Article I, Section 8, Clause 1:
The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States; . . .
By the terms of the Constitution, the power of Congress to levy taxes is subject to but one exception and two qualifications. Articles exported from any State may not be taxed at all. Direct taxes must be levied by the rule of apportionment and indirect taxes by the rule of uniformity. The Court has emphasized the sweeping character of this power by saying from time to time that it
reaches every subject, 1 that it is
exhaustive 2 or that it
embraces every conceivable power of taxation. 3 Despite these generalizations, the power has been at times substantially curtailed by judicial decision with respect to the subject matter of taxation, the manner in which taxes are imposed, and the objects for which they may be levied.
Decline of the Forbidden Subject Matter Test
The Supreme Court has restored to Congress the power to tax most of the subject matter which had previously been withdrawn from its reach by judicial decision. The holding of Evans v. Gore 4 and Miles v. Graham 5 that the inclusion of the salaries received by federal judges in measuring the liability for a nondiscriminatory income tax violated the constitutional mandate that the compensation of such judges should not be diminished during their continuance in office was repudiated in O'Malley v. Woodrough. 6 The specific ruling of Collector v. Day 7 that the salary of a state officer is immune to federal income taxation also has been overruled. 8 But the principle underlying that decision – that Congress may not lay a tax that would impair the sovereignty of the states – is still recognized as retaining some vitality. 9
Federal Taxation of State Interests
In 1903 a succession tax upon a bequest to a municipality for public purposes was upheld on the ground that the tax was payable out of the estate before distribution to the legatee. Looking to form and not to substance, in disregard of the mandate of Brown v. Maryland, 10 a closely divided Court declined to
regard it as a tax upon the municipality, though it might operate incidentally to reduce the bequest by the amount of the tax. 11 When South Carolina embarked upon the business of dispensing alcoholic beverages, its agents were held to be subject to the national internal revenue tax, the ground of the holding being that in 1787 such a business was not regarded as one of the ordinary functions of government. 12
Another decision marking a clear departure from the logic of Collector v. Day was Flint v. Stone Tracy Co., 13 in which the Court sustained an act of Congress taxing the privilege of doing business as a corporation, the tax being measured by the income. The argument that the tax imposed an unconstitutional burden on the exercise by a state of its reserved power to create corporate franchises was rejected, partly because of the principle of national supremacy, and partly on the ground that the corporate franchises were private property. This case also qualified Pollock v. Farmers' Loan & Trust Co. to the extent that it allowed interest on state bonds to be included in measuring the tax on the corporation.
Subsequent cases have sustained an estate tax on the net estate of a decedent, including state bonds, 14 excise taxes on the transportation of merchandise in performance of a contract to sell and deliver it to a county, 15 on the importation of scientific apparatus by a state university, 16 on admissions to athletic contests sponsored by a state institution, the net proceeds of which were used to further its educational program, 17 and on admissions to recreational facilities operated on a nonprofit basis by a municipal corporation. 18 Income derived by independent engineering contractors from the performance of state functions, 19 the compensation of trustees appointed to manage a street railway taken over and operated by a state, 20 profits derived from the sale of state bonds, 21 or from oil produced by lessees of state lands, 22 have all been held to be subject to federal taxation despite a possible economic burden on the state.
In finally overruling Pollock, the Court stated that Pollock had
merely represented one application of the more general rule that neither the federal nor the state governments could tax income an individual directly derived from any contract with another government. 23 That rule, the Court observed, had already been rejected in numerous decisions involving intergovernmental immunity.
We see no constitutional reason for treating persons who receive interest on government bonds differently than persons who receive income from other types of contracts with the government, and no tenable rationale for distinguishing the costs imposed on States by a tax on state bond interest from the costs imposed by a tax on the income from any other state contract. 24
Regulation by Taxation
Congress has broad discretion in methods of taxation, and may, under the Necessary and Proper Clause, regulate business within a state in order to tax it more effectively. For instance, the Court has sustained regulations regarding the packaging of taxed articles such as tobacco 25 and oleomargarine, 26 which were ostensibly designed to prevent fraud in the collection of the tax. It has also upheld measures taxing drugs 27 and firearms, 28 which prescribed rigorous restrictions under which such articles could be sold or transferred, and imposed heavy penalties upon persons dealing with them in any other way. These regulations were sustained as conducive to the efficient collection of the tax though they clearly transcended in some respects this ground of justification. 29
Even where a tax is coupled with regulations that have no possible relation to the efficient collection of the tax, and no other purpose appears on the face of the statute, the Court has refused to inquire into the motives of the lawmakers and has sustained the tax despite its prohibitive proportions. 30
It is beyond serious question that a tax does not cease to be valid merely because it regulates, discourages, or even definitely deters the activities taxed. . . . The principle applies even though the revenue obtained is obviously negligible . . . or the revenue purpose of the tax may be secondary. . . . Nor does a tax statute necessarily fall because it touches on activities which Congress might not otherwise regulate. As was pointed out in Magnano Co. v. Hamilton,  31
In some cases, however, the structure of a taxation scheme is such as to suggest that the Congress actually intends to regulate under a separate constitutional authority. As long as such separate authority is available to Congress, the imposition of a tax as a penalty for such regulation is valid. 32 On the other hand, where Congress had levied a heavy tax upon liquor dealers who operated in violation of state law, the Court held that this tax was unenforceable after the repeal of the Eighteenth Amendment, because the National Government had no power to impose an additional penalty for infractions of state law. 33
Discerning whether Congress, in passing a regulation that purports to be under the taxing authority, intends to exercise a separate constitutional authority, requires evaluation of a number of factors. 34 Under the Child Labor Tax Case, 35 decided in 1922, the Court, which had previously rejected a federal prohibition of child labor laws as being outside of the Commerce Clause, 36 also rejected a tax on companies using such labor. First, the Court noted that the law in question set forth a specific and detailed regulatory scheme — including the ages, industry, and number of hours allowed — establishing when employment of underage youth would incur taxation. Second, the taxation in question functioned as a penalty, in that it was set at one-tenth of net income per year, regardless of the nature or degree of the infraction. Third, the tax had a scienter requirement, so that the employer had to know that the child was below a specified age in order to incur taxation. Fourth, the statute made the businesses subject to inspection by officers of the Secretary of Labor, positions not traditionally charged with the enforcement and collection of taxes.
More recently, in National Federation of Independent Business (NFIB) v. Sebelius, 37 the Court upheld as an exercise of the taxing authority a requirement under the Patient Protection and Affordable Care Act (ACA) 38 that mandates certain individuals to maintain a minimum level of health insurance. Failure to purchase health insurance may subject a person to a monetary penalty, administered through the tax code. Chief Justice Roberts, in a majority holding, 39 used a functional approach in evaluating the authority for the requirement, so that the use of the term
penalty in the ACA 40 to describe the enforcement mechanism for the individual mandate was found not to be determinative. The Court also found that the latter three factors identified in the Child Labor Tax Case (penal intent, scienter, enforcement by regulatory agency) were not present with respect to the individual mandate. Unlike the child labor taxation scheme, the tax level under the ACA is established based on traditional tax variables such as taxable income, number of dependents and joint filing status; there is no requirement of a knowing violation; and the tax is collected by the Internal Revenue Service.
The majority, however, did not appear to have addressed the first Child Labor Case factor: whether the ACA set forth a specific and detailed course of conduct and imposed an exaction on those who transgress its standard. The Court did note that the law did not bear characteristics of a regulatory penalty, as the cost of the tax was far outweighed by the cost of obtaining health insurance, making the payment of the tax a reasonable financial decision. 41 Still, the majority’s discussion suggests that, for constitutional purposes, the prominence of regulatory motivations for tax provisions may become less important than the nature of the exactions imposed and the manner in which they are administered.
In those areas where activities are subject to both taxation and regulation, the taxing authority is not limited from reaching activities otherwise prohibited. For instance, Congress may tax an activity, such as the business of accepting wagers, 42 regardless of whether it is permitted or prohibited by the laws of the United States 43 or by those of a state. 44 However, Congress's authority to regulate using the taxing power
reaches only existing subjects. 45 Thus, so-called federal
licenses, so far as they relate to topics outside Congress's constitutional authority, merely express,
the purpose of the government not to interfere . . . with the trade nominally licensed, if the required taxes are paid. In those instance, whether the
licensed trade shall be permitted at all is a question that remains a decision by the state. 46