In the United States, the term Direct Tax has a specific meaning under constitutional law. Direct taxes mainly include taxes imposed on property because of ownership and capitation taxes.
A tax on property is considered a direct tax when it is imposed on a person because the person owns the property. For example, an ordinary real estate property tax imposed on the owner of property is treated as a direct tax.
A capitation tax, also known as a head tax or poll tax, is another form of direct tax. It is imposed directly on an individual without reference to a specific transaction.
The United States Court of Appeals for the District of Columbia Circuit identified three taxes that are definitely considered direct taxes. These are capitation tax, tax on real property, and tax on personal property.
Income taxes imposed on income from personal services, such as wages and salaries, are not treated as direct taxes in this specific constitutional sense.
Health Insurance Penalty and Direct Tax
In National Federation of Independent Business v. Sebelius, the U.S. Supreme Court examined the penalty imposed on individuals who failed to maintain health insurance.
The Supreme Court held that the penalty could be considered a tax for constitutional purposes, but it was not a direct tax.
The Court explained that the tax was neither a tax on property nor a capitation tax. It was triggered by specific circumstances, namely the failure to possess health insurance. Therefore, it was not imposed without regard to property, profession, or other circumstances.
Constitutional Requirement of Apportionment
The U.S. Constitution requires direct taxes imposed by the national government to be apportioned among the states on the basis of population.
Apportionment means that the burden of a direct federal tax must be distributed among the states according to their respective populations.
The constitutional requirement of apportionment historically affected the power of the federal government to impose certain forms of taxation.
Pollock Ruling and Income Tax
In the 1895 Pollock ruling, taxes on income derived from property were treated as direct taxes.
Because direct taxes were subject to the constitutional requirement of apportionment among states according to population, the ruling made it difficult for the U.S. Congress to impose a national income tax covering all forms of income.
This constitutional difficulty continued until the ratification of the Sixteenth Amendment in 1913.
Sixteenth Amendment and Federal Income Tax
The Sixteenth Amendment was ratified in 1913. It gave Congress the constitutional authority to impose taxes on income without requiring apportionment among the states on the basis of population.
After the Sixteenth Amendment, federal income taxes became subject to the Rule of Uniformity rather than the Rule of Apportionment.
Therefore, income tax could be imposed across the United States without distributing the tax burden among states according to population.
Changes in Sources of Federal Revenue
Before the development of the modern federal income tax system, the major sources of revenue for the U.S. federal government were excise taxes and customs duties.
During the twentieth century, the importance of excise taxes and customs duties as major federal revenue sources declined.
Individual income taxes and payroll taxes became the principal sources of revenue for the federal government.
Changes also occurred at the state and local government levels. The relative importance of property taxes declined, while income taxes and sales taxes became more important.
Taxation of Wages and Salaries
U.S. courts have confirmed that wages, salaries, and other compensation received for personal services are taxable income.
Arguments that wages are not taxable under the Sixteenth Amendment have been rejected by U.S. courts.
Courts have also rejected the argument that income tax on wages must be apportioned among states according to population.
The Sixteenth Amendment authorizes Congress to impose taxes on income without apportionment among the states. Therefore, income earned from labour or personal services may be subject to federal income tax.
Key Exam Points
Under U.S. constitutional law, direct taxes mainly include capitation taxes, taxes on real property, and taxes on personal property.
Income tax on wages and salaries is not treated as a direct tax in the specific constitutional sense of direct taxation.
The U.S. Constitution requires federal direct taxes to be apportioned among states according to population.
The 1895 Pollock ruling treated taxes on income from property as direct taxes.
The Sixteenth Amendment was ratified in 1913 and allowed Congress to impose income taxes without apportionment among the states.
After the Sixteenth Amendment, federal income tax became subject to the Rule of Uniformity instead of the Rule of Apportionment.
Before the modern income tax system, excise taxes and customs duties were major sources of federal revenue. Later, individual income taxes and payroll taxes became major federal revenue sources.
U.S. courts have confirmed that wages, salaries, and compensation for personal services are taxable income.