Closing the Loop on Anti-Government Dogma: Is Every Tax Unconstitutional?

by Neil H. Buchanan
How far will Republicans go with their anti-tax jihad?  Long before any reality TV bigots came along, America's conservative party defined itself by its opposition to taxes.  They claim to hate deficits, and they certainly hate any government spending that helps Those People, but even when they have been given the opportunity to trade $1 of increased taxes for $10 of spending cuts, the self-styled Party of Fiscal Responsibility emphatically rejected any increases in tax revenues.

Last week, in the midst of everything else that is going wrong in the world, Republicans' anti-tax mania was given the opportunity to rear its ugly head when Senate Democrats proposed their so-called Billionaires Tax (BT).  Conservatives immediately claimed that the BT was most assuredly -- for some reason to be determined later -- an unconstitutional abomination, so I wrote a Verdict column explaining that the BT was not only constitutional but trivially so.  I followed up here on Dorf on Law with a column responding to an over-the-top recitation of anti-tax dogma from one of The Washington Post's resident conservative ideologues, whose rant was inspired by the BT but went far afield in making absurd assertions.

With a bit more time to think about it, I decided that the most interesting thing about the BT was not the proposal itself but the insanity of the arguments that had been offered from the right claiming that the tax simply has to be unconstitutional.  That is the more interesting issue for three reasons: (1) As anyone who has observed the Democrats for even a millisecond might have expected, they quickly abandoned the BT; (2) Even if the BT had been enacted, Republicans in the next Congress would have repealed it long before it could have reached the Supreme Court; but most importantly (3) the arguments that conservatives trotted out against the BT might well be repurposed to attack other taxes.
Even in the dystopian post-constitutional future that I have predicted, Republicans might find it more useful to use the courts to repeal progressive taxes than to do so through legislation.  If so, it would be interesting to think about what legal fig leaves they would use to hack away at the taxes that they hate.  I thus wrote a two-part Verdict column (published on Monday and this morning), laying the groundwork to explain how conservatives might try to twist the Constitution and a very bad (but not exactly overruled) precedent to go after taxes that are far more familiar than anything like the BT.

Here, I want to summarize just how wrong the conservatives' anti-tax constitutional analysis is (an analysis joined in part by some liberals, for some reason).  To the extent that I have not lost my entire potential readership by now, I will offer this teaser: Taking conservatives' anti-BT arguments seriously leads to the conclusion that all taxes are unconstitutional.  Even after democracy dies, the one-party state will need money.  Where will it turn?
The key technical concept that bears repeating here is the difference between realized and unrealized income.  By statute -- but very much not as a constitutional imperative -- our income tax system includes as potentially taxable income not just cash received as salaries and wages every year (along with things like royalties, debt forgiveness, and other smaller categories) but also the net proceeds from selling or otherwise disposing of property/assets.

So, under the current system, if a person buys a share of common stock for $1000 in Year 0 and it goes up in value by $200 every year for seven years, the tax system says that the annual $200 in unrealized income is not taxed, but when the owner sells for $2400 in Year 7, there is $1400 in realized income that must be included in that year's tax computation.  Even though the person has -- by the most widely accepted and non-ideological definition of income available -- received $200 in income each year, she need not pay taxes on it at the end of each year.  And if she chooses not to sell it in Year 7, she will continue not to pay taxes on the gain.  It is entirely within the taxpayer's power to decide when, or even if, she will pay taxes on the gain.  And if she dies without realizing the gains, the unrealized income will never be taxed.

Keeping that explanation on hold for later, we can now run through the constitutional comedy of errors that conservatives have offered against taxing rich people (although, as I suggested above, there is nothing other than Republicans' druthers stopping them from extending this to all taxes).  Interested readers will find more complete explanations in today's Part Two of my Verdict column, but it will be useful here to put in list form the chain of legal blunders underpinning conservatives' claim that "taxes on unrealized gains are taxes on wealth, so they're unconstitutional."

(1) Nothing in the Constitution bans any kind of tax under consideration here (or any kind of tax at all, unless the tax violates some other constitutional provision, such as equal protection).  The only constitutional barrier of any kind is that some taxes must be "apportioned," that is, each state's proportion of dollars collected by the tax must equal that state's proportion of the national population.  For example, if State A is home to one percent of all U.S. citizens, the tax must collect one percent of all revenues from State A.  (The rule actually has to do with congressional districts, but it amounts to a very nearly population-based requirement.)

So there is no such thing as an unconstitutional tax.  There are only taxes that must be apportioned.  Apportionment can lead to absurd results, but it can be done; and if Congress chooses not to do so, it is not because the tax is unconstitutional but because apportionment is unworkable or unacceptable as a policy matter.

(2) The only kinds of taxes that must be apportioned are Direct Taxes.  The problem is that no one knows the difference between a direct and an indirect tax.  There is no functional difference, the Constitution itself only gives one example (a "capitation tax," or equal-dollars-per-person tax), there is no evidence of what "original public meaning" the term "direct tax" had at the founding, and any distinction that might have once made sense has been lost to history over the life of the Constitution.  Pick any interpretive method you prefer, but you still will not have any guidance to determine what counts as a direct tax.

(3) Conservatives are now claiming that wealth taxes are direct taxes.  That is clearly wrong, because we have plenty of taxes that are absolutely, unquestionably taxes on wealth that have never been struck down as unconstitutional-because-direct-but-not-apportioned.  The estate tax is the most obvious example.

This, however, is where things start to become a bit nerve-wracking, because this could give ideas to conservatives, who have always hated the estate tax but have only been able to minimize it without fully repealing it.  A few months ago, people like me were asking: "Why are so many people rejecting the Covid vaccine requirements for schools, when we have long imposed many vaccine requirements that these people have never resisted?"  Rather than saying, "Silly me, you're right, so now I'll let my kid get the Covid vaccine," many of them are now saying, "Silly me, you're right, so I'm now against ALL vaccines!"

This is part of the reason that I expect conservatives to become more aggressive about challenging taxes in the courts.  With a sympathetic core of six justices on the Supreme Court, they might well succeed in having all wealth taxes deemed to be direct taxes, thus needing to be apportioned.  A Republican Congress could then refuse to alter those taxes to meet the apportionment requirement, saying: "So I guess the tax is unconstitutional now."

(4) Conservatives are now pushing the envelope by saying that taxes on unrealized incomes are taxes on wealth, which is their attempt to skirt the Sixteenth Amendment's elimination of the apportionment requirement for taxes on incomes — a requirement that never existed in the first place, but it took an amendment to undo a ridiculous Lochner-era case called Pollock that had invented such a rule.
Again, even if it were true that unrealized income taxes were wealth taxes (which they absolutely are not), that would not make them direct taxes and thus subject to apportionment -- and certainly not unconstitutional per se.  There are some particularly silly versions of this argument that I address in today's Verdict column, but here, I will simply point out that their logic requires one to willfully misunderstand the difference between taxing wealth itself and taxing changes in wealth over time (that is, income).
On Verdict, I draw a direct analogy between distance-versus-velocity and wealth-versus-income, pointing out that even if it were unconstitutional to limit the distances that people can travel, it would not be unconstitutional to limit how quickly people can cover those distances.  More to the immediate point, the most recent debate sees conservatives suggesting that unrealized income does not feel like income, and they say that taxing unrealized income means taxing wealth, which makes it all unconstitutional -- again, skipping steps (1), (2), and (3) entirely.
Beyond all of that, as my colleague David Hasen, who also teaches tax law at the Univesity of Florida, pointed out in an email:
"There are plenty of exceptions to the realization requirement already, including for dealers in securities, holders of certain financial contracts, holders of off-shore investment funds and certain income of controlled foreign corporations. They have all survived challenges. There is also case law that describes realization as a rule of administrative convenience and not a constitutional requirement."
David added: "Because of this history, I think the question is whether a court that was motivated to find it unconstitutional could do so without writing a truly embarrassing decision. I think it could, but it would not be pretty."  Quite so.  
Again, however, today’s Court might be willing to go there.  Just as I suggested in (3) above that the Court could revisit its precedents on wealth taxes -- just as it has upended precedents on guns, voting rights, and so on -- it could suddenly decide that, in fact, none of the taxes that David listed are constitutional after all.

(5) And now we close the loop.  The old, repudiated-but-not-overruled Supreme Court case that I mentioned above is 1920's Eisner v. Macomber, about which I have gone on at great length in all of my recent columns on this topic.  What more is there to say?  The non-embarrassing, limited holding of Macomber is that the taxpayer in that case not only did not have realized income, but she had no income at all.  Why?  Because the triggering event for levying the tax was a stock swap that had made her no richer -- she had about $820,000 in stock before the swap and $820,000 in stock afterward.  No increase in wealth, no income, no tax.

But consider how that logic could play out in unexpected ways.  Under the statutory realization rule, the person in my example above does not pay taxes while she systematically receives a total of $1400 in unrealized income.  When she sells the stock, however, she has turned $2400 in stock into $2400 in cash.  The triggering event, then, did not make her richer, any more than the stock swap made Ms Macomber richer.  The government had not taxed Macomber when the income was actually accruing, and when it tried to tax her later, the Court said that it could not tax her, because the triggering event had not made her richer.

Bottom line: A motivated conservative (as if there is any other kind) would say that we cannot tax the income when it is unrealized (because that is supposedly taxing wealth), but you cannot tax it when it is realized, either (because there is no income created on the date of the transaction)!  Again, if a Court wants to start messing with the definitions of direct taxes, wealth, and income, it might also want to start saying that even the surviving understanding of Macomber prohibits taxing realization events.

How far could that go?  It is tempting to imagine that the Court, if it went that far, would essentially be saying that the only incomes that can be taxed are wages and salaries.  Even that, however, is not the limit.  Consider that a person earns her salary or wage income over time, and periodically the accumulated obligation is deposited by the employer into the employee's bank account.  We have not taxed the income while it was being earned, but we typically have no problem saying that the income is clearly taxable when received as salary/wages because it has been realized.

Is it clear, though?  On the day that she receives the deposit into the account, the employee is not richer, because her employer has replaced the legal obligation to pay her, say, $3000 with $3000 in a bank deposit.  She is no richer the moment after the deposit than she was the moment before the deposit -- just as Ms Macomber was no richer after the stock swap than she was before the stock swap.  Thus, even the quintessential example of taxable income -- being paid by one's boss -- could be subject to the same logic:
You cannot tax me now, because you should have taxed me before; but that was not allowed either, because taxing unrealized income is a tax on wealth, which is a direct tax, which must be apportioned.
Do I think the Court would go this far?  Of course not.  My point is that the idea that unrealized income "obviously" cannot be taxed as income relies on a logical framework that ultimately makes everything nontaxable for all eternity.  Although that surely would sound good to some of the most anti-tax zealots out there, even this Court is unlikely to become full-on anarchists.
More likely, the Court will simply make opportunistic interventions to relieve wealthy people from the unpleasant task of paying taxes, but then refuse to extend the logic to exempt everyone else.  Elon Musk will be delighted, because even though he claims that he should not be taxed lest everyone else soon face his sorry fate, what he and other guardians of the rich truly want is for the government to collect money from the little people.  And surely this Court will not exempt everyone else from taxes, even as it hacks away at the vestiges of progressivity in our tax system.