A wealth tax proposed by Senator Elizabeth Warren has found favor in certain academic circles, including the University of California, Berkeley. It would be 2 percent of worldwide assets of U.S. citizens and residents in excess of $50 million and 3 percent of assets in excess of $1 billion, in addition to existing income and transfer taxes. It’s claimed this wealth tax would raise an estimated $2.75 trillion in revenue over 10 years. But is it constitutional?
It’s not, according to the billionaire former New York City Mayor Michael Bloomberg. He has opined that such a wealth tax would be unconstitutional “because the Sixteenth Amendment only allows an income tax.”
This argument relates to the constitutional limitation on direct taxes.
Article 1, §8, provides that:
“Congress shall have the Power to lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States.”
Section 9 adds the following reservation: “No Capitation, or other direct, Tax shall be laid, unless in proportion to the Census or enumeration hereinbefore directed to be taken.”
The phrase “hereinbefore directed” refers to Article 1, §2, relating to the composition of the House of Representatives. Section 2 provides:
“Representatives and direct Taxes shall be apportioned among the several States…according to their respective Numbers, which shall be determined by adding to the whole Number of free persons…three fifths of all other persons.”
In other words, by counting slaves as three-fifths of a person.
The same formula was used to raise revenue from the states under the former Articles of Confederation, which did not give Congress the power to levy taxes. But the issue was rendered moot with respect to representation by the Thirteenth Amendment, which abolished slavery in the United States.
Arguably, Bloomberg could be correct that a wealth tax is a direct tax under Article 1, and direct taxes must be proportional to population.
Indeed, the federal income tax was held unconstitutional for the same reason in Pollock v Farmers’ Loan & Trust Co. (1895) 157 US 429. The Supreme Court decision was overruled by the Sixteenth Amendment, which provides that
“Congress shall have the 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.”
In contrast to the income tax, the estate tax has always been regarded as a permissible excise tax on the transfer of property and so did not need an amendment to make it legal.
The constitutional argument against a wealth tax has some historical basis. Proportional direct taxes were actually used in the early days of the republic. Taxes were assessed on houses, slaves, and land. “The rate would be set so that the combined yield from the various taxes would add up to the quota Congress had decided for each state.” Edling, A Revolution in Favor of Government: Origins of the Constitution and the Making of the Amercian State 215 (2003).
But this taxation method wasn’t used after the War of 1812. Proportional direct taxes were not used during the Civil War when income and estate taxes were used for the first time and revenue could not be collected from the southern states in any event. So it seems the proportional limitation on direct taxation was specific to use of the fiscal formula as a proxy for representation.
Historically, the Sixteenth Amendment was seen as correcting the Supreme Court decision striking down the income tax, not as creating an exception to the proportional limitation on direct taxes. The proposed wealth tax also differs from a direct tax because it’s based on an individual’s net worth, while historical direct taxes were based on gross assets without regard to a taxpayer’s debts.
On balance, the proposed wealth tax is probably a policy question for Congress and not a constitutional issue for the Supreme Court, but you never know.
A wealth tax has valuation and compliance challenges, but the same is true of the estate and gift tax. The reporting regime required for a global wealth tax could help reduce income tax avoidance. A wealth tax would also mitigate the failure of the income tax to address unrealized capital gains. On the other hand, an estate tax combined with an income tax on unrealized capital gains at death could be a good substitute for a wealth tax.
For more on the interplay of income and transfer taxes, see CEB’s California Estate Planning, chapter 4. Also check out Drafting California Irrevocable Trusts, chapter 2. The April issue of CEB’s Estate Planning & California Probate Reporter discusses this wealth tax issue.
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