Introduction
As a resident of California, with the highest state Income tax rates in the country, this question is especially applicable to the 40 Million people in my state. This article shows how the wisdom of the founders could help halt the destruction of the US Dollar by out-of-control Federal spending. The use of gold and silver as currency has been around for over 5,000 years. Until 1971, United States Federal Reserve Notes were backed by gold. This article proposes that the removal of the US from the Gold Standard did not remove the obligation of the states to accept gold and silver coins as legal tender.This article describes with a concise example how the requirement that states accept gold and silver coins in the US Constitution creates a financial arbitrage opportunity. It then shows how this situation could result in the states applying pressure on the Federal Government to control spending to stabilize the dollar. Since this is a novel proposal, a series of possible arguments against the approach are described with proposed rebuttals. Ultimately, this is a theoretical question, and the practical and legal answer can only be determined by state taxing authorities and the courts.
Must States Accept Gold and Silver Coins as Payments to them?
The United States Constitution has an interesting requirement in Article 1, Section 10 that affects the states differently than the Federal Government. The relevant section is shown here:No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.
Under the US Constitution, the States are not allowed to coin their own money. Given the wisdom of the founders, they are also not permitted to make anything but gold and silver coin a tender in payment of debts. Further, states are not permitted to make ex post facto laws that punish actions retroactively.
Fiat paper money (not convertible into gold or silver) was first issued by the US Government during the Civil War in 1862 with the Legal Tender Act. The US Supreme Court ruled that states were not required to accept this new fiat paper money for state taxes in Lane County v. Oregon (1868) and Hagar v. Reclamation District No. 108 (1884). As a result, Congress eventually changed United States Code Title 31, Chapter 51, Section 5103 to the following:
United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues. Foreign gold or silver coins are not legal tender for debts.
The Federal Government was able through the Constitution’s Supremacy clause (Article 6, Clause 2) to force states to accept Federal Reserve Notes as legal tender in addition to gold and silver coins in payment of “debts, public charges, taxes and dues”. A law can not remove a specific Constitutional requirement, such as the requirement in Article 1, Section 10 that states not “make any Thing but gold and silver Coin a Tender in Payment of Debts”. Forcing the states to accept a new additional legal tender (Federal Reserve Notes) does not remove the original Constitutional obligation on the states to accept gold and silver coins as legal tender.
Scenario Describing this Theoretical Approach
Disclaimer: The author’s bio is included at the end of this article. He is not a professional investment advisor, tax advisor, or lawyer. The author’s opinion is that the questions and interpretations he is raising are ethically, morally, and legally sound. The questions raised in this article are for theoretical purposes, and the reader should consult professionals in these fields if they intend to act upon this approach.The requirement that states accept gold and silver coins creates an optional arbitrage situation for State Income Taxes. This is related to the potential change in the price of gold or silver from the point where income is earned, and the time when the tax payments are due up to 15+ months later. The described scenario has no downside risk, and significant upside potential for the taxpayer.
The following example is used to show how this could work:
- The taxpayer is going to have a large one-time amount of additional income. For the purposes of this example, the one-time additional income will be taxed at a 10% Marginal Tax Rate. Since this one-time income is in addition to the taxpayer’s normal income, there is no Estimated Tax requirement in the example. For instance, in California, if a taxpayer pays at least 110% of their prior year tax liability in Estimated Taxes, they will not incur a penalty.
- On January 1st of the new tax year, the taxpayer incurs a gain that will require $100,000 in State Income Taxes. The taxpayer purchases 4,000 ounces of silver coins at $25/ounce the same day as they receive the gain. This is equal to $100,000 of silver coins. (Silver has also been selected since the “National Bank Emergency Act” could be used again to confiscate gold. President Franklin Roosevelt did this with Executive Order No. 6260 in 1933, and Americans were not allowed to own gold again until President Ford signed Executive Order 11825 in 1974).
- If on April 15th of the following year, the price of silver has increased to $32/ounce, the taxpayer could sell the 4,000 ounces of silver for $128,000 in Federal Reserve Notes. Since the state presently must accept Federal Reserve Notes in addition to gold and silver coins, the taxpayer would pay the state $100,000 in Federal Reserve Notes and have a profit of $28,000 (which would need to be reported as taxable income for the year in which the April 15th payment was made).
- Instead, If on April 15th of the following year, the price of silver has fallen below $25/ounce, the taxpayer would deliver the 4,000 ounces of silver (that corresponded to 10% of the income at the time that the income was received) directly to the State to pay their State Income taxes in full.
Why can’t the State just use the Price of Gold or Silver on the day you pay your taxes?
In the above example, instead of $1 Million in cash in one-time income, the taxpayer could have been paid with 40,000 ounces of silver worth $25/ounce. A taxpayer could set aside 4,000 silver coins for state taxes (10% of the total with a value of $100,000 at the time of the income). If the price of silver dropped to $15/ounce by April 15 of the following year when the taxes are due, the market value of the 4,000 Silver coins would be $60,000. The State could then try to argue that this taxpayer owes them an additional $40,000 dollars in silver which would correspond to an additional 2666.7 ounces of silver on April 15. This would effectively raise the taxpayer’s Marginal tax rate to 16.7% as calculated by (4000 ounces + 2666.7 ounces) / (40,000 ounces).
Requiring the use of the price of gold or silver on the date the taxes are due can be argued to be wrong on two Constitutional grounds. First, this is a violation of the Equal Protection Clause of the 14th Amendment; since taxpayers who pay in gold or silver coin are being treated differently (they have different tax rates) than those who pay in Federal Reserve Notes. It can also be argued that this is a violation of the ex post facto clause of Article 1, Section 10 of the US Constitution. An ex post facto limitation means that something cannot be changed after the fact. The Supreme Court case of Calder v. Bull (1798), differentiated between civil and criminal cases for purposes of ex post facto laws. This example which involves payment of State Income Taxes is unusual; since failure to pay State Income taxes can result in both civil and criminal liability. For simplicity, the state should establish the exchange rates for gold and silver prior to the start of the tax year so as not to Constitutionally wrong its taxpayers.
Taxes are not Debts, so States should not have to accept Gold or Silver Coins for them
The Internal Revenue Service Collection Process is described in Publication 594. In the “Overview" of this publication, the IRS clearly views tax liabilities as debt:
If you don’t pay or make arrangements to pay, we can take actions to collect the debt. Our goal is to work with you to resolve your debt before we take collection actions.
Present day State Income Taxes are a deferred liability to the state, and in the simplest definition a debt is something that is owed. If the Supreme Court were to try to argue that State Income Tax liabilities are not debts, then how would they interpret Congress’ power to “coin money” in Article 1, Section 8 of the US Constitution? A strict interpretation of this clause would be that this means to produce coins of some metallic substance. In addition, our present fiat Federal Reserve Notes are not labeled as being legal tender for taxes, but say:
THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE
When the Supreme Court ruled in Lane County v. Oregon (1868) and Hagar v. Reclamation District No. 108 (1884) differentiating taxes and debts, it was due to the complicated text in the Legal Tender Act that created these US Notes. The Supreme Court was trying to avoid a superfluous clause in the text of the Legal Tender Act and therefore provided the states latitude in not having to accept US Notes for state taxes.
The Face Value of Gold or Silver Coins is much less than the actual Intrinsic Value
Since antiquity, it has been well understood that the weight of gold or silver creates the value of the coin. The US Mint produces American Eagle Gold and Silver bullion coins which are guaranteed as to their gold and silver content and meant to be traded based on weight. These United States coins can be saved in IRA accounts. The Constitution specifically provided that the government oversees weights and measures with the money coinage clauses in Article 1, Section 8. If the state wants to argue that they will only accept coins at their face value, then I would like my State Income Tax refunds in gold coins at their face value. Cases in various courts have ruled that you cannot pay people in coins and report the payments at their face value since this is a tax evasion scheme (i.e., giving someone a one-ounce Silver Coin marked as $1 but worth $25, or giving someone a one-ounce Gold Coin marked as $50 but worth $1,750). One such case was described in 2009 by the Las Vegas Review-Journal.
States do not have a way to process these coins
The Federal Reserve Act of 1913 clearly requires that Federal Reserve Banks must accept gold coins or gold bullion. For 70 years until the Coinage Act of 1857, citizens of the United States were able to use foreign gold and silver coins as legal tender. States could setup electronic means to buy/sell and transfer gold or silver to their accounts through intermediaries to avoid the physical issues of getting them the coins.
States will get Congress to Amend the US Constitution if this is done
A historical analogy to this is the Pollock v. Farmers' Loan & Trust Company (1895) Supreme Court decision that from a practicality perspective, struck down the Income Tax. This required the 16th Amendment to the Constitution to permit a nationwide income tax, and this was not ratified until 1913. The government survived in the intervening 18 years.
As of 2021, seven states do not have a State Income Tax (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming). Even states that do have a State Income Tax might relish this approach to pressure the Federal Government to rein in spending. We have an extremely tightly divided Congress, and it takes 2/3 of the House and 2/3 of the Senate to pass a Constitutional Amendment. It also takes 3/4 of the states to ratify a new Amendment.
Is this just a Scam to Rip off already struggling states?
States have alternatives to State Income Taxes. The purpose of this approach is to encourage the states to want a stable dollar. A state has a much better ability to adjust and absorb for inflationary instability than the individual taxpayer. States lost significant control over Congress with the 17th Amendment to the US Constitution that took away their selection of US Senators. This approach provides the states with a reason to apply indirect leverage to help control the spending of the Federal Government.
Conclusion
Some recent US Presidents have implemented policies that resulted in a stable dollar (especially Reagan and Clinton). Continued large increases in our National Debt will inevitably lead to significant inflationary pressures. When this happens, the approach outlined in this article will become even more relevant. The United States has benefited tremendously from the dollar being the reserve currency of the world, and I believe it would be a terrible thing for our country to lose that status.
Brian S. Messenger has been a corporate executive, entrepreneur, inventor, consultant, and expert witness over the last 35 years in Silicon Valley.