As Orin points out, the D.C. Circuit has just held that a small part of the federal tax code exceeds Congress’s power to lay income taxes under the Sixteenth Amendment. The tax code, the court held, does tax as income compensatory damages for emotional distress and loss of reputation. But such damages aren’t “income” for purposes of the Sixteenth Amendment (“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”), because they are not a gain but merely a compensation for loss; therefore, the court held, they can’t constitutionally be subjected to the income tax.
I don’t have much to say about the opinion but one thing did strike me. The court writes:
The Sixteenth Amendment simply does not authorize the Congress to tax as “incomes” every sort of revenue a taxpayer may receive…. [B]ecause the “the power to tax involves the power to destroy,” it would not be consistent with our constitutional government, and the sanctity of property in our system, merely to rely upon the legislature to decide what constitutes income.
Yet “the sanctity of property in our system” does not generally protect people from taxes on their capital. Not only may the federal government impose taxes on transactions involving property (such as importation, gift, or disposition on death), but state governments are free to tax property in a wide range of ways, including by imposing a percentage tax on all possessed property.
The state may, for instance, impose a percentage tax on all real estate; it may do the same for personal property, though my understanding is that administrative (and political) problems usually prevent that from happening; and I think it would be quite free to impose a tax on compensatory damage awards as well. States have long taxes real estate, to my knowledge from before the Constitution, though a property tax is often thought of as a quintessential direct non-income tax that the federal government may not impose. There’s just nothing in the federal Constitution, or to my knowledge in most state constitutions, that prohibits states from laying taxes either on capital or on compensation for loss. Our system just doesn’t view such taxes on property as inconsistent with “the sanctity of property.”
Rather, the limits on the federal income tax are limits specific to the federal government — limits that originated in the Direct Tax Clause and were then made much looser by the Sixteenth Amendment. They stem from concerns about federal power, not about government power more generally. And they thus have to do not with “the sanctity of property” as such, but rather with what only states and not the federal government should be able to do as to that property.