Is a Federal Tax on Damages for Emotional Distress Unconstitutional?

Marty Lederman

The U.S. Court of Appeals for the District of Columbia Circuit today held that a federal statute, which imposes a tax on awards of compensatory damages for emotional distress and loss of reputation, is unconstitutional because such awards are not "income" within the meaning of the Sixteenth Amendment.

I know very, very little about tax, and not much more than that about the Sixteenth Amendment, so please excuse me if the following question is obviously ridiculous for one reason or another:

Assuming the court is correct that such an award is not "income" for purposes of the Sixteenth Amendment -- which I will assume because I don't know enough about the meaning of "income" in that Amendment -- why does it follow that the tax is unconstitutional?

[I have edited this post to elaborate on certain points.] To say, as the court of appeals does, that "[t]he Sixteenth Amendment simply does not authorize the Congress to tax as 'incomes' every sort of revenue a taxpayer may receive," is not to explain why Congress is prohibited from doing so. The Sixteenth Amendment is not a limitation on congressional powers -- it's an authorization, or, more precisely, a clarification. Thus, even if the court of appeals were correct that an award for emotional distress is not "income" in a constitutional sense, the next question should be "SO WHAT?" After all, the federal government taxes plenty of things other than income, and those taxes are not all unconstitutional.

Congress has the power under Article I, section 8 to lay and collect Taxes. This, in and of itself, is presumably sufficient authority for the tax in the Murphy case, for "[t]he subject-matter of taxation open to the power of the Congress is as comprehensive as that open to the power of the states, though the method of apportionment may at times be different." Charles C. Steward Machine Co., 301 U.S. at 581. Indeed, the tax in that case was on a damage award provided by a federal agency (the Department of Labor), pursuant to a federal law, and therefore Congress could impose a tax on that federally-authorized award under the Necessary and Proper Clause, too (i.e., Congress obviously was not required to provide a mechnaism by which Ms. Murphy could recover damages in the first instance, and thus it can decide that it will not provide full compensation for injuries to emotion and reputation, but will instead direct that some of the "compensation" be remanded to the federal government itself).

So where does the Sixteenth Amendment come into play? It was ratified in order to clarify that income taxes may be assessed whether or not they are direct taxes. The constitutional restriction on Congress's power appears, not in the Sixteenth Amendment, but in Article I, section 9, which provides that "direct" taxes must be proportional to census results. The Sixteenth Amendment was ratified in order to effectively overturn the Supreme Court's 1895 decision in Pollock v. Farmers' Loan and Trust Co. -- a mistaken, outlier decision -- that a personal income tax was "direct" and therefore had to be apportioned by state census figures.

[Next three paragraphs updated.] Prior to Pollock, the Court had regularly held, beginning in the 1796 case of Hylton v. United States, that numerous taxes were not "direct," and thus did not have to be apportioned by census. So, for example, the Court held that federal taxes on corporate capital (Pacific Insurance v. Soule), estates (Scholey v. Rew), and even personal income (Springer), were not "direct." The general consensus during this century had been that the term "direct taxes" as used in Article I referred only to taxes on real estate and poll or capitation taxes.

Pollock, a 5-4 decision, took a sharp turn away from this long line of cases: The Court held that a tax on property-based income was a "direct" tax, prohibited by Article I, section 9 because it was not apportioned by state population. Pollock was widely criticised and reviled. President Taft would later say that "[n]othing has ever injured the prestige of the Supreme Court more."

The Court heard the criticism. After Pollock, the Court in effect returned to the Hylton line of cases. Between 1899 and 1911, it held that a trade tax on the Chicago Board of Trade (Nicol v. Ames), a graduated estate tax (Knowlton v. Moore), and a tax on a corporation's gross receipts (Spreckels Sugar Refining), were all not direct taxes, and thus permissible even if not apportioned. (Thanks to Calvin Johnson's 2004 article Fixing the Constitutional Absurdity of the Apportionment of Direct Tax for some of these historical details.) Finally, in 1911 the Court more or less relegated Pollock to its facts, by holding in Flint v. Stone Tracy Co. that a tax on corporate income was not a "direct tax."

In other words, even before ratification of the Sixteenth Amendment in 1913, virtually no federal taxes other than the personal income tax were deemed "direct." In 1913, the Sixteenth Amendment put the final nail in Pollock's coffin, by declaring that Congress could tax income without regard to census figures, i.e., whether or not it was a "direct" tax.

Thus, in order to invalidate the tax in the Murphy case, it is not enough to hold that the award is not "income." It would be necessary further to hold that the tax is a "direct" one, prohibited by Article I -- and to explain why it is not otherwise authorized by the Necessary and Proper Clause. The court of appeals did not peform these analyses, and thus its opinion is woefully incomplete. My rough sense is that the tax on the award in Murphy is authorized by Article I, section 8, and by the Necessary and Proper Clause, and, more importantly, is not a prohibited "direct" tax under Article I, section 9, just as with estate taxes (see Manufacturers National Bank, 363 U.S. 194) and gift taxes (see Bromley v. McCaughn, 280 U.S. 124). (In addition to the Johnson article cited above, see Bruce Ackerman's 1999 article Taxation and the Constitution.) Indeed, even the Court in Pollock acknowledged that taxes on "gains or profits from business, privileges, or employments" are not direct, and thus can be assessed without apportionment. 158 U.S. at 635. The award of damages in the Murphy case is a "privilege" created by federal law, and thus a tax on such damages would not appear to run afoul of any apportionment limitation in Article I.

If I'm correct about this, then the tax on the award of damages therefore is constitutional, wholly without regard to whether it is a tax on "income" -- although, again, I caution that I'm out of my league on this question, and would appreciate further information or clarification in the comments.

In any event, even if I'm wrong and the direct/indirect question is closer than that, the court's opinion today does not so much as mention Article I, or the direct/indirect distinction. Indeed, the court does not even acknowledge Congress's broad taxing power under Article I, section 8, nor does it identify where in the Constitution any restriction on such taxing power might appear, or describe the nature of that constitutional limitation. Thus, even if the judgment is correct because this is a "direct" tax and the award is not "income," the court's reasoning leaves a great deal to be desired. And this inexplicable failure in the opinion is especially conspicuous in light of the fact that the district court judge in the case, Judge Lamberth, specifically noted that the possible constitutional limitation derived from the apportionment requirement of Article I, and indicated that the tax was permissible either if it was assessed on "income" or if it was not "direct." 362 F. Supp. 2d at 217. Judge Ginsburg simply ignores one half of the equation -- and without that, he's provided no reason to invalidate the federal statute. [UPDATE: Surprisingly, the court of appeals judges are not the only ones who skipped right over the central question. In her brief, appellant Murphy stated, in a footnote and without any authority, that "[t]he taxation of damages received on account of personal injuries or personal sickness is a direct tax." But DOJ does not appear to have contested that assertion in its brief, which appears to (implictly) suggest that the constitutionality of the statute turns entirely on whether the award was "income." It's safe to predict, I think, that DOJ won't repeat that mistake in its petition for rehearing.]

If I'm right about all this -- and again, that remains to be seen -- it'll be interesting to see if Judge Ginsburg comes in for the same blogospheric slam-down that greeted Judge Taylor's craftwork in her recent opinion on the NSA surveillance question.

UPDATE: A commentor correctly notes that, in addition to section 9, section Section 2, clause 3 of Article I also provides that "direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers." This reminds me that, if I recall correctly, the census-based requirement for direct taxes in Article I was crafted as a protection against congressional discrimination against particular states. If this is correct, then it would be very odd to impose such a restriction, not simply on property held pursuant to state law, but on an award issued by a federal agency pursuant to federal law. That is to say, the rationale of the proportionality requirement of the direct-tax provisions of Article I appears at first glance to be especially ill-adapted to taxes on federally prescribed awards of money.
Posted 12:41 PM by Marty Lederman [link]