Direct and Indirect taxes

The distinction between direct and indirect taxes was first examined by Adam Smith in his Wealth of Nations, where we find at V.2.154

Taxes upon luxuries have no tendency to raise the price of any other commodities except that of the commodities taxed. Taxes upon necessaries, by raising the wages of labour, necessarily tend to raise the price of all manufactures, and consequently to diminish the extent of their sale and consumption. Taxes upon luxuries are finally paid by the consumers of the commodities taxed without any retribution. They fall indifferently upon every species of revenue, the wages of labour, the profits of stock, and the rent of land. Taxes upon necessaries, so far as they affect the labouring poor, are finally paid, partly by landlords in the diminished rent of their lands, and partly by rich consumers, whether landlords or others, in the advanced price of manufactured goods, and always with a considerable overcharge. The advanced price of such manufactures as are real necessaries of life, and are destined for the consumption of the poor, of coarse woollens, for example, must be compensated to the poor by a further advancement of their wages. The middling and superior ranks of people, if they understand their own interest, ought always to oppose all taxes upon the necessaries of life, as well as all direct taxes upon the wages of labour.

In other words, taxes were not direct or indirect in themselves, but in the impact they had on the decisions of taxpayers and consumers. We may attempt to summarize them by saying that direct taxes were those that fell on the proximate taxpayers and could not be passed on, and indirect on those who paid higher prices on items on which a tax had been paid before they were sold.

So in the sense Smith uses the term (he does not use "indirect tax"), a "direct" tax can be applied to wages, but that will raise the cost of labor to the employers. An indirect tax is a tax on luxuries, not on necessities consumed by the taxpayer.

Now the framers, or at least some of them, were familiar with Adam Smith, although they may not have systematized his use of those terms very well, and they were aiming at what Smith was examining when they drafted the Constitution. The result is that the tax provisions of the Constitution are based on a misunderstanding of economics (which was not a term of art in 1787, when the subject was discussed under the term "commerce" see

The Pollock Court was not aware of this discussion. All they came up with were two examples of "direct tax", on real property and a head tax on each living individual. That became their "definition of it, and we have stuck with it ever since. However, they got it wrong.

So to better understand the distinction applied to an income tax, a tax on wages is direct, because the taxpayer can't pass the tax on to the next buyer. It might have an aggregate effect on the cost of labor, but not a proximate one. The proper definition of "income" would be earnings on land and capital, in the forms of rents, interest, dividends, or profits on sales. Thus, wages would not be profit on the sale of labor, but an equal exchange. If the employer held back payment of wages, thereby taking it as a loan to himself, and he paid interest for doing so, that interest would be properly taxed as income, but not the wages themselves. This is the distinction made by Jeff Dickstein in Judicial Tyranny.

The problem with the Income tax Amendment is that it did not define "income", but left it to bureaucrats to presume it meant all revenues received, not just rents, interest, dividends, and profits. That is why it needs to be struck down, preferably by Congress rescinding the certification that it had been ratified. It was not.

Weak minds make bad laws.