Is a 'Wealth Tax' Legal and Constitutional?
Last updated 11/13/2019
Wealth taxes gained widespread attention in the U.S. in 2019, when Democratic presidential candidates Bernie Sanders and Elizabeth Warren proposed them as a means of reducing economic inequality. While their plans differed, both candidates argued that a properly-administered wealth tax would shift a greater burden of paying for government to very rich families than is currently the case with income taxes. In addition, they argued, a wealth tax would make it less likely that huge fortunes would develop.
Income taxes, the primary method the U.S. government has used to tax individuals for more than a century, fail to tax all the kinds of income that wealthy people have. In theory, at least, a wealth tax would greatly expand taxation's reach by placing a levy on the total value of wealthy individuals' and families' personal assets. These would include real estate, bank deposits, financial securities, ownership of unincorporated businesses, assets in insurance and pension plans, and personal trusts.
Wealth Taxes: The European Experience
While wealth taxes are a new concept in the U.S., they've existed in European countries for several decades, but with limited effectiveness. In 1990, 12 European countries had wealth taxes; by 2019, that number had declined to three.
Supporters of a wealth tax in the U.S. say the reason for failure in Europe is because most of the countries who tried it set the threshold too low, at $1 million. The result was a large cohort that was able to push successfully for exemptions. A much smaller percentage of the population would be affected in the U.S. under either Sanders' or Warren's plan, which set the minimum at $32 million and $50 million, respectively.
Opponents of an American wealth tax say there are other explanations for the European experience. They say wealth taxes prompted affected taxpayers to ship capital out of the country and also to leave the country themselves. As people and capital left their countries, their governments lost revenues from all the other taxes they would have paid.
Are Wealth Taxes Constitutional?
In addition to arguing that wealthy people will be too good at evading the tax, critics also suggest that there are constitutional issues with wealth taxes. Unlike the income tax, which is clearly constitutional due to the enactment of the 16th Amendment in 1913, a wealth tax lacks a solid legal foundation.
Direct Taxes vs. Indirect Taxes
The argument over whether a wealth tax is constitutional or not revolves around understanding the difference between direct taxes and indirect taxes. A direct tax is one that is paid directly to the government by taxpayers, whereas an indirect tax (like a sales tax) can be shifted to other parties (like those who engage in a commercial act).
Those who say that a wealth tax is unconstitutional contend that it would be a direct tax and, as such, would be prohibited by the Constitution because direct taxes must be apportioned by state population.
For example, if a wealth tax is deemed to be a direct tax, the federal government could collect only slightly more tax revenue from Connecticut's 3.5 million people than from Mississippi's 2.9 million, despite the fact that Connecticut is far wealthier. If a tax were levied on wealth, the number of payments coming from Connecticut would be far more than from Mississippi, and therefore would violate the constitutional limits placed on direct taxes, critics argue.
In other words, those who argue that a wealth tax is unconstitutional are saying that it would be a disproportionately-levied direct tax that could only be fixed by a constitutional amendment. That's what was required in 1913 when the income tax, an obvious direct tax, came to be only after a constitutional amendment.
Is Strict Interpretation of 'Direct Tax' Unreasonable?
Those who believe that a wealth tax is constitutional, however, point out that this strict interpretation of "direct tax" is unreasonable and not supported by the judicial record.
As early as 1796, in Hylton v. United States, the Supreme Court held that a carriage tax (which was common at the time) was not a direct tax because apportioning it by state population was unreasonable. Arguing before the Court, Alexander Hamilton pointed to the fact that New York had 10 times as many carriages as Virginia, meaning that if a carriage tax were considered a direct tax, the levy in Virginia would need to be 10 times higher than in New York.
For the next 99 years, "reasonable application" of the apportionment rule was settled doctrine in the U.S. Then, in 1895, the Court overruled the precedent in Pollock v. Farmers' Loan & Trust Co., ruling 5-4 that a federal income tax was a direct tax. The ruling was highly unpopular at a time when the public and the federal government alike were alarmed by economic disparity and saw Pollock as a surrender of the government's taxing power to the moneyed classes.
Despite the unpopularity of Pollock, Congress didn't try to implement another income tax until it ratified the 16th Amendment 14 years later.
Those who argue that a wealth tax would be constitutional contend that Pollock was an extreme aberration that was so contrary to national interests that it led to a constitutional amendment. The 16th Amendment, however, limited itself to income tax, not taxes on personal property. And Pollock has never been overturned.
How Would a Wealth Tax Be Calculated?
In theory, at least, the federal government already taxes wealth through the estate tax. But the estate tax is only levied once against wealth that is accumulated in a lifetime. (It has also been criticized for containing many loopholes that wealthy people can use to avoid taxes.)
A wealth tax, on the other hand, would be levied every year. One of the criticisms of European countries' use of the wealth tax is that they relied on the affected individuals and families to provide their own calculations.
Proponents of wealth taxes in the U.S. say that a key requirement would be for third-party financial institutions to provide information to the IRS and taxpayers showing the value of their assets at year's end. Examples of these assets would include interest-bearing accounts and publicly-listed stocks, bonds, and mutual funds. Real estate values are monitored and recorded by local governments for property taxes and those records could be provided to the IRS, proponents say.
Pros and Cons of Wealth Taxes: A Summary
Proponents of wealth taxes emphasize the following points:
- The money it could potentially generate would fund much-needed programs.
- The economic disparity between the top 1 percent and everyone else is getting worse. It's time to take action.
- A wealth tax is constitutional.
Opponents of wealth taxes say:
- It would be difficult to administer.
- The wealthy will find ways to avoid paying the tax.
- A wealth tax is unconstitutional.