Will the Supreme Court's Conservative Super-Majority Make their Patrons Untaxable?

Earlier this week, the Supreme Court heard oral argument in a case, Moore v. US, that has the potential to effectively immunize the wealthiest Americans from taxation.  The anti-tax arguments in that case are tendentious, ahistorical, constitutionally and economically illiterate, and profoundly regressive.  They therefore have a very good chance of winning in front of the six Republican appointees on this Court.

This Supreme Court majority barely even bothers to make a public show of preventing themselves from engaging in the most nakedly self-dealing behavior.  Indeed, Professor Dorf pointed out a few weeks ago that while the just-released Code of Conduct deserved the scorn that accompanied its release, the Court's unusual description of its new code makes it even "less official than it otherwise might have been."

And to be clear, that is what this group of six felt free to do after months of front-page scandals had brought the Court into unprecedented levels of disrepute.  If they cannot be roused to make a better show of something so high profile, what in the world would stop them from doing exactly what their political movement's financial backers want now?  Over the last several years, there have been rumblings about imposing a modest wealth tax on the richest people in the country.  Why bother winning in the political arena when the people who are beholden to you for their exalted positions can simply assert that the very idea of taxing you is unconstitutional?

I should state up front that this is not going to be a typical review of a Supreme Court argument.  I am not a "Court watcher," which means that I cannot competently read the tea leaves in the way that others can.  And given that the overall mantra from people who write about such things is that oral arguments are highly unreliable guides to how the Court might rule, that suggests that even the most savvy and experienced observers are mostly left to make educated guesses based on deliberately opaque evidence. 

I thus did not read any of the commentary in the major papers or the blogs after the argument.  And even if Court watchers had a higher success rate in predicting outcomes, I would not want to allow others' analysis to bias my own, much as I sequester myself before writing about candidates' faux-debates.  Here, however, rather than focusing on the lawyers' performances in front of the Court, I will refer to the oral argument only inasmuch as doing so cuts to the substance of the legal issues underlying the case.

What possible basis could there be to say that the Constitution prohibits taxing rich people?  In Moore, the issue is not in fact about taxing wealth, a la Senator Elizabeth Warren's "2-cent" tax on wealth accumulations in excess of $50 million (and 6 cents on everything above $1 billion).  The question presented in the case is "[w]hether the 16th Amendment authorizes Congress to tax unrealized sums without apportionment among the states."

Huh?  Interested readers can dive into some of the details in two of my many prior columns about this issue (one on Verdict, the other here on Dorf on Law, both from late 2021), but the basic story is that the 16th Amendment was passed after the Lochner Court decided that income taxes were "direct" taxes, which the original Constitution says must be apportioned among the states.  I cannot improve on Professor Vikram Amar's Verdict column explaining the meaning of direct and indirect taxes, but the point of the 16th Amendment was to say that even though the Court was wrong in deeming the income tax to be a direct ax, the income tax would henceforth no longer be subject to its misguided holding.  That Amendment reads: "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration."

Therefore, the only way to make a tax subject to the direct/indirect analysis, and thus to possible apportionment, is to claim that the tax is not a tax on incomes.  To be clear, that does not in any way mean that a tax on something other than incomes is per se unconstitutional.  Even a non-income tax must first be deemed a direct tax, and even then Congress could keep the tax so long as it met the requirements for apportionment.  Because apportionment in taxation is administratively burdensome (and, to be blunt, stupid), however, Congress would prefer to be able to avoid the entire mess.

Again, however, the question presented in Moore is whether Congress can tax "unrealized sums" while sidestepping the direct/indirect and apportionment analysis.  Notice that the question presented uses the word "sums" as a way to present the issue neutrally, even though every tax expert in the world already refers to such "sums" as income.  That is, income is sometimes realized and sometimes unrealized, but either way, it is still income.  This case, then, attempts to completely upend the long-accepted, textually coherent, and economically required definition of income.

SCOTUSblog describes the fact pattern:

In the 2017 Tax Cuts and Jobs Act, Congress enacted a one-time “mandatory repatriation tax” in an effort to obtain tax revenue from large earnings that corporations held abroad. The MRT classifies a U.S.-taxpayer-controlled foreign corporation’s “accumulated post-1986 deferred foreign income” as part of the corporation’s taxable income during 2017. And under the MRT, U.S. shareholders owning 10% or more of such a foreign corporation could be required to pay a one-time tax due to their obligation to “include in [their 2017] gross income” their “pro rata share” of the CFC’s relevant “income for such year.” Essentially, the tax requires 10% shareholders to pay a tax on their share of the corporation’s retained earnings even though that money has not been distributed to them.

The key is the last eight words -- "that money has not been distributed to them" -- that is, that it has not been "realized" in the sense that the taxpayers have cash in hand.  There are all kinds of unrealized gains that are not subject to the income tax -- some capital gains, gains on the sale of a home, and so on -- but the nontaxation of those forms of income is due to Congress's ill-fated decision to embed a realization requirement in the statute.  It is not a constitutional requirement, which we know because there are various forms of unrealized income that have been taxed for decades -- the most salient to me being the "exit tax" for US citizens, who must pay taxes on unrealized gains under statutorily specified conditions.

Being the savvy operators that they are, the groups who are trying to use Moore as a camel's nose under the tent found a sympathetic lead plaintiff (the Moores being part owners of a "corporation formed to supply affordable equipment to small farmers in poor regions of India"), but the key background fact about this case is that the conservative movement wants to make it impossible not only to tax wealth but to tax income that has not been cashed out.  And because of the infamous "buy, borrow, die" strategy, people with the means to derive their income from owning assets rather than from wages or salaries can effectively make sure that their incomes are never taxed.  To be sure, that is mostly already happening (which is a big reason why income inequality in the US has skyrocketed in recent decades), but the result of Moore could prevent any future Congress from changing its mind and enacting a more progressive (or at least less regressive) tax system.

Readers might recall the recent low comedy in the US Senate, when Bernie Sanders had to scold his Republican colleague from Oklahoma for trying to start a physical fight with the President of the Teamsters.  The bad blood there had begun at a hearing of that committee earlier this year, when the Senator claimed to have earned a salary of only $50,000 from his plumbing business before becoming a Senator.  The head Teamster correctly observed that the now-Senator "hid money," that is, that the Senator paid himself a low salary for tax and other purposes and then enriched himself by keeping the money in the company that he owned.  He could have paid himself, say, $2,050,000 of realized income, but instead he realized $50,000 in cash and then increased the net worth of his closely-held company by two million dollars, the latter of which is not taxed until realized -- that is, never (again, because of buy/borrow/die).

There is apparently an argument out there that "gains" are not necessarily income, but what are gains?  The reason tax experts refer to unrealized gains and unrealized income interchangeably is that the gains are measured as the change in the value of underlying assets, which is the definition of income.  If, for example, I own $100,000 in common stocks that rise in value over the course of a year to $125,000, I have gained $25,000, and that is definitionally income.  Even people who took only one tax course in their lives -- and probably disliked it -- might remember "Haig-Simons income," which formalizes this identity.  Income is defined as the fair-market value of consumption in a year plus or minus the change in the value of all assets owned during the year.  That latter gain or loss is income (positive or negative), whether realized or not.

How do the petitioners get around that?  By invoking a later Lochner-era case, Eisner v. Macomber, and then mischaracterizing it.  In the fourth and fifth sentences of his opening statement, the petitioners' lawyer claimed that "a gain is not income unless and until it has been realized by the taxpayer. The Court squarely held as much in Eisner versus Macomber just a few years following adoption of the [16th] amendment, and the Court's decisions have held that line for a century."

That is simply wrong, but before I get there, one must note that those two sentences were preceded by this: "Appreciation in the value of a home, a stock investment, or other property is not and never has been taxed as income."  That is (mostly) true, but not because of Macomber.  Rather, Congress enacted -- at its option -- a realization requirement for most (but not all) income.  The Macomber Court did in fact hold that realization was constitutionally required, but the Court's decisions have not at all "held that line" since then.

If what the petitioner is saying were true, this case would have been trivial.  Instead, as the Ninth Circuit's decision below pointed out: "[T]he Supreme Court has made clear that realization of income is not a constitutional requirement," citing Helvering v. Horst (1940), which was decided 20 years after Macomber), with this devastating (for the petitioners) quote: "[T]he rule that income is not taxable until realized .... [is] founded on administrative convenience," not on the Constitution.

At oral argument, the Solicitor General (Elizabeth Prelogar) brought up Horst as well as the even more devastating Court decision from the same year, Helvering v. Bruun.  There, the Court narrowed Macomber to its bare facts, not formally overruling the earlier case but simply saying that the receipt of a "stock dividend" in that case was not income at all -- that is, that the taxpayer's wealth had not increased, meaning that the receipt of the stock dividend did not even give her any income to realize.

Undaunted, Justice Gorsuch opined that "it seems to me at least as I read [Horst, Bruun, and other cases] that they're all trying to work within Macomber's framework."  Yes, that is true, but not in a way that matters.  For reasons that no one understands, the Courts that rejected Macomber did so without explicitly overruling it, choosing instead to say that it did not stand for what that Court's majority had claimed it to stand for in 1920.  And as I predicted in a January 2019 column, that presents an opportunity for mischief, which Gorsuch (almost certainly not standing alone) was more than willing to engage in.

When Prelogar pointed out that the government's argument was essentially an argument in the alternative -- you can call what happened to the Moores a realization event, or you can say that no such event is necessary -- Gorsuch responded: "[Y]ou say no, it doesn't require realization, and now today you're saying maybe it requires realization but not to the taxpayer.  The one argument that I'm missing is that there was realization here to the taxpayer. That's just not even in the briefs."

Prelogar pushed back on that, and if that is the issue, then people like me who are worried about a decision that would turn the world upside down might be able to calm down.  Recall that the question presented was "[w]hether the 16th Amendment authorizes Congress to tax unrealized sums without apportionment among the states."  If the Court holds that there was realization for the Moores, the case can be decided without ever implicating the constitutional viability of the realization doctrine.  There is every reason to think, however, that Gorsuch and his colleagues want to say that the government did not argue the narrower, dispositive issue, clearing the way for them to say that Macomber means that all unrealized income is not income at all under the 16th Amendment.

How radical would that be?  In one of the leading tax law casebooks, the editors try to explain Macomber's "notoriety," describing the decision's "much-maligned definition" of income and referring to "the general rejection of the constitutional principle" in the case.  The casebook also includes a few paragraphs from a 1938 essay by Henry Simons (of Haig-Simons fame), who argued that gain rather than realization "is the true sine qua non" of "the existence of income."  The 16th Amendment removes the apportionment requirement from any statute that taxes income, even if income were (incorrectly) deemed to be a direct tax.  Unrealized gains are unrealized income, and unrealized income is income.

But in Gorsuch's words, he would be required to undermine the very notion of income taxation "if I'm not willing to overturn a hundred years' worth of precedent."  Right.  Fifty-year-old precedents are fair game, I guess, when they are wrongly described as "egregiously wrong."  He is suddenly a big believer in stare decisis, however, when a 1920 mess of a case that has been abandoned, mocked, and discredited becomes useful for his movement's regressive policy agenda.

Do I wish that the Court in 1940 had been more aggressive in rejecting Macomber's ridiculous reasoning?  Sure.  However, I argued in that January 2019 column that even if Macomber had never been decided or had been explicitly overruled, that would not stop this Court from making it up out of whole cloth.  And it appears that Gorsuch and the five other beneficiaries of the largesse of the super-wealthy are eagerly looking for an excuse to say that income can be permanently exempted from taxation so long as it is received in a form that most of the rest of us never receive.  Taxation will quite possibly become an obligation only for working stiffs.  I imagine that the party on Harlan Crow's super-yacht (itself a tax dodge) will be a rager.