Is a federal income tax permitted under the Constitution?
For much of its first century, the United States financed its government through tariffs on imported goods. When more money was needed to fund the Civil War, Congress enacted an income tax, but it expired when the war ended. By the 1890s, most of America had come to believe that funding the government through tariffs was both unfair and unwise. It was unfair because the extra cost of imported goods was paid by consumers regardless of their wealth: the poor paid just as much as the rich. It was unwise because it would leave the government stranded in wartime, when imports would cease.
In 1894, Congress responded by approving a 2 percent levy on incomes over $4,000, the first peacetime income tax in history. Despite the low number, the advent of a peacetime income tax put great fear in the hearts of the richest Americans, who believed that, left to its own devices, Congress would keep taxing their fortunes at ever-higher rates to pay for government services for the poor.
Lawyers representing the interests of the very wealthiest Americans came up with a longshot theory to persuade the Supreme Court to declare the tax unconstitutional. Under the Constitution, the federal government was banned from imposing “direct” taxes – that is, flat amounts on each person or piece of property. A tax on income, however, had long been considered permissible. But, the lawyers argued, didn’t an income tax alter the value of property – such as by taxing the rents collected by property owners or dividends paid to shareholders? Wouldn’t that make it little different from a property tax?
Challenges to the court’s interpretation of what constituted a “direct” tax had been rejected for decades, but those who funded the case of Pollock v. Farmers’ Loan and Trust found a receptive audience among some Supreme Court justices whose wealth rivaled their own. Stunningly, they were able to defeat the income tax, 5-4.
The most impassioned – and most sweeping – of the dissenters was John Marshall Harlan, who railed against his colleagues in one of the most dramatic speeches in court history.
“In my judgment – to say nothing of the disregard of the former adjudications of this court, and of the settled practice of the government – this decision may well excite the gravest apprehensions,” Harlan thundered. “It strikes at the very foundation of national authority, in that it denies to the general government a power which is more vital to the very existence and preservation of the union in a national emergency, such as that of war with a great commercial nation, during which the collection of all duties upon imports will cease or be materially diminished. It tends to reestablish the condition of helplessness in which Congress found itself during the Articles of Confederation.”
The court’s decision in the Pollock case did indeed tie the hands of the government. With no income tax at all, economic inequality soared to record levels. Finally,18 years later, the states approved a new constitutional amendment to counteract the Supreme Court’s decision. Congress quickly passed a new income tax, and the vast excesses of the Gilded Age soon became history.