by Peter Schiff: The
Power To Tax Is the Power To Destroy
In the wake of my last commentary on the horrendous Supreme Court
decision upholding Obama's health care plan, several people have
pointed out that I erred in saying that the income tax is a "direct
tax." While it is technically correct that the Court ultimately
declared it to be an excise, not a direct tax, it is important to
understand how it arrived at that opinion and why the decision has
no practical relevance to the way the tax has been enforced. Just
as it has done with Obamacare, the Court came up with a technically
constitutional pathway to allow the government to collect a tax
in a blatantly unconstitutional manner.
In the 1895
Pollock v. Farmers' Loan and Trust case, the Supreme Court declared
the original Income Tax of 1894 unconstitutional because it imposed
a direct tax that was not apportioned to the states according to
the taxing provisions of the Constitution. For example it said that
a tax on rental income is the same as direct tax on the property
that produced the income. In other words, a tax on income was tantamount
to a tax on its source.
To get around
this, in 1913 Congress passed, and the state governments ratified,
the 16th Amendment that authorized a tax on income from whatever
source derived without regard to apportionment. However, in 1916
the Supreme Court ruled in Brushaber v. Union Pacific Rail Road
that the Amendment "conferred no new taxing power to the Federal
government," and that it "contained nothing challenging
or repudiated its ruling in the Pollock case." Instead, the
Court said that in order to be constitutionally taxed as an excise,
income must first be separated from its source. A few years later
in Eisner v. Macomber (1918) and Merchants Loan and Trust v. Smietanka
(1921) the Court provided a practical guide to doing just that,
by defining income, for purposes of the Sixteenth Amendment, as
a corporate profit.
determines profit by subtracting its expenses from its income. The
difference, called profit, could then be subject to an income tax.
So if a corporation has rental income, but derives no profit after
backing out all of its expenses, then the rents, and therefore the
property, are not taxed. In that respect, the income is separated
from the sources that produced it. Were it not for this separation,
a tax on rents, dividends, fees, etc. would be a direct tax on the
sources of income, as described by Pollock, Brushaber, Eisner and
Smietanka. That is why many U.S. corporations can have billions
of dollars of income but pay no tax, because they derive no profits
from that income. This proves the income tax is, in reality, a profits
is that the modern income tax is not merely being levied as an excise
tax on corporate profits, but as an unapportioned direct tax on
the personal income of every American. This is precisely what the
Supreme Court has repeatedly held to be unconstitutional. Yet lower
courts have serially ignored the reasoning behind these Supreme
Court decisions and have allowed the Federal Government to impose
a tax in the precise manner that the Supreme Court ruled it lacked
the constitutional authority to do.
Fathers made it difficult for Congress to levy direct taxes because
they considered the more easily avoidable excise taxes to be self-correcting
as to abuse. They also wanted to make it more difficult for poorer
states to vote for taxes that would be paid disproportionately by
wealthier states. As a result, they believed that during peacetime
the Federal Government would rely primarily on excise taxes and
would resort to direct taxes mainly during wartime.
To levy an
apportioned direct tax on personal income, Congress would first
have to decide how much it wanted to raise and then assign each
state its pro-rata share. So a $1 trillion dollar income tax would
require Mississippi and Connecticut (each with about 1% of the U.S.
population) to pay about $10 billion. However since per capita income
in Connecticut is 80% higher than it is in Mississippi, federal
income tax rates in Mississippi would have to be 80% higher than
the rates in Connecticut. This makes it less likely that Mississippi
would support such a tax. But given the way the income tax is currently
enforced, Mississippi happily votes for levies that fall predominately
on residents of wealthier states. This is precisely what the Constitution
was written to prevent.
Just as a tax
on land based solely on its rental income is the same as a direct
tax on the land itself, a tax on individuals based solely on their
decision not to buy health insurance is a direct tax on individuals.
To get around this, Chief Justice Roberts ruled that the new healthcare
tax is indirect because not everyone will have to pay it. However,
the percentage of people ultimately subject to a tax does not determine
into which category it falls. Less than two percent of Americans
were subject to the original income tax, yet the court still viewed
it as a direct tax.
line is that the Supreme Court has a history of giving the government
latitude to get around the Constitution. Instead of looking at the
intent of legislation (even when the legislators are alive to be
asked), or even its practical effect, the Court looks for any legal
technicality upon which to base a ruling of constitutionality. That
is what happened with the income tax, and is now occurring with
the Affordable Care Act. Had the Supreme Court been more forthright
with the income tax, the country would not now be suffering from
a destructive and pervasive tax that was originally intended to
be a small levy targeted only at the top 1% of American earners.
Court's sole rationale for ruling the exactions in the Affordable
Care Act are taxes rather than penalties was its belief that the
taxes are too low to actually compel anyone to buy health insurance.
This made it consistent with the Court's view that Congress lacks
the authority, under the commerce clause, to compel Americans to
buy health insurance. If the Court believed that the tax was actually
high enough to leave Americans with no rational choice, Roberts
would have ruled it unconstitutional. This may be the one thing
the Court got right.
the government realizes that it has underpriced the fines, it will
certainly raise the tax rate substantially to stop healthy people
from rationally dropping their coverage (because insurance companies
could not deny them similarly priced coverage after they got sick).
Just as they routinely do now with respect to the income taxes,
the lower courts will likely misinterpret the Supreme Court's ruling
and rubber stamp any future rate hikes. For political reasons it
is unlikely that a Constitutional challenge to such an increase
will ever make it back up to the Supreme Court.
us few good options. Unless Congress repeals the legislation quickly
we will likely have to live with it for a long, long time. Sadly,
despite the Romney and the Republicans' promises to do just that
with election victories this fall, there is virtually no precedent
for government giving up a power that it has fought to take. In
the end Americans will be forced to purchase health insurance in
the manner the Supreme Court just ruled to be unconstitutional.
company created by Peter Schiff that produces this show is not affiliated
with Euro Pacific Capital.
Schiff is president of Euro Pacific Capital and author of The
Little Book of Bull Moves in Bear Markets and Crash
Proof: How to Profit from the Coming Economic Collapse. His
latest book is The
Real Crash: America's Coming Bankruptcy, How to Save Yourself and
© 2012 Euro Pacific Capital
Best of Peter Schiff