Steven Weisman argues in the
Washington
Post that most people believe the tax rate they pay is fair, but worry that
the rich don’t pay their fair share. I
just wanted to elaborate a bit on the history of the income tax. Weisman writes about the introduction of an
income tax during the Civil War and then states that
“The income tax disappeared when the war ended. But it
returned on the eve of World War I, enabling President Woodrow Wilson
to raise the marginal income tax rate to 70 percent. Wilson called paying
taxes a “glorious privilege” and a way for the businesses profiting from
military buildup to give back. Sen. Hiram Johnson of California even attacked
“the skin-deep dollar patriotism” of those who favored war but opposed taxes on
the wealthy.”
The tax did disappear when the war ended and did return on
the eve of World War I, but that was the second time it had returned. The first time was in the 1890s. I suspect it
was an editorial decision to leave this episode out. Weisman has written a book
about the history of the income tax and certainly knows about the events of the
1890s. Unlike him, I have no space constraint on my blog so I have room to
recount the story of the Wilson-Gorman Act. If anyone wants the references for
the information below see chapter seven of my book on the Farmers Loan and Trust
Company.
Generally referred to as the Wilson-Gorman Act, or simply
the Wilson Act, the official name of the 1894 income tax legislation was
"An act to reduce taxation, to provide revenue for the government, and for
other purposes." The tax reduction referred to in the Act was a reduction
in tariff rates. To make up for the reduction in tariff revenue, the Act
imposed a two percent tax on incomes over $4,000. “The object,” the lawyer
James C. Carter later explained, “was to redress in some degree the flagrant
inequality by which the great mass of the people were made to furnish nearly all
the revenue, and leave the very wealthy classes to furnish very little of it in
comparison with their means.”
In addition to being part of the wealthy classes, executives
of trust, banking and insurance companies had additional reasons for opposing
the new taxes. In addition to the individual income tax, the Act also imposed a
two percent tax on the income of corporations. This tax alone would have raised
considerable opposition, but the leaders of these particular financial firms
were even more troubled that the Act exempted financial institutions organized
on a mutual plan from the tax. They wanted to have the law ruled
unconstitutional but, there were two obstacles to challenging the law in court.
The first obstacle was that the Supreme Court had already rejected a challenge
to the constitutionality of an income tax. The income tax imposed during the
Civil War had been challenged and upheld.
The second obstacle was that §3224 of the United States Revised
Statutes, declared that “No suit for restraining the assessment or collection
of any tax shall be maintained in any court.”
Thus individuals and corporations subject to the tax could not directly
oppose the collection of the tax through the courts. Only after they had paid
the tax under protest could they mount a legal challenge.
William D. Guthrie, a partner in one of the most prominent
legal firms in New York: Seward, Guthrie, Morawetz and Steele, believed that
the first obstacle was really no obstacle at all. In his opinion, the previous
decisions upholding income taxes were in error and, therefore, the Court was
not bound by them. The second obstacle was a little more difficult, but Guthrie
thought that there was a way around it as well. He believed that a “suit in
equity, with the remedy of injunction, often affords the most prompt and
satisfactory relief where property rights are involved.” But to bring the case within equitable
jurisdiction it was necessary to show that “there is no plain, adequate and
complete remedy at law.” An injunction
could not be obtained simply by arguing the law was unconstitutional. “Before
the aid of a court of equity can be invoked,” he explained, “it must appear
that the enforcement of the tax would lead to a multiplicity of suits, or
produce irreparable injury, or, where the property is real estate, would throw
a cloud upon the title of the complaint, or that there is an element of fraud
or breach of trust, or some other ground of equitable jurisdiction.” He concluded that “if a trust company should
be about to voluntarily comply with an unconstitutional tax law, and should
decline to accede to the request of a shareholder asking the trustees to pay
under protest and to contest the legality of the tax, a suit might be brought
against the trustees to restrain them from violating their duty.” The case would not technically be a case to
prevent the collection of the tax but a case to prevent a corporation from
violating its duty to its shareholders. Nevertheless, the Court would be forced
to rule on the constitutionality of the tax. Guthrie worked to initiate two cases based
upon this plan, one with the Farmers’ Loan and Trust Company and the other with
the Continental Trust Company.
The boards of trustees of both companies agreed to adopt a resolution
“somewhat to the effect that while there is doubt about the constitutionality
of the Act, they are not disposed to hamper the Government in collecting its
revenue, and that they will, therefore, set aside from the profits of last year
a sufficient amount to pay the income tax and will pay it when it becomes due.”
After the announcement, Guthrie made a formal request on behalf of Charles
Pollock that the company seek the advice of the courts or pay the tax under
protest. Charles Pollock was a citizen of Boston and, since 1892, the owner of
ten shares of stock in the Farmers’ Loan and Trust Company. The board of
directors refused to comply with Pollock’s request and Guthrie filed a bill in
equity on behalf of Pollock and all other similarly situated stockholders
seeking to enjoin the Farmers’ Loan and Trust Company from paying the tax. The
bill claimed that the tax was unconstitutional, that Farmers’ would violate its
duty to its shareholders if it paid the tax voluntarily, and that great
injustice would be done if the tax were paid.
Newspapers throughout the country speculated as to who was
ultimately footing the bill for the case: New York businessmen, the trust
companies, or simply wealthy New Yorkers such as the Astors. The speculations were largely correct. Guthrie’s corporate clients were the ones
funding the case. Essentially, the lawyers on both sides of the case were
working for the trust companies.
Historians have tended to emphasize the personal income tax
and the issue of whether or not it was a direct tax: Article I, Section 8 of the Constitution
requires that “Duties, Excises and Imposts, Shall be Uniform throughout the
United States.” Although the personal
income tax has received the most attention, Guthrie and his team placed
considerable emphasis on the tax on financial institutions and the issue of
uniformity. In Guthrie’s view, “Congress
has no power, at the expense of others owning property of the same character,
to foster and aid private trading corporations, such as building and loan
associations, savings banks and mutual life, fire, marine, inland, and accident
insurance companies or associations, which serve no national purpose or public
interest whatsoever and which exist solely for the pecuniary profit of their
members.”
Justice Fuller delivered his opinion on April 8. The Court
held the law to be invalid in so far as the tax on income from real estate was
held to be a direct tax that was not apportioned among the states and the tax
on municipal and state bonds impinged on the power of states to borrow. Fuller
went on to observe, however, that many of the central issues of the case had
not been settled. Justice Jackson had been absent and the remaining justices
had not been able to arrive at a majority opinion on whether the entire income
tax was unconstitutional. “Upon each of the other questions argued at the bar,”
Justice Fuller noted, “the justices who heard the argument are equally divided,
and, therefore, no opinion is expressed.”
Because of the importance of the unanswered questions, both sides asked
for a rehearing before the full Court. In the meantime, Guthrie attempted to
ready other challenges to the Act. Though he did not proceed with them after
the application for a rehearing of the Pollock case was quickly accepted by the
Court, and the rehearing was scheduled for May 6,7, and 8.
Counsel on both sides made essentially the same arguments
they made at the original hearing. The decision of the Court was announced on
May 20. The majority of the Court determined the income tax imposed in the law
to be invalid. The vote was five to four with Fuller, Field, Brewer, Gray and
Shiras in the majority and Harlan, Brown, Jackson and White dissenting
The victory of the anti-tax forces in 1895 is generally
regarded as a fleeting one. The Sixteenth Amendment (1913) allowed for direct
taxes that were not apportioned among the states and Congress soon passed an
income tax. But the view that Pollock v. Farmers’ Loan and Trust Co. lost its
relevance with the passage of the Sixteenth Amendment arises from a tendency to
focus solely on the second hearing of Pollock v. Farmers’ Loan and Trust Co.
and the issue of the personal income tax. The opinions in both the first and
the second hearing of the case contained other rulings on taxation. In both
opinions, the Court ruled that the federal government could not tax the bonds
of states and municipalities.
Some feared that the Sixteenth Amendment would overturn the
exemption of state and municipal bonds. The wording of the Sixteenth Amendment
was quite broad. “The Congress shall have power to lay and collect taxes on
incomes, from whatever source derived, without apportionment among the several
States, and without any regard to enumeration.” But it only overturned the
portions of the Pollock opinion dealing with income. The exemption of income
from state and municipal bonds expressed in Pollock was not explicitly
overturned by the Supreme Court until 1988 in South Carolina v Baker. Even then the Court did not reject Fuller’s
logic in the Pollock case. Instead, it declared that the case law regarding
intergovernmental relations had evolved.
Justice Brennan explained that “under the intergovernmental tax immunity
jurisprudence prevailing at the time, Pollock did not represent a unique
immunity limited to income derived from state bonds. Rather, Pollock merely
represented one application of the more general rule that neither the Federal
nor the State Governments could tax income an individual directly derived from
any contract with another government.”
The rule applied to an employee’s income and rental income from a state
government as well as interest payments on its bonds. Brennan went on to
explain that ruling in Pollock no longer applied because this underlying rule
had since been rejected. “The rationale underlying Pollock and the general
immunity for government contract income,” he declared, “has been thoroughly
repudiated by modern intergovernmental immunity case law.”
By the way, if you were wondering about the picture, it is photograph of Guthrie's Long Island estate.
