Constitutional Considerations on Elizabeth Warren’s Proposed Wealth Tax

With all the major contenders having announced their candidacies for the 2020 Democratic Nomination, the contest is progressing in earnest as each attempts to assert themselves at the national level by exploiting a particular campaign niche. While some highlight their experience (e.g., Biden), passion (e.g., Sanders) or charisma (e.g., O’Rourke), Elizabeth Warren has been staking her reputation on expansive policy proposals designed to usher “big, structural change[s]” to U.S. government. In addition to proposing the implementation of orthodox progressive policies such as the Green New Deal and universal healthcare, Warren has put forward innovative ideas such as an “ultra-millionaire” wealth tax which would collect nearly $3 trillion over the next decade to offset the whopping $42 trillion estimated cost of her democratic socialist agenda.

Warren’s wealth tax would certainly be revolutionary for the United States. While nearly a dozen European countries have implemented the idea in the past, only three retain any semblance of a wealth tax in their national tax codes, each with limited success. As proposed, the ultra-millionaire (and billionaire) tax rests on two provisions. First, all wealth (defined as the “sum of all assets net of debts”) above $50 million would be taxed annually at two percent with an additional one percent surtax (total three percent) to be levied on all wealth above $1 billion. Second, in order to deter tax evasion and limit loopholes, Warren’s plan would impose a forty percent “exit tax” on all wealth above $50 million of a U.S. citizen who renounces their citizenship and would include virtually all asset classes in the calculation of net wealth. This latter provision is meant to compensate for the previous failures of European plans which exempted assets such as artwork and collectibles, enabling a shifting of wealth to these non-taxables. The ultimate goal of the wealth tax is to ensure that the rich contribute more equitably to the society that is indirectly responsible for their success (i.e., by educating workers, building roads and maintaining peace) and to help fund Warren’s cornucopia of social programs, specifically her education reforms.

Such a radical taxation overhaul is bound to be a complicated proposal to turn into law and much of the plan, including its feasibility and potential for revenue, is likely to be vigorously debated in Congress. As with all taxation reform, Warren’s wealth tax will start its legislative journey as a bill in the House of Representatives before (if passed) moving to the Senate and ultimately (if passed in agreement) to the President’s desk. Being a major piece of legislation, the wealth tax is not likely to escape the lethargic tendencies of Congress when considering laws. Indeed, the last structural overhaul presented by Democrats (in the context of a unified government no less) was the Affordable Care Act which took almost exactly a year (from Obama’s “health summit” with industry experts to the impossibly close 219-212 House vote on the amended Senate bill in March 2010) to enact. While Warren’s seemingly simplistic proposal may be far less complicated than the machinations of expanded government healthcare, questions raised about the actual revenue potential of the tax (e.g., some claiming only 40 percent of Warren’s estimate) as well as the unanswered questions of both how IRS enforcement will expand (e.g., how will it start valuing art) and how much that expansion with cost, make the issue a contentious one even when ideological factors are discounted.

Furthermore, much like the Affordable Care Act before it, if ever enacted the wealth tax will face an even more daunting challenge: passing the muster of the Supreme Court on the inevitable constitutional challenge. Already, a contentious disagreement exists between legal scholars as to whether Warren’s plan, as presented, is harmonious with the U.S. Constitution. Like other pieces of legislation, its constitutionality can be in whole or only in part (as was the case with Obamacare) and any challenge to the hypothetical law would focus on both whether taxing net-wealth generally falls under Congress’s taxing power and whether Warren’s other provisions dis-incentivizing evasion are allowed by the Constitution.

First, the question of whether taxing wealth is constitutional hinges on the meaning of the term “direct tax.” As per the U.S. Constitution’s Article I Section 8 and Amendment 16, Congress has the power to lay taxes on various transactions (i.e., “indirect” taxation), including on all incomes (wages being an exchange of money). However, Article I Section 9 Clause 4 limits Congress’s taxing authority by prohibiting the collection of direct taxes without employing a convoluted scheme of equal apportionment between the states based on population. Followed to the letter, this means that if the wealth tax is treated as a direct tax, states’ populations would have to pay an equal percentage of the total amount raised. Such a system would be grossly unfair (e.g., Connecticut’s inhabitants with a per capital income of $36k would pay the same amount as Mississippi’s inhabitants with a per capita income of $20k) and equally impractical. Thus, determining the meaning of “direct taxation” is of central importance to understanding both the constitutionality and feasibility of Warren’s plan.

With even the Founding Fathers having skirted the question, the exact meaning of a direct tax remains unanswered in U.S. constitutional theory. Case law suggests an oscillation of judicial understanding of what encompasses direct taxation. In Hylton v. United States (1796), the Court ruled that a tax on carriages (i.e., a form of personal wealth) was not considered to be a direct tax. While ruling specifically on the permissibility of a tax on a type of wealth (rather than on all personal or real property), the Hylton decision justified broad federal taxation for nearly a century before the Court reversed course in Pollock v. Farmers’ Loan & Trust Co. (1895). With the adoption of the 16th Amendment in 1913, Pollock was left unchallenged since the question of an income tax (the central focus of the case) had been resolved. Subsequently, the direct tax question was not elaborated upon and was even broadened in cases such as Brushaber v. Union Pacific (1916) (“taxes levied directly on personal property”) and Eisner v. Macomber (1920) (extended to stock dividends). Indeed, while in later years the Court gradually expanded Congress’s authority to tax forms of wealth, such as estates and corporate income, these expansions were based on the rationale that such taxes were laid on the transfer of assets (e.g., from decedent to beneficiary) or the privilege of operating (i.e., through the corporate form) rather than on the value of the assets themselves.

In reaction to the perceived judicial neglect, legal scholars have put forward the idea that taxes on general wealth should not be considered direct levies for various reasons. First, academics such as Dawn Johnson and Walter Dellinger argue in their assessment on The Constitutionality of a National Wealth Tax that the Pollock decision and its related cases were based on a “pro-business, anti-labor” (p.129) attitude that compromised their reasoning. As such, the earlier precedent of Hylton should stand and a federal tax on personal wealth should be considered constitutional. Second, with the modern Courts having largely ignored the Pollock decision and with many aspects of the current tax code incompatible with decisions such as Eisner (i.e., dividends are now taxed), contemporary scholars have reasoned that a modern Court challenge should result in the formal overturning of Pollock and the narrowing of the informal definition of a direct tax to capitations and real property taxes. However, by conceding that real property taxes would be exempt from a wealth tax this argument runs the risk of allowing a lucrative loophole for potential tax evasion should the Court come to a similar conclusion.

Adequately compensating for evasion is the second central theme of Warren’s wealth tax and the constitutionality of her proposed measures will likely also face the scrutiny of the Court in any challenge. Casting aside the above mentioned argument concerning the Article 9 prohibition of un-apportioned federal taxation on real property, should the Hylton decision be taken as precedent Congress would indeed possess the constitutional authority to levy taxes on most classes of wealth (i.e., art collections and collectibles). Furthermore, wealth moved overseas would also be liable to seizure due to the constitutionally accepted Foreign Account Tax Compliance Act of 2010 which requires that foreign financial institutions report on foreign assets held by U.S. nationals or face a fine, thereby greatly strengthening the government’s ability to tax wealth overseas.

Of more interest however is Warren’s plan to impose a hefty exit tax on U.S. nationals who renounce their citizenship and move the bulk of their wealth overseas. As mentioned, since the bill will likely take a significant amount of time to materialize into law, and since many “ultra-millionaires” are likely to initiate such measures as soon as possible in the event of a hypothetical Warren presidency, to be effective the exit tax will need to be imposed retroactively. While the Courts have historically been lenient with the retroactive application of tax legislation, all prior cases have only dealt with amendments to the existing tax codes (i.e., an increase or decrease in rates). In contrast, the exit tax would be considered a wholly new tax for which the retroactive application has no discernible precedent. A challenge against the retroactive exit tax is likely to rest on the Constitutional prohibition of ex post facto laws, that is, laws that punish conduct that was lawful when it was done, as outline in Article I Section 9 Clause 3. Since Calder v. Bull (1798) it is understood that ex post facto laws apply only to criminal laws or those that impose a prohibitive punishment. By this measure, since applying pecuniary penalties is not considered criminal punishment and since the legitimate state interest to raise revenue would satisfy the rational basis test as to preclude the 40 percent fee from being taken as too punitive, it seems that a retroactive application of the exit tax may in fact be constitutional. However, the ex post facto issue is still important to note as the Court will be considering an entirely new issue (i.e., the retroactive application of a new tax law) and since the current exemption of civil law is not unanimously accepted and could be revisited in such a charged case.

By understanding the constitutional questions at stake, it becomes easier to anticipate a hypothetical ruling by the current Supreme Court. As it stands, and especially with the two new recruits to the high bench, the Supreme Court leans conservative, making it unlikely that a wealth tax will emerge from its deliberations unscathed. Furthermore, since most conservative justices are either judicial originalists (i.e., concerned with the original meaning of the Constitution as expounded upon by the Founders) or strict textualists (i.e., concerned with the literal meaning of the text of the Constitution), it is equally unlikely that they will be persuaded by the outpour of amicus briefs by wealth tax adherents over the insistence of Hamilton in Federalist No. 12 that the Union should focus on indirect taxation. Indeed, with incumbent Justice Clarence Thomas having previously opined that the prohibition on ex post facto laws should also apply to civil penalties and with Chief Justice John Roberts, the Justice most likely to be the tie breaking vote, having linked direct taxation with “the ownership of land or personal property” in the very same opinion where he admits that the Court has “inadequatly deliberat[ed]” on the subject, a Supreme Court challenge to Warren’s wealth tax has a high probability of leading to the plan’s downfall.