THE ORIGIN OF THE “INCOME” TAX
“It is to be noted that, by the language of the Act, it is not salaries, wages, or compensation for personal services that are to be included in gross income. That which is to be included is gains, profits, and income derived from salaries, wages, or compensation for personal services.” The United States Supreme Court, Lucas v. Earl, 281 U.S. 111 (1930)
On July 1st, 1862, in the heat of the Civil War and in the face of looming and intractable revenue troubles for the Northern government, its congress passed the Revenue Act of 1862, being,
“An Act to provide Internal Revenue to support the Government and to pay interest on the Public Debt”. Among a lengthy list of measures imposing a variety of excises and duties were the following sections under the heading “Income Duty”:
Sec. 86. And be it further enacted, That on and after the first day of August, eighteen hundred and sixty-two, there shall be levied, collected, and paid on all salaries of officers, or payments to persons in the civil, military, naval, or other employment or service of the United States, including senators and representatives and delegates in Congress, when exceeding the rate of six hundred dollars per annum, a duty of three per centum on the excess above the said six hundred dollars; and it shall be the duty of all paymasters, and all disbursing officers, under the government of the United States, or in the employ thereof, when making any payments to officers and persons as aforesaid, or upon settling and adjusting the accounts of such officers and persons, to deduct and withhold the aforesaid duty of three per centum, and shall, at the same time, make a certificate stating the name of the officer or person from whom such deduction was made, and the amount thereof, which shall be transmitted to the office of the Commissioner of lnternai Revenue, and entered as part of the internal duties;…
Sec. 90. And be it further enacted, That there shall be levied, collected, and paid annually, upon the annual gains, profits, or income of every person residing in the United States, whether derived from any kind of property, rents, interest, dividends, salaries, or from any profession, trade, employment, or vocation carried on in the United States or elsewhere, or from any other source whatever, except as hereinafter mentioned, if such annual gains, profits, or income exceed the sum of six hundred dollars, and do not exceed the sum of ten thousand dollars, a duty of three per centum on the amount of such annual gains, profits, or income over and above the said sum of six hundred dollars; if said income exceeds the sum of ten thousand dollars, a duty of five per centum upon the amount thereof exceeding six hundred dollars;… “(The section goes on to extend the tax to citizens residing abroad who are not government workers at a rate of 5% and without the $600 exemption).
Sec. 93. And be it further enacted,…that any party, in his or her own behalf,…shall be permitted to declare, under oath or affirmation, the form and manner of which shall be prescribed by the Commissioner of Internal Revenue, that he or she was not possessed of an income of six hundred dollars, liable to be assessed according to the provisions of this act, or… has been assessed elsewhere… and shall thereupon be exempt from an income duty; or, if the list or return of any party shall have been increased…,…. he or she may be permitted to declare,… the amount of his or her annual income,… liable to be assessed,… and the same so declared shall be received as the sum upon which duties are to be assessed and declared.
So, in 1862, in the first artless and innocent iteration of an American “income” tax, an excise with provisions for withholding is laid upon the pay of government workers. At the same time, a separate, essentially voluntary excise is laid upon “gains, profits, or income” ‘that might be derived from the pay (or other sources) of private-sector United States residents and government workers alike.
By its explicit, separate, and otherwise unnecessary identification in section 86 of the remuneration (pay) of government workers as taxable— and taxed- this original enactment provides a rare, forthright statutory acknowledgement that the remuneration of private-sectors workers is not. After all, if “gains, profits, or income derived from” pay is the same thing as the pay itself, the pay of government workers identified in section 86 would be being taxed under section 90, and the relevant portion of section 86 would be nonsensically superfluous. This clearly lawful distinction will not, and could not, change through the many less candid re-enactments and modifications of the tax since. The similar exclusion of private-sector receipts of any otherkind from the legal category of’taxable’ is not, unfortunately, as lucidly spelled out in this act other than in their sharing the Implications of the qualifier “derived from” but is satisfactorily clarified elsewhere, as we shall see.
Subsequent acts changed the rate, and eventually added progressivity, but the imposition of the tax, and the specifications of- and exclusions from– its object remain. (There is a persistent factoid of misinformation to the effect that this 1862 act was repealed in 1872. While it is true that certain portions of the earlier act were repealed or modified in the revenue act of December 24th, 1872, sections 86, 90, and 93, reproduced above, were not among them. Enforcement of the “income” duty was temporarily relaxed at that time, but it was never repealed.)
In 1880, the act was tested in the Supreme Court in Springer v. United States, 102 U.S. 586 (1880), by an litigant- attorney as a direct tax upon him in seeking a portion of the proceeds from his federally licensed profession and interest on bonds that he held. The court unremarkably ruled against him in a brief opinion of interest only due to an observation that to treat a tax on “incomes” as direct- and therefore apportioned— would be inequitable because,
“Where the population [of a state] is large and the incomes are few and small, it would be intolerably oppressive”.
If “income” is understood as meaning ‘pay’, or ‘all that comes in’, the court’s observation is gibberish. It’s possible that one of the welfare states of today might come to have a large population with few people making a living, but in 1880 there certainly was no such place. With its observation, the court was matter-of-factly confirming the distinction between “incomes” and the common receipts of private-sector persons, just as had the 1862 act.
In 1894, Congress re-enacted the “income” tax- combining certain elements of the original sections 86 and 90 to explicitly require the inclusion of “the salary or other compensation paid to any person in the employment or service of the United States… in the calculation of [taxable] total gains, profits or income” of that person; and again providing for withholding. The new act was promptly challenged in the Supreme Court, insofar as it attempted to characterize dividends paid by an investment fund as taxable “gains, profit, or income”. Ruling on the question in Pollock v. Farmers Loan & Trust, 157 U.S. 429 and 158 U.S. 601 (1895), the court made two important declarations prior to its final ruling, the first of which being,
“The power to tax real and personal property and the income from both, there being an apportionment, is conceded: that such a tax is a direct tax in the meaning of the Constitution has not been, and, in our judgment, cannot be successfully denied:…”.
The court is saying that a tax connected with receipts from property already acquired was indistinguishable in essence from a tax upon the property itself- without regard to any exercise of privilege in deriving such receipts- because the mere possession of the property is meaningless without deriving gain from it. In other words, even otherwise taxable “income” is untaxable if connected with personally owned property. The court referred to Springer, indicating regret that the earlier ruling had not distinguished between the plaintiff’s two types of receipts because while those reflecting profitable activity from his federally licensed profession might have been properly subject to an excise, those from his bonds should not have been.
The second important observational element of the Pollock ruling, arrived at after an exhaustive recital of the history of taxation in Great Britain and the United States, was that,
“Ordinarily, all taxes paid primarily by persons who can shift the burden upon some one else, or who are under no legal compulsion to pay them, are considered indirect [excise] taxes;”
and,
“… taxation on income is in its nature an excise entitled to be enforced as such “,
in other words indirectly- as a tax upon an optional exercise of privilege.