the salaries of all civil officers of the United States, which included, in their literal application, the salaries of the President and of the judges of the United States. The question arose whether the law which imposed such a tax upon them was constitutional. The opinion of the Attorney General thereon was requested by the Secretary of the Treasury. The Attorney General, in reply, gave an elaborate opinion advising the Secretary of the Treasury that no income tax could be lawfully assessed and collected upon the salaries of those officers who were in office at the time the statute imposing the tax was passed, holding on this subject the views expressed by Chief Justice Taney. His opinion is published in volume XIII of the Opinions of the Attorneys General, at page 161. ́ I am informed that it has been followed ever since without question by the department supervising or directing the collection of the public_revenue.'

This question again arose under the Revenue Act of 1918 in Evans v. Gore (253 U. S. 245). Evans, a United States district judge for the western district of Kentucky, was appointed by the President, with the advice and consent of the Senate, in 1899. The Government taxed his salary under the Revenue Act of 1918, which included as income, for the purpose of the income tax, the salaries of the judges of the inferior courts of the United States. The Supreme Court held that the taxation of such income amounted to a diminution of salary in the constitutional sense and, therefore, was unconstitutional.

The decision in this case was rendered by Justice Van Devanter, and there were two dissents, making it a 7–2 decision. This case settled the question as to the taxability of the salaries of Federal judges appointed prior to the enactment of the income-tax law. It left open the question as to the right of Congress to tax the salaries of Federal judges appointed after the taxing act became effective. The court attempted to pass upon this last question in the case of Miles v. Graham (268 U. S. 501), in which a judge of the Court of Claims sued to recover the income tax paid on his salary for the years 1919 and 1920. This judge assumed office on September 1, 1919, which was after the date of the enactment of the Revenue Act of 1918 (Feb. 24, 1919), under authority of which the Government collected the tax. The Supreme Court also held this tax invalid, Justice McReynolds rendering the opinion. There was one dissent; so this was an 8-1 decision.

The difficulty with this decision is that judges of the Court of Claims are not judges of constitutional courts, but are judges of legislative courts. Therefore, the application of the constitutional provision preventing their salaries from being diminished during their term of office was erroneous. This was brought out very clearly in subsequent decisions of the Supreme Court, namely, Ex parte Bakelite Corporation (279 U. S. 438), and Williams v. United States (289 U. S. 553). Therefore, judges of the Court of Claims, being judges of a legislative court and not of a constitutional court, should not have been exempted from the income tax under any theory.

Among other legislative courts which might be mentioned are the Court of Customs and Patent Appeals and the territorial courts. The constitutional courts consist of the district courts of the United States, the circuit court of appeals of the United States and the Supreme Court of the United States, including the Supreme Court of the District of Columbia, and the United States Court of Appeals for the District of Columbia.

In the Revenue Act of 1932, Congress has by legislation attempted to subject to the income tax the salaries of all judges, constitutional or otherwise, taking office after June 6, 1932, the date of the enactment of that act, and has amended all such acts, fixing the compensation of the judges accordingly. Whether this provision will be upheld in view of the decisions of the court already referred to, is problematical. At any event, judges of all constitutional courts who took office prior to June 6, 1932, are exempt from the income tax. Not only are judges of constitutional courts exempt from the income tax, but the court also held that they were not subject to the provisions of the Economy Act; for, to apply the Economy Act to them, would, according to the court, violate the constitutional provision preventing their salaries from being reduced during their term of office. This was decided in the case of O'Donohue v. United States (289 U. S. 516).

In the case of judges of constitutional courts who retire instead of resigning, their retirement pay is also not subject to reduction by Congress; nor is it subject to the income tax. This was brought out in Booth v. United States (291 U. S. 339), in an opinion rendered by Justice Roberts in 1934, to which there were no dissents. Judges who resign instead of retiring are no longer in office in the constitutional sense, and, therefore, the compensation received by them after resigning is subject to the income tax and to reduction by the Congress. For instance, Justice Holmes' salary was reduced under the Economy Act and also made subject to the income tax.

EXCERPTS FROM REPORT TO JOINT COMMITTEE ON INTERNAL REVENUE TAXATION PURSUANT TO SECTION 1203 (B) (6), REVENUE ACT OF 1926, ON "THE TAXING POWER OF THE FEDERAL AND STATE GOVERNMENTS"

1. STATE SECURITIES

(1) Development of doctrine of State immunity

The Federal Government has no power to tax the obligations or the interest therefrom of a State or political subdivision. This limitation is not based upon any express prohibition in the Constitution but is implied from the independence of the National and State Governments within their respective spheres and from the provisions of the Constitution looking toward the maintenance of our dual system of government. It first developed from the doctrine announced by the Supreme Court in McCulloch v. Maryland,1 decided in 1819. In that case Chief Justice Marshall, who rendered the opinion, held that a State could not constitutionally impose a tax upon notes issued by the Bank of the United States. For the same reason it was held in 18292 that the city of Charleston could not tax securities issued by the United States. In 1870 the Supreme Court, in an opinion rendered by Mr. Justice Nelson in Collector v. Day, made it clear that this prohibition was reciprocal in character and that, therefore, Congress has no power under the Constitution to tax State officers or employees. In that case the Federal Government assessed an income tax levied under the act of 1864 against the salary of J. M. Day, a judge of the Court of Probate and Insolvency for the County of Barnstable, Mass. The salary was fixed by law and payable out of the treasury of the State. Day paid the tax and brought suit to recover. holding the tax unconstitutional, the Supreme Court relied upon the case of McCulloch v. Maryland and the Dobbins case, already cited. Its argument may be summed up by the following statement taken from the opinion:

In

"It is admitted that there is no express provision in the Constitution that prohibits the General Government from taxing the means and instrumentalities of the State, nor is there any prohibiting the States from taxing the means and instrumentalities of that Government. In both cases the exemption rests upon necessary implication and is upheld by the great law of self-preservation; as any government, whose means employed in conducting its operations is subject to the control of another and distinct government, can exist only at the mercy of that government. Of what avail are these means if another power may tax them at discretion?"

Two years later the case of United States v. Railroad Company was decided, which held that the Federal Government could not levy a tax on revenue paid to the city of Baltimore. However, it was not until the Pollock case 5 that the Supreme Court specifically held that the Federal Government could not tax the income from securities issued by States or political subdivisions thereof. Chief Justice Fuller, who delivered the opinion of the Court, made the following statement as to this point:

"It is contended that, although the property or revenues of the States or their instrumentalities cannot be taxed, nevertheless the income derived from State, county, and municipal securities can be taxed. But 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, and for the same reason; 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 Pollock case held the 1894 act unconstitutional, not only on the ground that it taxed the income from State securities but also on the ground that a tax on the income from property was a direct tax and, therefore, invalid because not apportioned according to population. This last ground was the primary cause of the adoption of the sixteenth amendment, which provides that "The Congress shall have the 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." The first draft of this amendment did not contain the clause "from whatever source derived", this being inserted later. For

some time it was contended that this clause permitted the taxation of the income from State bonds by the Federal Government. In an article appearing in Fortune magazine of October 1933, Mr. Murray I. Gurfein, assistant United States attorney for the southern district of New York, makes the following comment as to this point:

"After the resolution had been passed by Congress and while ratification was pending, Governor Hughes, of New York (the present Chief Justice), raised this question. He informed his legislature that he thought that the amendment was broad enough to permit the taxation of income from State securities and that it should, therefore, not be ratified. The Hughes message raised a storm of debate. Elihu Root denied that the amendment was subject to such construction. Senator Borah also disagreed with Governor Hughes. Professor Seligman argued that the only purpose of the amendment was to permit an income tax not apportioned according to population. On the other hand, Senator Brown, sponsor of the amendment, thought that the Hughes construction was tenable, but that the amendment ought, nevertheless, to be ratified. Eminent members of the bar, opposing the amendment, presented a memorial to the New York Legislature in accord with the Hughes view. Governors of other States who made public declarations were divided in opinion. In the face of these legalistic conflicts the amendment was ratified."

(2) Present status

6

However, since the sixteenth amendment applies only to the Federal Government and not to the States, it could not be construed as giving the States any authority to tax the income from Federal securities. Moreover, in 1920, the Supreme Court in Evans v. Gore, held that the sixteenth amendment conferred no new power on Congress to tax as income something which Congress could not tax as income prior to the adoption of the sixteenth amendment. In this connection Justice Van Devanter 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."

That the Federal Government has no power to tax the income of State securities, notwithstanding the provisions of the sixteenth amendment, is further established in the case of the National Life Insurance Company v. United States." In that case an act of Congress taxing incomes of insurance companies granted a deduction for income-tax purposes equal to 4 percent of their reserve. Under the terms of the statute this deduction was considerably restricted if the taxpayer received income from tax-exempt securities. The Court held that such a method of taxation constituted a discrimination against the holders of tax-exempt securities and was, therefore, invalid. Other cases, Willcuts v. Bunn,3 Indian Motocycle Company v. U. S., and Educational Films Corp. v. Ward, 10 all reaffirm the principle that the Federal Government has no power to tax the securities of a State or political subdivision or the income therefrom. In an opinion rendered by the Supreme Court on May 25, 1936,11 in connection with a water-improvement district of the State of Texas seeking relief under a Federal bankruptcy statute, the Court said:

"Notwithstanding the broad grant of power "to lay and collect taxes", opinions here plainly show that Congress could not levy a tax on the bonds issued by respondent or upon income derived therefrom.

"The difficulties arising out of our dual form of government, and the opportunities for different opinions concerning the relative rights of State and National Governments are many; but for a very long time this court has steadfastly adhered to the doctrine that the taxing power of Congress does not extend to the States or their political subdivisions. The same basic reasoning which leads to that conclusion, we think, requires like limitation upon the power which springs from the bankruptcy clause."

6 253 U. S. 245; see also Eisner v. Macomber (252 U. S. 189).

7 277 U. S. 508.

8 282 U. S. 216.

9 283 U. S. 570.

10 282 U. S. 379.

11 Ashton et al. v. Cameron Co., Water Improvement District No. 1 (56 Supreme Court 892).

(3) Indirect effect on borrowing power

But the Court will not invalidate a tax where it only remotely interferes with the borrowing power of the States. Thus, in Denman v. Slayton, 12 the Supreme Court upheld the provisions of the Revenue Act of 1921 denying deductions of interest on money borrowed to purchase or acquire tax-exempt securities of a State or political subdivision even though the Federal Government could not tax the interest from such securities. Furthermore, in Willcuts v. Bunn it was held that the Federal Government could tax as income the gain from the sale of the securities of a State or political subdivision. Also the Court has held that Congress has the power to reach by means of privilege taxes State securities or the income therefrom. Thus, in Greiner v. Lewellyn,13 it was held that municipal bonds owned by the decedent may be included in the gross estate for the purpose of the Federal estate tax on the ground that an estate tax is a tax on the privilege of transferring property at death, and not a tax on the securities themselves. And in Flint v. Stone Tracy Co.,14 the Supreme Court upheld the corporation excise tax of 1909 which taxed the privilege of carrying on or doing business by corporations, but measured the tax by the net income of the corporation from all sources. Since the subject of the tax was an exercise fo a franchise or privilege, the court held it was proper for Congress to include in the measure of the tax the income from tax-exempt securities, although such income could not be directly taxed.

(4) Suggested remedies

Several remedies have been suggested to overcome this constitutional limitation. Briefly, these are as follows:

First, the Federal Government could tax the income from subsequent issues of its own securities and the States could tax the income from subsequent issues of their securities. This would not violate the constitutional provision. Of course, the States could not tax the income from past issues, as the Constitution specifically provides that no State shall impair the obligations of a contract. Furthermore, the Federal Government could not tax its past issues, for to do so would constitute a violation of the due process clause of the fifth amendment. This suggestion has certain practical difficulties, for unless both the States and the Federal Government acted simultaneously it would permit one government to gain an additional field for revenue at the expense of the other.

Second, the rate of tax might be computed upon the total income of the taxpayer, including his income from tax-exempt securities, and then applied only to the taxable income. While this plan has possibilities, it is believed that it violates the principle announced by the Supreme Court in the National Life Insurance Company case, cited supra, in which the Court said: "One may not be subjected to greater burdens upon his taxable property solely because he owns some that is free.

Third, Congress might grant to the States the power to tax the income from Federal securities if the States would grant a similar privilege to the Federal Government. However, this plan is not entirely free of constitutional doubts since the Supreme Court has stated that "Neither consent nor submission by the States can enlarge the powers of Congress; none can exist except those which are granted. ((Butler v. Ünited States, decided Jan. 6, 1936.15) The sovereignty of the State essential to its prlper functioning under the Federal Constitution cannot be surrendered; it cannot be taken away by any form of legislation." 16 On the other hand, the Federal Government gives the States the power to tax national bank shares, and this has been upheld by the courts.17

In

Fourth, there is a possibility that the income from tax-exempt securities might be reached through an excise tax measured by the net income from all sources. the case of corporations, it seems clear that this can be done. As already pointed out, 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 the 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.18 Moreover, some of the States through

12 282 U. S. 514.

13 258 U. S. 384. 14 220 U. S. 107.

15 297 U. S. 1.

16 Ashton v. Cameron Company, Water Improvement District No. 1 (56 Sup. Ct. 892).

17 See cases cited in Baltimore National Bank v. State Tax Commission of Maryland (297 U. S. 209). 18 Flint v. Stone Tracy Company (220 U. S. 107).

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. 19 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 a 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. 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 form 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.

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. This 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.

Fifth, tax-exempt securities might be subject to a higher estate tax than other property of the decedent on the theory that such securities had escaped income tax during the decedent's lifetime. However, it is believed that this plan would fall counter to the National Life Insurance case, already referred to.

Sixth, the States and the Federal Government could pass a constitutional amendment giving both the authority to tax the securities of each other. This last suggestion would undoubtedly overcome all legal objections. However, from a practical standpoint, it might be impossible to secure a sufficient number of States to agree to the adoption of such an amendment unless certain restrictions were placed on the rate of tax which could be imposed on the income of such securities

2. FEDERAL SECURITIES

(a) Development of doctrine of Federal immunity

The Constitution 20 gives Congress the power to borrow money on the credit of the United States. This is a limitation upon State taxing power. A State has no right by taxation to burden this power, either directly or indirectly. For instance, it is elementary that bonds or other securities of the United States may not be taxed by State authorities, for if this were permitted the power of Congress to borrow money on the credit of the United States would be burdened and might be destroyed for that purpose. In the case of Weston v. Charleston 21, the court held that stock issued for loans made to the Government of the United States is not liable to be taxed by State or municipal corporations. In this connection, the court made the following statement:

"The American people have conferred the power of borrowing money on their Government, and by making that Government supreme, have shielded its action, in the exercise of this power, from the action of the local government."

United States notes, although issued as currency, are nevertheless national obligations and are exempt from State taxation 22 and the Federal Government may exempt bonds of its instrumentalities, created pursuant to constitutional authority, from State taxation.23

19 Pacific Company v. Johnson (285 U. S. 480).

20 U. S. Constitution, art. I, sec. 3, cl. 2.

21 2 Pet. 449; see also Bank of Commerce v. New York (2 Black. 620); Bank Tax case (2 Wall. 200).

22 Bank of New York v. Supervisors (7 Wall. 26).

23 Smith v. Kansas City Title & Trust Company (255 U. S. 180).