The Supreme Court will soon hear a lawsuit that seeks to kill a leading proposal to reduce wealth inequality in the United States, even before that proposal becomes reality.
During her 2020 presidential campaign, Sen. Elizabeth Warren (D-MA) proposed a 2 percent wealth tax on Americans worth over $50 million. The idea was that, rather than merely taxing very wealthy people’s income and leaving their accumulated capital intact, the new tax would gradually chip away at massive fortunes and start to bring wealth inequality under control.
Warren, of course, did not become president. And congressional Republicans would endorse appointing Lucifer to lead the Treasury Department before they would allow such a tax to become law. So the idea of a wealth tax remains a pipe dream — shared by many in the Democratic Party, but with no chance of becoming law anytime soon.
Nevertheless, on December 5, the Supreme Court will hear a preemptive strike on the very concept of wealth taxes.
The plaintiffs’ arguments in Moore v. United States have little basis in law — unless you think that a list of long-ago-discarded laissez-faire decisions from the early 20th century remain good law. And a decision favoring these plaintiffs could blow a huge hole in the federal budget. While no Warren-style wealth tax is on the books, the Moore plaintiffs do challenge an existing tax that is expected to raise $340 billion over the course of a decade.
But Republicans also hold six seats on the nation’s highest Court, so there is some risk that a majority of the justices will accept the plaintiffs’ dubious legal arguments. And if they do so, they could do considerable damage to the government’s ability to fund itself.
“Realization,” briefly explained
Moore involves a fairly basic tax accounting concept: realization. Ordinarily, the federal government does not tax income until it has been “realized,” which most of the time means that someone purchased an asset, sold it at a profit, and now must pay income taxes on those profits.
As a general rule, investors are not taxed right away when their assets gain value. If an investor buys $1,000 worth of stock in Company X, and that stock increases in value to $1,500, they pay no taxes on that gain until after they sell or otherwise dispose of the stock and earn a profit. If this investor does sell their stock for $1,500, they will pay income taxes on the $500 in profit.
This rule, the Supreme Court explained in Helvering v. Horst (1940), is “founded on administrative convenience.” It is often difficult to determine how much an asset is actually worth until the asset is sold, especially if that asset is anything other than stock in a publicly traded company. So the requirement that profits ordinarily must be realized before they are taxed prevents a situation where an investor cannot figure out how much they owe in taxes, because they don’t know the specific value of all their assets.
Additionally, the realization requirement helps prevent a situation where a taxpayer owes a significant amount of taxes on assets they cannot easily sell, and doesn’t have any other source of cash they can use to pay the taxes.
But, while no-taxation-without-realization is typically the rule in federal taxation, it is not always the rule. Partial owners of some kinds of businesses — including partnerships, S corporations, and some foreign corporations — are often taxed on the company’s profits before they sell their stake in the company (or otherwise receive any of those profits in the form of a distribution or dividend). Securities dealers are also sometimes taxed on unrealized investments.
For most of the last century, Congress has been allowed to determine when unrealized gains are taxed, and when taxation of these gains will be delayed until after the asset is sold or the investor otherwise realizes those gains. In most cases, Congress has chosen to delay taxing appreciated assets until realization — again, this rule makes sense because it is often difficult to determine how much an asset is worth until it is sold — but the Constitution does not prevent Congress from taxing unrealized gains if it chooses to do so.
The plaintiffs in Moore, however, claim that it is unconstitutional for the federal government to tax profits before those profits are realized. This case is widely viewed as a stalking horse against Warren-style wealth taxes, as it would be impossible to tax wealth (as opposed to merely taxing the income generated by wealth) if the Constitution were to prohibit taxation of unrealized gains on the very assets that Warren-style proposals target. But a sweeping decision in favor of these plaintiffs could also endanger numerous other, existing taxes — forcing the entire government to scramble as hundreds of billions of dollars’ worth of anticipated tax revenue is suddenly declared unconstitutional.
So what, specifically, is Moore about?
The specific tax challenged by the Moore plaintiffs is a provision of the Tax Cuts and Jobs Act, the law signed by former President Donald Trump in 2017, which imposed a one-time tax on certain investors in foreign corporations.
Before the Trump tax bill became law, the United States attempted to tax US corporations’ overseas income. Under the old regime, however, corporations could defer taxation of their foreign profits indefinitely by creating a foreign subsidiary. Income earned by these foreign subsidiaries would not be taxed until it was repatriated into the United States, giving companies a strong incentive to hoard money overseas and away from US tax collectors.
By 2015, US corporations were keeping an estimated $2.6 trillion overseas to prevent this money from being taxed in the United States.
The Trump tax bill largely gave up on taxing US companies’ foreign assets in the future — corporate money kept overseas is now generally immune from taxation, even if it is brought into the United States. But the Trump tax bill also imposed a one-time tax on US investors in foreign corporations in order to offset some of the lost revenue resulting from the new tax regime.
Under this one-time tax, certain investors in foreign corporations must pay a percentage of the money that the corporation has kept overseas, even though the investor has not sold their stock or received any of that money as a dividend. This one-time tax, which investors may pay in installments over eight years, is expected to raise $340 billion by 2027.
The plaintiffs in Moore are US investors in a company that provides supplies to farmers in India. In 2017, these investors paid $14,729 in additional taxes due to the one-time tax provision in the Trump tax bill. They then sued to get this money back.
The specific details of this very complicated change to the US tax code are not especially important — although, for reasons discussed below, they could matter a great deal if the Moore plaintiffs prevail. The most important detail to understand, if you want to get your head around the Moore case, is that the plaintiffs and their lawyers successfully identified a tax on unrealized gains. And that gives them a vehicle they can use to claim that taxes on such gains are unconstitutional.
Moore is simultaneously a case about slavery and a case about robber barons
In order to understand the legal arguments in the Moore case, one must first understand two dark periods in American history — the 1787 debates over how to form a durable Union between slave and free states, and the Supreme Court’s Lochner era, a period when the justices frequently embraced far-fetched interpretations of the Constitution that benefited entrenched wealth and capital.
The Moore plaintiffs claim that taxes on unrealized income violate a provision of the Constitution that states that “direct taxes” must be “apportioned among the several states.” This meant that, if, say, the state of Maryland contained 6 percent of the US population, then any “direct” tax enacted by Congress must collect exactly 6 percent of its total receipts from people in Maryland.
This direct tax clause also incorporated the Constitution’s infamous three-fifths compromise. So enslaved people were counted as three-fifths of a person whenever Congress had to calculate how much money it could raise from each individual state.
Of course, this clause raises one fairly obvious question: What on earth is a “direct” tax? The unsatisfying answer to this question is that no one knows, and the framers themselves had wildly divergent views on what this vague phrase might mean. As legal scholar Bruce Ackerman wrote in a 1999 law review article, this provision was included in the Constitution largely to offer “symbolic satisfaction” to constitutional delegates concerned with the slavery question.
Among other things, the direct tax clause “served as a fig-leaf for anti-slavery Northerners opposed to the explicit grant of extra representation for Southern slaves,” because it also suggested that white residents of slave states would pay higher federal taxes than residents of free states. According to Ackerman, the framers largely avoided discussing what the word “direct” actually means because “more debate on the meaning of ‘direct taxation’ might destroy” any hope of a deal that could bring Northern and Southern states together in a single Union.
For much of American history, the direct tax clause lay dormant — and it certainly wasn’t understood to prevent taxation of unrealized income. Indeed, in Collector v. Hubbard (1871), the Supreme Court held that “it is as competent for Congress to tax annual gains and profits before they are divided among the holders of the stock as afterwards.” That’s an explicit declaration that taxes on unrealized income are permitted.
But then the Supreme Court reversed course in Pollock v. Farmer’s Loan & Trust (1895), holding that a tax on investment income is a “direct” tax that must be apportioned among the states. As a practical matter, Pollock made it impossible to tax investment income, because taxable investments are not evenly distributed among the residents of the many states.
The Pollock decision was widely criticized, poorly reasoned, and eventually sparked an entire constitutional amendment — the 16th Amendment, which was enacted in 1909 in order to overrule Pollock. That amendment provides that Congress may tax incomes “from whatever source derived,” thus abolishing Pollock’s ban on taxing the proceeds from investments.
Indeed, Pollock is best understood as part of a wide-ranging effort by conservative justices to impose strict limits on the government’s power to disturb the interests of capital, while simultaneously giving the courts unprecedented power to protect capital’s interests.
In the first six months of 1895, the Court handed down three cases, which destroyed Congress’s ability to tax the rich (Pollock), gutted Congress’s power to regulate business, and gave the Supreme Court’s blessing to “labor injunctions,” court orders requiring unions to end strikes and similar labor actions. These three cases arguably mark the dawn of the Lochner era, which is named for a 1905 Supreme Court decision that imposed strict limits on both the federal government and the states’ power to enact laws seeking to improve workplace conditions for workers.
The Lochner era ended in 1937, after a four-year fight between President Franklin Roosevelt and far-right justices who relied on cases like Lochner to strike down New Deal programs. Many Lochner-era cases are now taught to law students as examples of how judges should never behave.
So what does all of this dark history have to do with the Moore case?
The plaintiffs in Moore are represented by Andrew Grossman, an adjunct scholar at the right-libertarian Cato Institute, and David Rivkin, a Republican lawyer known for defending torture during the George W. Bush administration, and for filing one of the first lawsuits claiming that Obamacare is unconstitutional.
Grossman and Rivkin’s brief is a love letter to the Lochner era. Their argument rests largely upon decisions that were handed down between 1895 and 1937, and the linchpin of their argument is Eisner v. Macomber (1920), a Lochner-era case interpreting the 16th Amendment that has repeatedly been repudiated by more recent Supreme Court decisions.
Indeed, an early section of their brief opens with a quote from Justice Stephen Field’s concurring opinion in Pollock, an anti-tax jeremiad that claimed that, if Congress were allowed to enact an income tax, then it would inevitably lead to “a war of the poor against the rich.” Field was arguably the most strident proponent of laissez-faire social Darwinism in the Supreme Court’s history. So opening a brief with a Stephen Field quotation is a bit like beginning a political speech by citing Ron Paul, or opening an economics paper with a quote from Ludwig von Mises.
In any event, if the Moore case were being argued during the Lochner era, then Grossman and Rivkin would have a very strong argument that their client should prevail. Macomber, a 5-4 decision mostly joined by pro-Lochner justices, said that “enrichment through increase in value of capital investment is not income in any proper meaning of the term.” That conclusion closely tracks the reasoning of Pollock, which was supposed to have been overruled by the 16th Amendment. It also mirrors the Moore plaintiffs’ claim that unrealized gains may not be taxed.
But, as legal scholars Ackerman, Joseph Fishkin, and William Forbath argue in an amicus brief, this language in Macomber is best understood as “short-lived judicial resistance to the Sixteenth Amendment” which “exhumed the logic of Pollock.” And, regardless of why these Lochner-era justices handed down such a confused decision, Macomber has repeatedly been repudiated by the post-Lochner Supreme Court.
Thus, in Horst, the Court said that “the rule that income is not taxable until realized” is “founded on administrative convenience,” instead of in the Constitution. In Helvering v. Griffiths (1943), the Court said that Macomber’s reasoning is “limited” to “the kind of dividend there dealt with” (Macomber held that an investor who benefits from a stock split — an event that does not change the value of the investment itself — may not be taxed because of this split). And in Commissioner v. Glenshaw Glass (1955), the Court said that Macomber’s narrow definition of “income” was “not meant to provide a touchstone to all future gross income questions.”
As one federal appeals court explained in 1954, “even as to income derived from capital the Eisner [v. Macomber] case has been limited to its specific facts.”
So Moore should not be a difficult case. Its plaintiffs rest their suit upon a nebulous provision of the Constitution that is a relic of an age when the United States enslaved people. And they rely on discredited Supreme Court opinions that have been repudiated by the Court itself — or by a whole damn constitutional amendment!
Regardless of whether it is a good idea or a bad idea for Congress to tax unrealized income — or to tax wealth itself, for that matter — the Constitution primarily leaves it up to Congress to decide what America’s tax policy should be. The Moore plaintiffs’ approach will be familiar to anyone who has studied the Lochner era, the age when the Court routinely struck down laws, not because they violated the Constitution, but because five justices deemed them “unwise, improvident, or out of harmony with a particular school of thought.”
A victory for the plaintiffs in the Moore case invites chaos
If the Moore plaintiffs prevail, the immediate impact is likely to be a huge hole in the federal budget. Again, they challenge a tax that is supposed to raise $340 billion in revenue.
Such a decision would also produce a wave of new litigation. As the Justice Department warns in its brief, a decision for the Moore plaintiffs would “require the government to adjudicate a flood of ... refund claims” brought by other taxpayers who paid the Trump tax bill’s one-time tax. And these claims would “raise complex statute-of-limitations” and similar questions because the tax in question was first paid in 2017.
And then there’s the problem of severability. When a court strikes down one provision of a broader statute, it must ask whether the remainder of the law can be “severed” from the unconstitutional provision — and thus remain in effect — or whether Congress would have preferred for other provisions of the broader law to fall along with the unconstitutional provision.
The Supreme Court typically applies a strong presumption in favor of severability. As the Supreme Court held in Murphy v. National Collegiate Athletic Association (2018), “in order for other ... provisions to fall, it must be ‘evident that [Congress] would not have enacted those provisions which are within its power, independently of [those] which [are] not.’”
But there’s a very strong argument that Congress would not have enacted at least some parts of the Trump tax bill if it knew that the one-time tax at issue in Moore would fall. After all, the whole purpose of this one-time tax was to offset some of the costs of no longer taxing US corporations’ overseas income.
And, if the old regime governing taxation of foreign corporate income must be reinstated, that will trigger countless other lawsuits. The government will likely attempt to collect taxes that were outlawed by the Trump tax bill, but that would suddenly become mandated by law once again. And numerous businesses will suddenly be hit with unexpected tax bills that could severely harm their operations.
Indeed, the severability inquiry may be even more complicated. When Congress passed the Tax Cuts and Jobs Act in 2017, it used a process that imposed a $1 trillion cap on how much the bill could add to the budget deficit over the next decade. So there’s a decent argument that, if Congress had known that the bill would increase the deficit by an additional $340 billion, it would have chosen not to enact any tax law at all.
But if the entire Trump tax bill is struck down, that would mean that millions of taxpayers would potentially need to litigate whether they paid the right amount of income taxes between 2018 and 2023. Some of these taxpayers would be hit with surprising new taxes that could seriously harm their finances. Others would receive unexpected windfalls that they did nothing to earn. And the federal government would potentially be thrust into an extended period of uncertainty over how much money it could keep, how much it could collect in back taxes, and how much money it had to pay for its obligations.
There are very good reasons, in other words, why the post-Lochner Supreme Court has historically been cautious about mucking around with tax policy. Federal budgeting is a complicated and politically fraught process that literally has implications for every single American.
This is the very sort of process that should be conducted by elected officials, and not by black-robed lawyers with a vendetta against Elizabeth Warren.