Senate Democrats and the Biden administration are reportedly nearing a deal on a new “billionaire tax” to pay for the package of spending programs that is stalled in Congress. The tax — which would apply annually to the increase in the value of stocks and other assets held by taxpayers with a net worth of $1 billion or more — appears to be one of the few revenue-raising measures that Sen. Kyrsten Sinema (D-Ariz.), a key swing vote, is willing to countenance. But there is a potentially fatal flaw in the proposal that should cause progressives to view it as a Trojan horse: The current Supreme Court is quite likely to strike it down as unconstitutional.
To be sure, the constitutional case against the proposed billionaire tax isn’t open and shut. If I were on the Supreme Court, I would say that the tax is constitutional and ought to be upheld. But I’m not on the Supreme Court — and six conservative justices appointed by Republican presidents are. Faced with a genuinely unresolved legal question for which there are plausible arguments on both sides, those justices would not have a hard time saying that the billionaire tax flunks the constitutional test.
For Democrats, that’s a real problem. President Biden has promised a “serious piece of legislation” that ensures that “the very wealthy … begin to pay their fair share.” If the billionaire tax is axed by the Supreme Court, it won’t accomplish the goal of making the very wealthy ante up. Biden also has vowed that his overall plan won’t “add a single penny to our deficit.” If the budget bill is passed and then the billionaire tax is struck down, the overall package certainly will increase the deficit.
The constitutional objections to the billionaire tax are based on the direct tax clause in Section 2 of Article 1, which provides that “direct Taxes shall be apportioned among the several States … according to their respective Numbers.” (Another clause in Section 9 of Article 1 restates this rule.) In other words, if a tax is a “direct tax,” and 1.5 percent of the U.S. population lives in Alabama, then 1.5 percent of the revenue from the tax needs to come from Alabama. If the billionaire tax is deemed to be a direct tax, then the apportionment requirement would be impossible to satisfy: According to Forbes, Alabama has no known billionaires, and neither does Alaska, Delaware, New Hampshire, North Dakota, Vermont or West Virginia.
What counts as a “direct tax”? It’s never been crystal clear. According to James Madison’s notes from the Constitutional Convention, when Rufus King of Massachusetts asked the other delegates to explain the “precise meaning of direct taxation,” no one answered. Some of the Supreme Court’s early opinions suggest that direct taxes may be limited to land taxes and head taxes (head taxes are taxes where every person pays the same amount).
But in the 1895 case Pollock v. Farmers’ Loan & Trust Co., the Supreme Court ruled 5-to-4 that the term “direct tax” encompasses taxes on both “real” and “personal” property. (Real property is land and buildings; personal property is everything else, including financial assets like stocks and bonds.) The court went one step further in Pollock and said that taxes on income generated by real and personal property are also direct taxes subject to the apportionment requirement.
The Pollock decision was extraordinarily controversial, and most legal scholars, including me, think the court got it wrong. Congress partially corrected the court’s error by passing the 16th Amendment, ratified in 1913, which provides that “taxes on incomes” do not need to be apportioned among the states. That amendment cleared the way for the modern system of federal income taxes.
Unfortunately, the framers of the 16th Amendment didn’t repeal the direct tax clauses — they just carved out an exception for “taxes on incomes.” As Chief Justice John G. Roberts Jr. noted in his 2012 opinion upholding the Obamacare individual mandate, the Supreme Court has “continued to consider taxes on personal property to be direct taxes.” And the 16th Amendment didn’t overturn the long-standing rule that taxes on real property (again, land and buildings) are direct taxes that must be apportioned among the states.
Billionaires — aided by the best lawyers money can buy — are likely to make two main constitutional arguments against the proposed wealth tax, which would take a “mark to market” approach. (“Mark to market” means billionaires would be required to calculate the fair market value of their assets at the end of each year and to pay tax on any increase over the previous 12 months.) First, they will say that a mark-to-market tax isn’t a tax on “income” for purposes of the 16th Amendment. The current income tax typically applies only when gains have been “realized” — for example, when an asset has been sold or exchanged. A mark-to-market tax would apply to unrealized gains.
That objection is potentially surmountable. The Supreme Court has twice said that the realization requirement is a matter of “administrative convenience” — a statement many scholars have interpreted to mean that a tax on unrealized gains still can be a tax on “income” under the 16th Amendment. Moreover, Congress has imposed taxes on individuals’ unrealized gains several times in the past — most recently, a levy on the unrealized gains of taxpayers who relinquish their U.S. citizenship (enacted in 2008). Although none of these taxes has been the subject of a Supreme Court decision, the court might say that the ship has sailed on the idea that “income” depends upon realization.
But that still leaves a second and more serious objection: The proposed billionaire tax depends not only on a taxpayer’s unrealized gains but also — as the name implies — on her wealth. The tax kicks in only if a taxpayer’s wealth — the value of her real and personal property — passes the $1 billion threshold. And if it’s a tax on wealth, then it must be apportioned among the states based on population — which, again, is impossible, given the existing geographic distribution of billionaires.
Defenders of the billionaire tax will probably argue that the justices should jettison Pollock. I agree. But even if they did, that wouldn’t solve the problem entirely, because the billionaire tax still would depend in part on the value of a taxpayer’s land. And the Supreme Court has consistently said, even before Pollock, that a tax on land is a direct tax that needs to be apportioned.
The justices could certainly find ways to uphold the tax, if they wished. Law professors Jake Brooks and David Gamage have argued, for example, that when a tax can be characterized as either direct or indirect, courts generally have construed it as indirect and should continue to do so to give Congress wide latitude in the exercise of its revenue-raising power. But it’s far from clear the current Supreme Court would agree with that reasoning. Note that the constitutional arguments against the Violence Against Women Act, the Obamacare Medicaid expansion and Section 5 of the Voting Rights Act were considerably weaker than the arguments against the billionaire tax — yet the court had no qualms about striking down those progressive legislative achievements.
What can Democrats do about the problem? If they decide to proceed with a billionaire tax, they can draft it to be as well steeled against constitutional challenge as possible. For example, they can include the real property and personal property tax components in separate sections, along with a “severability” clause clarifying that the rest of the statute should remain intact if any individual part is invalidated. That way, if the court chooses to return to the pre-Pollock conception of direct taxes as limited to land and head taxes, the bulk of the billionaire tax still will survive.
Yes, some billionaires with large real estate fortunes would escape the new tax if land is left out of the base. Other billionaires may shift the composition of their portfolios toward real estate. But the wealth of the very richest Americans consists mostly of appreciated stock, which would remain subject to the tax under this scenario.
Still, it’s entirely possible that the court would invalidate the billionaire tax, full stop.
Some might say that the Democrats should go ahead, pass the billionaire tax, and dare the Supreme Court to strike it down. There is a good argument that Democrats shouldn’t trim their sails just because of how the current court might react; we don’t know for sure how it would respond, and the high court’s composition could change as the matter is litigated.
But today, the Democrats have an exceedingly rare opportunity to enact meaningful progressive tax reform. They can choose from a menu of constitutionally secure options, including raising rates on high-income earners and corporations, ending tax-free stepped-up basis at death and closing loopholes in the partnership and trust tax laws. Instead, it looks like they may waste this opportunity on a measure that, after years of court battles, ultimately accomplishes nothing. If that happens, conservative justices on the Supreme Court will deserve some of the blame. But the Democratic lawmakers who sent us down that dead end will too.