Davis v. Coler

Decision Date12 May 1986
Docket Number85-2481,Nos. 85-2366,s. 85-2366
Parties, 4 Fed.R.Serv.3d 702 Tommie E. WATKINS, et al., Plaintiffs-Appellants, v. Donald BLINZINGER, et al., Defendants-Appellees. Dorothy DAVIS, et al., Plaintiffs-Appellants, v. Gregory COLER, et al., Defendants-Appellees.
CourtU.S. Court of Appeals — Seventh Circuit

Donald R. Lundberg, Legal Organization of Indiana, Indianapolis, Ind., for Watkins.

Gary L. Shaw, Dep. Atty. Gen., Indianapolis, Ind., James R. Goeser, Dept. of Health & Human Service, Chicago, Ill., for Blinzinger.

John M. Bouman, Beverly V. Groudine, and Barbara Stob, Legal Assistance Foundation, Chicago, Ill., for Davis.

Steven Hogroian, Owen M. Field, and James C. O'Connell, Special Assist. Attys. Gen., Chicago, Ill., for Coler.

Before BAUER, WOOD and EASTERBROOK, Circuit Judges.

EASTERBROOK, Circuit Judge.

Recipients of Aid to Families with Dependent Children (AFDC) are dropped from the program if their incomes exceed the "standard of need" in their states. They also are dropped if their "resources" exceed $1,000. A person who receives a lump-sum payment wants to have the payment called a "resource" rather than "income."

If the lump sum is a "resource," the recipient may spend it as he pleases; once cash on hand and other valuable assets dwindle to less than $1,000, the person will be restored to the rolls. If the lump sum is "income," however, it must be budgeted. Under 42 U.S.C. Sec. 602(a)(17), the state's welfare officials divide the lump sum by the monthly "standard of need." See also 45 C.F.R. Sec. 233.20(a)(3)(ii). The quotient gives the number of months the person will be ineligible for aid. For example, if a person receives $20,000, and the monthly standard of need is $500, the state will divide $20,000 by $500, producing a quotient of 40. The recipient will be ineligible for AFDC for 40 months. This method treats the lump sum as if the amount of the "standard of need" had been received as monthly income during the months following receipt of the lump sum. 1 A recipient who spends a lump sum classified as "income" and becomes destitute remains ineligible for the program nevertheless, while if the lump sum had been called a "resource" eligibility would have been restored.

We have consolidated two cases presenting the question whether lump sums that compensate victims for personal injuries are "income" or "resources" for purposes of AFDC. Watkins v. Blinzinger is a challenge to Indiana's implementation of the AFDC program, Davis v. Coler a challenge to Illinois's. Both states have chosen to treat lump sum payments attributable to personal injuries as "income," an option that the Department of Health and Human Services contends states possess. 2 Both cases were filed as class actions on behalf of all AFDC recipients who have received or will receive lump-sum payments on account of personal injuries. 3 Both courts sustained the states' positions, concluding that the states and the Secretary of Health and Human Services have discretion to treat such payments as either income or resources. Watkins v. Blinzinger, 610 F.Supp. 1443 (S.D.Ind.1985); Davis v. Coler, 601 F.Supp. 444 (N.D. Ill.1984). Watkins also rejected the plaintiffs' request for a declaratory judgment that until 1983 Indiana had been violating Sec. 602(a)(17) by dividing the lump-sum payment by the portion of the "standard of need" (90%) that the state customarily paid to AFDC households, rather than by the "full" standard of need. The district court concluded that because Indiana had switched to the use of the "full" standard of need, the claim was moot. We discuss this in Part II below.


There has been a good deal of litigation about the treatment of personal injury awards. Reed v. Health and Human Services, 774 F.2d 1270 (4th Cir.1985), pet. for cert., 783 F.2d 454 (4th Cir.1986), the only appellate decision on the question, holds that lump sum payments for personal injuries must be treated as "resources." The district courts are divided. Jackson v. Guissinger, 589 F.Supp. 1288 (W.D.La.1984), and Betson v. Cohen, 578 F.Supp. 154 (E.D.Pa.1983), rev'd on other grounds sub nom. Barnes v. Cohen, 749 F.2d 1009 (3d Cir.1984), cert. denied, --- U.S. ----, 105 S.Ct. 2126, 85 L.Ed.2d 490 (1985), like the two cases we have on appeal, hold that states may treat personal injury awards as income. LaMadrid v. Hegstrom, 599 F.Supp. 1450 (D.Ore.1984); White v. Rahm, No. C85-007T (W.D.Wa. Apr. 20, 1985); and Payne v. Toan, 626 F.Supp. 553 (W.D.Mo.1985), come out the other way. We disagree with these cases and with Reed. 4 The language and legislative history of Sec. 602(a)(17) allow the states and the Secretary to define "income," and therefore Illinois and Indiana were entitled to treat compensation for personal injury as "income."

The statute uses the word "income" but does not define that word. We must look elsewhere for help. Start with the obvious. Money paid to compensate people for personal injuries is income in a fundamental sense. It may be spent. It is no different from money received as wages, though as we discuss later it is usually not taxable. Much of the value of an award may represent lost wages, past and future. Whoever computes the award will start with the reduction in earnings, discount this to present value, and award that sum to the injured person. O'Shea v. Riverway Towing Co., 677 F.2d 1194 (7th Cir.1982). That the injured person receives his future wages all at once through the award rather than in weekly installments over the course of a lifetime does not change the character of the money.

An award may have other sources, too--compensation for pain and suffering, for mutilation, for property damage, for emotional injury, for medical expenses. To the extent these reflect loss in future market opportunities, they are the same as a replacement of future earnings. The loss of a limb, for example, may reduce potential earnings, and the award for the loss therefore is a substitute for these earnings. The other bases of personal injury awards are less closely tied to the employment market, and plaintiffs urge us to treat these sources, indeed the whole award, as "compensation" rather than "income"--as an even trade for the loss of one's body or an injury to one's psyche. What makes one whole is not gain, and without gain there can be no income.

This is wrong as a statement of legal life. Suppose a person bought a painting for $50,000 in 1970 and sold it for $100,000 in 1985. During these 15 years the cost of living rose by more than 100%; the increase in the price of the painting did not keep pace with the reduction in the value of money. The painting's owner is poorer with $100,000 in 1985 than he was with a $50,000 painting in 1970. As an economic matter he has suffered a loss. Yet as a legal matter he has received $50,000 in "income," on which he must pay tax at the capital gains rate. The law looks to the receipt of money, not to the existence of economic gain. (We discuss below the extent to which this exchange would yield a "resource" in the AFDC program.)

The point may be plainer if we consider how anyone earns wages. To earn money a person must sell a little bit of himself. He sells time, and with it the right to engage in leisure; sometimes he sells his health (by working in a place with contaminants) or his body (by working in a place with physical risks). In exchange for giving up these things, he receives a wage. Over the course of a lifetime this will wear him down. Time and labor wear us all down. Is the wage "gain," or is it just "compensation" for the time, the labor, the risk of injury, that goes with work? The inquiry is metaphysical, the answer arbitrary. The answer of the tax system is that the wage is "income;" the answer of the tax protester is that the depreciation of the person (a wasting asset) exactly offsets the wage, and so there is no income. The plaintiffs in this case have taken the tax protesters' view of income, as only the excess of receipts over the costs borne to obtain those receipts.

The plaintiffs also say that pain and suffering is different, clearly not a substitute for earnings. Even here, though, things are not so clear. Football players sacrifice their bodies (they "play with pain" ) to perform their jobs. They trade pain for income. People sell parts of their bodies (blood and kidneys) for money. See Susan Rose-Ackerman, Inalienability and the Theory of Property Rights, 85 Colum.L.Rev. 931, 945-49 (1985) (collecting sources). What they get in return is "income." United States v. Garber, 607 F.2d 92, 102-05 (5th Cir.1979) (en banc) (dissenting opinion; the majority reversed a conviction because of improper instructions on wilfulness without resolving this question). People may participate in experiments in which they receive electrical shocks for incorrect answers, or they may take new drugs. Here, too, they receive income in exchange for the pain or the risk of ill health.

All of this is not to say that compensation for lost wages, or for pain, must be deemed "income." "Income" is a legal construct rather than an economic truth; there is no natural meaning of a legal construct. The tax law has things both ways. It defines almost every receipt of money as income, see 26 U.S.C. Sec. 61, and then establishes special exclusions for damages, see 26 U.S.C. Sec. 104. The definition of income in Sec. 61 includes damages representing income of every kind, see United States v. Safety Car Heating & Lighting Co., 297 U.S. 88, 93-94, 56 S.Ct. 353, 356, 80 L.Ed. 500 (1936), though it does not cover a replacement of "capital." Section 104(a)(2) then allows exclusion of damages received "on account of personal injuries or sickness". Section 104(a)(3) establishes still another rule for sums received through accident or health insurance (which may cover...

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