Posted on 08/29/2006 6:38:28 AM PDT by Uncledave
Last week, a federal appeals court in Washington handed down an important decision relating to the definition of income for tax purposes. What is important about the decision is that it is the first one in decades saying that the Constitution itself limits what the government may tax. If upheld by the Supreme Court, it could significantly alter tax policy and possibly open the door to radical reform.
In the case, a woman named Marrita Murphy was awarded a legal settlement that included compensation for physical injury and emotional distress. The former has always been tax-exempt, just as insurance settlements are. Obviously, it makes no sense to tax as income the payment for a loss that only makes one whole again. One is not being made better off, and therefore there is no income. But under current law, compensation for non-physical injuries are taxed.
Murphy argued that just as compensation for physical injuries only makes one whole after a loss, the same is true of awards for emotional distress, as well. In short, it is not income within the meaning of the 16th Amendment to the Constitution. The appeals court agreed and ruled that her award for emotional distress is not income and therefore not taxable.
Tax experts immediately recognized the far-reaching implications of the Murphy decision for other areas of tax law. Tax protesters have long argued that the 16th Amendment did not grant the federal government the power to tax every single receipt that it deems to be income. Yet in practice, that is what the Internal Revenue Service does.
The problem is that the very concept of income itself has never been defined in the tax law. It is pretty much whatever the IRS says it is. Tax analysts generally use a definition devised by two economists named Robert Haig and Henry Simons, which says that income consists of consumption plus the change in net worth between two points in time.
But the Haig-Simons definition goes far beyond that in the tax law. Most importantly, it includes unrealized capital gains. There is also no place in the Haig-Simons definition for things like 401(k) plans, individual retirement accounts or other retirement savings, nor for lower tax rates on realized capital gains.
Under Haig-Simons, owner-occupied homes would be treated as businesses, with homeowners taxed on the implicit rent they pay to themselves, less depreciation. And if your home's value increased over the course of a year, you should pay tax on that even if you didn't sell your house.
Now, clearly, the IRS is not going to do any of these things, nor would Congress allow it to do so. But because tax analysts implicitly accept the Haig-Simons definition of income, even though it appears nowhere in law, there has been a long-term tendency for the IRS to push the limit of what can be considered taxable income. Now, a federal court has said there is a constitutional limit.
One area where I would like to see the court go further has to do with the question of whether interest constitutes income. To economists, some portion of the interest we receive on our savings is merely compensation for loss -- loss of the immediate enjoyment we would receive if we consumed our income today instead of saving it.
Think of it this way. Would you be satisfied receiving your paycheck a year from now instead of on payday? Of course not. You would be suffering a real loss if you had to wait a year to get paid for your work. But if you were offered, say, 10 percent more in a year, you might say that was OK. Collectively, our willingness to put off consumption today for greater consumption in the future is what determines the pure rate of interest.
But in the view of many great economists, such as John Stuart Mill, the future interest one receives is merely compensation for the loss of immediate satisfaction. Therefore, it is not income, but more like an insurance settlement that simply makes us whole. Now, obviously, market interest rates are more than simply a discount between present and future, as my example implies. A lot represents a return to risk and an adjustment for expected inflation. But in principle, some portion of interest is compensation for loss and therefore not income.
Given the logic of the Murphy decision, it is quite possible that the risk-free, inflation-adjusted rate of interest could also be excluded from taxation on constitutional grounds. Following through that logic consistently would revolutionize taxation and eventually lead to a pure consumption tax, which most economists today favor.
I'm not predicting that the Supreme Court will follow this logic. But it does open an interesting possibility that tax analysts will follow with interest.
(No more Olmert! No more Kadima! No more Oslo! )
Don't be on it....they'd tax every use of a commode, it they could install squat-counters.....there's no end to what they will attempt to tax.
I don't think you're giving the New Deal and deficit spending nearly enough credit where credit is due.
Taxing the dead is indication enough, wouldn't you say?
this is Bush's fault. He should have appointed real conservatives to the court. we should all complain about the fact that the IRS does not have free rein over all of us and the Bush is at fault for appointing judges that take the side of the people. Where are the business people who protest that the little guy is able to keep Her money? Don't the DemocRATS realize the injustice of a woman keeping money from an accident? Where are the people who complain about new ropes and Bush not doing his job for conservatives? /rant off
(No more Olmert! No more Kadima! No more Oslo! )
Boortz says that it takes 1/3 of the money that the IRS extorts from the citizens just to fund the IRS. That isnt right, it just isnt right. They need to be done away with. They are worse than the Nazis of WWII.
I don't see how the absence of an income tax would keep them from spending money they don't have.
Absolutely beyond the pale. I think that's why the expression ends with "death and taxes", as opposed to "taxes and death".....in the first instance, even the taxes come AFTER death in the sentence!
The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.
The wording is pretty plain and far too broad. We being strict constructionists, "from whatever source derived" unfortunately could and does mean from whatever source derived. Only a biased interpretation could see other meanings in the plain language. This amendment needs to go.
The purpose of taxes is supposed to be to raise money to run the government. The socialists have turned the tax system to the task of wealth redistribution and made it a bureaucratic quagmire.
"The problem is that the very concept of income itself has never been defined in the tax law. It is pretty much whatever the IRS says it is."
Does anyone know where in the constitutional penumbra it says that unelected, unaccountable executive branch bureaucrats can write law? I always thought only legislators can write law.
Thanks for the post, Uncledave. BB is on target on this one. It does open the door to radical reform, specifically a consumption tax, and the best design for doing so is the Fair Tax (HR 25, S 25). Another point of attack is the current taxation of the inflated value of currency as income. Much of what is taxed as income, including particularly capital gains, is really just compensation for the loss of value in the dollar, courtesy of the Federal Reserve. Of course, the problem in all this is the Supreme Court's "swingman" presently, Anthony Kennedy, who is not friendly to anything requiring radical reform. Good chance he will go with the "lefties" on the Court.
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Time for the people to take the matters into their own hands and straighten things up. Either do away with the IRS and institute a fair tax, or have a TAX REVOLT, and stop their money dead until there are referendums where the people can have a voice. The Kongresskritters are not representing the people, they are representing themselves and big government. It is time that the People re-aligned the processes.
Whining about it on FR does not one lick of good. It takes contacting those politicians and reminding them that there are elections coming up and that they need to act in a responsible fashion.
BUMP!
If we can't do "one lick of good" here, then FR is a failure. I don't think that's the case. Yes, we need to contact our representatives, both individually and collectively. We also need to work on finding ways to keep the influence of the unelected bureaucrats that inhabit the beltway from diluting that message. In many ways they have better access to and more opportunity to influence our representatives than we do, and will act in their own best interest.
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