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decided: December 16, 1935.



Hughes, Van Devanter, McReynolds, Brandeis, Sutherland, Butler, Stone, Roberts, Cardozo

Author: Sutherland

[ 296 U.S. Page 416]

 MR. JUSTICE SUTHERLAND delivered the opinion of the Court.

The Vermont Income and Franchise Tax Act of 1931, Public Laws of Vermont, 1933, § 872 et seq. (the pertinent provisions of which are copied in the margin*fn1), imposes

[ 296 U.S. Page 417]

     individual income taxes as follows: First, with respect to net income derived from salaries, wages, etc., denominated by the court below class A income, at the rate of 2%; second, with respect to income received on account of the ownership or use of or interest in any interest bearing security, denominated class B income, at the rate of 4%, excluding, however, from such income (a) interest received

[ 296 U.S. Page 418]

     on account of money loaned within the state at a rate of interest not exceeding 5% per annum, evidenced by a promissory note, mortgage, or bond for a deed bearing a like rate of interest; (b) dividends on stocks of corporations subject to taxation under §§ 887, 888 of the statute. If the income taxed is derived wholly from interest-bearing securities, there is allowed in the case of a single individual, a personal exemption of $400, and, in the case of a head of a family or of a married individual living with husband or wife, a personal exemption of $800. If, however, either husband or wife shall receive any income other than that derived from such securities, then the personal exemption is not allowed. A distinct and larger personal exemption is allowed in the case of net income derived from salaries, wages, etc. (§ 880) -- namely, $1,000 in the case of a single individual, and $2,000 in the case of a head of a family or a married individual living with husband or wife.

Appellant is a resident of Vermont, married and living with his wife. During the taxable year in question, he received both class A and class B income; but his class A income, although large, was absorbed by allowable deductions, so that there was no net income from that source, and consequently nothing subject to taxation. His class B income amounted to a larger sum, part of which consisted of interest on notes, mortgages, etc., representing money loaned outside the State of Vermont at not exceeding 5% per annum, and another part from taxable dividends received from corporations other than Vermont corporations. Upon these two sums a tax was assessed against him at the rate of 4%. Under the statute he was allowed no personal exemption whatever.

The validity of the statute under the federal Constitution was properly challenged. The grounds of attack, so far as necessary to be stated, are as follows: (1) The act imposes a tax upon dividends earned outside the State of

[ 296 U.S. Page 419]

     Vermont, while exempting from the tax dividends earned within the state, thereby denying petitioner the equal protection of the laws in violation of the Fourteenth Amendment; (2) the act, in violation of the same clause, discriminates in favor of money loaned within the state as against money loaned outside the state; (3) the act arbitrarily denies appellant the $800 exemption while giving it to other persons whose situation differed from his only in that they had no income from business, and thereby denies appellant the equal protection of the laws guaranteed by the Fourteenth Amendment; and in each of these three particulars the act abridges the privileges and immunities of appellant as a citizen of the United States in contravention of the same amendment.*fn2

The court below denied the contentions of appellant and sustained the validity of the act in every particular. 107 Vt. 28; 175 Atl. 352.

First. Does the imposition of a tax upon dividends earned outside the state, from which tax dividends earned within the state are exempt, constitute, under the Fourteenth Amendment, an allowable classification? The basis of the classification rests in the consideration that by §§ 887 and 888 a tax of 2%, measured by net income, is imposed upon every corporation for the privilege of exercising

[ 296 U.S. Page 420]

     its franchise in the state and of doing business therein. If the entire business of the corporation be transacted within the state, the amount of the tax is fixed with regard to the entire net income. If the entire business be not so transacted, the net income is calculated with respect to that part of the business done within the state, to be allocated so as fairly and justly to reflect such net income. Dividends upon shares of corporations which are subjected to this tax are exempted from the income tax. In addition to the 2% franchise tax, all tangible corporate property lying within the state is subjected to a property tax. The evident aim of the classification, therefore, is to produce equality and not inequality; and, obviously, that aim will become effective in fact, to a greater or less extent, in the administration of the legislation.

The theory upon which the tax is laid upon dividends realized from out-of-state business while leaving dividends realized from domestic business untaxed, is that the 2% franchise tax, especially with the property tax added, has the effect of indirectly imposing a tax burden upon the latter measurably equivalent to that imposed directly upon the former. Thus, the tendency of the plan is to avoid taxing twice what is, in effect, the same thing. And conceding the power of the state to impose double or even multiple taxation, legislation which is calculated to avoid that undesirable result certainly cannot be condemned as arbitrary. Thus far, the question is settled in favor of the validity of the tax by prior decisions of this court. Kidd v. Alabama, 188 U.S. 730; Darnell v. Indiana, 226 U.S. 390, 398; Traveller's Insurance Co. v. Connecticut, 185 U.S. 364; Watson v. State Comptroller, 254 U.S. 122, 124-125; Lawrence v. State Tax Comm'n, 286 U.S. 276, 284. True, it well may be assumed that similar franchise and property taxes are imposed upon the outside corporations by other states; but the assumption is immaterial

[ 296 U.S. Page 421]

     to the issue here involved. It is enough that such taxes are not imposed by the State of Vermont. It was so decided in Kidd v. Alabama, supra, where Mr. Justice Holmes, speaking for the court, said (p. 732):

"The State of Alabama is not bound to make its laws harmonize in principle with those of other States. If property is untaxed by its laws, then for the purpose of its laws the property is not taxed at all." And see Bacon v. Board of Tax Comm'rs, 126 Mich. 22, 25-26; 85 N. W. 307.

Appellant urges that the franchise tax measured by the corporation's income is at the rate of 2%, while the tax on dividends is at the rate of 4%; and concludes that this results in putting a burden on dividends directly taxed twice as great as that imposed indirectly by the franchise tax. But it is obvious that, since the 4% tax is imposed only upon such part of the corporate net income as passes to the shareholders in the form of dividends, and the 2% tax is measured by the entire net income of the corporation, this conclusion is erroneous. Corporations do not, at least as a general rule, pay out their entire net income in dividends. Something is reserved for future contingencies; and it may well result that a tax of 2% measured by the entire net income of the corporation will roughly approximate the amount imposed by a 4% tax on that part of the net income paid out as dividends. There is nothing in the equality clause of the Constitution which requires that the two sums shall be mathematically equivalent. Concordia Fire Ins. Co. v. Illinois, 292 U.S. 535, 547. In Klein v. Board of Supervisors, 282 U.S. 19, this court sustained an act exempting corporate shares from taxation where 75% of the total property of the corporation was taxable in the state and the taxes thereon were paid. It was said that this was plainly a reasonable effort to do justice to all in view of the way other assessments were made.

[ 296 U.S. Page 422]

     It is impossible to say from the record before us that there is a greater disproportion here than was presented in the Klein case, or to conclude that the disproportion is so great as to stamp the classification as wholly arbitrary or capricious. Moreover, as a general thing, a corporation subject to the 2% franchise tax will pay also a tax upon property located within the state, with the effect of still further narrowing, if not altogether extinguishing, the difference.

This court has frequently said that absolute equality in taxation cannot be obtained and is not required under the Fourteenth Amendment. This, of course, is not to say that, because some degree of inequality from the nature of things must be permitted, gross inequality must also be allowed. The boundary between what is permissible and what is forbidden by the constitutional requirement has never been precisely fixed and is incapable of exact delimitation. In the great variety of cases which have arisen, decisions may seem to be difficult of reconcilement; but investigation will generally cause apparent conflicts to disappear when due weight is given to material circumstances which distinguish the cases. If the evident intent and general operation of the tax legislation are to adjust the burden with a fair and reasonable degree of equality, the constitutional requirement is satisfied. We think the provision now under consideration meets this test. Cf. State Railroad Tax Cases, 92 U.S. 575, 612; Tappan v. Merchants' National Bank, 19 Wall. 490, 504; Merchants' Bank v. Pennsylvania, 167 U.S. 461, 464.

Second. It is settled beyond the admissibility of further inquiry that the equal protection clause of the Fourteenth Amendment does not preclude the states from resorting to classification for the purposes of legislation. Royster Guano Co. v. Virginia, 253 U.S. 412, 415. And "the power of the state to classify for purposes of taxation is

[ 296 U.S. Page 423]

     of wide range and flexibility . . ." Louisville Gas Co. v. Coleman, 277 U.S. 32, 37. But the classification "must be reasonable, not arbitrary, and must rest upon some ground of difference having a fair and substantial relation to the object of the legislation, so that all persons similarly circumstanced shall be treated alike." Royster Guano Co. v. Virginia, supra; Air-Way Corp. v. Day, 266 U.S. 71, 85; Schlesinger v. Wisconsin, 270 U.S. 230, 240. The classification, in order to avoid the constitutional prohibition, must be founded upon pertinent and real differences, as distinguished from irrelevant and artificial ones. The test to be applied in such cases as the present one is -- does the statute arbitrarily and without genuine reason impose a burden upon one group of taxpayers from which it exempts another group, both of them occupying substantially the same relation toward the subject matter of the legislation? " Mere difference is not enough . . ." Louisville Gas Co. v. Coleman, supra; Frost v. Corporation Commission, 278 U.S. 515, 522.

The question depends here upon whether the income taxed and the income exempted from taxation reasonably can be assigned to different classes. As the Supreme Court of Vermont itself has pointed out, in all such cases it must appear not only that a classification has been made, but that it is one based on some reasonable ground. State v. Hoyt, 71 Vt. 59, 64-66; 42 Atl. 973. The decision in that case held invalid a state statute the effect of which was to impose a tax upon sales of goods manufactured in the state, while leaving sales of goods manufactured in other states free from taxation. It was held that the classification could not be based on any difference in the goods, because there was none; nor on the fact that they were made in different states, for that bore no just and proper relation to the classification, but was purely arbitrary; nor on the difference of residence of the manufacturers, for the same reason. And clearly the view of the court was that

[ 296 U.S. Page 424]

     a like discrimination against the products of another state would have been open to the same objections.

Let us apply these principles to the statute creating the exemption now in question. Upon the face of the statute the classification is based upon a difference having no substantial or fair relation to the object of the act -- which, so far as this question is concerned, simply is to secure revenue. The statute itself suggests no other public purpose which will be served by the exemption. The language creating the exemption is "(a) Interest received on account of money loaned within this state, at a rate of interest not exceeding five per cent per annum . . ." The naked and complete test afforded by the statute is that the money shall be loaned within the state. What is to be done with the money, whether it is to be invested in the state or elsewhere -- indeed, whether it is to be devoted to any useful purpose -- are matters having nothing to do with the imposition of the tax or the exemption therefrom. If the statute had provided that interest on account of money so loaned when invested in property having a situs within the state shall be free from the tax, a different question as to classification might be presented. In that event the actual wealth of the state would be increased, and in addition, and as a consequence, opportunity to obtain additional revenue through taxation would result. But this exempting provision, we repeat, contains neither this qualification nor any other. Its terms are positive and all-inclusive and will be fully satisfied whenever it appears that money has been loaned within the state. The Supreme Court of Vermont has not read into the statute a qualification that loans shall be deemed to be made within the state only if their proceeds be invested in the state. Obviously this court cannot so read the provision, for that would be to amend and not to construe it. We are unable to find in the provision any public purpose which can be subserved by

[ 296 U.S. Page 425]

     making the taxation of income from loans dependent merely upon the adventitious circumstance as to the place of making the loan.

It is suggested, however, that, aside from anything in the statute, money loaned within the state generally will be invested therein. But there is nothing in the record to indicate that this will result; and for aught this court can know judicially, there is no warrant for saying either that it will or will not result. All we can say is that money so loaned may be invested in Vermont, or may be invested in some other state -- for example, in property having a situs in New York -- or may not be invested at all. If there be circumstances which will justify the exemption of any income derived from money loaned within the state while taxing the income from that loaned outside, it is for the state legislature to point them out and limit the exemption accordingly. To import any such circumstances into the present situation is to indulge in pure speculation. Compare Travis v. Yale & Towne Mfg. Co., 252 U.S. 60, 81.

To assume that some unnamed public interest exists, which will sustain the discrimination, does not help the matter here; because the assumption can rest only upon surmise, with nothing concrete or explicit appearing to support it or to indicate a legislative intent to relate the exemption to any public purpose or to anything else beyond the mere fact that the favored loans are effected within the state. In principle, the classification is quite as arbitrary as that dealt with by this court in Louisville Gas Co. v. Coleman, supra, pp. 38-39. If the exemption had been made to depend upon the time when the loan was made, instead of upon the locality where it was made -- as, for example, a tax upon all income from loans except those made on Mondays -- the arbitrary and capricious nature of the classification would scarcely be doubted, although a minute inspection of the field of

[ 296 U.S. Page 426]

     possibilities might persuade an anxious mind, bent on sustaining the tax at all events, to the view that in some far-fetched way a loan made on Monday would further some public purpose, other than that of revenue, which a loan made on another day of the week would not.

It is said that an exemption which may have for its aim the advancement of local interests can hardly be condemned under a Constitution which for a century has known a protective tariff. Considering the suggestion categorically, a pertinent answer to it is that while the general government may, for the benefit of national interests, exact impost duties which discriminate against foreign interests, one state, even for the advancement of its own interests, is not permitted to exact taxes discriminating against goods brought from a sister state. See, for example, Welton v. Missouri, 91 U.S. 275; cf. Burnet v. Brooks, 288 U.S. 378, 401, et seq.

But, assuming that the State of Vermont is benefited by the exemption, the complete answer is that appellant is a citizen of the United States; and, quite apart from the equal protection of the laws clause, the suggestion is effectively met and overcome, and the fallacy of other attempts to sustain the validity of the exemption here under review clearly demonstrated, by reference to the privileges and immunities clause of the Fourteenth Amendment. "For all the great purposes for which the Federal government was formed," this court has said, "we are one people, with one common country." Crandall v. Nevada, 6 Wall. 35, 48-49. As citizens of the United States we are members of a single great community consisting of all the states united and not of distinct communities consisting of the states severally. No citizen of the United ...

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