So the snap ring will pull the small gear away from the housing? I'll have to try that.
And yes the small gear on the input shaft sits right against cover number two. Step #58.
http://www.marlincrawler.com/tech/4701-gear-install I know in step #58 pic you cant see the small gear because it is behind the large gear on the input shaft but it is rubbing housing #2 as it sits in the bearing on case #2.
I will try the snap ring to set the shaft out from case #2 hopefully giving clearance. I just didn't want to put everything together with the rubbing untill it was resolved. Thanks for the input.