Another Blow to the Tax Deniers

As expected, the U.S. Court of Appeals for the District of Columbia has reversed itself in Murphy v. IRS. The background is in my posts here and here. When the court first stunned the government by declaring part of the federal tax code unconstitutional, the frantic Bush Justice Department won a rehearing by the same three judges. Surprise, surprise! The judges reversed themselves, holding that Murphy's compensatory damages for mental distress and loss of reputation are indeed taxable income, and even if they are not income, they are still taxable. Taxing her, the court said, is not unconstitutional.

In essence, the court said that compensatory damages are in fact payment in a forced sale. Weird, but that's what it said. If someone damages your reputation, it's as though he deprived you of something that belongs to you. So when he compensates you, he is completing the forced transaction. Read on.

Some choice quotes from the opinion today:

The Government petitioned for rehearing en banc, arguing for the first time that, even if Murphy’s award is not income, there is no constitutional impediment to taxing it because a tax on the award is not a direct tax and is imposed uniformly. In view of the importance of the issue thus belatedly raised, the panel sua sponte vacated its judgment and reheard the case. . . . In the present opinion, we affirm the judgment of the district court based upon the newly argued ground that Murphy’s award, even if it is not income within the meaning of the Sixteenth Amendment, is within the reach of the congressional power to tax under Article I, Section 8 of the Constitution....

Principles of statutory interpretation could show § 61(a) [of the Internal Revenue Code] includes Murphy’s award in her gross income regardless whether it was an “accession to wealth,” as Glenshaw Glass requires. For example, if § 61(a) were amended specifically to include in gross income “$100,000 in addition to all other gross income,” then that additional sum would be a part of gross income under § 61 even though no actual gain was associated with it. In other words, although the “Congress cannot make a thing income which is not so in fact,” ... it can label a thing income and tax it, so long as it acts within its constitutional authority, which includes not only the Sixteenth Amendment but also Article I, Sections 8 and 9. ... (“Congress has the power to impose taxes generally, and if the particular imposition does not run afoul of any constitutional restrictions then the tax is lawful, call it what you will” [Penn Mut. Indem. Co. v. Comm’r, 3d Cir. 1960])... Accordingly, rather than ask whether Murphy’s award was an accession to her wealth, we go to the heart of the matter, which is whether her award is properly included within the definition of gross income in § 61(a), to wit, “all income from whatever source derived.”...

Even if we assume one’s human capital should be treated as personal property, it does not appear that this tax is upon ownership; rather, as the Government points out, Murphy is taxed only after she receives a compensatory award, which makes the tax seem to be laid upon a transaction.... Murphy’s situation seems akin to an involuntary conversion of assets; she was forced to surrender some part of her mental health and reputation in return for monetary damages....

Therefore, even if we were to accept Murphy’s argument that the human capital concept is reflected in the Sixteenth Amendment, a tax upon the involuntary conversion of that capital would still be an excise and not subject to the requirement of apportionment....

[W]e conclude (1) Murphy’s compensatory award was not received on account of personal physical injuries, and therefore is not exempt from taxation pursuant to § 104(a)(2) of the IRC; (2) the award is part of her “gross income,” as defined by § 61 of the IRC; and (3) the tax upon the award is an excise and not a direct tax subject to the apportionment requirement of Article I, Section 9 of the Constitution. The tax is uniform throughout the United States and therefore passes constitutional muster.

This is a dreadful ruling, but one entirely consistent with the law, the Constitution, and how governments typically behave. Indeed, that's the problem! Reading the opinion gave me a sense that the judges were engaged in a purely expedient exercise, without a principle in their heads. It was as though they were determined to find any case that supported their preconceived notion that the state may tax anything. Unfortunately, that is how states have been viewed historically. And the American state is no exception, however much the tax deniers think it is.