in Indiana the bank could elect to pay the tax but if it did the tax could not be charged against the depositors. In many places no effort was made to assess deposits. It was said that taxes on deposits could not be imposed on national banks because of section 5219; therefore assessments were made in the names of depositors. In Ohio, the taxes were assessed in the name of the bank but the bank was given a lien for reimbursement. In Kentucky, no State deposits taxes were paid by banks, but out-of-State deposits were reported and the taxes paid by the depositors. North Carolina followed the same policy. In practice, many banks assumed and paid the tax for depositors, as in Ohio and Illinois. Competition for deposits led many banks to absorb the deposit taxes, regardless of law, as a matter of good business.

However much the taxes on deposits may have figured in the development of State taxation devices, they were not the primary concern of Congress. Indeed, deposit taxes were not even mentioned in debates reported in the Congressional Record when the taxation of notes and deposits was being considered. Nor had they been mentioned in Congress in connection with the Acts of 1864, 1865, or 1868, "yet such a tax would be as effective in destroying these important functions as was the Federal tax upon the circulation of State banks in destroying their note issues" 35 The law of 1894 was directed primarily at permitting the taxation of U.S. notes (greenbacks) and bank notes, which had been made legal tender and were intended to circulate as money. Non-circulating bonds, obligations of the U.S., were recognized as non-taxable. But the general practice among the States had been to tax bank notes and greenbacks as money subject to assessment to individuals, as other personal property. Considerable furor had been caused by a decision of the Mississippi Supreme Court in 1876, which held that national bank notes were obligations of the United States and therefore not taxable by States and local governments.37 It was reported in Congress that Mississippi was the only State which adhered to this opinion.38 Nevertheless the decision in Mississippi and the use of greenbacks and bank notes as devices to avoid State and local property taxes created much concern for remedial legislation among State taxing officials and members of Congress.

36

The State Tax Board of Indiana petitioned Congress to act. When H.R. 4326 in the 53d Congress was being debated in the House, Mr. Cooper of Indiana said: 39

*** in Indiana * * * we have yet found ourselves wholly unable to secure honest returns of money on hand or on deposit without the assistance of Congressional action."

The use of greenbacks for tax avoidance loomed large in the debates on H.R. 4326. Nor were these practices limited to greenbacks; they could be (and were) facilitated by the use of U.S. bonds.40 (And it should be added that Federal tax-exempt securities were so used in many general property tax States and have doubtless continued to be so used until the present time.) How the system worked was clearly

35 Welch, op. cit., p. 115.

36 26 C.R., p. H7140 (July 5, 1894).

37 J. R. Horne, Tax Collector v. J. & T. Green, 52 Miss. 452 (1876).

38 Statement of Mr. Cox, 26 C. R., p. H7143 (July 5, 1894).

39 Ibid., pp. H7177 (July 6, 1894).

40 See ibid., pp. H7141, 7146, 7151, and cf. statement of Mr. McCall, ibid., July 6, 1894, p. H7176. H.R. 4326 was signed by the President on August 16, 1894.

stated by Mr. Hall (Mo.), citing a Leavenworth case with this statement of facts:

41

"A man with a little over $19,000 in currency in one of the banks the day before the assessors came made his check out for his $19,000, and asks that it be paid him in greenbacks. It is handed to him, and he puts it in an envelope and makes a special deposit of the same. The assessor comes the next day and the holder of the $19,000 of greenbacks says, 'I have no money that is subject to State or municipal taxation.' This is simply used as a cloak, a stalking horse, a shield to cover the men who desire to make fraudulent returns of their property for assessment purposes; and the Government of the United States, by letting this law remain on the statute books, becomes particeps criminis to that proceeding.

"He reconverted them the second day afterward." After some discussion, Mr. Hall added:

42

"These Treasury notes are now used by the trust companies of the United States and are used by unscrupulous men of all kinds and classes to shield themselves from taxation by making a return similar to the Leavenworth man to whom I have referred. We cannot afford to lay down such precedents."

43

In its decision on the Leavenworth case, the Supreme Court said: "U.S. notes are exempt from taxation by or under State or municipal authority; but a court of equity will not knowingly use its extraordinary powers to promote any such scheme as this plaintiff devised to escape his proportional share of burdens of taxation."

44

But bona fide transactions involving the conversion of notes or bonds have been held to be legal "-a cover which amply protected tax avoidance maneuvers in many States for many years.

Those who opposed the adoption of a law to permit State taxation of Treasury notes because they facilitated tax dodging had a good answer to the arguments of the proponents. Mr. Johnson (Ind.) remarked: 45

"Why, sir if the mere fact that governmental powers are used by dishonest men for improper purposes be a reason for surrendering those powers or cedings them away, you will soon emasculate the General Government and leave it stripped of every attribute of sovereignty; for I know of no particular power which cannot be made the subject of abuse by bad and unscrupulous men."

The fact that greenbacks (Treasury notes) had been issued as tax exempt and that this "obligation" was now being repudiated bothered many members of Congress, especially in the Senate. It was argued that the issue of notes created a contract with those who accepted and held them. Some thought that the issuance amounted only to coining money. Others thought since the good faith of the nation was at stake if the notes were to be taxed, they should be called and reissued as taxable notes.46 Proponents of the bill could see little difference

41 26 C.R., H7141 (July 5, 1894). The case referred to is Mitchell v. Board of Commissioners of Leavenworth County, Kansas, 91 Sup. Ct. 206 (1875). Similar instances were cited by Mr. Powers; ibid, p. H7151, and by Mr. Connors (Ill.) p. H7180 (July 7, 1894) Fraudulent use of notes was referred to in the Senate by Sen. Turpie, p. S8209 (Aug. 4, 1894).

42 Ibid., p. H7141. (July 5, 1894).

43 91 Sup. Ct. 206, at p. 208.

44 Cf. Stillwell v. Corwin, 55 Ind. 433 (1876).

45 26 C.R., p. H7145 (July 1, 1894).

46 Act of March 3, 1863. 26 C.R. (July 6, 1894), p. H7151; (July 5, 1894) pp. H7151, 7170, 7171, 7172, 717′′ 7178, 7179, 7180. But it was not a contract in perpetuity; Mr. Turpie, p. S8209 (Aug. 4, 1894).

between greenbacks, bank notes, gold and silver coin, and even horses and cattle as personal property taxable to the holders.47 Moreover, one form of circulating notes or legal tender could easily be exchanged for another and then spent for any kind of taxable property. Senator Kyle (Miss.) remarked,48

*

"Why **is there any equity or justice in exempting my property from taxation because I have greenbacks or Treasury notes . [but taxing] my neighbor's property because it happens to be invested in gold or silver or national bank notes?"

Nor was the issue of Federal vs. State authority overlooked. Mr. McCall thought national sovereignty was being surrendered by giving States and municipalities the right to tax greenbacks.49 But Mr. Cooper thought that the "States were capable of self government" and "ought to be allowed to do some self government in the matter of collecting taxes." 50 The issue of taxing greenbacks and bonds had even been made a political issue in campaigns in Ohio, Illinois, and "in all our northern States." 51

The debates, like others on section 5219, evidenced much confusion and frequent digressions. Members of Congress were not always clear whether the taxes they were considering were to be upon the banks or upon individuals as stockholders. Instrumentalities, agencies, and government property also were drawn into the debate. On the whole, more concern and discussion revolved around the taxation of greenbacks than over the taxation of national bank notes. Even the cost to the States of the exemption of notes got short shrift.52

In due course H.R. 4326 became the Act of August 13, 1894 (reproduced in appendix 1-F above),

Two things were made perfectly clear by this act: (1) That States were not permitted to impose discriminatory taxes on circulating notes or currency, be they greenbacks or national bank notes; and (2) that the new law did not change existing law (section 5219) regulating taxation of national banks.

G. The Federal Reserve Act of 1913

Although the Federal Reserve Act, adopted in 1913,53 did not change a single word, jot, or tittle of section 5219, it so changed the functions and positions of national banks as to undermine their status

as

"instrumentalities" of the United States government. As "instrumentalities," national banks long enjoyed a preferred position with tax immunities under the decisions of the Supreme Court. However, since the creation of the Federal Reserve System their role in the scheme of things governmental has so changed that it is believed to be only a matter of time until national banks are no longer regarded as federal "instrumentalities."

47 Mr. Hepburn, ibid., p. H7181 (July 6, 1894). On coining money, Mr. Northway: Let the government redeem them and "let the tax be levied on what is ued to accomplish that redemption." Ibid., p. H7175. Mr. McCall expressed the same view, ibid., p. H7176. Mr. Hublick concurred, ibid., p. H7177. Ibid., pp. H7143, 7144, 7150 (horses and cattle) (July 5, 1894). Difference between notes and gold and silver coin is for the Senate to determine; Mr. Sherman, p. S8145 (Aug. 3, 1894). Free coinage advocates added an amendment as sec. 3 and 4; presented by Sen. Stewart (Nevada), p. S8147 (Aug. 3, 1894).

48 Ibid, p. H7180, July 7, 1894.

49 Ibid., p. H7176, July 6, 1894. See also pp. H7146-49, 7170.

50 Ibid., p. H7146, July 5, 1894.

51 Mr. Northway, ibid., p. H7175, July 6, 1894; Mr. Grosvenor, p. H7178.

52 Mr. Cooper: ". in most of the cities and towns of this country, including county and State taxation, the rate of taxation is at least 22 percent We are therefore paying 22 percent on these notes by exempting them from taxation." Ibid., p. H7173. The total issue of greenbacks was said to be $346,381,016, with $268,772,371 in circulation-Mr. Hulick, ibid., p. H7177. But Mr. McColl pointed out that if all the States taxed greenbacks the yield would be very small. Ibid., p. H7176. Beyond this little was said as to the cost of such exemption to the States.

53 Act of December 23, 1913 (12 U.S. Code ch. 3).

In the economic history of the nation the establishment of the Federal Reserve System ranks as one of the most important steps taken by the United States government along with creation of the national banking system in 1863. The Federal Reserve System was imposed upon the national banking structure, not only without upsetting that established system but making it stronger and more efficient. The new arrangement was tested immediately by the financial exigencies of World War I. It is doubtful if that war could have been financed successfully without it.

Perhaps the most significant thing about the Federal Reserve System was that it provided a currency designed to be responsive to the needs of trade, which supplemented and eventually superseded the earlier inelastic system of national bank notes. Initially, this new currency was secured by commercial collateral, such as notes, drafts, bills of exchange, and acceptances, but later gold and direct obligations of the United States also were made eligible. It had long been apparent that the national bank notes, backed by bank-purchased portfolios of selected Government obligations deposited with the Secretary of the Treasury, did not satisfy the currency needs of the growing economy of the country. The supply of notes had proved to be perversely elastic. It was ofter excessive when the need was least; when expansion of the money supply was needed the banks were often in no position to provide it. The panic of 1907 clearly demonstrated this. Even the retirement of U.S. bonds by the Treasury reduced the money supply. This inelasticity was recognized before the Federal Reserve System was created, and was one of the effective forces for its establishment.54

Under the Federal Reserve Act the new asset currency-Federal Reserve notes-began to supplant national bank notes. by 1935 the latter were completely retired. Thus the national banks were deprived of their function of supplying a large part of the necessary money supply. Nevertheless, with the growing acceptance of checks and drafts as the customary mode of settling commercial transactions, the role of national banks in supporting the money supply (defined to include demand deposits as well as currency) continued important. Deposit creation, too, has been made more efficient, more responsive to business needs, and given both direction and control by the Federal Reserve. This, however, is not the place to discuss the operations of that system. It is enough to indicate that the traditional role of the national banking system in providing a nationally uniform currency has been superseded. The Federal Reserve banks were made depositaries for Treasury and other U.S. funds, a function formerly performed by the national banks. They took over also the fiscal agency functions the sale, issuance, retirement, and exchange of various Federal bonds, notes, bills, etc., which, expecially during World War II, was a large scale operation. The Federal Reserve banks also buy and sell bankers acceptances. They perform a clearing function for checks drawn against banks that remit at par. They fix rates of interest member banks may pay on time deposits, and do various other things not only for national banks but also for other member banks.

The Federal Reserve System is completely integrated into the banking system of the country. All national banks were required to

54 See Alexander Dana Noyes, History of the National Bank Currency, National Monetary Commission, Senate Document No. 572, 61st Congress, 2nd session, Washington, D.C., 1910, pp. 9-20.

subscribe and pay into the system a small part of their capital; State banks also were permitted to join. Both are functioning "member" banks and the stockholders of the System, which is under the direction of a federally-appointed Board of Governors.

As is indicated in subsequent pages, when the 1923 and 1926 amendments to section 5219 were being considered, it was frequently argued, in and outside Congress, that tampering with these provisions might injure the national banks and through them undermine the Federal Reserve System. There was little substance in such talk. Neither the banks nor the Federal Reserve System were in any real danger.

An interesting feature of the Federal Reserve Act was a provision permitting States and localities to tax Federal Reserve Bank real estate.55 This was in recognition of the fact that the exemption of Federal Reserve Bank buildings and land would cast a burden upon taxpayers in the communities where the banks were located, whereas the benefits of the System would extend throughout the country. In other respects the banks were to be exempt from taxation by Federal, State, and local governments.

With the advent of the Federal Reserve System and changes made over time in the powers and functions of national banks, it was natural that the immunities of the national banks as "instrumentalities of the United States" should be questioned. The issue came to a head in First Agricultural National Bank v. State Tax Commission when the Supreme Judicial Court of Massachusetts sustained the Massachusetts sales and use taxes on purchases of tangible personal property by national banks.56 The Massachusetts court held that national banks were not "instrumentalities" of the United States government and hence were not entitled to immunity from sales and use taxes. This decision was promptly reversed by the United States Supreme Court, June 18, 1968.57 The majority opinion by Justice Black held that, since sales and use taxes were not listed among the permitted state taxes on national banks in section 5219, such taxes were void. Justice Black found it unnecessary to decide whether national banks were Federal "instrumentalities": 58

"The decision below recognized the strong precedents against taxation, but the Massachusetts Supreme Judicial Court was of the opinion that the status of national banks has been so changed by the establishment of the Federal Reserve System that they should no longer be considered nontaxable by the States as instumentalities of the United States. Essentially the reasoning of the Supreme Judicial Court is that under present-day conditions and regulations there is no substantial difference between national banks and State banks; and the implication of this is, of course, that national banks lack any unique quality giving them the character of a Federal instrumentality. Because of pertinent congressional legislation in the banking field, we find it unnecessary to reach the constitutional question of whether today national banks should be considered nontaxable as Federal instrumentalities."

55 Act of December 23, 1913, sec. 12 U.S.C. 531. See appendix 1-D(1), p. 5, above, for the text.

56 353 Massachusetts 172, 229 N.E. 2nd 245 (1967). See discussion in Thomas J. Holdych, "Tax Immunity and Taxation of National Banks: One Hundred and Fifty Years After McCulloch v. Maryland,” University of Illinois Law Forum, vol. 1969, no. 2 (1970), pp. 224-47.

57 First Agricultural National Bank of Berkshire County v. State Tax Commission, 392 U.S. 339, 20 L. Ed. 2d 1138, 88 S. Ct. 2173 (1968).

88 Ibid., p. 341.