[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 munic.i.p.al 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 unconst.i.tutional 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 Const.i.tution 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 munic.i.p.al 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 munic.i.p.al 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 Const.i.tution, 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 const.i.tutional amendment, not by pa.s.sing taxing statutes which a reluctant Court will be obliged to declare unconst.i.tutional.

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 Const.i.tution 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 CONSt.i.tUTIONAL?[1]

[Footnote 1: Since this chapter was first published in 1909 as an article in the Outlook magazine the specific question propounded in its t.i.tle 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 p.r.o.nounced 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 pa.s.sing a general income tax act. The previous Income Tax Law had been p.r.o.nounced unconst.i.tutional by the Supreme Court as violating the provision of the Const.i.tution 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 const.i.tuted 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 Const.i.tution, not by an a.s.sault upon the Supreme Court. Accordingly on June 16, 1909, the President transmitted a message to Congress[2] recommending a const.i.tutional 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 const.i.tutional lawyer, in his message recommending the law expressed full confidence in its const.i.tutionality. 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 const.i.tutional law.

Against opinions from such sources one takes the field with diffidence. I venture, however, to outline briefly some reasons for doubting the const.i.tutionality 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 ent.i.ty and of freedom from a general partnership liability enjoyed by those who own the stock.

a.s.suming, then, that this is the real nature of the tax, is it const.i.tutional?

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 a.s.sociates 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 Const.i.tution 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 Const.i.tution nowhere expressly confers upon Congress the right to grant corporate charters, and it is well settled that this right exists only in the limited cla.s.s 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 Const.i.tution it is expressly provided: "The powers not delegated to the United States by the Const.i.tution 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 const.i.tute an interference with the power? If so the tax is unconst.i.tutional.

The Supreme Court has repeatedly held, that the National Government "cannot exercise its power of taxation so as to destroy the state governments or embarra.s.s 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. p.e.n.i.ston, 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 Const.i.tution 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]