CHAPTER V

THE POWERS OF CONGRESS

TAXATION AND FINANCE

THE powers of Congress have been the great battle-ground of the Constitution. Around them have surged the legal combats of Strict and Broad Construction, of Tariff and Taxation; of Nullification, of Secession, of the Currency and finally of Commerce Regulation and Corporation Control. Each of these great conflicts has arrayed the statesmen of the time in two opposing schools, one holding that Congress had the constitutional power needed, the other contending that it had not. In each struggle too, there has been some vital interest of the nation at stake and on the answer to the question "Has Congress the power" has hung the decision whether we should go forward or backward. We can now see that the men who contended for a broad interpretation, and who supported the powers of Congress, were fighting for national progress and that their success meant a freer, stronger national government to cope with the problems of the time. It is interesting to see that during this century and a quarter of struggle many foreign nations have adopted federal constitutions, notably Canada, Germany, Switzerland, Australia, South Africa and Mexico, and all of these without exception have conferred upon their federal authorities far more power than ours possessed.

The powers given to Congress in 1787 were those that seemed absolutely necessary to answer the immediate needs of that time. Taxation, borrowing, and coinage.

Regulation of foreign trade and commerce between the States. Maintenance of an army and navy.

These were the points at which the Articles of Confederation had broken down. Any new government must control these essential points of sovereignty if it was to be truly national in character and to hold the respect and loyalty of the people. But since that time no new authority over business conditions has been conferred by any amendment of the Constitution and Congress is now struggling to solve our industrial and commercial questions by means of a group of powers that are no longer adequate to the task. As each decade passes it becomes clearer that the Federal authority must be substantially increased.

Taxation and Finance.-The taxing power is by general consent the most vital and important of all government prerogatives. Without it no national government can long exist. All the early conflicts between the King and the barons in England centered at

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this point, and the rise of English political liberty dates from the time when the Parliament won for itself the right to be consulted in taxation. The first national Douma or Assembly of Russia had been in existence just seven days when it demanded this essential authority from the Czar. Our own Congress, under the Articles of Confederation, had been obliged to rely upon the contributions of the States for its uncertain financial resources; it might levy a tax upon the States but they paid or not as they saw fit. It is not strange that a government without resources of its own could not long command respect. To remedy this weakness it was provided by the new Constitution that Congress should have power "to lay and collect taxes, duties, imposts and excises."

The effect of this change was far-reaching. First, it gave the national government an independent source of revenue, yielding abundant funds for all its expenses; the dignity and power of the nation were thereby at once raised to an unquestionable plane. Henceforth it could plan and undertake its administrative duties without fear of bankruptcy or humiliation. Second, it has made possible the protective tariff system by which the national manufacturing industries have been built up and developed. The first Congress under the new Constitution passed in 1789 a tax law with the following preamble: "Whereas, it is necessary for the support of government, for the discharge of the debts of the United States and the encouragement and protection of manufacturers that duties be laid on goods, wares and merchandise imported, Be it enacted, etc."

Third, it has enabled Congress to regulate many industries by means of taxation; for example the manufacture and sale of alcoholic liquors, oleomargarine, etc., have been heavily taxed by Congress in such a way as to control to a large extent the production and use of these articles, and by the Corporation Tax of 1909 the Government has secured information about the finances of all the principal companies operating in the United States.

Under the constitutional taxing power a number of practical questions have arisen:

What may Congress tax, and what may it not tax?

What may the States tax, and what may they not tax?

What May Congress Tax?-Congress may in general tax anything except the State governments and their agents. It may not tax the State governments because by doing so it might seriously interfere with them, and it is the purpose of the Constitution to preserve and protect the States as well as the national government. A good instance of this principle is seen in the case of Tax Collector v. Day, 11 Wallace, 113; 1870. Here the Supreme Court ruled that Congress could not tax the salary of a State official because it might obstruct and hinder the necessary work of the State. Day was a State Judge and the Court declared that a Federal tax upon his salary would be in effect an interference with the State's judi

cial department. If the Federal Government could tax the salary of such officials it might become impossible for the State to carry on its affairs. Each State is supreme in its own sphere and must not be hindered or obstructed by the Federal Government.

A different ruling was made in the case of Veazie Bank v. Fenno, 8 Wallace, 533; 1869. Here Congress had taxed the circulating notes of State banks with the apparent purpose of discouraging their circulation, and the question arose, could Congress interfere in this way with the privileges granted by the State government to its local banks? The Supreme Court decided that Congress had the constitutional authority to do so because the Constitution had granted it not only the taxing power, but also the control over the national currency, and in pursuance of this control Congress had established a national banking system which should issue bank notes. This new national currency authorized by the Constitution must be made supreme in order to displace the currency issued by the State banks. If Congress had the right to issue such currency it had the right to prevent other forms from interfering with it and this it had chosen to do by a heavy tax of 10% on State bank notes. The law was accordingly held to be constitutional under the authority to levy taxes and to provide a national currency.

Can Congress Tax the Funds of a Municipality?—In United States v. The B. & O., 17 Wallace, 322; 1873, the railway company had an agreement with the city of Baltimore by which part of the earnings of the company were to be paid to the city, at regular intervals. The Federal Government sought to collect a tax from the entire earnings of the railway and this the company protested, claiming that it need not pay a tax on that part of its funds which were due to the city of Baltimore. The Supreme Court upheld the company and declared this part of its earnings to be exempt from Federal taxation on the ground that a city was an agent of the State government and that the funds of a municipality, no matter where located, were not subject to Federal taxation because by taxing the revenues of a city the Federal Government might embarrass and hinder its operations and to that extent interfere with the State. Accordingly, following the same principle which later guided the decision in Pollock v. The Farmers' Loan & Trust Company, 158 U. S. 601; 1895, the tax was declared unconstitutional as applied to such a city fund.

Can Congress Tax a Business in which a State Engages? This problem arose in the South Carolina liquor dispensary system; here the State had prohibited the private sale, either wholesale or retail, of intoxicating liquors within its borders, and had taken up this sale itself by a dispensary system, turning the profits therefrom into the State treasury. Upon the Federal tax collector's attempt to levy the usual internal revenue duty upon sales of intoxicants, the State officials claimed exemption from the tax on the ground that the State could not be interfered with by the Federal taxing power.

In the subsequent suit, South Carolina v. United States, 199 U. S. 437; 1905, the Supreme Court held that the Federal internal revenue tax on intoxicating liquors was a tax, not upon State governments, but upon an ordinary private business, and that even if a State chose to engage in this business, the levy of a tax was not upon the State but upon the business. Such a levy must be regarded not as an interference with the State government but as an ordinary revenue measure to which the State authorities subject themselves when they engage in the industry. The tax could therefore constitutionally be applied to the dispensary system managed by South Carolina.

Can Congress Tax a State or City Bond?-In 1894 Congress had levied a tax on incomes, including the income or interest from city bonds. The owner of such a bond claimed that the law was unconstitutional because it interfered with the borrowing power of the city, and the city was a part of the State government. This claim brought up for decision in the Supreme Court the case of Pollock v. The Farmers' Loan & Trust Co., 158 U. S. 601; 1895, in which the Court held the Federal income tax to be unconstitutional. The city as part of the State government was obliged to borrow money in order to carry out its powers. It did this by selling bonds. If its borrowing power could be interfered with by the Federal Government in any way the city would be prevented from transacting the business confided to it by the State and from performing its duties. This would be an interference with the State powers by the Federal taxing power and therefore contrary to the purpose of the Constitution. The Federal tax on the interest on municipal bonds was, in substance, a tax on the bonds themselves, and this was a tax on the State government's power to borrow. Hence the Act was unconstitutional. The reasoning here, on broad lines, is the same as in Collector v. Day, 11 Wallace, 113; 1870. The national government like the State governments, is supreme in its sphere. Congress must therefore not reach out over into the sphere of the States and use its taxing power to hinder them in any way.

From these rulings it is clear that all the necessary and proper means by which the State carries out its duties are free from taxation by Congress. With this exception, however, Congress may tax all the property of the people. It is even possible that the national government and the States may tax the same property.

Express Constitutional Limits:-But the Constitution imposes certain limits and restrictions upon the way in which national taxes may be levied; all of these were intended to secure fair treatment for all the States and complete freedom of trade among them.

(a) Direct taxes, except those on incomes, must be levied among the States in proportion to population. (Article 1, Section 9; and the 16th Amendment.)

(b) Indirect taxes must be uniform throughout the United States. (Article 1, Section 8, Clause 1.)

(c) No tax shall be laid on articles exported from any State. (Article 1, Section 9, Clause 5.)

(d) No preference shall be given by any regulation of commerce or revenue to the ports of one State over those of another, nor shall vessels bound to or from one State be obliged to enter, clear, or pay duties in another. (Article 1, Section 9, Clause 6.)

All of the above restrictions apply only to Federal or national taxes. (a) The rule requiring direct taxes to be levied according to the population of the various States has caused great difficulty. What is a direct tax? The answer to this question has changed greatly in the recent history of our government. In the case of Hylton v. United States, 3 Dallas, 171, the Supreme Court decided that a carriage tax was not a direct tax. In Springer v. The United States, 102 U. S. 586, the Court declared that "direct tax" includes only capitation or head taxes and land taxes, these being the forms of direct taxation accepted as such at the adoption of the Constitution. But in Pollock v. The Farmers' Loan Company (re-hearing 158 U. S. 601, decided in 1895) the Court reasoned that the national income tax levied by the Act of 1894 was direct. That part of the tax which was laid on the rents from real estate must necessarily be direct because there was no substantial difference between a tax on land and a tax on the rents from land. Since land taxes were admittedly direct, taxes on rents from land must also be direct. Next arose the question, is a tax on income from personal property, including invested funds, etc. also, direct? The Court decided that it was. Congress had never attempted to lay a direct tax in precisely this form but that did not prove that Congress could not do so. The words, "direct tax" should be interpreted in their plainer meaning, and from this standpoint, the Court ruled that a direct tax included taxes on the income from personal property. On these grounds the income tax of 1894 was direct and it therefore should have been apportioned according to the population of the various States; as it was not apportioned in this way as required by Article I, Section 9, Clause 4, of the Constitution, the law was unconstitutional. Since by this ruling the income tax for the first time became a direct tax, we then had the following classes of levies which the Court considered direct:

Capitation, or so much per head of the population.

Levies on land or on the rent of land.

General income taxes.

The decision also made it difficult if not impossible for Congress to levy any income tax upon an equitable basis. The amount of income in the various States is not in proportion to the population; therefore, a tax which must be raised according to the numbers of people rather than according to the amount of income in each State, would be an unequal burden upon the respective States.

The Sixteenth Amendment and the New Income Tax.-The Pollock decision having repealed the income tax law of 1894, an agita