Tax on Billionaires’ Unrealized Capital Gains Faces Strong Headwinds

By: Andrew Schwartz, Class of 2023

In June 2021, ProPublica reported that from 2014 to 2018, the 25 wealthiest Americans paid 3.4% of their increase in net worth in income taxes.[1] During the same period, the average American household paid over 95%.[2] Senator Ron Wyden, who has long been an advocate of reforming our tax system, responded to these shocking figures by proposing a tax on unrealized capital gains for individuals with over $1 billion in assets or $100 million in income.[3] Under Senator Wyden’s proposal, individuals would pay an annual tax on the appreciation in value on their easily-liquidated assets, such as stocks.[4] For assets that are more difficult to value, like land, individuals would only pay tax when the asset is sold, but the tax bill would include interest charges for the period the asset was held.[5] While this proposal could raise hundreds of billions of dollars, it likely faces strong headwinds in the form of constitutional challenges before the IRS could collect those billions.[6]

History of Direct Taxes Imposed By the Federal Government

The Constitution prohibits unapportioned direct taxes.[7] Direct taxes, simply put, are any tax that is paid directly by the subject of the tax to the entity that imposed the tax.[8] These include taxes on property, income, and capital gains. Indirect taxes are the corollary of direct taxes and can be viewed as taxes paid at the point of sale of a product to a merchant who then pays the tax to the government.[9] In other words, buyers indirectly pay the tax.

In response to a declaration by the Supreme Court that income taxes constituted direct taxes and, thus, were unconstitutional, the States ratified the 16th Amendment to explicitly allow the federal government to “lay and collect taxes on incomes.”[10] Therefore, the question to keep in mind when thinking about Senator Wyden’s proposed tax on unrealized capital gains is not whether it is a direct tax (it is), but rather whether it is exempted from the apportionment requirement of Article I, Section 9 because it is in the narrow type of direct tax classified as income.

Practical Considerations Must Guide Us

Opponents of a tax on unrealized capital gains look to a 1920 Supreme Court decision, Eisner v. Macomber, that suggests that “there must be some actual transfer of rights” for Congress to tax the increase in value of an asset.[11] Further, an annual tax on the value of a piece of land would never pass constitutional muster, and a tax on the value of a stock portfolio is analogous.[12] This line of reasoning suggests that unrealized capital gains would not qualify as income. Proponents of the tax argue that the weight of Eisner has been diminished to the point that it should simply be overruled, allowing Congress to tax unrealized gains as income. [13]

Although the constitutional arguments on both sides are strong and would result in intense debate across the country, it is unlikely anything resembling this proposal gets passed into law anytime soon—Democrats are not united in their support of this plan, and there is wholesale Republican opposition.[14] ProPublica’s report is shocking. Equally as shocking is that the information revealed will do little to push our Congressional leaders to consider steps that would ultimately allow the Supreme Court to decide what exactly income is under the 16th Amendment.

[1] Jesse Eisinger et al., The Secret IRS Files: Trove of Never-Before-Seen Records Reveal How the Wealthiest Avoid Income Tax, ProPublica (June 8, 2021, 5:00 AM), https://www.propublica.org/article/the-secret-irs-files-trove-of-never-before-seen-records-reveal-how-the-wealthiest-avoid-income-tax. [2]See Id. [3] Press Release, Senator Ron Wyden, Billionaires Income Tax (Oct. 27, 2021), https://www.finance.senate.gov/imo/media/doc/Billionaires%20Income%20Tax%20-%20One%20Pager.pdf. [4]Id. [5]Id. [6] Richard Rubin, Billionaire Tax Faces Likely Constitutional Challenge, WSJ (Oct. 26, 2021), https://www.wsj.com/articles/democrats-billionaire-tax-constitution-11635258358. [7]U.S. Const. art. I, § 9. [8] Julia Kagan, Direct Tax, Investopedia (updated Feb. 5, 2022), https://www.investopedia.com/terms/d/directtax.asp. [9]Id. [10] Pollock v. Farmers’ Loan and Trust Co., 158 U.S. 601 (1895); U.S. Const. amend 16. [11] Erik M. Jensen, Wealth Taxes Can’t Satisfy Constitutional Requirements, Bloomberg Tax – Daily Tax Report (July 27, 2021, 4:01 AM), https://news.bloombergtax.com/daily-tax-report/wealth-taxes-cant-satisfy-constitutional-requirements; Neil H. Buchanan, Can the Supreme Court Shelter Rich People From Taxation?, Verdict (Jan. 10, 2019), https://verdict.justia.com/2019/01/10/can-the-supreme-court-shelter-rich-people-from-taxation. [12] Rubin, supra note 6. [13] Buchanan, supra note 11. [14] Debra Cassens Weiss, Is The Proposed Wealth Tax Constitutional? Answer Depends on “Direct Tax” Definition, ABA Journal (Oct. 27, 2021, 11:46 AM), https://www.abajournal.com/news/article/is-the-proposed-wealth-tax-constitutional-answer-depends-on-direct-tax-definition; Andrew Ross Sorkin et al., The New Billionaire Tax in Democrats’ Sights, New York Times (Oct. 27, 2021), https://www.nytimes.com/2021/10/25/business/dealbook/democrats-capital-gains-tax.html.