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* A clearer comprehension of the issue between the majority and minority of
the court in this case will perhaps be aided by conceiving the following set of
facts: The X W Z corporation, chartered under the laws of state M, is capitalized
at one million dollars. A buys one hundred shares of stock at par, which is
$100. Later the company accumulates a surplus of $200,000, with the result
that A's stock is now worth $120 per share. At this moment the directors take
up the question of what should be done with the surplus, and five possible courses
are found to be open: 1. The surplus, which is at present held, let us suppose,
in stock of the ABC corporation, may be liquidated and paid in cash to the
stockholders of the X Y Z corporation. By Lynch v. Hornby (247 U. S. 339),
A's share of the dividend, though extraordinary in amount and based upon
earnings, or even upon increase in the value of the corporation assets, which
accrued before the Sixteenth Amendment was added to the Constitution, is tax-
able income under the amendment. 2. Or the surplus may be paid in the stock
held in the ABC company, in which case A's share of it is, by Peabody v. Eisner
(247 U. S. 347), still taxable as income, under the same conditions as before.
3. Or the directors may decide that it is desirable to increase the capital assets
of the company to the amount of the surplus, and with that end in view, they
may arrange for an increase of stock to the amount of $200,000, to be oifered to
the stockholders pro rata at par at the same time that the cash dividend is paid
as under "1." In this case too, it appears, A would be taxed on his share of
the dividend whether he availed himself of the option to subscribe for his pro
rata of the new stock or not (see J. Brandeis' dissenting opinion in Eisner v.
Macomber). 4. Or the directors might decide to transfer the surplus directly
to the capital account of the company and vote*no dividend at all. In this case
A's share of the benefit would still appear in the fact that his original stock stood
at a premium, but probably would be taxable as income only if he sold this stock
and then only to the extent that the proceeds of the sale represented a profit
accruing to him — not the company — since 1913, the date when the Sixteenth
Amendment was added to the Constitution (see Justice Pitney's opinion in
Eisner v. Macomber). 5. Or finally, the directors might decide to transfer the
surplus to the capital account of the company by issuing $200,000 worth of new

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Justice Pitney's argument nins, in substance, as follows: In the first
place, he points out the obvious fact that the stockholder is not enriched
by the new stock since this has absorbed the premium on his original
holding; instead, for instance, of owning 1000 shares valued at $120
each, he now owns 1200 shares valued at $100 each. But that this
fact is immaterial to the case is shown by the equally obvious fact that
the same effect would result from a cash dividend of like size. Before
the payment of the dividend, the owner's stock would be worth $120
a share; after it, it would be worth only $100, but the difference would
be in his pocket, and taxable, the cases show, as income. In the latter
case, in other words, Congress is permitted to take account of the fact
that the stockholder has been enriched in consequence of the earnings
of his company, while in the former case, by the decision under review,
it is not permitted to do so.

In the second place. Justice Pitney makes much of the fact that a
stockholder's share of a stock dividend is necessary to entitle him to
his original participation in the control of the company and in future
dividends. Suppose, he says, the shareholder has not the wherewithal
to pay an income tax upon his dividend stock; then, of course, he would
have to sell some of this stock, and with it a proportionate share of his
voting power in the corporation. "Nothing," Justice Pitney continues,
''could more clearly show that to tax a stock dividend is to tax a capital
increase, and not income, than this demonstration that in the nature
of things it requires conversion of capital in order to pay the tax."
But the very question at issue is whether a stock dividend is capital or
income. Grant, however, that it is capital, because it carries with it
"a right preservative of rights" in the control of the corporation, still
the question arises, how did the stockholder come into possession of it?
The answer is obvious: It was bought for him by his duly authorized
agent, the corporation, out of funds earned by that agent for his benefit,
which benefit is now returned to him in the form of the same relative
control indeed, but over a larger capital investment.

In the third place. Justice Pitney points out that a stock dividend
takes nothing from the property of the corporation. But the answer
again is clear. The very purpose of a stock dividend is to add to the
property of the corporation, that is to say, its fixed capital. What was

stock against it, the new shares to be distributed among the stockholders pro
rata. A's share of the distribution would be 200 shares, representing a value
of $20,000; and by Macomber v. Eisner would not be taxable as income under the
Sixteenth Amendment, that is, without apportionment.

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a fund out of which cash dividends might have been paid, is now trans-
ferred permanently to the active assets of the company. The original
question, therefore, still remains. What was the source of this fmid;
and also, what was the nature of the transaction by which it was added
to the corporation's permanent capital? Obviously the fimd came
from the earnings of the corporation, that is of the stockholders acting
through a corporate agent, and its permanent transference to capital
account was a further investment effected by the stockholders through
the same agency, in the business thus conducted.

But this point is worth scrutinizing a little further, since it embodies
an idea which underlies Justice Pitney's entire argument. This is
that the corporate surplus against which a stock dividend is issued is,
as to stockholders, capital even before the dividend is issued, that
indeed the issuance of the dividend is * 'merely bookkeeping." It must
of course be conceded to Justice Ktney that, by the law ordinarily
governing corporations, no stockholder has "a right to any particular
portion of the assets'' of the corporation "unless or until the directors
conclude that dividends shall be made and a part of the company^s
assets segregated from the common fund for the purpose." Never-
theless, we are also confronted with the palpable fact that where a
corporate surplus has accumulated, the stock-holder has been thereby
enriched. The question accordingly arises, why may not Congress,
penetrating the corporate veil, proceed to treat the stockholder's
interest in an undistributed corporate surplus as income, and so taxable
under the Sixteenth Amendment?

Jusrt.ice Pitney bases his answer to this question on his reading of
the words "incomes from whatever source derived" of the amendment
itself. These, he contends, set forth "a fundamental conception" of
income as something "severed from capital." And from this it follows,
he urges, that "we must treat the corporation as a substantial entity
distinct from the stockholders," and that in fact, "it is only by recog-
nizing such separateness that any dividend — even one paid in money
or property — can be regarded as income of the stockholder."

The argument qeems far-fetched, to say the least. If we regard the
history of the Sixteenth Amendment, all that the words which Justice
Pitney so much labors signify is that Congress may tax without resort
to the rule of apportionment all incomes however produced — ^that and
nothing more. Yet without this aid from the amendment, what
becomes of Justice Pitney's apotheosis of the corporate entity? That
the power of Congress may not be obstructed by the corporate entity

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or any of its attributes from reaching what is, but for the corporation's
intervention, stockholders' income, must follow from fundamental
principles. The corporate entity is not the offspring of the Constitu-
tion, nor is it adopted by the Sixteenth Amendment; it is the creature
exclusively of statute law, and whether such statute law comes from
Congress itself or from a state, it is necessarily subordinate to the
constitutional power of Congress over taxation.

Moreover, what does Justice Pitney mean when he says that income
must be "severed" from its source — severed in what sense? Is, for
example, the interest which is left by a depositor in a bank to draw
further interest severed from the capital which produced it? Or take
the instance mentioned by Justice Brandeis in his dissenting opinion.
As he there points out, "the year's gains of a partner are taxable as
income," even though there has been no segregation of his share in the
total gains of the partnership. "CleUrly," Justice Brandeis concludes,
"segregation of assets in the physical sense is not an essential of income."
Indeed it is to be feared that Justice Pitney will tell us next that there
are no incomes except such as are constituted from corporate dividends
formally declared, in which case he will have approximated to the
Reverend Mr. Capstick's thesis with regard to the relation of sin and

This brings us to the final turn in Justice Pitney's argument, and
perhaps its most significant one. It consists of an appeal to the defini-
tion of "direct tax," laid down in the Pollock case of 1895 as a tax on
property "because of ownership," which is shortly followed by the
caution that the constitutional provision requiring that such taxes be
apportioned "still has an appropriate and important function," and,
at a considerable distance, by the assertion that "enrichment through
increase in value of capital investment is not income in any proper
meaning of the word." The argument thus insinuated clearly rests
upon the assumption already dealt with, that a corporate surplus is to
be treated as capital — or capital increase — prior to dividend declared,
and so adds no independent force to Justice Pitney's position. It may,
however, indicate the feeling of the court that it must henceforth
endeavor to distinguish capital earnings and capital accretions, and
when the two are merged to treat the whole as capital. The danger
is that such an idea would, if persisted in, eventually so entangle the
power of Congress to tax incomes in "a net work of juridical niceties"
as to disable it entirely.

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How, then, are we to assess Eisner v. Macomber at the present
moment? That it falls in line with earlier decisions under the amend-
ment and even farther back* is apparent, and this fact — ^it is equally

* The first of these is Gibbons v. Mahon (136 U. S. 548) in which the court,
following what is called "the Massachusetts rulci" decided that as between the
holder of a life interest in an estate and the remainder man, the latter was entitled
to receive a stock dividend. The decision turns of course upon the proposition
that a stock dividend is not income and for this proposition the court urges
several of the arguments which are reviewed above in Justice Pitney's opinion.
The second precedent lies nearer to hand. It is the case of Towne v. Eisner
(245 U. S. 418), in which the question at issue was whether the word "income''
as used in the Act of 1913 included stock dividends. A unanimous court, speak-
ing through Justice Holmes, who is a dissentient in Eisner v. Macomber, said
no. It is true that Justice Holmes took pains to state in his opinion that the
word "income'' did not "necessarily'' mean "the same thing in the Constitution
and in the act" under review, but thi^ does not prevent him from anticipating
Justice Pitney ixv repeating the arguments which had been advanced in the Gib-
bons' case, arguments which are equally available, it would seem, to define the
term "income" wherever it occurs. But the really compelling precedent is the
decision in Lynch v. Hornby, which was noted above. This decision, clearly,
could have been reached only by regarding the corporation and the stockholder
as distinct entities, nor indeed could the tax there involved have been sustained
under the Sixteenth Amendment on any other assumption. The majority of the
court accordingly felt in the Macomber case, that Congress, having profited so
conspicuously by this idea, ought also to shoulder its disadvantages. Indeed,
Justice Brandeis himself virtually admits this degree of justification for the
court's decision. He says:

"The equivalency of all dividends representing profits, whether paid in cash
or in stock, is so complete that serious question of the taxability of stock divi-
dends would probably never have been made if Congress had undertaken to tax
only those dividends which represented profits earned during the year in which
the dividend was paid, or in the year preceding. But this court, construing
liberally not only the constitutional grant of power, but also the Revenue Act
of October 3, 1913 [38 Stat, at L. 114, chap. 16, Comp. Stat. § 5291, 2 Fed. SUt.
Anno 2d ed. p. 724], held that Congress might tax, and had taxed, to the stock-
holder, dividends received during the year, although earned by the company
long before, and even prior to the adoption of the 16th Amendment. Lynch v.
Hornby, 247 U. S. 339, 62 L. ed. 1149, 38 Sup. Ct. Rep. 543. That rule, if indis-
criminatingly applied to all stock dividends, representing profits earned, might,
in view of corporate practice, have worked considerable hardship, and have
raised serious questions."

Recurring to Gibbons v. Mahon, it should be noted that the "Massachusetts
rule" has been generally rejected by the state courts in favor of the "Pennsyl-
vania," or as it is often called, the "American rule," which is that "where a
stock dividend is paid, the court shall inquire into the circumstances imder
which the fund had been earned and accimiulated out of which the dividend,
whether a regular, an ordinary, or an extraordinary one, was paid. If it finds

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evident — must constitute its principal justification. On the other
hand, no more than its predecessors does it yield any clear cut theory
of * 'income." Justice Ktney, to be sure, tells us that the word is used
in the amendment in its '^ordinary sense," but his own pursuit of this
will-o-the-wisp appears to have landed him in a bog. Justice Brandeis,
in his dissenting opinion, proffers, more or less casually, ''the year's
gains" as a definition, and certainly if any one feature presents itself
to "ordinary sense" as demarking income from capital, it is its strict
contemporaneity — ^income is current profits, capital is accumulated
profits. Indeed, were the exactions of Congress to be confined to gains
of the tax year, or approximately so, it may well be doubted whether
it would ever be necessary for the court to concern itself with distinc-
tions between capital increments and earnings, or even between the
corporate entity and stockholders. Furthermore, this definition would
slam the door once and for all on retroactive tax proposals, such as
appeared in Congress last spring in connection with the Bonus Bill.
Tliat the court should ever have opened the door to such proposals is
quite inexplicable, but having done so, it requires no seventh son of a
seventh son to foresee that sooner or later it will have occasion to
retr^kce some of its steps, not merely in deference to the distinction
between "income" taxes and "direct" taxes, but to that between
taxation and confiscation.^ Altogether the case is important rather as
a point of departure than for final results.

2-. Taxation of Judicial Salaries

In Evans v. Gore^ the court held that a general income tax levied,
albeit without discrimination, upon the salaries of federal judges con-
that the stock dividend was paid out of profits earned since the decedent's
death, the stock dividend belongs to the life tenant; if the court finds that the
stock dividend was paid from capital or from profits earned before the dece-
dent's death, tl^e stock dividend belongs to the remainderman." Justice
Brandeis, citing Earp's Appeal, 28 Pa. St. 368. It should also be noted that the
Massachusetts Supreme Judicial Court has refused to regard the "Massachusetts
rule" as pertinent in determining whether a stock dividend is "income" for
purposes of taxation, which is accordingly held to be the case. Trefrey v.
Putnam, 227 Mass. 522.

* See in this connection a communication by Charles Robinson Smith in the
Weekly Review, June 22, 1920. Retroactive income taxes — supposing there can be
such a thing — are obviously a double injustice when the rate of taxation is pro-
gressive, for then the past accumulation swells the rate at which the total income
is. taxed.

' 262 U. S., decided June 1, Justices Holmes and Brandeis dissenting.

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stitutes a ' 'diminution" of such salaries within the meaning of the
Constitution/ and so held void section 213 of the Income Tax Act of
February 24, 1919. Justice Van Devanter, speaking for the court,
insists strongly upon the importance in the minds of the f ramers of the
Constitution of the idea of judicial independence,^ and from this
deduces the conclusion that the constitutional provision involved is to
be construed, not as a private grant, but as a limitation imposed in the
public interest, and, therefore, broadly. So far he is imquestionably
right, as also he is in claiming the support of precedent for the decision,
notwithstanding the subsequent intervention of the Sixteenth Amend-
ment, since it has been repeatedly ruled by the court in recent cases that
this amendment 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 incomes."^

Nevertheless, this decision can hardly avoid the charge, on the one
hand of pedantry, on the other hand of missing essential distinctions.
Thus Justice Van Devanter cites previous cases for such propositions
as, that the power to tax carries with it the power ''to embarrass and
destroy," the power "to select one calling and omit another,"** etc.
The answer is that a tax which selected judicial salaries for peculiar
burdens would be unconstitutional on the face of it, but that the tax
before the court made no such discrimination, and as Justice Holmes
puts it in his dissenting opinion, there is no good reason why a federal
judge should be exonerated "from the ordinary duties of a citizen,

''Article 3, section 1, which reads as follows: "The judicial power of the
United States shall be vested in one Supreme Court, and in such inferior courts
as the Congress may from time to time ordain and establish. The judges, both
of the supreme and inferior courts, shall hold their offices during good behavior,
and shall, at stated times, receive for their services a compensation which shall
not be diminished during their continuance in office."

" Quoting from the Federalist, Nos. 78 and 79; Marshall's speech in the Virginia
Convention of 1829; Sparks' Writings of Washington^ Vol. 10, pp. 35-36; Story's
CornmerUaries, Vol. 2, § 1628; Kent's Commentaries, Vol. 1, p. 294; Woodrow
Wilson's Constitutional Government, 17, 142.

•Citing Brushaber v. Union P. R. Co., 240 U. S. 1; Stanton v. Baltic Min.
Co., ibid,, 103; W. E. Peck & Co. v. Lowe, 247 U. S. 165; and Eisner v. Macomber

"Citing M'CuUoch v. Maryland, 4 Wheat. 316; Pacific Ins. Co. v. Soule, 7
Wall. 433; Austin v. Boston, 7 Wall. 694; Veazie Bank. v. Fenno, 8 Wall. 533;
Knowlton v. Moore, 178 U. S. 41 ; Treat v. White, 181 U. S. 264; McCray v. United
States, 195 U. S. 27; Flint v. Stone Tracy Co. 220 U. S. 107; Billings v. United
States, 232 U. S. 261; Brushaber v. Union P. R. Co. 240 U. S. 1.

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which he shares with all others." And in the same spirit should be
answered Justice Van Devanter's poser: "Of what avail to him [the
judge] was the part which was paid with one hand and then taken
back with another?" It was of just this avail, that it enabled him to
discharge a civic duty by contributing his proper share to the support
of the government which gives him protection.

Moreover, in strict logic, the decision actually invites the very thing
which it is intended to prevent. What the Constitution forbids is a
diminution of salary during the term of the incumbent. What, then,
is to prevent Congress, in view of the idea that the power to tax carries
with it the power to make discriminations, from taxing salaries of
future appointees to the federal bench at an especially high rate? In
the case of the President, an even more curious result follows. His
salary may be neither diminished nor increased during his term." If,
therefore, a President entered office under an act which taxed his salary
as income, this tax could not be removed during the entire four years
for which he was elected. As to all others the tax, supposing it to be a
general one, might be repealed but the Presiderft would have to con-
tinue paying it to the end of the chapter.

A more serious aspect of Evans v. Gore is the intention which it
manifests on the part of the court to sustain indefinitely the immunity
of salaries of state officials and of incomes from state and municipal
bonds from federal taxation. This immunity follows mathematically
from the proposition that the Sixteenth Amendment does not increase
the taxing power of Congress, when this is read in the light of the
decision in Collector v. Day,^^ which is one of the precedents relied

" Article 2, section 1, which reads: ''The President shall, at stated times, re-
ceive for his services a compensation, which shall neither be increased nor dimin-
ished during the period for which he may have been elected, and he shall not
receive within that period any other emolument from the United States or any of

"11 Wall. 113. In passing the Income Tax Law of 1919 Congress refused to
treat interest received from bonds issued by a state or any of its counties or
municipalities as within the taxing power (Cong. Rec., Vol. 67, pp. 653, 774-
777, 2988; ch. 18, § 213, 40 Stat., at L. 1065, Comp. Stat. § 6336i ff.); and in the
regulations issued under that law the administrative officers recognize that the
salaries and emoluments of the officers of a state and its political subdivisions
are not taxable by the United States (Reg. 45, published 1920, pp. 47, 313).
Indeed, the provision pronpunced void in the instant case was evidently re-
garded in Congress as of very doubtful constitutionality. Said the chairman
of the house committee: ''I wish to say, Mr. Chairman, that while there is con-
siderable doubt as to the constitutionality of taxing . . . Federal judges'

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upon for the present decision. This view of the Sixteenth Amendment
is no doubt sound. Collector v. Day, on the contrary, ought to be
reexamined at the first opportunity from the point of view of more .
recent developments of constitutional law." Nobody of course would
claim that Congress may exercise its taxing power in a way to impair
a republican form of government in the states.^^ But that fact fur-
nishes no reason for building up a privileged class of property holders
exempt from taxation by the national government as to their incomes,
nor for thus stimulating extravagance in the state govenmients.^


1. War Prohibition

The provisions of the first War Prohibition Act, which was approved
by the President ten dajrs after the signing of the armistice, were con-
fined to distilled liquors and to "intoxicating malt or vinous liquors."
In Hamilton v. Kentucky Distilleries and Warehouse Company and
Dryfoos v. Edwards," the validity of the act and its enforcibiUty in
the case of plaintiffs in error were challenged, on the ground that it
violated the "due process of law*' clause of the Fifth Amendment, that
the war emergency which was urged in justification of it was at an

Online LibraryWestel Woodbury WilloughbyThe American political science review → online text (page 63 of 77)