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Constitutional Concerns Are a Major Risk for a Federal Wealth Tax

Senator Elizabeth Warren. Photo: Michael Dwyer/AP

Senator Elizabeth Warren was ready for claims that her proposed tax on wealth — a 2 percent annual tax on fortunes over $50 million, plus an additional one percent on wealth over $1 billion — would be unconstitutional. When she announced the plan, her Senate office produced two letters from groups of prominent legal academics, including specialists in constitutional law and tax law, saying her plan passes muster.

Their position is plausible enough: Bruce Ackerman, a law and political science professor at Yale and one of the signers of one of Warren’s letters, has been making scholarly arguments for the constitutionality of a wealth tax for two decades. A lot of academics agree with him.

But there are others who do not. And this is a key implementation challenge for Warren’s plan: Unlike obviously constitutional ideas like raising income tax rates, or expanding the taxation of capital gains, or raising estate taxes, this is the kind of proposal where you need to produce letters from legal academics to argue it would survive the courts. What they are making is just that — an argument. And judges might disagree with it.

“I think a constitutional challenge to an actual tax on wealth is inevitable,” says Michael Graetz, a professor of tax law at Columbia University. “That it would fail does not seem to me to be obvious.”

When Graetz refers to an “actual tax on wealth,” he means to contrast Warren’s proposal against a tax on income from wealth, which has been clearly constitutional since the enactment over 100 years ago of the 16th Amendment, allowing Congress to “lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states.”

That amendment gave Congress more leeway than it had previously under a provision in Article I, Section 9 of the Constitution, which specifies that “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” That is, if the federal government is going to levy a direct tax, it has to do so in such a way that an equal amount of tax is collected per capita in each state — except the 16th Amendment says Congress doesn’t have to do this if the direct tax is an income tax.

Okay. So. What the hell is a direct tax? That is a good question, and one about which the Supreme Court has not provided a clear and current answer, which is the reason there would be a debate about whether Warren’s plan is constitutional.

The gist of the usual answers is that a direct tax is a tax that applies to a state of being, while an indirect tax applies to an action. Lots of early federal taxes were taxes on transactions — excise taxes, tariffs, and the like. Because these apply to people only when they engage in a specific commercial act, they are indirect taxes. Taxes on wage income are also indirect, as they apply to a transaction of labor for money.

An obvious example of a direct tax is one cited explicitly in the constitution: a capitation, also known as a poll tax, which is charged in a fixed amount on each person. A more difficult question — one on which the courts have periodically changed their minds, and one on which the survival of Warren’s proposed tax would hinge — is whether and which property taxes are direct taxes.

The 16th Amendment only became necessary because, in 1895, in Pollock v. Farmers’ Loan & Trust Co., a closely divided Supreme Court struck down a federal income tax on the grounds that its taxation of income generated from property made it a tax on property, and therefore a direct tax. And because the tax was not apportioned across the states by population, it was therefore unconstitutional.

That 5-4 decision was controversial at the time, in part because it not only extended the Constitution’s “direct tax” restrictions to taxes on income from property, it also newly said direct taxes were not just those on real property — land and buildings — but also those on personal property, such as securities.

In effect, the decision said the Congress could tax workers’ earned income but not the unearned income of the wealthy. Congress and the states reversed this unpopular decision by passing the 16th Amendment, and ever since the federal government has primarily financed itself through taxes on income. Because the question of what constitutes a direct tax has become mostly moot, the Supreme Court has rarely talked about it in the ensuing century.

A new federal tax on wealth would make the question relevant again.

In 1920, shortly after the enactment of the 16th Amendment, the Supreme Court showed in the Eisner v. Macomber decision that it continued to take a restrictive view of what Congress could tax without running afoul of the obligation to apportion direct taxes. The court threw out an income tax on dividends paid to shareholders in stock, finding the tax amounted to an unconstitutionally non-apportioned direct tax on personal property — stocks — because the tax was not limited to actual cash distributions.

But there are reasons to believe the Supreme Court would not take such a stringent view today. There are aspects of the current federal income tax code that would appear to be unconstitutional under Eisner v. Macomber — such as rules that require companies to mark assets to market and pay income tax when they rise in value, even if they do not sell them for cash — but federal courts have allowed those provisions to stand.

“I think it’s fair to say virtually all the tax lawyers who have thought about this no longer regard the Macomber decision as good law these days,” says Graetz.

Daniel Hemel, a tax law professor at the University of Chicago, shares that assessment, saying he believes the Court likely would no longer hold, as it did in Pollock and Macomber, that taxes on personal property are direct taxes. But Hemel thinks it would be a much tougher sell to get the Court to agree that you can have an unapportioned wealth tax that also applies to land and buildings, since there was a long tradition of treating real-estate taxes as direct taxes prior to the controversial Pollock decision. And if you excluded land and buildings from a wealth tax, that would create a huge loophole: Very wealthy people would shift their wealth out of other investments and into real estate — anything from opulent estates to commercial office buildings to timberland and working cattle ranches — to avoid the tax.

Hemel suggests you could have a work-around for that: To the extent Warren’s wealth tax applies to land and buildings, you could rebate that portion of tax receipts to the state where the taxpayer resides. While apportioning the entire wealth tax would be impractical, only 7 percent of the wealth of Americans with net worth over $50 million is in real property. So the federal government would send about 7 percent of the overall total receipts from the wealth tax — whatever portion applied to real property wealth — back to the states where the taxpayers reside. Hemel has run the numbers and thinks a rule apportioning only that part of the tax would not lead to too large a divergence in fiscal benefits among states. Richer states would get more generous distributions than poorer ones — he estimates North Dakota would get a rebate of $79 per person while West Virginia would get just $6 — but because these rebates would be very small compared to total wealth tax collections, the overall result would still be reasonably equitable.

Still, there are uncertainties.

“Any answer regarding the constitutionality of a wealth tax should come with the caveat that we have no idea what the Supreme Court would say,” Hemel wrote to me. “I think that rebates to states would satisfy the apportionment requirement but it’s conceivable that the Court would say apportionment applies to gross revenues rather than net revenues.”

The last Supreme Court case to deal with the direct tax issue at length was NFIB v. Sebelius, the case upholding the Affordable Care Act individual mandate as an exercise of Congress’s taxing power. Since the Court held the mandate was a tax, they had to address the question of whether it was a direct tax, and whether it must therefore be apportioned.

“Even when the Direct Tax Clause was written it was unclear what else, other than a capitation (also known as a ‘head tax’ or a ‘poll tax’), might be a direct tax,” Chief Justice Roberts wrote in the opinion of the court. He provided a tour of other things the Court had called direct taxes over the course of its history: land taxes, real-estate taxes more generally, and, in Pollock and Macomber, taxes on personal property. He then went on to note that the ACA mandate penalty was none of these things, and therefore was not a direct tax, and therefore was constitutional.

This does not address the question of which of the kinds of taxes the court has called direct taxes in the past it would still call direct taxes today.

A matter that should worry advocates of a wealth tax is that judges, faced with truly ambiguous questions like what’s a direct tax, can have a way of resolving those questions in the direction of their policy preferences — and this is a conservative court. I am not a judicial nihilist: Sometimes, the meaning of the Constitution is clear, and that clarity forces judges of differing ideologies toward the same legal outcomes. The direct tax clause is not one of those instances of clarity.

Warren hopes to collect about one percent of GDP each year from this tax, or about 5 percent of the current federal budget. The tax would not be a mere symbol, and it wouldn’t be just a way to constrain the power of billionaires; it would be intended to serve as a real and enduring source of revenue to finance government programs. And unlike some other tax proposals, that endurance would face significant risk from the courts.

Constitutional Concerns Are a Major Risk for a Wealth Tax