"Congressional Generosity" and the Power to Tax
JANUARY 19, 2007 by SHELDON RICHMAN
Every now and then we get a glimpse into what government officials really think about our rights to life, liberty, and property. The U.S. Justice Department recently provided such a glimpse in a controversial tax case, Murphy v. IRS.
How revealing it is! Did you know that if the government abstains from taxing all your income, you should be grateful for this congressional generosity?
To recap the case, Marrita Murphy was awarded $70,000 in compensatory damages for the mental distress and loss of reputation she claimed to have suffered after she acted as a whistleblower against her employer, the New York Air National Guard. She paid about $20,000 in federal income taxes on that money, but later asked for a refund on grounds that the damage award should have been excluded from her gross income under sect;104(a)(2) of the Internal Revenue Code (Title 26 of the U.S. Code), which states:
gross income does not include —
. . . (2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness . . . .
The IRS rejected the request for a refund because her injuries were nonphysical and the section specifies physical injuries. When she sued in federal district court she lost.
Murphy appealed to the U.S. Court of Appeals for the District of Columbia Circuit. She argued that the compensation was covered by sect;104(a)(2) but if not, then the section is unconstitutional because it would permit the taxation of money that is not included in the constitutional and statutory meaning of income.
The government rebutted that Murphy's injuries were nonphysical — and hence not included in sect;104(a)(2) — and that IRS policy was consistent with the concept of income as used since the Sixteenth Amendment was ratified in 1913.
In August a three-judge panel stunned the government by ruling in Murphy's favor that sect;104(a)(2) is unconstitutional: [T]he framers of the Sixteenth Amendment would not have understood compensation for a personal injury — including a nonphysical injury — to be income. (The opinion is here [pdf]. Point of historical fact: the Amendment did not delegate to the government the power to tax wages and other income. According to the courts, it always had that power. See Is the Income Tax Unconstitutional?)
Before anyone could recover from the shock of having part of the tax code declared unconstitutional, the judges shook the tax world again. In October the Bush administration's Department of Justice petitioned to have the case heard by the circuit court's entire complement of judges (en banc). However, before the court could rule on the petition, the original three judges announced they would rehear the case themselves. Tax watchers couldn't remember when this kind of thing last happened and speculated that the panel realized it had erred and wanted to reverse itself rather than be reversed.
The case will be reheard in April. The glimpse into the Justice Department's thinking is provided by its 19-page petition (pdf) for rehearing, which details its grounds for believing the court wrongly decided the case. The petition is revealing and chilling.
The Justice Department's task in the petition was to convince the court that the judges had defined income too narrowly, allowing them to exclude compensation for nonphysical injury from gross income. The judges pinned its ruling on the finding that compensatory damages for injuries are intended to make a victim whole — that is, to restore something (in this case mental well-being and reputation) that is not taxable. Since the damage award was not a replacement for something taxable, such as wages, the judges said, the award itself should not be taxable. Had the damage award been intended to replace lost wages, it would have been a different story.
What is ominous about the petition is how broadly the Justice Department views the government's power to tax. These views are hardly consistent with limited government and low taxes. Unfortunately, the Department has a long line of cases to back up its position. This is blunt notice to anyone who thinks the government has no legal authority to tax wages and other income.
Here's a sample of what the Justice Department argued (internal quotes are from previous court opinions, citations are excised, and all emphasis is added):
Congress's power to tax income, like its power to levy non-direct taxes generally, is indeed 'expansive.' In Brushaber [v. Union Pacific Railroad, 1916], the Supreme Court emphasized that Congress's taxing power is 'exhaustive and embraces every conceivable power of taxation.' It referred to the constitutional limitations as 'not so much a limitation upon the complete and all-embracing authority to tax, but in their essence [ ] simply regulations concerning the mode in which the plenary power was to be exerted.'
In [Commissioner v.] Glenshaw Glass , the Court reviewed the 'sweeping scope' of the predecessor to sect;61(a) [the beginning of the section of the law defining gross income] and observed that it had 'given a liberal construction to this broad phraseology in recognition of the intent of Congress to tax all gains except those specifically exempted.' The Court held that income includes 'undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.' The Court explained that the definition contained in [Eisner v.] Macomber  had, in the context of that case, 'served a useful purpose,' but cautioned that the definition 'was not meant to provide a touchstone to all future gross income questions.' (Eisner and earlier courts had defined income as the gain derived from capital, from labor, or from both combined.)
The Department's petition then proceeded to quote earlier opinions on the broad range of the government's power to tax:
We have repeatedly emphasized the 'sweeping scope' of [sect;61, the code section that defines gross income] and its statutory predecessors. (Commissioner v Schleier, 1995)
The definition of gross income under the Internal Revenue Code sweeps broadly, (including all income) subject only to the exclusions specifically enumerated elsewhere in the Code. (U.S. v. Burke, 1992)
[Income] extends broadly to all economic gain not otherwise exempted. (Commissioner v. Banks, 2005)
[The court has] emphasized the corollary to sect;61(a)'s broad construction, namely, the 'default rule of statutory interpretation that exclusions from income must be narrowly construed.''' (Schleier quoting Burke)
The government's petition emphasizes that the decision not to tax something belongs to Congress — and Congress alone:
Any determination to exclude such damages from income is not required by the Constitution or driven by tax considerations, but is one of policy based upon value judgments. . . . Such determinations are the sole province of Congress, and in amending sect;104(a)(2) in 1996 to cover only damages received on account of a physical injury or physical sickness, Congress established its clear intent to tax the type of award (for nonphysical damages) taxpayer here received.
In this connection, the petition quotes a 1996 Supreme Court case, O'Gilvie v. U.S., which attributed the exclusion from gross income of compensatory damages for personal injury to — congressional generosity!
The petition closes with the Justice Department's claim that even if the damage award is not construed to be income within the meaning of the Sixteenth Amendment, the government may still tax it:
[T]he constitutional restrictions on Congress's taxing power deal only with how to tax, not what to tax. To conclude that the tax here is unconstitutional, the panel had to determine that it is either a direct tax requiring apportionment, or an indirect excise that is not uniform. . . . The panel wholly failed to perform this critical part of the analysis.
To boil the petition down to the fewest words: Congress may tax whatever it darn well pleases, thank you. If it abstains from taxing a type of revenue (be it income or not), just be thankful for its generosity. But don't go thinking you have a right not to have it taxed.
Political officials may talk a low-tax, limited-government game, but let a judge suggest there's something they can't tax and they show their true colors.
To be sure, Murphy's attorney, David Colapinto, responded to the petition. (Read the response here [pdf].) He too is able to cite Supreme Court cases, this time in support of Murphy's position that the three appellate judges were correct. Eventually the Supreme Court will pick the winner. But it would be mistake to think there is an objectively right answer. In the constitutional game, right (in the sense of what gets enforced) is whatever the courts decide. Constitutions and laws don't interpret themselves. (On this unappreciated point, see Where Is the Constitution?)
Watching two lawyers invoke legal precedents to reach diametrically opposed conclusions reminds me of what Georgetown University law professor John Hasnas wrote in his Wisconsin Law Review article, The Myth of the Rule of Law (pdf):
Because the legal world is comprised of contradictory rules, there will be sound legal arguments available not only for the hypothesis one is investigating, but for other, competing hypotheses as well. The assumption that there is a unique, correct resolution which serves so well in empirical investigations is what leads one astray when dealing with legal matters. . .
[W]hat conclusion one finds will be determined by what conclusion one looks for, i.e., by the hypothesis one decides to test. This will invariably be the one that intuitively feels right, the one that is most congruent with one's antecedent, underlying political and moral beliefs. Thus, legal conclusions are always determined by the normative assumptions of the decisionmaker.
We really have no reason to be shocked by the government's extravagant claim because we were warned 220 years ago. In 1787 the Anti-federalist Robert Yates (Brutus), objecting to Congress's power to tax under the proposed Constitution, wrote, [T]his power therefore is neither more nor less, than a power to lay and collect taxes, imposts, and excises at their pleasure; not only the power to lay taxes unlimited, as to the amount they may require, but it is perfect and absolute to raise them in any mode they please.