Yes, A Wealth Tax Is Constitutional-- A Elizabeth Warren's Plan Is Solid

Last week, even before Elizabeth Warren announced her wealth tax plan, I went back and forth with Alan Grayson about the constitutionality of the whole concept of a wealth tax. The original wealth tax post we ran about it on Thursday left out the constitutionality piece from the Institute on Taxation and Economic Policy report, the assertion that it would be constitutional. He was worried that the Supreme Court-- especially the current Supreme Court-- would look for reasons to overturn a wealth tax. The states could o it of course, as Florida did before Jeb Bush was elected, as Grayson feels that the underlying principle is correct. "We have a major unnoticed economic problem, which is that corporations and rich people remove around a trillion dollars each year from the purchase of goods and services through stock buybacks, etc. That money has to be made up somehow, or the economy will collapse. For the last ten years, we’ve been closing the gap with quantitative easing and massive increases in public and private debt. That probably can’t go on forever.  At least Ocasio is thinking about the problem, and offering a potential solution."

The folks at the Institute on Taxation and Economic Policy argue that "the Supreme Court opinions that are often claimed to bar any such tax are themselves aberrations in the Court’s long history of giving deference to Congress’s power to impose taxes, and if followed today they would bar some tax provisions that have been in effect for years. Whether a federal wealth tax would be consistent with the U.S. Constitution hinges on the question of what is a “direct” tax. Two different parts of the Constitution describe how Congress can impose a direct tax without defining what a direct tax is."

The direct tax clauses of the Constitution are part of the infamous Three-Fifths Compromise. Delegates to the Constitutional Convention from southern states wanted slaves counted as part of their populations for determining the number of Representatives elected to the House from each state. At the same time, the southern delegates did not want slaves counted as part of the population for the purpose of any federal tax that was apportioned by population. The men who spoke on behalf of southern states at the Convention wanted to maximize their clout in Congress while minimizing the federal taxes paid by their states. The “compromise” that southern and northern delegates settled upon was to count each slave as three-fifths of a person for both purposes. The direct tax clauses are part of that compromise.

Johnsen and Dellinger explain that “constitutional text may not be ignored simply because it was the product of compromise rather than thoughtful policy-- even compromise inextricably infected by the evils of slavery. At the same time, in construing this unclear, undefined eighteenth-century text, we must keep in mind the inherent ambiguity given that compromise, and more generally, the great differences in the economic circumstances and understandings of that time.

Ackerman goes even further and refers to Three-Fifths Compromise as the “tainted origins” of these clauses. The Thirteenth Amendment abolished slavery and made the Three-Fifths Compromise irrelevant, and, he argues, the rest of the language referring to direct taxes is also mostly irrelevant for all practical purposes today.

The language makes clear that a “capitation” tax or a head tax, imposed in equal amount per individual, would be a direct tax. It was also commonly believed that a tax on real property (land and buildings on it) would also constitute a direct tax. At the time the Constitution was drafted, some held the view that all income was derived from land so a tax on land itself was a direct tax. (Note that even though a wealth tax would be imposed on net worth, which can include real estate, it is fundamentally different from a tax on land or real estate alone.) Many people at the time also apparently believed that slaves were a type of real estate.

Most types of taxes that we are familiar with today would be unworkable if they were to be apportioned. Imagine there are two states, Poorland and Richland, that have the exact same population. If a tax is apportioned by population, the total amount of that tax paid by these states would be the same. Imagine that Richland had twice as much wealth as Poorland. If a wealth tax was subject to the apportionment requirement, then the residents of Poorland would have to pay the wealth tax at a rate that is exactly twice the rate paid by those of Richland. That is the only way that residents of both states would pay the same amount of tax per capita, as required under an apportionment rule.

In the 1796 case Hylton v. United States, the Supreme Court saw that this would be absurd and held that a federal tax on carriages was not a “direct” tax. Because carriages were owned mainly by the wealthy, one might think of this as something like a tax on yachts or luxury cars today. The Justices who ruled on the case had been involved in drafting and ratification of the Constitution. They found that the apportionment requirement applied “in such cases where it can reasonably apply,” as one of them put it. Another of the Justices noted that southern states “possessed a large number of slaves” and “extensive tracts of territory, thinly settled, and not very productive,” and could therefore be burdened by either a per-head tax or a per-acre tax imposed by the federal government and thus these were the taxes that the Framers most clearly meant to limit. The Supreme Court applied this reasoning for a century, upholding unapportioned federal taxes on income, financial transactions and inheritances.

Those who argue that a federal wealth tax is unconstitutional point to the Supreme Court’s sharp turn away from this reasoning in 1895 in Pollock v. Farmers’ Loan & Trust Company, when the closely divided court decided that the term “direct tax” included any tax on real or personal property, and any tax on the income earned from such property. The income tax that Congress had enacted the year before was thus struck down.

The court’s decision was widely criticized by legal scholars and was, according to Johnsen and Dellinger, “contrary to all authority when a bare majority announced it.”

The Pollock decision so outraged the public that Americans took the extraordinary step of amending the Constitution to reverse Pollock’s holding and allow a federal income tax. The Supreme Court never entirely reversed Pollock—it never needed to because the 16th Amendment, ratified in 1913, allowed Congress to impose a federal income tax. But what is left of Pollock’s reasoning regarding other types of federal taxes?

Ackerman, Johnson and Dellinger explain that the Supreme Court quickly backed away from its reasoning in Pollock in many ways, largely returning to the logic of Hylton, so that Pollock stands out as an aberration in the Court’s history of addressing the issue.

For example, in 1900, just five years after Pollock, the Supreme Court upheld a federal tax on inheritances as a tax on the transfer of wealth. (An inheritance tax is like an estate tax but is technically paid by the recipient of the inheritance rather than by the estate itself.) As already explained, a federal wealth tax in principle is very similar to a federal inheritance or estate tax except that it is imposed each year rather than just once, upon an individual’s death. It is difficult to believe that a wealth tax violates the Constitution while an inheritance or estate tax does not.

The only case in which the Court again applied the type of reasoning found in Pollock was Eisner v. Macomber in 1920. In that case, the Court struck down a federal tax on stock dividends on the theory that the tax was partly being imposed on unrealized capital gains.

While never expressly overturned, this opinion has been limited to the point of irrelevance by subsequent court opinions. If the logic of Macomber was truly in force today, several tax provisions that have been on the books for years would actually be unconstitutional. For example unrealized capital gains are already to some degree subject to federal income tax under section 1256 of the code, which subjects certain derivatives to mark-to-market taxation, and section 475, which subjects securities held by dealers to mark-to-market taxation. No one has ever suggested that these parts of the tax code must be struck down.

Grayson's worry about constitutionality wasn't about the Direct Tax Clause however, but about the Fifth Amendment, while acknowledging that both the Obamacare tax and the inheritance tax could be held analogous to wealth taxes... A pure wealth tax, on the hand," he worried, "looks a lot like a deprivation of 'life, liberty or property' under the 5th Amendment, which would be unconstitutional."

After further deliberation, though, Grayson told me that he sees "two ways to do this that would probably be constitutional.  The first is to tax unrealized capital gains.  The second is to tax corporate equity."

Wealth consists of gifts, invested capital, realized capital gains and unrealized capital gains. The first three already are taxed. The fourth almost always is not (the only exceptions between a tax on unrealized profit from futures, and arguable property taxes), and the absence of such taxation is arbitrary. Virtually all of the wealth that Warren wants to tax, like Mark Zuckerberg’s wealth, consists of unrealized capital gains. If unrealized capital gains were taxed, it would generate more than $100 billion a year, and the absence of such taxation has been going on for 100 years (literally, since 1916), so the accumulated amount subject to taxation is trillions of dollars.

Regarding corporate equity, it’s not at all clear that the Fifth Amendment applies to corporations. The fact that corporations are chartered by the states is arbitrary. Nothing prevents the federal government from requiring a federal charter for every business doing interstate commerce, and nothing prevents the federal government from imposing an excise tax on the share value of every federally chartered corporation (or LLC, or whatever). This would be a de facto wealth tax on every business interest doing interstate commerce, which is basically everyone.

So these are two proper, Constitutional methods that would prevent the Kavanaugh Court from wiping the whole thing away. These also are economically correct results, because not taxing unrealized capital gains creates an improper and inefficient barrier to the free market in capital (because if you sell, you have to pay a tax, even if the new owner would generate more income from the asset, so you don’t sell, although the free market says you should).

Just one reminder: Trump's own wealth tax proposal absolutely dwarfed Warren's. Where she doesn't want to tax anyone whose worth is under $50 million and then only at the rate of 2% (until the worth is a billion dollars, at which point, the rate goes to 3%), Trump proposed taxing everyone with $10 million or more and a the gargantuan rate of $14.25%. Warren's proposal is basically a mild reform. Trump's proposal was... relatively revolutionary-- and confiscatory. Unless he plans to bring it up again, not likely, let's just pass Warren's and call it a day.

I should see if I can find someone from the Bernie-Stacey 2020 campaign and find out if they plan on embracing the idea as well. After all, it is a very good one, even if it was proposed by Trump!