Social Issues Before the Supreme Court

The Justices of the Supreme Court are arbiters of social policy because their duties make them so. For the words of the Constitution which invoke the legal judgment are usually so unrestrained by their intrinsic meaning or by their history or by prior decisions that they leave the individual Justice free, if indeed they do not compel him, to gather meaning not from reading the Constitution but from reading life. Only an alert and self-critical awareness of the true nature of the judicial process in these public controversies will avert the translation of discredited assumption or unconscious bias into national policy.

In a period of rapid change like ours, the pace of social adjustments must be quickened. Poignant experience has made us realize the public implications of interests heretofore treated as private. Such interests must be stripped of many of their past immunities and subjected to appropriate responsibility. Courts will thus be called upon to make and to sustain extensive readjustments.

For example, the law must become more sophisticated in its conception of trustees’ obligations. It must sharpen and extend the duties incident to the fiduciary relations of corporate directors and officers. The whole process of corporate salaries disproportionate to services rendered must be fearlessly faced, but especially the abuse of agreement for swollen contingent compensation. The Bethlehem Steel bonus system is a notorious example. Another instance, recently before the courts, merits recital. The directors of the American Tobacco Company in 1912 initiated a by-law authorizing six senior officers to divide among themselves ten per cent of any annual profits in excess of those earned by the Company in 1910. Since 1921, $10,000,000 has been thus distributed. In addition to his regular salary of $168,000 and “special cash credits” of $273,000, the President of the Company in 1930 received a bonus of $840,000. Even these rewards, apparently, did not provide sufficient incentive. The directors therefore adopted an Employee Stock Subscription Plan, which resulted in the sale to themselves, as officer-employees, of 32,000 shares of stock at $25 a share when the market price was $112. The millions which the President and Vice-President of the American Tobacco Company thus received appeared to a majority of the United States Circuit Court of Appeals, in New York, only reasonable compensation for making Lucky Strike the most popular cigarette in the world. That Court seemed impressed by the fact that both schemes were approved by the stockholders. To which Judge Thomas W. Swan, with real insight into the actualities of corporate management, suggested, in his dissent, that the shareholders when they adopted the by-law in 1912 could hardly have anticipated that they were conferring upon their President in 1930 a bonus five times his salary, or that through the Employee Stock Subscription Plan three-fifths of the stock would be allotted to directors by themselves. Equally unreal seems the Court’s failure to explore whether the conventional assent by proxies really signifies considered approval.

An effort to secure a reversal of this decision in the Supreme Court unfortunately failed. On technical considerations which cannot here be canvassed, that Court (Mr. Justice Roberts not sitting) invoked a doctrine of convenience against consideration of the case by the federal courts, and left the matter to the New Jersey courts because the American Tobacco Company was organized under New Jersey law. Against this disposition, three of the Justices—Brandeis, Stone, and Cardozo—protested. They found that “a breach of the fiduciary duties of the directors is a legitimate inference from the allegations,” and therefore they could not agree that a “proper exercise of discretion” required them “to deny to the petitioner the relief to which he is so clearly entitled.” Mr. Justice Stone admirably expressed the far-reaching objections to the considerations of parochialism to which the Supreme Court, most surprisingly in the light of precedents, deferred in this case: “Extension of corporate activities, distribution of corporate personnel, stockholders and directors through many States, and the diffusion of corporate ownership, separated from corporate management, make the integrity of the conduct of large business corporations increasingly a matter of national rather than local concern, . . . to which the Federal courts should be quick to respond, when their jurisdiction is rightly invoked.”

The case furnishes an illuminating glimpse into the traditional operations of big business and its opportunities for socially indefensible profit to the insiders.* The law cannot long continue to give such unbridled rein to the acquisitive motive. Our social health cannot afford it.

Disastrous defects have been exposed in our financial institutions; tighter controls must be devised. Secretary Mills calls for legislation that will “remedy the fundamental weakness of our banking structure.” Schemes have been adumbrated for a unified national banking system which raise intricate questions of policy and administration as well as of constitutionality. All these will call for judicial understanding of banking and finance, their relation to government and industry and agriculture. But surely legislation and courts must also address themselves to the disclosed tendency of banks to confound three functions which ought to be kept fastidiously segregated:

By combining these three functions, our banking men have not only dulled and confused their banking wits; they have sometimes also confused the funds of the three departments of banking and thereby disregarded trust obligations. The Glass bill in part addresses itself to some of these abuses. The development and enforcement of effective legal standards for the promotion of sound banking require insight into financial facts, a sympathetic understanding of legislative proposals and the application of exigent public policy, all too frequently forgotten.

Cutting across all our problems are the manifold aspects of taxation. The enormous increase in the cost of society and the subtle forms which modern wealth so largely takes are putting public finance to its severest test. To balance budgets, to pay for the cost of progressively civilized social standards, to safeguard the future and to divide these burdens with substantial fairness to the different interests in the community—these endeavors present problems more gruelling than were ever faced by Colbert or Hamilton. Financial statesmanship must constantly explore new sources of revenue and find means to prevent the circumvention of their discovery. Such a task is bound to fail without wide latitude for experimentation, within the most promising areas of trial, in devising and executing fiscal measures. No finicky limitation upon the discretion of those charged with the duty of providing revenue, nor jejune conceptions about formal equality, should circumscribe the necessarily empirical process of tapping new revenue or stopping new devices for its evasion. The fiscal difficulties of government at best are hard and thorny. They ought not to be made insuperable by reading into the Constitution private notions of social policy. Too often, talk about scientific taxation is only a verbal screen for distributing the incidence of taxation according to traditional notions. Judgments of fairness in taxation, as in other activities of government, are functions of their time. Governing ideas of taxation of the eighteenth century, or even of the nineteenth century, were not permanently frozen into the Constitution.

Indeed, we must recognize the profound shift in the very purposes of taxation. Senator Root once reminded the American bar that “the vast increase of wealth resulting from the increased power of production is still in the first stages of the inevitable processes of distribution.” Mr. Root was himself a member of an Administration which such distribution. Theodore Roosevelt was the first President avowedly to use the taxing power as a direct agency of social policy. More and more, it is bound to serve as a powerful means for directing the modern flow of wealth to social uses. The historical ambitions of American democracy and fiscal necessities alike demand it.

“The true principle of a free and popular government would seem to be so to construct it as to give to all, or at least to a very great majority, an interest in its preservation; to found it, as other things are founded, on men’s interest. . . . The freest government, if it could exist, would not be long acceptable, if the tendency of the laws were to create a rapid accumulation of property in few hands, and to render the great mass of the population dependent and penniless. . . . Universal suffrage, for example, could not long exist in a community where there was great inequality of property.” So wrote Daniel Webster in his famous oration celebrating the bicentennial of the Pilgrims’ landing. A hundred years later, “great inequality of property” is characteristic of our national economy. Perhaps its most devastating consequence is the permeation of American life with material preoccupations. Even a President of the United States could say that the business of America is business, without realizing that he was uttering words of condemnation. The federal statistics of income dryly tell the tale only in part, as figures do. For a representative year before the depression, out of 6,787,481 who filed income tax returns 5,003,155 reported incomes below $3,000, and 6,193,270 incomes below $5,000; while 4,031 had incomes above $100,000; 1,860 had above $150,000; 537, above $300,000; 228, above $500,000; and 67, above $1,000,000 a year. Beneath such quiet figures lie, perhaps, the most pulsating problems of American society.

The law’s concern with taxation covers a very wide front, and it must extensively modify its precedents and its predispositions. Much new legislation is indispensable; effective investigation must precede legislation; sympathetic judicial insight will have to support the legislation. Leaks must be stopped; skillful avoidances and evasions must be circumvented. In part, this will involve a correction of detail, a reversal of rulings and decisions both of the taxing agencies and of the courts. More drastic changes will also be required. Professional skill and imagination, if directed to increase of revenue and not to protection of heavy taxpayers, will be able to overcome strained interpretations of the Supreme Court and to limit the baneful effects of some of its holdings of unconstitutionality. Thereby, without a doubt, vast sums will be reached which have been withdrawn from their fair share of taxation.

These are only a few of the new paths to be explored if we are to work ourselves out of the morass. Lawyers have a special responsibility in breaking these new paths and allowing free travel upon them. In this country, theirs is probably the greatest power for good or evil. High technical competence is, of course, demanded in formulating the complicated adjustments necessary for our complicated society. But technical power can thwart as well as promote necessary social invention. The times demand new methods adapted to new problems, the removal of what is obstructive and wasteful in old principles or old applications.

The Supreme Court is indispensable to the effective workings of our federal government. If it did not exist, we should have to create it. I know of no other peaceful method for making the adjustments necessary to a society like ours—for maintaining the equilibrium between state and federal power, for settling the eternal conflicts between liberty and authority—than through a court of great traditions free from the tensions and temptations of party strife, detached from the fleeting interests of the moment. But because, inextricably, the Supreme Court is also an organ of statesmanship and the most powerful organ, it must have a seasoned understanding of affairs, the imagination to see the organic relations of society, above all, the humility not to set up its own judgment against the conscientious efforts of those whose primary duty it is to govern. So wise and temperate a scholar as the late Ernst Freund expressed this judgment after a lifetime’s study of our government: “It is unlikely that a legislature will otherwise than through inadvertence violate the most obvious and cardinal dictates of justice; gross miscarriages of justice are probably less frequent in legislation than they are in the judicial determination of controversies.” And the Supreme Court itself has told us that “it must be remembered that legislatures are ultimate guardians of the liberties and welfare of the people in quite as great a degree as the courts.”

Unfortunately, the Supreme Court forgets at times to remember its own wisdom. In view of the tasks in hand, the price of judicial obscurantism is too great. Let me give two or three instances, reflecting controversies neither minor in character nor resurrected from the dim past, but dealing with the liveliest issues of our day.

The reorganization of the St. Paul has implications far beyond the receivership even of an important railroad. In one form or another, whether through administrative action or legislation or voluntary arrangement, or a combination of these, we must contract the capital structures, certainly of some of the railroads. This process will entail the interplay of financial and moral considerations and will demand the best thought of our regulatory agencies. The recent decision of the Supreme Court in the St. Paul case thus affects railroad credit, the financial burdens incident to railroad consolidation, the effective powers of the Interstate Commerce Commission to protect the public interest, and, not least, the standards of fiduciary obligation of investment bankers.

According to Mr. Justice Stone, the question before the Supreme Court was “whether the salutary provisions” of the Interstate Commerce Act can be avoided. Can “an issue of securities to defray excessive reorganization expenses” be withdrawn from the control of the Interstate Commerce Commission? The majority of the Court decided that by astuteness in the drafting of documents the bankers’ lawyers had deprived the Commission of power to enforce necessary public safeguards. As a result, the reorganization managers of the St. Paul secured for themselves over a million dollars, and half a dozen New York law firms, an amount estimated by one of the managers to be between two-thirds of a million and a million.

The minority opinion, representing the views of Justices Stone, Holmes, and Brandeis, characterizes the methods by which the bankers and lawyers were able to get these fees without Commission regulation as a “failure to conform to those elementary standards of fairness and good conscience which equity may always demand.” The St. Paul reorganization plan was placed before the Commission in order to obtain its approval of the securities to be issued. A majority of the Commission granted approval, but subject to the condition that testimony be taken as to the fairness of the fees, and subject to such order as the Commission might make on that point. As appears from Mr. Justice Stone's statement of the facts, neither the bankers nor their lawyers disclosed an intention to take advantage of the Commission’s approval in order later to deny the validity of the conditions attached to such permission.

The formal party in these proceedings was the reorganized company, which the bankers “created and controlled.” They caused it to go before the federal district court which had charge of the receivership and which had ruled that the properties could not be transferred to the new company until the reorganization securities were approved by the Commission. The bankers caused the new company to display the Commission’s order to the court, but withheld their plan “to repudiate the condition upon which the order was founded.” After the reorganization was thus consummated and nothing remained but settlement of the fees, the new company applied to the federal courts for immunity against the Interstate Commerce Commission's interference with private arrangement for such fees. The lower court said that the prior moves in the game constituted “a representation” that the new company “had accepted the order and expected to comply with the condition.” This was the view adopted by the minority members of the Supreme Court.

But the majority held that the Commission did not have jurisdiction, since the fees were fixed by a “contract between private persons to which the carrier was not a party.” Therefore, it was treated as though it were merely a contract between the reorganization managers, the committees, and the stockholders. Mr. Justice Stone and his colleagues felt that these were “technical distinctions” which “ought not to affect the authority of the Commission.” He dealt with realities. “No one,” he wrote, “familiar with the financial and corporate history of this country could say, I think, that railroad credit and the marketability of railroad securities have not been profoundly affected, for long periods of time, if not continuously, by the numerous railroad reorganizations, in the course of which junior security holders have found it impossible to save more than a remnant of their investment, and that only by the assumption of a heavy burden of expense, too often the result of wasteful and extravagant methods of reorganization.”

Proposed railroad consolidations will involve issues similar to those in the St. Paul case. For instance, among the men who will guide the Eastern roads in these consolidations are lawyers and bankers who successfully denied that the Interstate Commerce Commission had jurisdiction over their St. Paul fees. Those fees will probably appear petty in amount when compared with the bankers’ and lawyers’ charges for consolidating the Eastern roads. If these should prove to be excessive, the losers will be the railroads, and thus the investors and the public. If the Interstate Commerce Commission attempts to determine whether the charges are reasonable or not, its authority to do so may again be put in question. These methods for avoiding control may also be employed in other phases of railroad affairs. In the past, the public has relied on the Interstate Commerce Commission to regulate the railroads in the public interest. That feeling of security is disturbed by the St. Paul decision.

Foreigners are fond of calling this the land of paradoxes. Our public finances certainly justify that characterization. The richest country in the world has been the most dilatory in balancing its budget and appears the most distracted and embarrassed in its accomplishment. I venture to believe that a major explanation is the systematically inculcated hostility to the taxation of wealth. For a decade the press has sedulously repeated the Mellon doctrine that the immunity of the rich from taxation is a blessing for the poor. In times of prosperity taxes on bloated incomes will discourage enterprise; in days of adversity there are no bloated incomes—such was the governing philosophy.

It ought not to be too surprising that this deep-seated sentiment against the taxation of wealth should be shared by members of our Supreme Court. How easily private notions of economic or social policy are transmuted into constitutional dogma is amply proved by the United States Reports since the war. Enormous wealth has been withdrawn from the taxing power of the nation and the States on the gossamer claim that otherwise governmental instrumentalities would be defeated. The history of taxation is, to no small extent, a battle of wits between skill in devising taxes and astuteness in evading them. By creating constitutional obstructions to safeguards against evasion, the Supreme Court has put the Constitution at the disposal of the evaders. A few years ago the Supreme Court sheltered great wealth by interposing the benevolent “due process” clause on behalf of rich donors who made gifts in anticipation of tax measures especially designed for them. One might suppose the Supreme Court would at least be friendly to the effective enforcement of the inheritance tax. The social justification of that tax has become an accepted postulate even of our individualistic society. But the other day the Court, again under the blessed versatility of “due process,” nullified the attempt of Congress, in response to the compelling experience of the Treasury Department, to prevent gross evasions of the inheritance tax.

From the original enactment of the estate tax law in 1916, it was realized that a single tax on estates could be too easily avoided by well-timed and astute disposition of property before death. To check such practices, the Act of 1916 contained two safeguards. Gifts made “in contemplation of death,” and those in which the donor retained a joint interest during his lifetime, were taxed as part of his estate at death. But other means remained by which property might be withdrawn from the operation of the tax and yet remain within the effective control of the donor: he might, for example, place it in trust with a power of revocation or control reserved in himself. The possibility of escape by this device was materially reduced by legislation, which taxed gifts, by way of trust, taking effect “in possession or enjoyment” at the time of the donor’s death. The courts threatened the effectiveness of much of this legislation by technical and sterile definitions of “possession or enjoyment,” and in 1931 Congress was forced to close a broad avenue of escape from the estate tax by making specific provision for the inclusion of property which is transferred on trust for another but from which the income is reserved for the donor during his life.

Meanwhile, the tax authorities were beset by difficulties growing out of the vague phrase, “in contemplation of death.” In what degree the donor must have apprehended his end, and how to prove that apprehension, were questions which made the collection of a tax precarious at best. The devil himself, the lawyers are fond of quoting, knoweth not the mind of man; and even if he did, the devil’s advocate might experience considerable difficulty in proving it to a court of law. Realizing that the limited omniscience of the taxing authorities was finding it impossible to isolate successfully those gifts that were made “in contemplation of death,” Congress in 1924 imposed a tax on all gifts, irrespective of date or motive, at rates equal to those under the estate tax. This general gift tax was upheld by the Supreme Court. In addition, the tax on gifts made in contemplation of death was retained, giving the government a second string to its bow, although, of course, credit was allowed where a gift tax had already been paid on the transfer.

The arm of the government was strengthened, moreover, by requiring the representatives of the estate to prove, where the gift was within two years of death, that it was not in contemplation thereof. But this shift of the burden of proof was of little value to the government in a contest against an elderly man of wealth contemplating death with one eye and the tax law with the other. The gift tax itself promised better results, but in 1926 it was repealed. (By the revenue Act of 1932 it has been restored.)

Congress was alive to the need of conserving the gain which the gift tax had made in the enforcement of the estate tax. Ten years’ experience in administering the revenue Acts had taught its lesson. Congress provided that gifts made within two years of death should be “deemed to have been made in contemplation of death," and so might be assessed under the estate tax. “The inclusion of this provision,” reported the Ways and Means Committee of the House, “will prevent most of the evasion and is the only way in which it can be prevented.” This is the provision which the Supreme Court declared unconstitutional. Again “due process” worked its charm on behalf of wealth.

In thus setting at naught the considered effort of Congress to obtain a really effective tax on decedents’ estates, a majority of the Court found the provision arbitrary and unreasonable because it might apply to gifts made with no thought of death or taxes. “The young man in abounding health,” writes Mr. Justice Sutherland, “bereft of life by a stroke of lightning within two years after making a gift, is conclusively presumed to have acted under the inducement of the thought of death, equally with the old and ailing who already stands in the shadow of the inevitable.” The pity aroused by this affecting apparition of the benevolent young plutocrat is somewhat mollified by the fact that if the property had not been given to kith and kin—gifts to charity being exempted—so shortly before the donor’s end, it would in all likelihood have passed by will and been taxed accordingly.

The apparition fades completely before the picture drawn by Mr. Justice Stone in a dissenting opinion, in which he was joined by Mr. Justice Brandeis. (Mr. Justice Cardozo did not sit in the case.) This opinion reveals graphically by whom these gifts are made, and with what effect on the operation of the taxing system. Mr. Justice Stone analyzes one hundred and two cases in which the government and the decedent’s estate engaged in litigation over the question whether a gift had been made "in contemplation of death," under the law as it existed before the 1926 provision. He writes:

“In twenty cases involving gifts of approximately $4,250,000, the government was successful. In three it was partially successful; and in seventy-eight involving gifts largely in excess of $120,000,000, it was unsuccessful. In another the jury disagreed. In fifty-six of the total of seventy-eight cases decided against the government, the gifts were made within two years of death. In this group of fifty-six donors, two were more than ninety years of age at the time of death; ten were between eighty and ninety; twenty-seven were between seventy and eighty; six were between sixty and seventy; six were between fifty and sixty; and only one was younger than fifty. There was one gift of $46,000,000 made within two months of death by a donor seventy-one years of age at death; one of $36,790,000 made by a donor over eighty, who consulted a tax expert before making the gift; one of over $10,400,000 made by a donor aged seventy-six, six months before death; and one by a donor aged seventy-five at death, in which the tax assessed was over $1,000,000. There was one other in excess of $2,000,000; five others largely in excess of $1,000,000; four others in excess of $500,000; thirteen in excess of $250,000; and fourteen in excess of $100,000. The value of the gifts was not shown definitely in three cases; twelve involved gifts totaling less than $100,000. In the remaining twenty-two cases the gifts were made more than two years before the death of the donor.”

This decision does not touch technical issues that are in the special province of learned judges. How taxes are evaded and how fine a net must be woven to keep big fish from escaping, what the experience of a decade of federal estates administration indicated and what means are adapted to prevent wholesale evasion—these are matters which tax administrators, members of the Ways and Means Committee, students of public finance, are as competent to understand as Mr. Justice Sutherland and his brethren. Is it not the plain truth that Mr. Justice Stone’s powerful opinion deals with actualities and demolishes the hollow fabric of unreality erected by the majority? And if it be the truth, the Supreme Court has its duty towards a balanced budget—it ought not to sanctify gross tax evasion or call the word-spinning by which it does so, the Constitution.

Finally, what of the Supreme Court’s attitude towards the most inclusive of all our problems, namely, how to subdue our anarchic competitive economy to reason, how to correct the disharmonies between production and consumption? This issue was raised last spring in the now famous Oklahoma Ice case. On the basis of watchful scrutiny of the actual operation of the ice industry in Oklahoma, the legislature of that State, acting upon the recommendation of its Corporation Commission, availed itself of a well-tested instrument of public control—the device of a certificate of public convenience and necessity—to subject the ice business to a regulated instead of a wildcat economy. By this means, Oklahoma, within the limited area of the ice industry, endeavored to avoid excessive equipment and the demoralization of deflation and unemployment, and thereby promote stability. But the majority of the Court struck down this very modest essay in regulated economy. It denied Oklahoma’s right to act upon its own experience, and, for a time at least, unbridled competition was given the sanction of the United States Constitution.

Against such an attitude, Mr. Justice Brandeis raised his magistral voice. It is not hazardous prophecy to believe that Mr. Justice Brandeis’s opinion (concurred in by Mr. Justice Stone, Mr. Justice Cardozo taking no part in the decision) merely anticipates history, even the history of future opinions of the Court. The closing observations of this memorable dissent deserve quotation:

“To stay experimentation in things social and economic is a grave responsibility. Denial of the right to experiment may be fraught with serious consequences to the Nation. It is one of the happy incidents of the federal system that a single courageous State may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country. This Court has the power to prevent an experiment. We may strike down the statute which embodies it on the ground that, in our opinion, the measure is arbitrary, capricious or unreasonable. We have power to do this, because the due process clause has been held by the Court applicable to matters of substantive law as well as to matters of procedure. But in the exercise of this high power, we must be ever on our guard, lest we erect our prejudices into legal principles. If we would guide by the light of reason, we must let our minds be bold.”

The faith and enterprise which built this nation are unimpaired. Our intrinsic resources are greater than ever. We have also the unparalleled advantage of a fluid society. Under the guidance of a Supreme Court responsive to the potentialities of the Constitution to meet the needs of our society, it would now lie within our power to have an enduring diffusion of the goods of civilization to an extent never before attainable.

* On February 10, 1933, the President of the American Tobacco Company announced that he had “decided to decline the allotment” of 13,440 shares made to him in 1931.

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