In Defense of Income: How a Wealth Tax is Income

Since the Reagan era, inequality across the United States has reached an all-time high, with clashes over the issue increasingly erupting into the forefront. Over the past few years, however, various attempts to mitigate and even alleviate these economic inequalities have been unsuccessful. One of the main proposals to alleviate economic inequality has been the addition of a wealth tax. A wealth tax is distinct from other taxes such as capital gains taxes and federal income taxes because it seeks to tax unrealized income, meaning that it seeks to tax gains in wealth that aren’t realized from the sale of capital.

Though there is not an explicit wealth tax in America, repatriation tax has the same effect as a wealth tax. Implemented under President Trump, the Republican-led 2017 tax reform enacted a one-time mandatory repatriation tax for American taxpayers who owned more than 10% of a foreign corporation. [1] This term, the Supreme Court is scheduled to consider Moore v. United States (2023) to determine the constitutionality of the repatriation tax. The central issue revolves around whether Congress possesses the constitutional authority, as per the Sixteenth Amendment, to enact the current form of this tax, which is argued to function as a wealth tax. The Supreme Court, in the interest of stare decisis, should rule in favor of the government following the Sixteenth Amendment and its subsequent interpretations by the Court. It is vital that the Supreme Court uphold the lower court’s decision, for redefining income would leave the potential to challenge other taxes levied by Congress.

Moore v. United States arose because Charles and Kathleen Moore owned an 11% stake in an Indian farming equipment company in 2017, and thus under the repatriation tax, they owed the Federal government $15,000. [2] The Moores filed a lawsuit against the federal government, arguing that this tax was beyond the scope of the Sixteenth Amendment under the auspices that unrealized gains from ownership in a corporation don’t constitute a form of income. That is, the increase in value of their stake in the company isn’t the same as realizable, liquid income. The lower courts rejected this argument, holding instead that the repatriation tax effectively amounted to collecting on years of deferred foreign income resulting from their ownership in the company under previous precedent outlining the scope of the Sixteenth Amendment. [3]

The Moores appealed their claim to the Supreme Court under the argument that the repatriation tax—as a wealth tax— falls outside of the purview of the Sixteenth Amendment’s definition of income pursuant to Eisner v. Macomber (1920). [4] Eisner held that pro rata stock dividends, which is the distribution of additional stocks to someone beyond their actual stake, could not be taxed as income because no cash had exchanged hands. However, their actual proportionate share in the corporation had not changed, meaning that a stock dividend merely serves to “postpone such realization” of income. [5] Only when the stock was sold could it be realized as taxable income. Although the Court acknowledged that “the shareholder is richer because of an increase in his capital,” they maintain that “he has not realized or received any income in the transaction.” [6] Thus, even though the volume of wealth in Eisner increased—insofar as the actual number of shares held increased—the Supreme Court held that it could not be considered income under the Sixteenth Amendment because Eisner defined income in such a way that demanded income first be realized before it can be taxed.

As a result of the narrow definition of income, the Sixteenth Amendment “did not extend the taxing power to new subjects,” income such as dividends, “but merely removed the necessity which otherwise might exist for an apportionment among the States of taxes laid on income.” [7] By this definition, income is to be understood in the most literal sense as realized liquid assets, and only in this most literal definition might Congress tax income without apportionment. In other words, the Courts in Eisner understood the Sixteenth Amendment not as a vehicle to free Congress of apportionment, but rather a surgically carved exception to the apportionment clause. It is here that the Moores believe that their ownership of a stake in a corporation cannot be conflated with income.

This question of how to define income in the courts is not a particularly new one. Article I, §2 and §8 of the Constitution endows Congress with a wide discretion to levy taxes, though the mechanism through which they levy are different according to if they are considered direct or indirect. Taxes that are considered to be direct upon individuals must be apportioned amongst the states, meaning that Congress will first decide how much revenue they wish to raise before divvying it amongst states according to their population. Taxes thus become purely teleological, meaning that they can only be levied with an intended budgetary target. [8] Prior to the ratification of the Sixteenth Amendment, the only case defining income was Pollock v. Farmers’ Loan & Trust Co., which classified income taxes as direct taxes, thus subjecting them to apportionment. [9]

Though apportionment was done with the intention of equitably distributing the tax burden amongst states, the practical effect has been such that it is a regressive tax. To understand this better, apportionment makes it such that the poorest state in the Union — say, Mississippi — will be paying more than the wealthiest state in the Union — Washington DC, for example — by virtue of the fact that Mississippi’s population is nearly five times that of DC. For better or for worse, apportionment naively assumes that all states will be economically equal. Therefore, even though Congress can constitutionally implement a wealth tax, if it isn’t protected as income under the Sixteenth Amendment, it will be subject to apportionment, which defeats its very purpose. Crucially, the question in Moore isn’t about whether or not Congress can constitutionally levy a wealth tax — it absolutely can pursuant to Article 1 — the question is whether or not Congress can levy a wealth tax without apportionment. Thus, it is absolutely critical that income generated from wealth be classified as income under the purview of the Sixteenth Amendment if it is to accomplish what it intends to. That is why in one of the dissenting opinions in Pollock, Justice Henry Billings Brown declared that the majority opinion amounted to “nothing less than the surrender of the taxing power to the moneyed class.” [10]  The burden of apportioned taxes inevitability disproportionately impacts the poorest Americans to the benefit of the wealthiest. 

Despite the fact that the Moores cite Eisner’s definition of income as the principle argument for the unconstitutionality of an unapportioned wealth tax, Eisner’s notion of realized versus unrealized gains in the form of stocks was effectively overturned in United States v. Phellis (1921). Phellis engaged with the question of whether converted stocks from an old corporation reorganized into a new corporate subsidiary could be taxed as income. Holding the value of stocks equal — that is, the stockholders did not see an aggregate increase in wealth in the restructuring of the stocks — the Court held that “in substance and fact, as well as in appearance, the dividend received by claimant was a gain, a profit, derived from his capital interest in the old company, not in liquidation of the capital but in distribution of accumulated profits of the company.” [11] Even though the new stocks issued to the claimants were not realized as income and did not result in an increase in wealth, the stocks were to be to be taxed as income on the grounds that they were derived from the profits of the company. Crucially, the ruling maintained that income does not need to be realized to be taxed because their opinion stated that it was “not in liquidation of the capital” that the income was taxed, rather, it was in the fact that the wealth came from old income. [12] Under this definition, and despite the Moores’ reliance upon the earlier Eisner opinion, realization is not a requisite for something to be taxed as income under the Sixteenth Amendment.

Phellis, in a further rebuke of Eisner, emphasized that in the question of income under the Sixteenth Amendment, capital investment and any value derived therefrom amounts to “something of exchangeable value produced by and proceeding from his investment therein, severed from it and drawn by him for his separate use,” and thus “it constituted individual income.” [13] Phellis seeks to dissolve the distinction between realizable and unrealizable income on the grounds that any increase in the value of capital constitutes the creation of a value that can be exchanged at any given time. The crux of this conception of income rests upon its ability to be realized, not its actual realization. Because the ‘unrealized’ gains made by the Moores from their corporate shares have the capacity to eventually be realized, it thus demands unapportioned taxation pursuant to Phellis. It’s critical to remember that the key question in Moore is not whether or not Congress can tax unrealized gains such as gains in wealth, It is whether or not Congress can tax unrealized gains without apportionment, and in Phellis we find an established definition of income that does not require gains to be realized.

Eisner’s impact was further narrowed in Helvering v. Bruun in 1940 where it was ruled that a transaction need not occur for a gain to be taxed. In this case, a landowner’s tenant defaulted on his 99-year lease, but before the landowner repossessed the property, the tenant tore down the original structure and built a new one in its place that was worth substantially more than the previous one. [14] The landowner was ordered to pay an income tax on the gains from the increase in property value resulting from the new structure being built. The landowner argued that he shouldn’t have to pay income tax for it because no transaction had occurred, and thus no gains were realized. The Supreme Court disagreed, stating that realization doesn't require an economic gain to be strictly “cash derived from the sale of an asset.” [15] Rather, by employing a broader notion of income which includes property exchange, relief of indebtedness, and other agreements yielding in some gain, the Supreme Court endowed Congress the right to tax these forms of income without apportionment. Extrapolating from Helvering, the increase in value of capital assets is the result of transactions elsewhere in the corporation, and the continued passive increase in value of those assets, in this case by building a new structure on your land, results in economic gain even if it is not from an immediate transaction in which cash changes hands. Wealth begets more wealth, and thus — harkening back to Phellis — wealth produces something of exchangeable value. In Moore, first applying Phellis, a gain need not have been realized for it to be subject to an unapportioned income tax, and now applying Helvering, the notion of realization (and transitively income) is expanded to include non-transactional gains. Employing a combined interpretation of Phellis and Helvering, gains in wealth must be recognized as income not subject to apportionment precisely because these gains should either be recognized as unrealized under Phellis, or because they are realized under Helvering. The question becomes not whether wealth can be taxed without apportionment, but rather which context of income they wish to employ. Under either case, wealth obliges taxation.

The Sixteenth Amendment did not abolish apportionment from taxes levied by Congress, rather, Brushaber v. Union Pacific Railroad Co (1916) determined that the Sixteenth Amendment instead reclassified the federal income tax as an excise tax as opposed to a direct tax which isn’t subject to apportionment by Congress according to Article I, §8. [16] [17] Critically, Brushaber agreed in part with Pollock in differentiating income derived from interest, dividends, and property and income from labor. Brushaber reaffirmed Pollock’s decision that all income derived from non-labor interest is to be considered a direct tax, and thus subject to apportionment. [18] Taxable income from labor, however, is considered indirect, and is thus shielded from apportionment according to Article 1 Section 8. [19] In 1926, however, the Bowers v. Kerbaugh-Empire Co (1926) decision expanded the definition of income, stating that “income may be defined as gains derived from capital, from labor, or from both combined, including profit gained through sale or conversion of capital.” [20] This decision was further reaffirmed a few years later in United States v Kirby Lumber Co (1931) by interpreting income according to its “plain and popular meaning.” [21] Though the plain and popular meaning may be subject to controversy, income is generally thought of as an economic gain of some sort, and following from Phellis, wealth creates an economic gain that may be exchanged at some point. Gains in wealth are thus effectively the same as income in its plain and popular meaning.

It seems wholly uncontroversial that the Sixteenth Amendment should be broadly read at this point, that after decades of litigation and definition, income must be broadly interpreted to protect Congressional power— clearly at this point, for the Supreme Court to intervene and narrow the definition of income is nothing but an egregious incursion by the Supreme Court into the explicitly delegated and defined powers of Congress especially given the numerous instances of case law outlining the effect and scope of income above. To redefine income now would be to entirely disregard stare decisis and would thus call into question other income Congress currently taxes such as capital gains taxes.

The most important aspect of Moore will be how narrowly the Court chooses to define income if the court were to rule in favor of the Moores. Depending on how this Court defines income, an interesting question could arise as to the constitutionality of corporate gains taxes. Given the concept creep of legal personhood into corporations, there is a legitimate question as to whether or not Congress is legally allowed to tax corporate capital gains, particularly if the Court adopts an extremely narrow definition of income as seen in Pollock and Brushaber. Such a decision will injuriously limit the ability of Congress to effectively address pressing economic inequalities, and indeed, seriously limit Congressional power writ large and endow the Supreme Court with unprecedented and unwieldy power. The Supreme Court stands at a critical juncture at this moment, and to rule in favor of the Moores would be a flagrant disregard to existing case law and cause catastrophic harm to constitutional norms and precedents.

Edited by Sierra Luz Romero

[1] Moore v. United States, No. 22-800, 4 (U.S. 2024)

[2] Moore v. United States, No. 22-800, app. 23 (U.S. 2024)

[3] Moore v. United States, No. 22-800, 4 (U.S. 2024)

[4] Moore v. United States, No. 22-800, 2 (U.S. 2024)

[5] Eisner v. Macomber, 252  U.S. 189, 211 (U.S. 1920)

[6] Eisner v. Macomber, 252  U.S. 189, 212 (U.S. 1920)

[7] Eisner v. Macomber, 252  U.S. 189, 206 (U.S. 1920)

[8] U.S. Const. art 1, §2

[9] Pollock v. Farmers, 157  U.S. 429, 432 (U.S. 1894)

[10] Pollock v. Farmers, 158  U.S. 601, 603 (U.S. 1894)

[11] United States v. Phellis, 257 U.S. 156, 157 (U.S. 1921)

[12] United States v. Phellis, 257 U.S. 156, 175 (U.S. 1921)

[13] United States v. Phellis, 257 U.S. 156, 175 (U.S. 1921)

[14] Helvering v. Bruun, 271 U.S. 461, 461 (U.S. 1940)

[15] Helvering v. Bruun, 271 U.S. 461, 469 (U.S. 1940)

[16] Brushaber v. Pac R.R., 240 U.S. 1, 11 (U.S. 1915)

[17] U.S. Const. Amend. XVI

[18] Brushaber v. Pac R.R., 240 U.S. 1, 10 (U.S. 1915)

[19] Brushaber v. Pac R.R., 240 U.S. 1, 21 (U.S. 1915)

[20] Bowers v. Kerbaugh Empire Co., 271 U.S. 170, 174 (U.S. 1926)

[21] United States v. Kirby Lumber Co., 284 U.S. 1, 3 (U.S. 1931)