of a constitutional amendment, in favor of making the interest on Federal, State, and local bonds subject to surtaxes but not to normal taxes. It would have the effect of preventing tax avoidance without materially increasing the interest rate. "There is some possibility, in view of certain decisions of the Supreme Court of the United States, that even under existing law interest on governmental bonds can be reached by an excise tax in the case of individuals or corporations carrying on business. This question is discussed in the appended memorandum prepared by Mr. Stam, counsel to this committee. "As already stated, no obvious conclusion is apparent in connection with this matter. It is a subject of importance, and needs further investigation and (Italics supplied.) "Respectfully, study. "L. H. PARKER, Chief of Staff.” POWER OF CONGRESS TO TAX TAX-EXEMPT SECURITIES EXCISE TAX Many proposals have been submitted suggesting the taxation by the Federal Government of the income received from State and municipal securities. It is settled doctrine that without a constitutional amendment Congress has no power directly to tax the income received from State and municipal securities (Metcalf and Eddy v. Mitchell, Admx., 269 U. S. 514, 521; Pollock v. Farmers' Loan & Trust Co., 157 U. S. 429; National Life Insurance Co. v. U. S., 48 Sup. Ct. 593). However, there is a possibility that such income might be reached through an excise tax measured by the net income from all sources. In the case of corporations, it seems clear that this can be done. The corporation excise tax of 1909 taxed the privilege of carrying on or doing business by corporations. The tax was measured by the net income of the corporation from all sources. Since the subject of the tax was an exercise of a franchise or privilege, the Supreme Court held that Congress had the power to include in the measure of the tax the income from tax-exempt securities, although such income could not be directly taxed (Stone Tracy Co. v. Flint, 220 U. S. 107). Moreover, some of the States through corporation excise taxes are now taxing the income from Federal securities by measuring the excise by the net income of the corporation from all sources. In at least two of the States, namely, California and New York, their power to do this has been upheld by the Supreme Court (Pacific Co. v. Johnson, 285 U. S. 480; Educational Films Co. v. Ward, 282 U. S. 379). In the California case the Supreme Court made the following statement as to this point: "The owner may enjoy his exempt property free of tax, but if he asks and receives from the State the benefit of the taxable privilege as the implement of that enjoyment, he must bear the burden of the tax which the State exacts as its price. "So far as individuals are concerned, there is a possibility that the income received by them from tax-exempt securities may also be reached through an excise. To do this we must first find a taxable privilege upon which to base the excise. It seems clear that all trades, avocations, and employments by which individuals acquire a livelihood may be made the subject of an excise or privilege tax. (See the Stone Tracy and Pollock cases, cited above.) Accordingly, if Congress levied an excise on individuals engaged in any business, occupation, trade, avocation, or employment, it seems entirely possible that such tax could be measured by the net income of the individual from all sources, including the income from tax-exempt securities. As stated by the Supreme Court in the Stone Tracy Co. case, 'there is no rule which permits a court to say that the measure of a tax for the privilege of doing business, where income from property is the basis, must be limited to that derived from property used in the business.' It is up to Congress to determine the measure of the excise, and it seems entirely possible that the measure of such excise could be the net income of the individual from all sources, including tax-exempt securities. "Under this proposed scheme there would be three taxes levied by the Congress; (1) An excise tax upon the carrying on or doing business by corporations measured by the net income from all sources; (2) an excise tax upon individuals engaged in any trade, occupation, avocation, or employment, measured by the net income from all sources; and (3) a net-income tax imposed upon all individuals and corporations not subject to the excise tax. This "By this scheme most of the income from tax-exempt securities could be reached. Those persons that would escape would be only those who do not engage in any trade, avocation, or employment, but merely hold securities. scheme would also not extend to State employees engaged in governmental functions of the State, for such occupations being governmental in character could not be reached even through an excise. "COLIN F. STAM, Counsel." (NOTE. For tables listing income tax for individuals, present and proposed, showing effect of tax exemption, see exhibit A in exhibits hereto.) LEGAL OPINION OF DAVID M. WOOD In addition to the statement of Mr. Stam, I quote from an opinion by Mr. David M. Wood, of New York: "The Constitution of the United States nowhere expressly declares that Congress has no power to tax the bonds of the States or of their subdivisions, or the income derived from such bonds. It is, however, equally silent regarding the power of the States to tax the bonds of the United States and the income derived from those bonds. The limitations upon the powers of Congress and of the State legislatures with respect to such taxation, therefore, if they exist at all, are implied limitations, and the intention to impose such limitations must be determined from a study of the entire Constitution and its historical background. "When, as a result of the American Revolution the Thirteen Colonies achieved their independence from Great Britain they became 13 independent nations, each jealous of its own sovereignty and suspicious and distrustful of its neighbors. Men at that time did not consider themselves Americans. They were Virginians, Pennsylvanians, New Yorkers, etc. No idea of national unity at that time existed except in the minds of a few remarkable men. At length, however, the necessity for a Federal Union of these 13 independent nations became apparent, and a convention was assembled which undertook the drafting of a Federal Constitution. The representatives of no State in this convention, however, had any intention of surrendering the sovereignty of their State to the new Federal Government which they hoped to set up, and yet it was necessary to vest in the new Government the attributes of sovereignty. The result was a compromise. The States delegated to the Federal Government some of their sovereign powers and reserved all others to themselves. Thus arose a system of dual sovereignty which has prevailed in this country ever since. "The Federal Government and the States, although both exist within the same territorial limits, are separate and distinct sovereignties, acting separately and independently of each other, within their respective spheres. The Federal Government, in its sphere, is supreme, but the States, within the limits of the powers which they have not granted to the Federal Government, are as independent of it as that Government, within its sphere, is independent of the States. "FEDERAL TAXING POWERS LIMITED "Of necessity, the Federal Government had to be granted the power of taxation, but certain limitations were imposed upon the exercise of that power. All direct taxes were prohibited, unless levied in proportion to the census, which the Constitution directed to be taken. This limitation should be remembered as it is one which affects the question under discussion. The States, however, reserved to themselves the power of taxation for State and local purposes. Thus it is quite possible for the States and the Federal Government to levy taxes upon the same source of revenue. Conflicts in the exercise of these respective taxing powers were almost inevitable, and the courts had occasion to decide cases arising out of these conflicts almost immediately after the establishment of the Federal Government. "Chief Justice Marshall, in McCulloch v. Maryland (4 Wheat. 316), pointed out that, if the States possessed the power to tax the Federal Government or the means or instrumentalities through which it exercised its constitutional powers, the Federal Government would be subordinate to the States. He declared the power to tax was the power to destroy, and that if it were conceded that the States possessed the power to tax the Federal Government or its governmental instrumentalities, they could impede, if not destroy, the Federal Government. To maintain the supremacy of the Federal Government, within its appropriate sphere, as the Constitution clearly intended, Chief Justice Marshall rendered his famous decision in McCulloch v. Maryland, that the States had no power, by taxation or otherwise, to impede, burden, or in any manner control the operation of the laws enacted by Congress to carry into effect the powers vested in the Federal Government. "Applying the principle announced in this decision, the same Court, in the case of Western v. Charleston (2 Pet. 449), held that an ordinance of the city of Charleston, S. C., attempting to tax securities issued by the United States, was unconstitutional. The Court pointed out that such a tax would inevitably fall upon the borrower, and that, in reality, it would be a tax upon the exercise of the power of the Federal Government to borrow money; in short, a tax upon the United States Government itself. That decision has been repeatedly followed by the Federal courts as well as by the courts of the various States. EARLY, DECISIONS NEVER SERIOUSLY QUESTIONED "But it is equally true to admit the power of the Federal Government to tax the States or the means or agencies through which they exercise their sovereign powers would subordinate the States to the Federal Government, which, likewise, was not intended by the framers of the Constitution. It follows, therefore, as a necessary corollary to the decisions in McCulloch v. Maryland and Weston v. Charleston that the United States cannot tax the governmental functions of the States. Accordingly we find the Supreme Court of the United States, in the case of Collector v. Day (11 Wall. 113) and in the United States v. Railroad Co. (17 Wall. 322), holding that the United States could not levy taxes upon bonds issued by an instrumentality of State government. These decisions likewise have not been seriously questioned since they were rendered generations ago. INCOME TAX LAW OF 1894 "In the year 1894, however, Congress passed a law providing for the taxing of income, including income derived from interest upon notes, bonds, or other securities, except certain bonds of the United States. It was contended that, while the bonds issued by the States or their instrumentalities of government could not be taxed by Congress, there was no reason why it could not tax the income derived from these bonds. The validity of this law was considered by the Supreme Court of the United States in Pollock v. Farmers Loan & Trust Co. (157 U. S. 429). Chief Justice Fuller, in delivering the opinion of the Court, said: "We think the same want of power to tax the property or revenues of the States or their instrumentalities exists in relation to a tax on the income from their securities * * * it is obvious that taxation on the interest therefrom would operate on the power to borrow before it is exercised, and would have a sensible influence on the contract, and that the tax in question is a tax on the power of the States and their instrumentalities to borrow money, and consequently repugnant to the Constitution.' "The income tax law of 1894 was held unconstitutional in this same case on still another ground. I have referred to the fact that the Constitution required an apportionment among the States, based upon the census, of any direct taxes levied by Congress. In the Pollock case the Court held that an income tax was a direct tax and as the tax had not been apportioned among the several States in proportion to the census it was unconstitutional. NECESSITY FOR THE SIXTEENTH AMENDMENT "This decision rendered the levy of income taxes by the Federal Government impracticable until the ratification of the sixteenth amendment, which provides as follows: "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.' "Upon the ratification of this amendment, indeed before it was ratified, it was contended that its effect would be to vest in Congress the power to levy taxes upon the income derived from State and municipal bonds, but when the Supreme Court of the United States had occasion to consider the effect of the amendment, it declared that it merely removed the requirement for an apportionment among the States of taxes laid upon income. Justice Van Devanter in Evans v. Gore (253 U. S. 245) said: ""Thus the genesis and words of the amendment unite in showing that it does not extend the taxing power to new or excepted subjects, but merely removes all occasion otherwise existing for an apportionment among the States of taxes laid on income, whether derived from one source or another.' "If the effect of the sixteenth amendment was not to extend the taxing power of Congress to new or excepted subjects, then it did not confer upon Congress power to tax the income from State and municipal securities, for such income had been excepted from the taxing power of the Federal Government. NATIONAL LIFE CASE "The Supreme Court of the United States has never had occasion to pass upon the constitutionality of an act of Congress attempting directly to tax income derived from State or municipal bonds, but in National Life Insurance Co. v. United States (277 U. S. 508) it was called upon to consider whether the effect of a statutory computation of deductions was to impose a tax upon the income of State and municipal securities. It held that the act did indirectly impose a tax upon such income and that insofar as it affected State and municipal bonds it was unconstitutional. Justice McKeynolds, in delivering the opinion of the Court, said: "It is settled doctrine that directly to tax the income from securities amounts to taxation of the securities themselves (Northwestern Mutual Life Ins. Co. v. Wisconsin, 275 U. S. 136). Also that the United States may not tax State or municipal obligations.' "In Willcuts v. Bunn (282 U. S. 216) Chief Justice Hughes said: "The well-established principle is invoked that a tax upon the instrumentalities of the States is forbidden by the Federal Constitution, the exemption resting upon necessary implication in order effectively to maintain our dual system of government. The familiar aphorism is "that if the means and instrumentalities employed by the General Government to carry out into operation the powers granted to it are exempt from taxation by the States, so are those of the States exempt from taxation by the General Government" (Ambrosini v. United States, 1, 7). And a tax upon the obligations of a State or of its political subdivisions falls within the constitutional prohibition as a tax upon the exercise of the borrowing power of the State. * * * "In the case of the obligations of a State or of its political subdivisions, the subject held to be exempt from Federal taxation is the principal and interest of the obligations (Pollock v. Farmers Loan & Trust Co., supra). These obligations constitute the contract made by the State, or by its political agency pursuant to its authority, and a tax upon the amounts payable by the terms of the contract has, therefore, been regarded as bearing directly upon the exercise of the borrowing power of the Government. In Weston v. Charleston (2 Pet. 449, 468, 469), where the tax, laid under an ordinance of the city council upon United States stock which had been issued for loans made to the United States, was held invalid,the principle was thus stated by Chief Justice Marshall: "The right to tax the contract to any extent, when made, must operate upon the power to borrow before it is exercised and have a sensible influence on the contract. The extent of this influence depends on the will of a distinct government. To any extent, however inconsiderable, it is a burden on the operations of government * * *. The tax on Government stock is thought by this court to be a tax on the contract, a tax on the power to borrow money on the credit of the United States, and consequently to be repugnant to the Constitution." This language was applied by the court in Pollock v. Farmers' Loan & Trust Co., supra (157 U. S. at p. 586) in holding invalid Federal taxation "on the interest" from municipal securities." (Italics mine.) OTHER RECENT CASES "In Indian Motorcycle Co. v. United States (283 U. S. 570) Justice Van Devanter said at page 576: "It has been adjudged that bonds of the United States issued to raise money for governmental purposes, and the interest thereon, are immune from State taxation, because such a tax, even though inconsiderable in amount and imposed only on holders of the bonds, would burden the exercise by the United States of its powers to borrow money. * * * And this immunity has been held to include bonds of a municipal corporation in a territory issued to raise money for municipal purposes, the decision being put on the ground that such a corporation is an instrumentality of the United States exercising delegated governmental powers. It also has been adjudged that bonds of municipal corporations in the several States issued to raise money for public municipal purposes, and the interest thereon, are immune from Federal taxation, and this on the ground that such corporations are representatives of the States and exercise some of their powers, and that under the implications of the Constitution the governmental agencies and operations of the States have the same immunity from * * * Federal taxation that like agencies and operations of the United States have from taxation by the States. (Italics mine.) "In Educational Films Corporation v. Ward (282 U. S. 379), Mr. Justice Stone declared that, 'this Court, since McCulloch v. Maryland (4 Wheat. 316) has consistently held that the instrumentalities of either government, or the income derived from them, may not be made the direct object of taxation by the other * * *' (Italics mine.) REVERSAL OF DECISIONS NOT PROBABLE "To my mind it is inconceivable that the Supreme Court of the United States would reverse a long line of decisions extending from John Marshall's time down almost to the present date, and sustain, as constitutional, an act of Congress levying a tax on the income derived from State and municipal securities. The recent opinions, above quoted, clearly indicate that the court would hold such an act unconstitutional. Indeed, were it to do otherwise, it would open a Pandora's box of evils. If Congress is not prohibited by the Constitution from taxing the income from State and municipal bonds, then the States are not prohibited from taxing the income derived from bonds issued by the Federal Government. The consequences of such a decision would be very far-reaching, but I do not intend to indulge in needless speculation upon them, as I am firmly convinced that it would never be rendered. "Lest I be misunderstood, let me make it perfectly clear that I have been discussing taxes levied by Congress directly upon the income derived from State and municipal securities. Such securities, and the income derived therefrom, may be made, indirectly, the subject of taxation, as, for instance, through the levy of inheritance taxes, or corporation franchise taxes, etc. An inheritance tax is not a tax upon the security, but upon the right to inherit, and it may be measured by the value of the inheritance, notwithstanding the fact that the property passing may consist wholly of tax-exempt securities. Likewise franchise taxes have been sustained, which are measured by the corporate income, including income from tax-exempt securities. Such taxes are taxes upon the right to exercise the corporate franchise, and are not taxes upon the securities themselves. Other forms of excise taxes exist or may hereafter be devised, which may, indirectly, affect State and municipal securities. These taxes, however, are not within the scope of this opinion. "If the taxation of income from State and municipal bonds is desirable, the remedy lies in a constitutional amendment. In that way the extent to which such taxation might be permitted could be definitely fixed, and the desired result could be accomplished, without endangering the existence of the dual system of government, which, with all its frictions and imperfections, has worked remarkably well. UNDER CONSTITUTIONAL AMENDMENT, OUTSTANDING AS WELL AS NEW BONDS "The question is sometimes asked whether, under such a constitutional amendment, Congress could tax the income of outstanding State and municipal bonds, or whether it would be limited to taxation of income from bonds issued after the ratification of the amendment. The answer to that question would depend upon the terms of the amendment. There is nothing to prevent the amendment of the Constitution so as to confer upon Congress the power to tax the income from all outstanding State and municipal bonds. Indeed, Congress might be authorized to tax the bonds themselves. That would not amount to a breach of contract on the part of the Federal Government. The Federal Government has entered into no contract with the holders of State and municipal bonds to refrain from taxing them or the income derived from them. The only contract which exists is between the State or municipality which issued the instrument and the holder, a contract to which the United States is not a party. The reason taxes are not now levied by Congress upon income derived from such securities is only because of the fact that the taxing power of Congress does not extend to that subject and not because of any contract made by the United States with the holder of the bonds to refrain from taxing them or the income derived from them. "Whenever the people of the United States determine to vest in Congress, by constitutional amendment, the power to tax State and municipal bonds or the income derived therefrom, Congress will possess that power to whatever extent the people grant it, but, until such a constitutional amendment is ratified, Con |