by Senator Elihu Root and others of scarcely less authority in the domain of constitutional law.

Against opinions from such sources one takes the field with diffidence. I venture, however, to outline briefly some reasons for doubting the constitutionality of the act.

At the outset it is essential to determine the exact nature of the tax. Obviously it is not a tax upon income _as income_. If it were, it would be obnoxious to the decision in the Pollock case as imposing a direct tax without apportionment among the states. The language of the act, as well as the declarations of its sponsors, clearly indicate that it is intended, not as a direct tax on property, but as an excise tax on privilege. The phraseology of the act itself is--"A special excise tax with respect to the carrying on or doing business by such corporation," etc. Undoubtedly Congress has power to impose an excise tax upon occupation or business. This was expressly decided, in the case of the businesses of refining petroleum and refining sugar, by the Spreckels case,[1] referred to in President Taft's message. The message says:

The decision of the Supreme Court in the case of Spreckels
Sugar Refining Company against McClain (192 U.S., 397) seems
clearly to establish the principle that such a tax as this is
an excise tax upon privilege and not a direct tax on property,
and is within the federal power without apportionment
according to population.

[Footnote 1: _Spreckels Sugar Refining Co. vs. McClain_, 192 U.S., 397.]

What, then, is the privilege with respect to which the tax is imposed? Is it, like the tax involved in the Spreckels case, the privilege of doing the various kinds of business (manufacturing, mercantile, and the rest) in which the corporations subject to the operation of the law are engaged? Obviously not. No kind or kinds of business are specified in the act. The tax falls not only on corporations doing every conceivable kind of business, but also on the corporation that does no specific business whatever--the corporation which, in the language of an eminent judge, is merely "an incorporated gentleman of leisure."[1] Moreover, if the tax were merely upon the privilege of doing business, it would seem to be obnoxious to the cardinal principle of just taxation that taxes should be uniform. In other words, if the privilege of doing a business--say conducting a department store--were the thing taxed and the only thing taxed, the rule of uniformity would seem to require that a corporation and a copartnership conducting similar stores on opposite corners of the street should both be taxed. Nothing inconsistent with this view will be found in the Spreckels case. The party to that suit was, to be sure, a corporation, but the act under which the tax was imposed applied to individuals, firms, and corporations alike.

[Footnote 1: Vann, J., in _People ex rel. vs. Roberts_, 154 N.Y., 1.]

It must be concluded, therefore, that the tax is not upon the privilege of doing the businesses in which the various corporations in the land are engaged, but is rather a _tax upon the privilege of doing business in a corporate capacity_, or, in other words, upon the exercise of the corporate franchise. That this is so appears very clearly from the message of President Taft. He says:

This is an excise tax upon the privilege of doing business as
an artificial entity and of freedom from a general partnership
liability enjoyed by those who own the stock.

Assuming, then, that this is the real nature of the tax, is it constitutional?

Unquestionably Congress may tax corporations organized under federal laws upon their franchises; any sovereignty may tax the creatures of its creation for the privilege of exercising their franchises; but how about corporations chartered by the states and doing purely an intrastate business? A state confers on John Doe and his associates the privilege or franchise of doing business in a corporate capacity. Can Congress impose a tax on the exercise of that privilege or franchise? The power to tax involves the power to destroy.[1] If Congress can impose a tax of one per cent., it can impose a tax of ten per cent. or fifty per cent., and thus impair or destroy altogether the value of corporate charters for business purposes. Does Congress possess such a power? The Constitution puts no express limitation on the right of Congress to levy excises except that they shall be "uniform throughout the United States." But there are certain implied limitations inherent in our dual system of government. The sovereignty and independence of the separate states within their spheres are as complete as are the sovereignty and independence of the General Government within its sphere.[2] Neither may interfere with or encroach upon the other.

[Footnote 1: _McCulloch vs. Maryland_, 4 Wheat., 316.]

[Footnote 2: _The Collector vs. Day_, 11 Wall., 113, 124.]

The right to grant corporate charters for ordinary business purposes is an attribute of sovereignty belonging to the states, not to the General Government. The United States is a government of enumerated powers. The Constitution nowhere expressly confers upon Congress the right to grant corporate charters, and it is well settled that this right exists only in the limited class of cases where the granting of charters becomes incidental to some power expressly conferred on Congress, e.g., the power to establish a uniform currency, or the power to regulate interstate commerce. On the other hand, the right of the separate states to grant charters of incorporation is unquestionable. By the Tenth Amendment of the Constitution it is expressly provided: "The powers not delegated to the United States by the Constitution nor prohibited by it to the states are reserved to the states respectively or to the people." The Supreme Court long ago said: "A state may grant acts of incorporation for the attainment of those objects which are essential to the interests of society. _This power is incident to sovereignty._"[1]

[Footnote 1: _Briscoe v. Bank of Kentucky_, 11 Peters, 257, 317.]

The power to grant the franchise of corporate capacity being therefore inherent in the sovereignty of the states, will not a tax imposed by Congress upon the exercise of the franchise constitute an interference with the power? If so the tax is unconstitutional.

The Supreme Court has repeatedly held, that the National Government "cannot exercise its power of taxation so as to destroy the state governments or embarrass their lawful action."[1] In the case of _California vs. Central Pacific R.R. Co._[2] the question was whether franchises granted to the Central Pacific Railroad Company by the United States were legitimate subjects of taxation by the State of California. The Supreme Court, in language frequently quoted in subsequent cases, discusses the nature and origin of franchises, concluding that a franchise is "a right, privilege, or power of public concern" existing and exercised by legislative authority. After enumerating various kinds of franchises, the Court remarks: "No persons can make themselves a body corporate and politic without legislative authority. Corporate capacity is a franchise." The Court continues:

In view of this description of the nature of a franchise, how
can it be possible that a franchise granted by Congress can be
subject to taxation by a state without the consent of
Congress? Taxation is a burden and may be laid so heavily as
to destroy the thing taxed or render it valueless. As Chief
Justice Marshall said in _McCulloch v. Maryland_, "The power
to tax involves the power to destroy."... It seems to us
almost absurd to contend that a power given to a person or
corporation by the United States may be subjected to taxation
by a state. The power conferred emanates from and is a portion
of the power of the government that confers it. To tax it is
not only derogatory to the dignity but subversive of the
powers of the government, and repugnant to its paramount
sovereignty.

[Footnote 1: _Railroad Company v. Peniston_, 18 Wall., 5, 30.]

[Footnote 2: 127 U.S., 1.]

It is true that the Court was here discussing the right of a state to tax franchises granted by the United States, and not the converse of that question. The reasoning of the Court would seem, however, to apply with equal force to the right of the United States to tax a franchise granted by a state acting within the scope of its sovereign authority.

Patent rights and copyrights are special privileges or franchises granted by the sovereign or government, and under the United States Constitution the right to grant patents and copyrights is expressly conferred on Congress. It has been held repeatedly that patent rights and copyrights are not taxable by the states[1]. As said by the New York Court of Appeals in a case involving the power of the state to tax copyrights:[2]

To concede a right to tax them would be to concede a power to
impede or burden the operation of the laws enacted by Congress
to carry into execution a power vested in the National
Government by the Constitution.

[Footnote 1: _People ex rel. Edison, &c., Co., v. Assessors_, 156 N.Y., 417; _People ex rel. v. Roberts_, 159 N.Y., 70; _In Re Sheffield_, 64 Fed. Rep., 833; _Commonwealth v. Westinghouse, &c., Co._, 151 Pa., 265.]

[Footnote 2: 159 N.Y., p. 75.]

Apparently the same rule would be applicable were the granting of patent rights, like the granting of ordinary corporate franchises, a prerogative reserved under our system of government to the states instead of being expressly conferred on the United States. By parity of reasoning, the Federal Government in that case would have no power to tax them.

It is familiar law, reiterated over and over again by the Supreme Court, that Congress cannot tax the means or instrumentalities employed by the states in exercising their powers and functions, any more than a state can tax the instrumentalities similarly employed by the General Government. Thus, it has been held that Congress cannot tax a municipal corporation (being a portion of the sovereign power of the state) upon its municipal revenues[1]; that Congress cannot impose a tax upon the salary of a judicial officer of a state[2]; that Congress cannot tax a bond given in pursuance of a state law to secure a liquor license.[3]

[Footnote 1: _United States vs. Railroad Co._, 17 Wall., 322.]

[Footnote 2: _Collector v. Day_, 11 Wall., 113.]

[Footnote 3: _Ambrosini v. United States_, 185 U.S., 1.]

In the light of these decisions it is not apparent how Congress can tax the franchises of those state corporations (and they are many and important) which perform some public or quasi-public function. A state, to carry out its purposes of internal improvement, charters an intrastate railway or ferry company with power to charge tolls and exercise the right of eminent domain. Is not the grant of corporate existence and privileges to such a corporation one of the means or instrumentalities employed by the state for carrying out its legitimate functions, and is not a tax by the Federal Government upon the exercise by such a corporation of its corporate powers an interference with such means or instrumentalities?

In any discussion of the right of Congress to tax the agencies of or franchises granted by a state, the distinction must be borne in mind between a tax upon _property_ acquired by means of the franchise from the state and a tax upon the exercise of the franchise itself. The former tax may be perfectly valid where the latter would be unconstitutional. Thus, the Supreme Court has upheld a tax by a state upon the real and personal property (as distinct from the franchises) of a railway company chartered by Congress for private gain, while conceding that the state could not tax the franchises, because to do so would be a direct obstruction to federal powers.[1]

[Footnote 1: _Union Pacific Railroad Company vs. Peniston_, 18 Wall., 5.]

It remains to notice briefly one or two Supreme Court decisions which are relied upon by the sponsors of the new tax law. Reference has already been made to the decision in the Spreckels case[1] which upheld the validity of the tax imposed by the War Revenue Act of 1898 upon the gross receipts of corporations engaged in the businesses of refining petroleum and refining sugar. The Court held the tax to be an excise tax "in respect of the carrying on or doing the business of refining sugar," and such it obviously was. It was not a tax upon the privilege or franchise of doing business in a corporate capacity, like the tax now under debate. On the contrary, the act expressly applied to "every person, firm, corporation, or company carrying on or doing the business of refining sugar...." The case, therefore, has no bearing on the point we are discussing. Had the act applied only to corporations, a different question would have been involved.

[Footnote 1: _Spreckels Sugar Refining Co. vs. McClain_. 192 U.S., 397.]

The case of _Veazie Bank vs. Fenno_,[1] upholding the statute which taxed out of existence the circulation of the state banks, has frequently been cited as an authority sustaining the right of Congress to levy a tax upon a franchise or privilege granted by a state. It is true that in that case the eminent counsel for the bank (Messrs. Reverdy Johnson and Caleb Cushing) argued unsuccessfully "that the act imposing the tax impaired a franchise granted by the state, and that Congress had no power to pass any law which could do that;"[2] and that two justices dissented on that ground. The conclusive answer to this argument, was, however, that the power of the states to grant the particular right or privilege in question was subordinate to powers expressly conferred on Congress by the Constitution; that Congress was given power under the Constitution to provide a currency for the whole country, and the act in question was legislation appropriate to that end. The case does not hold that Congress has any general power to tax franchises or privileges granted by a state.

[Footnote 1: 8 Wall., 533.]

[Footnote 2: See 8 Wall., p. 535.]

The scope of this chapter does not admit of further reference to the decisions. It is strongly urged, however, that none of them, rightly construed, will be found to sustain the right of the General Government to impose a tax upon the exercise of franchises granted by a state in the exercise of its independent sovereignty, and that such a decision would mark a new departure in our jurisprudence.

In the debates in Congress over the bill many good lawyers appear to have assumed, somewhat too hastily, that the tax in question was an excise tax on business or occupation like that involved in the Spreckels case, and that the only constitutional question, therefore, was one of classification under the provision of the Constitution that excises shall be uniform throughout the United States. No less eminent a constitutional lawyer than Senator Bailey of Texas, in a colloquy with the junior Senator from New York, put the matter thus:[1]

Mr. Root: May I ask the Senator from Texas if I am right in
inferring from the statement which he has just made that he
does not seriously question the constitutional power of the
Congress to impose this tax on corporations?

Mr. Bailey: Mr. President, I answer the Senator frankly that I
do not.... I think the rule was and is that Congress can levy
any tax it pleases except an export tax. Of course a direct
tax must be apportioned and an indirect tax must be uniform.
But the uniformity rule simply requires that wherever the
subject of taxation is found, the tax shall operate equally
upon it.

I believe that Congress can tax all red-headed men engaged in
a given line of business if it pleases.... I have no doubt if
the tax fell upon every red-headed man in Massachusetts the
same as in Mississippi or Texas and all other states, the law
imposing such a tax would be perfectly valid.

[Footnote 1: _Congressional Record_ for July 6, 1909, pp. 4251 to 4252.]

The difficulty with this reasoning is that it overlooks the fact that the privilege of being red-headed is not a franchise granted by a sovereign state. From the viewpoint of constitutional law it may well be that Congress can tax a privilege conferred by the gods where it would be powerless to tax a franchise granted by the Legislature of New Jersey.

XI

THE CORPORATION TAX DECISION

The immediate consequences of the decision of the United States Supreme Court[1] affirming the constitutionality of the federal corporation tax are so slight that its profound significance is likely to be overlooked. Until it was merged with the general income tax the exaction was not burdensome and proved easy of collection. The thing upon which it fell--the privilege of doing business in a corporate capacity--is an abstraction which makes little appeal to the sympathies or the moral sense. The public, more concerned with present conditions than with the passing of a theory, is indifferent.

[Footnote 1: _Flint v. Stone Tracy Co._, 220 U.S., 107]

Thus it has sometimes been with the turning points in the affairs of nations. They came quietly and without observation, and it remained for the historians to mark the actual parting of the ways.

The Supreme Court holds, and in its opinion reiterates many times, that the tax is upon the _privilege of doing business in a corporate capacity_.

Right here is the crux of the matter. Corporate capacity is not a right granted by the National Government. It is something which Congress can neither give nor take away. In the division of powers which marked the creation of our dual government the power to confer corporate capacity was reserved to the states. The decision, therefore, comes to this: Congress can by taxation burden the exercise of a privilege which only a state can grant. And the power to tax, it must be remembered, involves the power to destroy. This seems a long step from the theory of the men who founded the Republic.

Nearly fifty years ago the Supreme Court stated the theory as follows:

The states are, and they must ever be, co-existent with the
National Government. Neither may destroy the other. Hence the
Federal Constitution must receive a practical construction.
Its limitations and its implied prohibitions must not be
extended so far as to destroy the necessary powers of the
States, or prevent their efficient exercise.[1]

[Footnote 1: _Railroad Co. v. Peniston_, 18 Wall., 5.]

The court buttresses its decision by the argument _ex necessitate_--that to hold otherwise would open the way for men to withdraw their business activities from the reach of federal taxation and thus cripple the National Government. The Court says:

The inquiry in this connection is: How far do the implied
limitations upon the taxing power of the United States over
objects which would otherwise be legitimate subjects of
federal taxation, withdraw them from the reach of the Federal
Government in raising revenue, because they are pursued under
franchises which are the creation of the states?... Let it be
supposed that a group of individuals, as partners, were
carrying on a business upon which Congress concluded to lay an
excise tax. If it be true that the forming of a state
corporation would defeat this purpose, by taking the necessary
steps required by the state law to create a corporation and
carrying on the business under rights granted by a state
statute, the federal tax would become invalid and that source
of national revenue be destroyed, except as to the business in
the hands of individuals or partnerships. It cannot be
supposed that it was intended that it should be within the
power of individuals acting under state authority thus to
impair and limit the exertion of authority which may be
essential to national existence.

This argument will not bear scrutiny. It apparently loses sight of the vital distinction between a tax on the mere doing of business and a tax on the privilege of doing that business in a corporate capacity. These are two very different things. The right of Congress to tax the doing of business was not disputed. It had been expressly upheld in the well-known case of _Spreckels Sugar Refining Co. v. McClain_,[1] which involved a tax on the business of refining sugar, whether done by a corporation or by individuals. The tax under consideration, however, goes further and fastens upon something new--something which in the case of individuals or partnerships has no existence at all--which comes into being only by the exercise of the sovereign power of a state. The opponents of the tax, far from attempting to narrow the existing field of federal taxation, were in fact resisting an encroachment by Congress on an entirely new field, created by, and theretofore reserved exclusively to, the separate states. It was conceded that Congress could tax a business when done by individuals and could tax the same business when done by a corporation. The inquiry was: Does the act of a state in clothing the individuals with corporate capacity create a new subject matter for taxation by the General Government? That was the real question before the Court, and the decision answers it in the affirmative.

[Footnote 1: 192 U.S., 397.]

Other illustrations of the same apparent confusion of thought are to be found in the opinion. For example, it is said (citing various cases involving a tax on business where the party taxed was a corporation):

We think it is the result of the cases heretofore decided in
this Court, that such _business activities_, though exercised
because of state-created franchises, are not beyond the taxing
power of the United States.

Here again the Court seems to lose sight of the distinction between a tax on "business activities" and a tax on the privilege of conducting such activities in a corporate capacity.

It is futile, however, to quarrel with the logic of the opinion. The question is closed and the Court, by affirming the judgments appealed from, has committed itself to the theory that the Federal Government may, by taxation, burden the exercise of a privilege which only a state can confer. With the expediency of that theory as applied to present-day political conditions we are not now concerned. The object of this chapter is to point out that the decision marks a distinct departure from the earlier doctrine that the two sovereignties, federal and state, are upon an equality within their respective spheres.

In view of the centralizing forces which are tending to transform these sovereign states into mere political subdivisions of a nation, the decision is of great significance. Moreover, in a very practical way it touches the right of each state under the compact evidenced by the Federal Constitution to manage its internal affairs free from compulsion or interference by the other states. To illustrate: In some parts of the country the anti-corporation feeling runs high. Many men if given their way would tax the larger corporations out of existence. Under this decision the way is open whenever a majority can be secured in Congress. An increase in the tax rate is all that would be necessary. Make the rate ten per cent. or twenty per cent. instead of one per cent. and the thing is accomplished.

New York may deem it good policy to encourage the carrying on of industry in a corporate form. Texas may take a different view and conclude that the solution of the trust problem lies in suppressing certain classes of corporations altogether. Under this decision it lies within the power of Texas and her associates if sufficiently numerous to impose their view on New York and make it impossible for her domestic industries to be carried on profitably in a corporate form. And yet the possibility of impressing the will of one state or group of states upon another state with respect to her internal affairs is the very thing which the founders of the republic sought most carefully to avoid. Had it been understood in 1787 that the grant of taxing powers to the General Government involved such a curtailment of state independence, few states, in all probability, would have been ready to ratify the Constitution.

XII

THE FEDERAL GOVERNMENT AND THE TRUSTS

The curbing of monopolies and combinations in restraint of trade was no part of the functions of the Federal Government as planned by the framers of the Constitution. To their minds such matters, under the dual system of government which they were establishing, belonged to the states. The Constitution was designed to limit the National Government to functions absolutely needed for the national welfare. All other powers were "reserved to the states respectively or to the people."

As time went on, however, and industries expanded it was seen that the power of no single state was adequate to control concerns operating in many states at the same time. The need of action by the General Government became manifest. Power in Congress to legislate on the subject, albeit somewhat indirectly, was found in the Commerce Clause of the Constitution, and in the year 1890 the Sherman Anti-Trust Act was enacted.

Few statutes have aroused more discussion or been the subject of more perplexity and misunderstanding. President Taft's remark, made after the decisions of the Supreme Court in the Standard Oil and Tobacco Trust cases,[1] that "the business community now knows or ought to know where it stands," was received with incredulity approaching derision. Yet from a lawyer's point of view (and it must be borne in mind that the President was a lawyer and is now Chief Justice of the Court) the statement cannot be controverted. The decisions in the Standard Oil and Tobacco cases did in fact dispel whatever uncertainty remained as to what the Sherman Act means.

[Footnote 1: _Standard Oil Co. v. United States_, 221 U.S., 1.

_United States v. American Tobacco Co._, id., 106.]

The Sherman Act[1] declares unlawful every contract, combination, or conspiracy in restraint of interstate trade, and every attempt to monopolize interstate trade. The legal uncertainties that have arisen in its enforcement have not been with respect to the meaning of the terms "restraint of trade" and "monopoly," although the popular impression is to the contrary. In 1890, when the statute was passed, contracts in restraint of trade and monopolies were already unlawful at common law, and these terms, by a long series of decisions both here and in England, had been defined as definitely as the nature of the subject matter permitted. While incapable (like the term "fraud") of precise definition covering all forms which the ingenuity of man might devise, nevertheless their meaning and scope were well within the understanding of any man of reasonable intelligence. Whatever legal uncertainties have arisen have been chiefly owing to two questions: first, What is _interstate_ trade within the meaning of the act? and second, Did the act enlarge the common-law rule as to what restraints were unlawful?