Is the proposed wealth tax constitutional? Answer depends on the definition of ‘direct taxes’
October 27, 2021, 11:46 a.m. CDT
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A tax on unrealized investment gains by the very wealthy could lead to constitutional challenges that land in a skeptical US Supreme Court.
It is controversial whether a federal tax on unrealized gains is a “direct tax” that the US Constitution requires to be apportioned based on the population of the state, or whether it is an income tax that is subject to the 16.
The Washington Post and the Wall Street Journal are looking into the matter.
The tax proposal unveiled Wednesday would apply to about 700 people, according to Senate Finance Committee Chairman Ron Wyden, an Oregon Democrat, Roll Call, the Hill and NBC News report.
The proposal would tax paper gains on stocks and other negotiable assets held by individuals who own more than $ 1 billion in assets or who have earned at least $ 100 million for three consecutive years. Current law only taxes profits when the assets are sold.
Gains or losses on stocks, dividends, and other tradable assets would be based on the change in market value over the previous year, an approach known as mark-to-market. In most cases, the profit will be taxed as long-term capital gain.
If the rich sell real estate, closely held businesses, or other assets that are not traded on a stock exchange, they would have to pay a premium on top of capital gains taxes.
Tax law experts disagree on the constitutionality of a wealth tax, according to NBC News.
Daniel Hemel, a professor at the University of Chicago Law School, described the constitutional argument in a comment for the Washington Post.
The direct tax clause in Article 1 Section 2 of the Constitution provides that “the direct taxes are divided between the individual states … according to their respective number”.
In other words, “said Hemel,” if a tax is a ‘direct tax’ and 1.5% of the US population lives in Alabama, then 1.5% of the tax revenue must come from Alabama. If the billionaire tax is a direct tax, the obligation to split would not have to be fulfilled: According to Forbes, Alabama has no known billionaires, neither does Alaska, Delaware, New Hampshire, North Dakota, Vermont or West Virginia. ”
So what is a direct tax? The answer is unclear, according to Hemel and the Wall Street Journal. Some early Supreme Court rulings suggest that a federal land tax or a poll tax of $ 500 would qualify as direct taxes to be apportioned among the states.
An 1895 Supreme Court decision, Pollock v Farmers’ Loan & Trust Co., gave direct taxes an even broader meaning. In response to the decision, Congress passed the 16th Amendment, which allows for a federal income tax without state split. But the change did not remove the direct tax clauses; rather, it created an exception that paved the way for federal income taxes.
Billionaires challenging the new tax are likely to make two arguments, Hemel said. First, they will argue that the tax on unrealized gains is not an income tax eligible for an apportionment exemption under the 16th Amendment. The second argument against constitutionality is that the tax depends on taxpayers’ wealth, which must be divided among the states according to the number of inhabitants. That is not possible with the geographic distribution of billionaires.
“Billionaire tax defenders are likely to argue that justices should throw Pollock overboard. I agree, ”wrote Hemel. “But even if they did, that wouldn’t completely solve the problem because the billionaire tax would still depend in part on the value of a taxpayer’s land. And the Supreme Court has said time and again, even before Pollock, that a property tax is a direct tax that needs to be shared. “
The outlook for the tax proposal clouded shortly after it was revealed on Wednesday, when Democratic Senator Joe Manchin of West Virginia spoke up, the New York Times reports.
Manchin said he didn’t like the idea that the tax would target people who “make a contribution to society” and “create lots of jobs, invest lots of money and do lots of philanthropy”.
Hat tip for How appealing.