Many politicians, such as Sen. Elizabeth Warren (D-MA), advocate taxes on wealth. These taxes are easy to abuse, which is why the Founders placed special requirements on them. It’s important to understand the constitutional limitations on such taxes, because the supporters of such taxes like to forget or avoid the topic. This is relevant to CEI’s ongoing case, Moore v. United States. Moore challenges such taxes, and we will shortly ask the Supreme Court review our case.
The Constitution splits taxes into two types: direct and indirect. Indirect taxes are applied to transactions or the use of goods and services. Every sale or transfer of property can be taxed through an indirect tax. But the Constitution requires that such taxes be uniform—different jurisdictions can’t be taxed at different rates. That was to ensure that all the states were treated equally. Also, with indirect taxes, people can decide before they buy or transfer property if it is worth paying the taxes to do so.
Direct taxes tax the existence and ownership of people and property. Things like a capitation tax—a tax on each person, known more informally as a “head tax”—is specifically identified as a direct tax. Other taxes on the ownership of property or wealth are also direct taxes.
The Founders feared that the federal government would directly tax property that is found more often in some states than others, causing disproportionate taxes to be borne by those states. For this reason, the Constitution requires direct taxes to be apportioned. A tax that is “apportioned” must raise the same amount of money per person in each state. Again, this is to ensure that such taxes are applied fairly throughout the country, so that specific states will never be targeted to fund benefits for other people.
The first case to explore the nature of a direct tax was Hylton v. United States (1796), which dealt with a tax on carriages. It found that such a tax was an indirect tax. The Supreme Court issued its opinion seriatim style—meaning each justice wrote a separate opinion, as was the common practice at the time. The following excerpts from the major opinions in the case will provide a sense of the court’s view.
Justice Samuel Chase wrote that he was inclined to think that capitation—a tax per person, regardless of circumstance—and taxes on land were the only direct taxes. But he was so unsure that he refused to give a binding judicial opinion on the topic as applied to a tax on other non-land property. Instead, he wrote that it was not necessary to decide whether a tax on carriages was not a tax on property.
Justice William Paterson likewise was unsure. He wrote, “Whether direct taxes, in the sense of the Constitution, comprehend any other tax than a capitation tax and taxes on land is a questionable point. … But as it is not before the court, it would be improper to give any decisive opinion upon it.” He concluded that “All taxes on expenses or consumption are indirect taxes. A tax on carriages is of this kind, and, of course, is not a direct tax.”
Justice James Iredell likewise, while recognizing that a tax on land and a capitation tax are direct taxes, wrote that “In regard to other articles, there may possibly be considerable doubt.” But as he didn’t consider the tax on carriages to be a tax on articles on property, it was not necessary to consider that question to decide the case.
It’s also worth considering the government’s argument in that case, argued personally by Alexander Hamilton: “The following are presumed to be the only direct taxes: capitation or poll taxes, taxes on lands and buildings, general assessments, whether on the whole property of individuals or on their whole real or personal estate. All else must of necessity be considered as indirect taxes.” He did not consider the tax on carriages to be a tax on the personal estate of the individual.
In Pollock v. Farmers’ Loan & Trust Co. (1985), the Supreme Court held that taxing rents on real property is a tax on the ownership of that property; therefore, it is a direct tax that must be apportioned. The Supreme Court relied upon numerous state taxes prior to the adoption of the Constitution which defined direct taxes to be “all taxes on real estate or personal property or the rents or income thereof were regarded as direct taxes.”
The Pollock court distinguished the tax on carriages in Hylton, holding that “whether the tax on carriages was direct or indirect was disputed [in Hylton], but the tax was sustained as a tax on the use and an excise” of carriages. It wasn’t a tax on the ownership of carriages, according to the Pollock court, but a tax on the use of carriages. This is why several of the justices in the Hylton case said it was unnecessary to determine if a tax on the ownership of carriages was a direct tax, because that wasn’t the type of tax they were interpreting.
The Sixteenth Amendment changed the legal landscape after Pollock, not by changing the rule of apportionment, but by allowing “income” taxes to be unapportioned, just as indirect taxes may be unapportioned. The special status of income taxes was affirmed most recently in NFIB v. Sebelius (2012), which held just 10 years ago that “we [have] continued to consider taxes on personal property to be direct taxes.”
In Eisner v. Macomber (1920), the Supreme Court held that, to be an “income” tax, the owner must have “realized or received … income in the transaction.” Merely owning property is not “income,” even if that property increased in value. The Supreme Court reaffirmed this in Helvering v. Horst (1940), Comm’r. v. Glenshaw Glass Co. (1955), and James v. United States (1961).
The dissent in our Moore case (from which all of the following quotes come) noted that the Ninth Circuit has “become the first court in the country to state that an ‘income tax’ doesn’t require that a ‘taxpayer has realized income’ under the Sixteenth Amendment.” “In other words, we allow a direct tax on the ownership interest of a taxpayer—even when the taxpayer has yet to receive any economic gain from the interest and has no ability to direct distribution of gain from the interest.”
“While the Supreme Court has allowed flexibility in identifying ‘incomes,’ it has never abandoned the core requirement that income must be realized to be taxable without apportionment under the Sixteenth Amendment.” But this Ninth Circuit ruling “essentially called Macomber a dead letter.”
Due to this ruling, “any tax on property or other interests can be categorized as an ‘income tax’ and elude the requirement of apportionment.” “Divorcing income from realization opens the door to new federal taxes on all sorts of wealth and property without the constitutional requirement of apportionment.”
In a few months, we will ask the Supreme Court to review the Ninth Circuit’s finding that the Supreme Court’s own decisions in Eisner v. Macomber, Helvering v. Horst, Comm’r v. Glenshaw Glass Co., and James v. United States are now a “dead letter” as claimed by the Ninth Circuit. We think the Ninth Circuit’s finding is a bit breathtaking in its scope and, quite literally, unprecedented—and that there is a reasonable chance that the United States Supreme Court will agree.