Understanding Constitutional Taxation: Direct & Indirect Taxes

The federal government is always proposing new things to tax. We know there’s an income tax. But the federal government also taxes things like gasoline, tobacco, alcoholic beverages, airfare and even fishing rods.

These are not sales taxes. They are excise taxes. It’s a tax that either the manufacturer pays when making a product or you pay when purchasing a product.

However, did you ever stop to consider if there are any restrictions on what or how the federal government can tax? Does the United States Constitution even allow the federal government to tax anything it wants, whenever it wants, and in any way it wants?

Many founders of our republic and one notable framer of the Constitution thought the Constitution allowed only limited taxation to the federal government. Others, however, thought the Constitution was much more liberal on what the federal government could tax.

This disagreement eventually led to a tax revolt in Virginia in 1794.

Ironically, the revolt led to a Supreme Court case which many at the time and today thought was poorly decided but would eventually become one of the most important Supreme Court decisions few people have heard of. It was important because it paved the way for ever expanding federal taxation.

Let’s examine the 1796 U.S. Supreme Court case of Hylton vs. The United States to learn what the Constitution actually says about taxation and why a simple tax on carriages exposed a deep ideological split within the new country itself.

Congress Passes a “Carriage Tax” (1794)

In June 1794 the United States Congress passed a tax on the ownership of carriages.

The tax called for a levy,

When the tax came due in September, Daniel Lawrence Hylton, a wealthy Virginia businessman, refused to pay it because in his opinion it was unconstitutional and void.

He was not alone in his refusal to pay the tax.

Virginia jurist and constitutional scholar St. George Tucker wrote to future president James Monroe,

“A friend of yours in this place refused to pay the carriage tax, upon the ground that it was a direct tax, & not imposed according to the Constitution. So did Mr. Pendleton, Mr. Roan[e], Col Taylor, Mr. Page & some others.”

The place was Williamsburg, Virginia. And the men who refused to pay the tax were some of the brightest legal minds in the country.

They, like Hylton, also believed that the tax was unconstitutional and thus void.

Their reasoning went like this:

  • The federal government’s carriage tax was a direct tax.
  • The tax however was not apportioned among the states but directly on the citizens of the states. Therefore, the tax was unconstitutional and thus did not have to be paid.

 At the urging of Alexander Hamilton, the federal government rejected this argument and proceeded to sue Daniel Hylton in federal court for the amount of the tax.

The case eventually made its way to the Supreme Court and became known as Hylton v. United States.

Interestingly, Professor Erik M. Jensen, an authority on taxation from Case Western Reserve University observed,

 Nonetheless, in a 4-0 decision the Court ruled against Hylton.

Justices Chase, Iredell, Paterson, and Wilson unanimously found that the federal government’s direct excise tax on the ownership of carriages was constitutional.

The justices’ opinion was essentially based on two main arguments.

The first went like this:

  • The only direct taxes are land and capitation taxes
  • The carriage tax is neither a land nor a capitation tax
  • Therefore, the carriage tax is an indirect tax and thus constitutional

The second argument was as follows:

  • Direct taxes must be apportioned among the states
  • The carriage tax cannot be apportioned among the states
  • Therefore, the carriage tax is an indirect tax and thus constitutional

Though many at the time considered the justices’ premises to be faulty and believed that the decision was based purely on politics, the case nonetheless became a landmark decision.

While Hylton was decided over two centuries ago, it has played an important role in numerous Supreme Court decisions that have justified the expansion of federal taxation.

Let’s briefly review some of these cases.

Passing Down the Memory Hole

While many today have not heard of Hylton v. United States, it has played a pivotal role in the development of current federal tax policy.

Consider this list of past cases where Hylton’s precedent was used to justify expanded federal taxation:

Though Hilton was instrumental in supporting numerous federal tax policies it seemed to have passed down the memory hole. That is until 2012.

In 2012, Chief Justice John Roberts, in the Supreme Court case of National Federation of Independent Business v. Sebelius, cited the Hylton case in support of his opinion that the Individual Mandate provision of the Affordable Care Act or Obamacare, was constitutional.

By doing so, Roberts followed the lead of a long line of Supreme Court justices who also appealed to Hylton in order to find a new federal tax constitutional.

Let’s take a deeper look at Hylton v. United States and see why it set such an important precedent for past and present Supreme Court cases.

Debating The Constitutional Taxation Clauses: Early Warnings From the Anti-Federalists

For 3 years, from 1787 – 1790, beginning at the Constitutional Convention in Philadelphia and later in state ratification conventions, Federalists and Anti-Federalists debated the merits of the newly proposed U.S. Constitution.

These debates often became contentious and many questioned whether the new Constitution should even be ratified.

Anti-Federalist George Mason, a delegate from Virginia to the Constitutional Convention, declared,

…he would sooner chop off his right hand” than see the Constitution, as it then stood, passed.

Miller, Helen Hill (1975). George Mason, Gentleman Revolutionary. The University of North Carolina Press.

Another Anti-Federalist, Patrick Henry speaking about the newly proposed U.S. Constitution at the Virginia ratifying convention remarked,

“And yet who knows the dangers that this new system may produce; they are out of the sight of the common people: They cannot foresee latent consequences… I see great jeopardy in this new Government.” Speech at the Virginia Ratifying Convention, 5 June 1788

One section of the Constitution the Anti-Federalists were particularly concerned with was the general taxation clause. The clause states,

“The Congress shall have power to lay and collect taxes, duties, imposts and excises, to pay the debts and provide for the common defense and general welfare of the United States; but all duties, imposts and excises shall be uniform throughout the United States;”

U.S. Constitution Article 1, Section 8, Clause 1

The Anti Federalists, led by Robert Yates and future president James Monroe, believed that the clause was too vague and would eventually allow the federal government unlimited taxing power.

About the clause Yates wrote, 

Yates was not vague on what he thought the clause would entail.

He believed that the clause would eventually lead the Federal government to tyrannically abuse their power to tax.

However, future president James Madison, an architect of the Constitution and Federalist leader, disagreed with Yates’ interpretation of the clause. In Federalist Paper #41 he wrote,

Madison obviously thought that unlimited federal taxation was a misunderstanding of Article 1 Section 8 clause 1. He explained why,

Madison believed that the Anti-federalist’s fears over the general taxation clause were unwarranted.

He argued that there were other enumerations or clauses in the proposed Constitution that would prevent a potential federal government abuse of this clause.

Madison was correct. There are other taxation clauses besides the general taxation clause in the constitution. 

It’s probable that the other federal taxation limiting enumerations Madison was referring to were the direct tax clauses in the Constitution.

These are,

Article 1 Section 9 Clause 4

Article 1 Section 2 Clause 3

They stipulate how direct taxes are to be apportioned among the states. Madison was sure these clauses would restrain federal taxation.

However, what if Madison’s interpretation of the direct tax clauses was different from other federalists leaders?

What if Madison’s interpretation of the direct tax clauses was different from the federalist judges?

What if the federalists did not view the direct tax clauses as a significant check on federal taxation?

As we’ll see, the federalists had a completely different vision of federal taxation than the anti-federalists, including one of their own party, namely James Madison.

Let’s take a look at these opposing ideologies.

Anti-Federalist Warnings Begin to Materialize (1791 -1794)

In spite of the Anti-federalist’s warnings against ratification, on May 29, 1790, Rhode Island became the last of the original 13 states to ratify the United States new Constitution. If anybody had illusions that the ratification of the Constitution would end the ideological clash between the Federalists and the Anti-Federalists, they were seriously mistaken.

In March of 1791, the federal government passed a whiskey excise tax that prompted a revolt by farmers in western Pennsylvania. The Whiskey Rebellion would not end until 1794 when George Washington led out an army of 13,000 men to suppress it.

Interestingly, Alexander Hamilton played a major role in the suppression of this tax rebellion.

Then again in 1794 a federal excise tax on carriages produced another tax rebellion, this time in Virginia. Unlike the Whiskey Rebellion, the federal government did not choose to put this rebellion down by force.

Instead, at the urging of Secretary of State Alexander Hamilton, the federal government sued Daniel Hylton in federal court.

However, it appears that Hamilton’s ultimate goal was to have this suit decided in the Supreme Court.

He wrote in a letter to U.S. Commissioner of the Revenue, Tench Coxe,

“It will be proper to instruct Mr. Carrington [U.S. Supervisor of the Revenue for the District of Virginia] to give facility to a legal decision in any case where it may be desired – taking care to secure an appeal in the last resort to the Supreme Court.” (Julius Goebel, The Law Practice of Alexander Hamilton: Documents and Commentary, Volume 4, p.309.)

Why was Hamilton so determined to have this case decided by the Supreme Court? 

Let’s take a look at the political landscape of the United States from 1792 – 1800 to see if we can answer this question.

THE POLITICAL LANDSCAPE 1792-1800

By 1792 two major parties had emerged from the United States political landscape, the Federalists and the Democratic Republicans (or simply Republicans).

The Republicans included men such as Thomas Jefferson, James Monroe, and James Madison. Interestingly Madison, one of the authors of the Federalist Papers, became associated with the Republicans after 1791.

The Republicans embraced ideas such as a strict interpretation of the Constitution and a federal government with limited powers and thus limited fiscal needs.

George Washington, Alexander Hamilton, and John Adams led the Federalist Party. The party was generally in favor of a liberal interpretation of the new Constitution, an expansive role for the national government, and Hamiltonian fiscal policies.

These opposing ideologies would be the cause of many of the country’s political woes for the next 60 years.

One of the Federalist ’s key fiscal policies included the use of a direct excise tax to raise funds.

Apparently a favorable decision from the court in the Hylton case would validate the constitutionality of such a tax and secure an important means of federal tax revenue in the future.

Events Leading Up to the Carriage Tax

In 1794 while Americans were fighting an Indian war in the Northwest Territory, the British began harassing U.S. merchant ships in the Atlantic. Many believed a two front war was about to ensue.

In response to a seeming need for national defense funding the Congressional Ways and Means committee proposed a number of revenue raising initiatives.

One of the proposed initiatives was the “carriage tax”. Treasury Secretary Alexander Hamilton had twice suggested a similar tax to Congress in 1790 & 1792.

 Again the wording of the tax was as follows,

This meant that if someone owned a carriage or purchased a new one the federal government would assess a tax directly on the owner of that carriage.

James Madison, considered the architect of the Constitution and now a U.S. Representative, as well as several other representatives, objected to the Carriage tax on constitutional grounds.

Their argument went like this.

  • The Carriage tax was a direct tax on a person’s property
  • Article 1 Section 9 Clause 4 of the Constitution mandates that direct taxes had to be apportioned among the states.
  • Therefore, since the tax was placed directly on the person’s property, the tax was unconstitutional and thus void.

In spite of protests by Madison and others, the carriage tax passed and became law.

Madison in a letter to Jefferson lamented,

 “…The tax on carriages succeeded in spite of the Constitution…”

Letter of James Madison to Thomas Jefferson, May 11, 1794

Professor Erik M. Jensen, an authority on taxation from Case Western Reserve Law School, says this about Madison’s opinion of the tax,

Jensen’s observations are insightful. Remember, Madison tried to convince the anti-federalists that other constitutional enumerations would be a safeguard against abusive federal taxation. Jensen identifies this enumeration as the direct tax clause in the constitution.

The new tax took effect in September of 1794 and generated immediate controversy, even to the point of civil disobedience.

The Supreme Court record states,

“Daniel Lawrence Hilton…owned, possessed, and kept one hundred and twenty-five chariots for the conveyance of persons, but exclusively for his own separate use, and not to let out to hire, or for the conveyance of persons for hire.”Hylton v. United States, 3 U.S. (3 Dall.) 171, 176 (1796).

The court also stated that Mr. Hylton had prior knowledge of the Carriage tax but that he,

“… Refused to…pay the duties thereupon as in and by the said recited law is required, alleging that the said law was unconstitutional and void.

In order to understand exactly what the Virginians were protesting and why they thought the tax was unconstitutional, let’s examine the constitutional clauses concerning indirect and direct taxation.

Indirect Taxes

Article 1 Section 8 clause 1 of the Constitution states,

Though the terms duties, imposts, and excises are not explained or explicitly designated as direct or indirect within the Constitution itself, today they are generally considered indirect taxes.

The United States government has provided a general definition of what these terms mean.

About duties it says,

“The term “duty” in its widest significance is hardly less comprehensive than the term “tax.” In its restricted sense it is synonymous with the term “impost.”

The Taxing Power of the Federal and State Governments, United States Government Printing office, 1936 Report to the Joint Committee on Internal Revenue Taxation (h

An impost is defined as a

“custom, or tax levied on articles brought into a country.” (The Taxing Power of the Federal and State Governments, United States Government Printing office, 1936 Report to the Joint Committee on Internal Revenue Taxation (https://www.jct.gov))

Duties and imposts therefore are generally used in relation to a tax on imports. They are also known as tariffs.

An excise has been defined as a tax laid on the manufacture, sale, or consumption of commodities within a country, upon licenses to pursue certain occupations and upon corporate privileges.

The IRS further defines excises taxes as,

“Taxes paid when purchases are made on a specific good, such as gasoline. Excise taxes are often included in the price of the product. There are also excise taxes on activities, such as on wagering or on highway usage by trucks.”http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Excise-Tax

The constitutional clause concerning duties, imposts, and excises specifically mandates that these taxes must be applied uniformly throughout the United States.

This means that a tax on an article or kind of property of the same class shall be taxed at the same rate regardless of geography. In other words, the tax rate must be uniform in all 50 states.

For example, under the Affordable Care Act, Congress imposed a 10% excise tax on tanning salon services.

This means that the federal excise tax on tanning services must be 10% in every state of the Union. No more, no less.

The following is a list of U.S. excise taxes as of 2010.

It is easy to see why the framers included the uniformity clause into the Constitution. It would prevent the federal government from showing favoritism toward one state or another concerning taxation.

However, there are a number of important questions about excise taxes that the Constitution does not answer.

Can some excise taxes be considered direct taxes?

Does the manner in which an excise tax is imposed determine whether it is a direct or indirect tax?

What items or activities can be excised and who determines this?

What happens if federal taxation of a particular item or activity is economically damaging to a particular state or region of the country or to a particular industry and the offended party does not have the votes to repeal the tax?

These unanswered questions will be central in the Hylton case.

Let’s take a look at the direct taxation clauses in the Constitution.

Direct Taxes

There are two direct tax clauses in the U. S. Constitution. Article 1 Section 9 Clause 4 states,

“No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken.”

A similar stipulation concerning direct taxation is found in Article 1, Section 2, Clause 3. It states,

“Representatives and direct taxes shall be apportioned among the several states which may be included within this union, according to their respective numbers, which shall be determined by adding to the whole number of free persons, including those bound to service for a term of years, and excluding Indians not taxed, three fifths of all other Persons.”

These are the direct tax clauses in the Constitution:

The second clause is only modified by the Fourteenth Amendment’s elimination of the distinction between “free Persons” and “all other Persons” and the elimination of the category of “Indians not taxed” through legislation.

These constitutional direct tax apportionment provisions are still in effect.

The apportionment rule ties a state’s share of the total direct-tax liability to its share of the nation’s population, measured using census rules.

This means that if a state has 1/10th of the national population, its residents would pay 1/10th of the total direct tax imposed.

For example, during the Civil War a direct tax of $20 million annually was imposed on the land of the United States. Each state’s population was divided into the $20 million to come up with each state’s share of the total.

The following is a partial example of the breakdown.

However what is extremely important concerning the direct tax clauses is their apparent vagueness.

Notice here in Article 1 Section 9 Clause 4 that the term “capitation” is not defined. Also, the phrase mentions “other direct tax”. What exactly are other direct taxes? The Constitution does not identify what they are.

This image has an empty alt attribute; its file name is Direct-Tax-1.001.jpeg

This again leaves open the possibilities of various definitions. The definition of these terms will become crucial in the Hylton case.

The question then becomes: was the carriage tax an indirect excise tax that was to be applied uniformly throughout the states or was it a direct excise tax that should have been apportioned among the states?

More specifically, according to the Constitution, could an excise tax be directly imposed on individuals?

The importance of this question should not be lost. If the carriage tax was classified as an indirect tax, then the federal government could tax virtually any class of property owned by Americans in any way and at any time.

This is not what the Republicans thought the Constitution allowed.

Lest we think that the controversy concerning the definitions of indirect and direct taxes is something that was only important for 18th century Americans, let’s briefly look at a recent Supreme Court case where the definitions affected all of us.

Obamacare and Hylton

On June 28, 2012 the Supreme Court in the case National Federation of Independent Business v. Sebelius ruled that most parts of the Affordable Care Act, also known as “Obamacare”, were constitutional.

Supreme Court Chief Justice John Roberts surprised many in the legal community when he found that the shared responsibility payment mandate of the act was constitutional based on the taxing power given to the federal government by the United States Constitution.

Justice Roberts wrote in his opinion,

In Roberts’ opinion, the shared responsibility payment, the key provision of the Affordable Care Act, is constitutional because it’s a tax. And, he added, it’s not a direct tax.

However, notice that Roberts stresses the fact that the payment was a tax and not a penalty. Why did he feel the necessity to do that?

Probably because of how Congress worded the law. This is what it states,

(a) Requirement to maintain minimum essential coverage

An applicable individual shall for each month beginning after 2013 ensure that the individual, and any dependent of the individual who is an applicable individual, is covered under minimum essential coverage for such month.

26 U.S. Code § 5000A – Requirement to maintain minimum essential coverage

(b) Shared responsibility payment

If a taxpayer who is an applicable individual… fails to meet the requirement of subsection (a) for 1 or more months, then, except as provided in subsection (e), there is hereby imposed on the taxpayer a penalty with respect to such failures in the amount determined under subsection (c).

26 U.S. Code § 5000A – Requirement to maintain minimum essential coverage

A cursory reading of the provision would make seem that the payment was indeed a penalty.

Nonetheless, Roberts continues,

“…The mandate is not a legal command to buy insurance. Rather, it makes going without insurance just another thing the Government taxes, like buying gasoline or earning income. And if the mandate is in effect just a tax hike on certain taxpayers who do not have health insurance, it may be within Congress’s constitutional power to tax.”

Roberts believed that the shared responsibility payment provision was simply just another way for the government to impose a tax. However, the key here was that this tax is imposed on not buying or not owning something.

In his dissenting opinion, Justice Scalia reacted strongly to Roberts’ opinion.

He wrote,

“We never have classified as a tax an exaction imposed for violation of the law, and so too, …we never have classified as a tax an exaction described in the legislation itself as a penalty.”

Justice Scalia pointed out that Roberts’ opinion was unique as no previous Supreme Court had ever classified a penalty as a tax and found it constitutional. Interestingly, the original congressional legislation never used the words tax to describe the penalty. It was Justice Roberts who actually classified the penalty as a tax.

Scalia also observed that if the Affordable Care Act were rewritten as a tax, it may fall under the Constitution’s definition of a direct tax.

He wrote,

Scalia here noted that if congress had called the act a tax, there could be restrictive constitutional direct tax guidelines imposed that would make the tax almost impossible to collect.

Justice Roberts, however, anticipating Scalia’s direct tax argument, twice appealed to Supreme Court precedent established in Hylton v. United States to show why in his opinion the ACA was not a direct tax.

First Roberts’ writes,

“See Hylton v. United States,  (1796) … The Court was unanimous, and those Justices who wrote opinions either directly asserted or strongly suggested that only two forms of taxation were direct: capitations and land taxes. See… the  (opinion of Paterson, J.) and…the (opinion of Iredell, J.)

By citing Hylton, Roberts shows that the Supreme Court has already established as precedent that the only direct taxes are capitations and land taxes.

Next, he cites the opinion of Justice Samuel Chase from Hylton,

“A tax on going without health insurance does not fall within any recognized category of direct tax. It is not a capitation. Capitations are taxes paid by every person, “without regard to property, profession, or any other circumstance.”

Here Roberts cites an opinion, also called dicta, from Hylton by Supreme Court Chief Justice Samuel Chase on the nature of a capitation tax. Since the Affordable Care Act did not meet Chase’s definition of a capitation, it was not in Roberts’ opinion a capitation tax.

Therefore, since the shared responsibility payment was neither a land tax nor a capitation, it was not in Roberts’ opinion a direct tax.

Roberts, by using Hylton to support his opinion that the ACA was not a direct tax, became one of many Supreme Court justices who had used the case to justify expanded federal taxation.

Conclusion

The Supreme Court’s frequent use of Hylton raises some important questions that we haven’t answered yet.

Was the Carriage Tax an indirect tax just because the Supreme Court says that it was?

Could an excise tax also be considered a direct tax?

Did the Supreme Court correctly analyze the difference between a direct and indirect excise tax according to what the Constitution and current economic theory said about them? Or was their decision based on politics?

Why did the Virginians see this tax as a threat to individual liberty and a threat to the very nation itself?

We’ll explore these questions in the next edition of Historical Spotlight.

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