Paul L. Caron

Monday, March 12, 2007

Germain Critiques Government's Brief in Murphy

On Friday, I blogged the Government's filing of its brief in the D.C. Circuit in Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 8/22/06). The panel, which held that § 104(a)(2) is unconstitutional under the 16th Amendment as applied to a recovery for a non-physical personal injury unrelated to lost wages or earnings, vacated its judgment and agreed to rehear the case, with oral argument scheduled for April 23, 2007.

Gregory L. Germain (Syracuse), author of the excellent article, Taxing Emotional Injury Recoveries: A Critical Analysis of Murphy v. IRS, critiques the Government's brief:

In the last go-round, the taxpayers convinced the Court of Appeals that the government could not constitutionally tax Ms. Murphy’s compensatory emotional distress damages award. The constitutional issues thus took center stage in the government’s brief, but not in the way I would have expected.

I was surprised by the government’s strong challenge to the continuing validity of the direct taxing clause in the Constitution. The government made Professor Calvin Johnson’s position – that the direct taxing clause became a dead letter with the ending of slavery, and at best should today be limited to real property taxes – the centerpiece of its constitutional argument.

I think the government erred by putting so much emphasis on this historical argument. The direct taxing clause was, after all, not removed from the Constitution at the end of slavery. Moreover, the Supreme Court continued to recognize the validity of the direct taxing clause in the Civil War tax cases (some of which were decided after the 13th amendment eliminated slavery), and of course in the famous Pollock cases, 157 U.S. 429 (1895) and 158 U.S. 607 (1895), in which the Court held that Congress lacked the power to tax income from real and personal property. The government contended in its brief that Pollock is no longer good law, but it overstated its case when it said that “every aspect of [Pollock’s] reasoning has been eroded.” It is certainly true that Pollock’s “source rule” – the notion that a tax on the income from property was a tax on the property itself – has been thoroughly repudiated. South Carolina v. Baker, 485 U.S. 505 (1988). However, the Supreme Court has not rejected or questioned the underlying holding in Pollock that taxes on the mere ownership of real or personal property – such as a traditional municipal property tax, for example – would have to be apportioned. The government’s argument that the repeal of slavery marked the effective repeal of the direct taxing clause runs headlong into the presumption against repeals by implication. See Morton v. Mancari, 417 U.S. 535 (1974).

Rather than taking a broad swing at the continuing validity of the direct taxing clause – an swing that will likely miss the ball because the Court of Appeals will likely not hold the direct taxing clause invalid – the government should have pointed out the substantial body of Supreme Court authority, issued after Pollock, upholding (as indirect excises requiring no apportionment) taxes on property transactions. See e.g. Thomas, 192 U.S. 363 (1904); Spreckles Sugar, 192 U.S. 397 (1904); Flint, 220 U.S. 107 (1911). Although the government did a good job arguing that taxes on emotional distress damages awards are not property taxes, it could have done more to emphasize that the tax would have been a valid excise, not requiring apportionment, even if damages for emotional distress were to be treated like property damages.

The government next failed to explain how its taxing power under Article I could be used to uphold the tax at issue if it did not constitute a tax on income under IRC Section 61. Having the power to tax, and actually imposing a tax, are two different things. If Congress did not tax the award, its power to do so under Article I would be irrelevant. The government made no effort to connect its Article I taxing power to the operative taxing statute. This was a serious fault, because the Court of Appeals is likely to focus at the rehearing on whether IRC section 61 effectively reached Ms. Murphy’s damages award.

I believe that the government should have connected its constitutional taxing power with the statutory language by pointing out that Congress manifested an interpretation of the ambiguous word “income” in section 61 when it amended section 104(a)(2) to eliminate the exclusion for non-physical injuries. Statutory interpretation scholars recognize that the Supreme Court uses a holistic approach to statutory interpretation, under which later-enacted statutes can define the meaning of earlier-enacted ambiguous statutory terms. See William N. Eskridge, Jr., Philip P. Frickey and Elizabeth Garrett, Legislation and Statutory Interpretation, p. 268 (Foundation Press 2000); Franklin v. Gwinnett County Public Schools, 503 U.S. 60 (1992). The meaning of “income” in IRC Section 61 may therefore not be entirely synonymous with the 1913 definition of the word in the 16th Amendment. This would allow the government to press its Article I taxing powers if the Court of Appeals retains its previous holding that emotional distress damages were not “income” within the understanding of the enactors of the 16th Amendment.

Instead of showing how its Article I powers bear on the statutory question, the government foolishly conceded that the enactors of the 16th Amendment had a narrower view of the word “income” than we have today. The Government stated that “income now includes many items that likely were not thought of as income when the 16th Amendment was ratified in 1913.” There was no reason for the government to make this concession. There is scant historical evidence to suggest that the enactors of the 16th Amendment held any uniform definition of the word “income.” The better argument was that the enactors of the 16th Amendment had a single intent - to permit Congress to impose broad-based income taxes – and they intentionally made no attempt to define the word “income.” Rather, they intentionally gave Congress the power to define its meaning when enacting tax legislation. The government played into the taxpayer’s hand by conceding that the enactors held a more narrow view of “income” than we have today, opening the door for the taxpayer’s argument that the enactors would not have thought compensatory emotional distress damages to be “income” when the 16th Amendment was adopted. The government’s argument is vulnerable to attack by those who do not believe in evolving constitutional meaning (including, I think, the majority of the current Supreme Court, and certainly the three judges on the hearing panel who previously ruled that the meaning of the word “income” in the 16th Amendment was fixed at enactment in 1913).

In other respects, the government did a fine job. It made a valiant argument that the Department of Labor did not award damages on account of the taxpayer’s physical manifestations of emotional distress. However, I remain unconvinced. The administrative law judge considered those manifestations in setting the amount of the award, and the ALJ’s award was ultimately adopted in toto by the Department of Labor. Wisely, the government also pointed out that both the statutory language and legislative history of section 104(a)(2) manifested a clear intent that physical manifestations of emotional distress not be excluded from income.

The government also did a fine job refuting the Court of Appeals’ previous conclusion that early administrative rulings recognized that the enactors of the 16th Amendment did not intend for compensatory injury awards to be taxable as income. In fact, as pointed out by the government, the earliest rulings treated damages awards as income – it was only after the Supreme Court’s narrow statutory interpretations that the government raised questions about its ability to tax damages awards.

I found the government’s brief far more convincing, and certainly more honest and straight-forward, than the taxpayer’s brief. Yet, I believe the government’s strategic mistakes could pave the way for a taxpayer victory on statutory grounds.

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Why? I'll give you two good reasons. First, because Congress said emotional distress damages should be taxed as income, and the Constitution gives Congress, not you or me, the power within broad limits to define what constitutes income. If you think as a policy matter that emotional distress damages should not be taxed, then take your case to Congress. Second, you are wealthier in a financial sense after receiving an emotional distress damages award than you were before. That is the essence of "income." Simple enough?

Posted by: Gregory Germain | Nov 30, 2007 6:46:32 PM

Would someone be kind enough to explain to this puzzled taxpayer why awards for "emotional distress" are (or ought to be) considered "income" in the first place?

And if it helps to make the explanation more concrete and less metaphysical, perhaps the explanation could illustrate the application of the concept of 'income' to this set of circumstances:

Leaving aside the awards on what would surely be a multi-count complaint, why on earth should the amount awarded to a mother by a jury be considered 'income' when it compensates her for the 'intentional infliction of emotional distress' she suffered when her ex-boyfriend forced her to watch as he strangled the baby she had with another man?

Posted by: Puzzled Taxpayer | Mar 21, 2007 2:37:58 PM

"The better argument was that the enactors of the 16th Amendment had a single intent - to permit Congress to impose broad-based income taxes – and they intentionally made no attempt to define the word 'income.' Rather, they intentionally gave Congress the power to define its meaning when enacting tax legislation.

"The government’s argument is vulnerable to attack by those who do not believe in evolving constitutional meaning"

I would just add that the suggestion that "income" is not defined in the Constitution but is instead meant to be defined by Congress as time passes does not require one to subscribe to the notion of a "living" constitution -- Prof. Germain's constitutional argument may be entirely consistent with an originalist's point of view. Originalists recognize that the language of the constitution can refer to something that itself changes, though the constitution's meaning itself does not change. See, e.g., Georgia v. Randolph, 126 S.Ct. 1515, 1541) (2006) (Scalia, J., dissenting) ("There is nothing new or surprising in the proposition that our unchanging Constitution refers to other bodies of law that might themselves change. The Fifth Amendment provides, for instance, that “private property” shall not “be taken for public use, without just compensation”; but it does not purport to define property rights. We have consistently held that “the existence of a property interest is determined by reference to ‘existing rules or understandings that stem from an independent source such as state law.’" The same is true of the Fourteenth Amendment Due Process Clause's protection of “property.” . . . This reference to changeable law presents no problem for the originalist. No one supposes that the meaning of the Constitution changes as States expand and contract property rights.").

Of course, the $64,000 question is whether "income" in the constituion was itself understood to refer to some changing body of law, or instead was understood to refer to only the precise items that would be thought of as "income" in 1913. That question, I think, is one the D.C. Circuit should consider, if it deems construction of the sixteenth amendment relevant to the outcome of the case. I haven't given it much thought, unfortunately.

Posted by: andy | Mar 13, 2007 12:48:50 AM