-- Posted by Neil H. Buchanan
One of the pleasures of teaching the same course many times is that one occasionally sees issues from an unexpected perspective. Often, this happens in response to an out-of-left-field question from a student, or sometimes it is just a matter of seeing something as if for the first time. No matter the reason, I had such an experience this week in my Federal Income Taxation class.
On Tuesday, we discussed Eisner v. Macomber, the famous 1920 case in which the U.S. Supreme Court decided, 5-4, that it violates the Sixteenth Amendment for Congress to tax income that has not been "severed" from its original source, for a taxpayer's "separate use, benefit and disposal." It is an utterly confused opinion, which has been roundly repudiated by scholars and courts, with the Supreme Court itself distinguishing Macomber effectively out of existence in 1940's Helvering v. Bruun decision. Even so, most tax professors still teach Macomber because of its historical significance, and because it is a way to introduce the fundamental concept of "realization," which is when taxpayers turn appreciated (or depreciated) property into cash. (There are some other ways to realize gains or losses, but cash sales are the paradigm case.)
Eric Segall's guest Dorf on Law post earlier this week discussed a recent conference in which various leading legal lights argued the relative merits of originalism and the theory of "living constitutionalism." As I went over the Macomber case in class later that day, I took special notice of the dissent that Justice Holmes filed in the case. (The other dissent was written by Justice Brandeis. As I tell my students each semester, it is obviously not a sure thing that Holmes and Brandeis are right, but it should not be surprising if the 5-justice majority that opposes them turns out to be confused.) In order to understand Holmes's dissent, a bit of technical background is necessary.
The government had assessed a tax liability on a part of the "gain" received by Ms. Macomber when Standard Oil of California issued a "stock dividend." Although not technically identical, a stock dividend can usefully be thought of as a "stock split." In this instance, every shareholder in the company exchanged 2 old shares for 3 new shares of the company. Measured at a benchmark price called "par value," which in this case was $100 per share, it therefore appeared that Ms. Macomber and every other shareholder were 50% richer than before. Ms. Macomber's 1100 additional shares (after turning 2200 shares into 3300 shares) thus seemed to make her $110,000 richer.
Of course, as a matter of economic reality, no shareholder was richer than before. This is logically equivalent to cutting a pie into 6 slices, where two people own 3 slices each rather than the 2 each that they would have owned had the pie been cut into 4 slices. The pie's size does not change, so if you own half of the shares, you own half of the pizza.
This makes the government's position in the case appear to be quite stupid. Why would the IRS assess tax on an illusory $110,000 gain (reduced to just under $20,000 for reasons not germane here), when everyone knew that Ms. Macomber's net worth (like those of other SoCal shareholders) had been unaffected by the issuance of the stock dividend?
The answer is simple. The IRS was -- as so often happens -- blamed for faithfully applying a nonsensical law that Congress had written. Specifically, as the majority opinion in Macomber notes, the Revenue Act of 1916 (the updated version of the original income tax act passed in 1913, after the adoption of the Sixteenth Amendment) stated that "stock dividend[s] shall be considered income." That is, Congress did not merely write the tax law in a sloppy way that happened to sweep some non-income into the definition of income. It wrote the law unambiguously to say that income includes the illusory gains from the issuance of a stock dividend.
Enter Holmes. In his brief dissent, he essentially takes an originalist view: "I think that the word 'incomes' in the Sixteenth Amendment should be read in 'a sense most obvious to the common understanding at the time of its adoption.' ... I cannot doubt that most people not lawyers would suppose when they voted for it that they put a question like the present one to rest. I am of the opinion that the Amendment justifies the tax."
Note that this decision was issued in 1920, only seven years after the adoption of the Sixteenth Amendment. I have not checked whether the relevant language in the 1916 Revenue Act existed in the 1913 Act; but even if it did not, the people in Congress who defined stock dividends as income were overwhelmingly the same people -- not just the same constitutional body, but the same human beings -- who passed the amendment allowing an unapportioned tax on incomes. Holmes's point, that most people would have thought that stock dividends were income (even though they would be incorrect, as a matter of economic reality) thus applies not merely to the "not lawyers" who voted for the amendment, but to the Congress as a whole that then turned the amendment into legislation.
So, Holmes's simple point is that, as a U.S. Senator put it more recently in a different context, "The people have the right to be wrong." There are various ways in which to define income, and if we want to know which definition was in the minds of the framers of the Sixteenth Amendment, the language of their revenue acts is pretty darned good evidence of what they thought about stock dividends.
In this view, Congress was thus not required to include stock dividends in gross income in the tax code, but it was not prohibited from doing so by the Sixteenth Amendment. This, presumably, is the same point that people like Justices Scalia and Thomas make when they say that, for example, we cannot replace the framers' understanding of "cruel and unusual punishment" with a more modern understanding.
Can Congress be counted on to fix the statute, to reflect what we now view as economic
reality? Although the law has been changed such that stock dividends are no longer taxed, there is plenty of evidence that economic reality means nothing to most members of Congress. (Compare, e.g., the bipartisan ignorance regarding budget deficits and federal debt.) Holmes's point would be that there is simply nothing, other than the political process, stopping a Congress from taxing what we might think is not really income.
How would the "living" version of this story be different? The question would presumably be whether it is acceptable for a court to define "income" for Sixteenth Amendment purposes to exclude what is really not income. Given that an income tax is, by definition, supposed to determine citizens' respective tax responsibilities by measuring their incomes, and especially given that Congress has from the beginning set up the tax system to be progressive (exempting entirely all but the most wealthy people from the federal income tax, in the early years), one could make an ability-to-pay argument for what the word income means, in a living sense.
That is, it is possible -- and probably desirable -- for courts to have the ability to say that the amendment's framers' purpose was to tax income in a substantial sense, not in a formal sense. If our understanding of what is and is not income changes over time, then the Sixteenth Amendment's coverage would change. Similarly, in NFIB v. Sebelius (the ACA case from 2012), the Chief Justice's controlling opinion held that it does not matter what Congress calls something (or, presumably, what Congress thinks it is doing), because if it looks and acts like a tax, then it is a tax for Constitutional purposes.
To be sure, one can get to that same living constitution result using "new" or "semantic" originalism. In this view, widely held by academics who call themselves originalists, the framers of the Sixteenth Amendment enacted a text -- "income" -- that invokes a particular concept, and it is the concept itself, not their subjective beliefs about the concrete applications of the text, that is fixed as the constitutional meaning. So I am describing a contrast between living constitutionalism and the "old" intentions-and-expectations originalism that still plays a prominent role in the practice of self-described originalist judges and in the rhetoric of conservative politicians.
What is interesting is that the living constitutionalists' view as I have described it here would limit Congress's powers, whereas a Holmesian originalist view would give Congress more power to tax non-income under the powers granted by an amendment that was supposed to be limited to taxing income. I am sure that there are plenty of other examples of such a role reversal, but given the centrality of the income tax to the development of the modern federal government, I find this irony to be particularly provocative.