Senator Warren, as a part of her presidential campaign, has proposed that a federal wealth tax be levied on high-net-worth individuals: a 2 percent annual assessment on individuals with a net worth of more than $50 million, increasing to 3 percent on those with a net worth of $1 billion or more.
The Senator’s proposal raises a number of significant issues: economic, administrative, and legal. For one thing, it runs directly counter to mainstream economic policies in the United states and across the developed world that have sought for years to lighten the tax burden on capital in order to encourage savings and investment, and stimulate economic growth.
Also, it will be a real administrative challenge to arrive at an undisputed figure every year for the tax to be paid by each covered person, given the fact that the holdings of high-net-worth individuals typically include a great many assets, such as real estate and works of art and investments in closely held businesses, that are illiquid and difficult to value. And capital is highly mobile. Tax it more heavily in a country and its owners will just move it elsewhere. The Senator’s proposal covers assets owned abroad, but experience has shown that it could be especially difficult to locate and properly value such assets. Recognizing the many complexities involved, the Senator’s proposal calls for a greatly expanded IRS bureaucracy to administer the new tax and enforce its provisions.
The economic and administrative burdens associated with a wealth tax have steadily diminished the appeal of such a concept for governments in developed countries around the world. For example, in 1990 a dozen countries belonging to the Organization for Economic Co-Operation and Development levied some sort of a national tax on net worth. Today, that number has dropped to just three: Switzerland, Norway, and Spain.
Quite apart from issues of economic policy and administration, the proposal raises significant legal issues. It is far from clear that the imposition of a federal tax directly on the wealth held by high-net-worth individuals would be constitutional.
As we well know, the Constitution was established to form a more perfect union by addressing the inadequacies of the Articles of Confederation while at the same time effectively protecting the rights of a sovereign people from abuses of government overreach like those that had characterized British rule.
The Framers were well-schooled in the abuses that a government could commit using its power to tax. In the Constitution, they sought to limit the taxing authority of the federal government in a number of ways. For example, Article I, Section 7 requires that all bills for raising revenue shall originate in the House of Representatives, the legislative chamber most directly accountable to the people. Article I, Section 8, grants power to the Congress to “lay and collect Taxes, Duties, Imposts and Excises,” but requires all such levies be uniform throughout the United States.
Most directly relevant to Senator Warren’s wealth tax proposal is a provision included in Article I, Section 9 that prohibits federal direct taxes unless they are apportioned among the states according to population. It states that;
No Capitation, or other direct, Tax shall be laid,
unless in Proportion to the Census or enumeration
herein before directed to be taken.
So, for example, if a state’s population equaled 10 percent of the country’s total population, then the people in that state would have to pay 10 percent of the total direct tax levied, regardless of the state’s percentage share of the actual tax base, i.e., the state’s percentage share of the aggregate value of the thing being taxed.
Thus, the Framers divided federal taxes into two mutually exclusive categories: direct taxes subject to apportionment, and all other non-direct taxes such as duties, imposts and excises subject to the uniformity requirement. Non-direct taxes generally fall on commercial transactions and related activity such as imports, exports, manufacturing activity, sales and consumption. The Framers considered non-direct taxes to be a relatively safe form of taxation because they tend to be self-limiting for reasons related to basic economics. If Congress raises non-direct taxes, that will increase the cost of the commercial activities being taxed. The commercial activity will decrease as a result of the greater economic burden, and so will government revenue. Congress has a real incentive to be reasonable, as well as a requirement to be uniform.
Direct taxes, by contrast, are not self-limiting in the way that taxes on commercial activities are. The Framers were more concerned that taxes levied directly on individuals might be increased to abusive levels, so they sought to limit the potential for abuse with the rather cumbersome apportionment requirement.
What, then is the scope of the apportionment requirement? What particular taxes are covered by the provision in Article I, Section 9? Capitation taxes are explicitly mentioned and clearly covered. Also, the Philadelphia debates contain numerous references to taxes on land as taxes that must be apportioned. Consistent with those references, Congress enacted a number of apportioned real estate taxes during the nineteenth century. Beyond capitation taxes and taxes on land, the record is less clear.
In the early days of the Republic, the Supreme Court upheld a tax on carriages as an excise tax rather than a direct tax; Hylton v. United States (1796). In the nineteenth century, the Court upheld un-apportioned federal taxes on insurance company receipts, Pacific Insurance Company v. Soule (1869) and on the inheritance of real estate, Scholey v. Rew (1875). Somewhat later, the Court upheld the Civil War income tax in Springer v. United States (1881).
However, near the end of the nineteenth century the Supreme Court acted to broaden the scope of the apportionment requirement when it struck down an un-apportioned 1894 federal income tax in Pollock v. Farmers’ Loan & Trust Company (1895). Congress responded to the limitations imposed by Pollock by enacting the Sixteenth Amendment. Ratified in 1913, the amendment grants Congress the power to “lay and collect taxes on incomes…without apportionment….” Since then, the federal government has raised money from individuals mostly by taxing what they earn from their work and investments, not on what they have.
After Pollock, the scope of the apportionment requirement is clearly broader than capitation taxes and taxes on land. Is it broad enough to include Senator Warren’s proposed wealth tax? In the twentieth century, un-apportioned federal taxes have been upheld, but only because the Supreme Court found each of the taxes in question not to be a direct tax prohibited by Article I, Section 9. For example, the Court upheld inheritance and estate taxes, not as direct taxes on wealth, but as indirect taxes on the transfer of wealth; Knowlton v. Moore (1900).
The wealth tax proposed by Senator Warren would not levy on income. Nor would it levy on the transfer of wealth. Much like a land tax, it would levy directly on the incidence of wealth, the possession of wealth, the existence of wealth. For this reason, a strong argument can be made that the Senator’s proposed wealth tax would be unconstitutional unless apportioned. Supporters of the Senator and her proposal differ, of course, and argue that the wealth tax would pass constitutional muster without apportionment. At the very least, the constitutional issues raised by the proposal should be carefully considered and thoroughly debated throughout the election cycle.
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J. Kennerly Davis, a former Deputy Attorney General for the Commonwealth of Virginia, is an active contributor to the Regulatory Transparency Project