Wealth tax proposals have been all the rage among progressive politicians of late, despite the many pitfalls of attempting to tax unrealized gains. But a case the Supreme Court just took up could render taxation of unrealized gains constitutionally untenable.
Moore v. United States looks at a provision in the 2017 Tax Cuts and Jobs Act (TCJA). One of the ways that legislators offset the foregone revenue from tax cuts was through a one-time “deemed” repatriation of earnings from U.S. citizens’ shares of foreign corporations.
Put simply, the deemed repatriation provision acted as if Americans with shares in foreign corporations (above a minimum threshold) had received a dividend representing their share of that corporation’s profits going back to 2006. Never mind that they hadn’t received this dividend — the TCJA treated them as if they had.
In this sense, the deemed repatriation provision acted very much like a wealth tax. Though corporate shares gain value as the corporation in question is profitable, investors’ gains from these shares are entirely theoretical until they either sell their shares or benefit from those corporate profits in the form of a dividend. The “deemed repatriation” ignored the distinction in American tax law between realized income (which is usually taxable) and unrealized income (which usually isn’t).
One couple affected by the deemed repatriation provision, Charles and Kathleen Moore, chose to challenge it in court. Though they had never received any dividends or sold their 13 percent stake in an Indian company that provides agriculture tools to impoverished Indian communities, they were hit by a tax bill under the TCJA just the same. Now, their challenge finds itself before the Supreme Court.
The case hinges upon the interpretation of the Sixteenth Amendment to the Constitution. Prior to the ratification of the Sixteenth Amendment in 1913, the Constitution granted Congress the power to levy “direct” taxes only if they were equally proportioned among the states — in other words, they could only be levied on a per capita basis.
The Sixteenth Amendment allowed Congress to ignore this proportionality requirement for “income” taxes specifically. That’s fairly straightforward for normal “income” taxes on wages, dividends, or capital gains — in other words, “realized” income that directly benefits the taxpayer. But whether the Sixteenth Amendment applies to unrealized income, where a taxpayer’s net worth increases but their cash on hand remains the same, is the question before the Court.
While the case will, of course, hinge upon legal interpretations, the distinction between realized and unrealized income is obvious to most taxpayers. When you receive cash (or an electronic deposit to your checking account), it’s easy enough to set aside part of that for your tax obligations. On the other hand, if your car’s theoretical sales price increases, as many did during the pandemic, it makes little sense for Uncle Sam to demand his share unless you actually go ahead and sell.
A ruling explicitly describing unrealized income as capital, rather than income, for the purposes of the Sixteenth Amendment would effectively place a judicial stamp of disapproval on wealth tax proposals of all stripes. That would effectively end some of the zanier ideas coming from the left.
Of course, wealth taxes should be something that Congress avoids because they’re bad policy, are an enormous headache and costly to administer, and harm entrepreneurship. But given that those have never been good enough reasons to stop Congress from doing things in the past, a judicial veto wouldn’t hurt either.
