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August 23, 2006

With a night to sleep on it, I am more convinced that yesterday's D.C. Circuit decision in Murphy is unlikely to stand. I think there are two major flaws in the decision.


The first flaw is the decisions conclusion that the "framers" of the 16th amendment authorizing the modern income tax would have not considered damages for emotional distress "income." Joseph M. Dodge, in his essay in "Tax Stories," notes that there were at least two competing conceptions of income at the time. One concept was based on the "principal and income" concepts of trust law. One was the "Haig-Simons" concept, which more or less covers most of what we think of as income now. Murphy ignores this debate entirely and concludes on the thin evidence of an Attorney General opinion and a House committee report that "income" was a settled concept.


Once the Murphy court decided that damages for personal injuries weren't "income," they concluded that the tax on them was unconstitutional without further discussion. This appears to be the weakest part of their analysis.

The federal government has broad taxing powers. The courts struck down the pre-1913 income tax as a violation of the constitutional requirement that "direct" taxes be apportioned among the states based on population. Many non-income taxes are recognized as constitutional, including gift, estate and excise taxes. As one professor puts it:

Thus, in order to invalidate the tax in the Murphy case, it is not enough to hold that the award is not "income." It would be necessary further to hold that the tax is a "direct" one, prohibited by Article I -- and to explain why it is not otherwise authorized by the Necessary and Proper Clause. The court of appeals did not perform these analyses, and thus its opinion is woefully incomplete. My very rough sense is that the tax on the award in Murphy is authorized by Article I, section 8, and by the Necessary and Proper Clause, and, more importantly, is not a prohibited "direct" tax under Article I, section 9, just as with estate taxes (see Manufacturers National Bank, 363 U.S. 194) and gift taxes (see Bromley v. McCaughn, 280 U.S. 124).
(Emphasis added).

My point? Even if it's not income, compensatory damages are still subject to Congress's power to tax unless they are imposing a "direct" tax, which they probably aren't.

The TaxProf has a good roundup of links and discussion of Murphy (not mine, alas). One theme of a number of these links is the notion that the Murphy decision is just about a narrow issue of personal injury damages. It claims no such modest goals. It subjects every item subject to income to a test of what the word income meant in 1913; it settles on a "common understanding" of the term and potentially subjects every item now subject to the income tax to the 1913 definition. Every day many millions of dollars are exchanged in transactions undreamed of in 1913. Under this logic, what income can Congress safely tax?

I doubt the full D.C. Circuit, or the Supreme Court if it comes to that, will be willing to throw out the long-settled Glenshaw Glass approach of deference to Congress and introduce such disruption to the tax law.


Tax Update initial discussion of Murphy

Stuart Levine's discussion

UPDATE: Dr. Maule takes his shot at the decision:

Where the court goes haywire is its conclusion that section 104(a)(2) is unconstitutional. This conclusion reflects a total misunderstanding of how the Internal Revenue is structured. There is no need to comment on, or decide, the constitutional validity of section 104(a)(2), and doing so opens up a hornet's nest of problems.

Well worth reading in full.

ONE MORE UPDATE: The TaxProf now has commentary from 10 academics on Murphy. They don't have much good to say about the legal basis for the decision. One makes the point that the rest of us have perhaps been reluctant to make (glass houses and all that):

By the way, wasn't the opinion's author they guy who lost a seat on the Supreme's for smoking dope?

Like totally, dude!

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