Weekly SSRN Tax Article Review And Roundup: Saito Reviews The 16th Amendment And Congress’s Income Tax Power By Brooks & Gamage

This week, Blaine Saito (Ohio State; Google Scholar) reviews a new work by John R. Brooks (Fordham; Google Scholar) & David Gamage (Indiana-Maurer; Google Scholar), “From Whatever Source Derived”: The Sixteenth Amendment and Congress’s Income Tax Power:

Like many of our readers, I am following the Supreme Court case of Moore v. United States. In their piece “From Whatever Source Derived”: The Sixteenth Amendment and Congress’s Income Tax Power, John R. Brooks and David Gamage makes a series of compelling arguments. First, the piece shows that the original understanding of the Sixteenth Amendment allowed for an income tax that included potential taxes on unrealized gains. They unearth new evidence in support of this view. Second, the piece argues that in light of Eisner v. Macomber, the Sixteenth Amendment has three potential views on “taxes on income”: “(1) the realization-based conception, (2) the presumptive-measurement conception, and (3) the economic-gains conception.” They show that under almost any conception, except for the economic-gains conception, a wealth tax could arise. Instead, the main result of the realization-based conception that the Moore petitioners advocate is to introduce chaos.

The authors first start with a bit of background. First, the Constitution’s Taxing and Apportionment Clauses requires the apportionment of direct taxes based on population and allows Congress to enact uniform excises, duties, and imposts. Essentially, up until Pollock v. Farmers’ Loan & Trust, direct taxes were taxes on head count or real property. Almost everything else was treated as a duty, excise, or impost in what the authors call an Excise Tax Canon.

What Pollock did to upset this balance was two-fold. First, it held that direct taxes are taxes on all types of property “solely by reason of ownership.” Second, it held that taxes on income sourced from property, like rent, are the legal equivalent of a property tax because of a look-through analysis. Pollock kept taxes on labor and business income as valid excises. The Sixteenth Amendment overruled this second holding relating to the source of the income and restore the status quo ante.

Thus, Macomber, in saying that a stock dividend was not income because there was no realization, was in error. The case ignores the long set of precedents and focused solely on the word “income,” when it should have looked at the full phrase “taxes on income, from whatever source derived.” Furthermore, the Court ignored prior precedents that allowed for income taxation of undistributed corporate returns at the shareholder level.

After discussing Moore, the authors then outline the heart of their argument, providing an originalist interpretation of the Sixteenth Amendment’s full phrase, “taxes on income, from whatever source derived.” The authors argue that the question is not what is the definition of income “income,” but rather what this full phrase means. The public at large at the ratification of Sixteenth Amendment understood “income tax” as term of art. And people at the time knew that an “income tax” could include taxing unrealized gains.

The authors then present their evidence as to why the Sixteenth Amendment does not include a realization requirement and was designed to return matters to the status quo before Pollock. They examine the debates in Congress, newspaper discussions, and Supreme Court precedents after the Sixteenth Amendment that preceded Macomber. These all show that the intent of the Amendment was to undo Pollock’s second holding and restore the prior concept of what were “taxes on income.”

The authors then show that the concept of “taxes on income” during the period from the Civil War through the ratification did not require realization.

For example, taxes on undistributed corporate earnings were upheld by the Court as a proper excise in Collector v. Hubbard, which preceded Pollock. The 1913 income tax, which was the first one Congress passed after the Sixteenth Amendment, also taxed some people on undistributed corporate earnings as an anti-abuse measure.

The authors also discovered a previously undiscussed tax that incorporated a mark-to-market type mechanism. This tax was the Corporation Excise Tax of 1909 and it was in force when the Sixteenth Amendment was ratified. The tax and the Treasury Rulings implementing it taxed increases in the values of unsold property included in the books of a corporation. Furthermore, many state income taxes from the Civil War through the period of the ratification of the Sixteenth Amendment also taxed unrealized gains. These income taxes show that people at the time of ratification understood an “income tax” to have the potential to reach unrealized gains.

Finally, the authors discuss two major areas where proponents of a constitutional realization requirement emphasize: legal treatises and dictionaries.

On the treatises, a lot of what proponents of constitutionalizing realization cite in their briefs are really the opinions of the treatise authors and not the parts where they state what the current law is. When one looks at the statements of the law, realization is not a necessity for an income tax. Additionally, many treatises distinguish between the constitutional definition of what is taxable income, which does not include realization requirements, to a statutory construction idea, where realization is required unless Congress explicitly says that realization is waived.

With respect to dictionaries, the term “income” is often defined as “that gain which proceeds from labor, business, property or capital of any kind.” But when one looks at the relevant definitions of “derived,” these dictionaries focus more on the concept of the source of income. Realization does not appear in the definitions of “derived.” Furthermore, the dictionaries in their definitions of “income” or “gain” seek to distinguish these terms from the concept of what we now call basis. Additionally, the term “gain” in most of the dictionaries include, in their definitions, concepts of unrealized gains like “accumulation” or “amassing.”

These dictionaries also have the term “realization.” But “realization” or related concepts do not generally get referenced in the definitions of “income.” Realization is rather understood as a conversion of something illiquid to something more liquid, like cash.

The final major part of the piece does two things. First, it introduces different concepts of income that the Court could take in deciding Moore: realization-based, presumptive-measurement, and economic-gains. Second, it shows out that other than under the economic-gains conception, wealth taxation could still arise. All a realization-based concept of income would do is wreak havoc on the existing tax system.

The first conception is realization-based. This view would require a transaction that causes some sort of material change in the relationship between a taxpayer and the property. Another way to have a realization-based system is to have realization when the taxpayer has some sort of power and dominion over the property and to include that under an expansive constructive receipt concept even if the taxpayer chooses not to use this power.

The second conception is the presumptive-measurement conception. The idea, which stems from authors’ prior work and recent work by Alex Zhang, is that we can presume that Congress can determine the methods of measuring income. Congress can thus use proxies, like observed wealth, to estimate income under this approach. Of course, this approach would gut the apportionment clause of the Constitution, and thus open the door to a wealth tax.

Finally, there is the economic-based approach. Under this view, taxation is allowed only on the familiar Haig-Simons definition of income. But here Congress does have the power here to determine the rules of the timing of the recovery of capital. This approach also best comports with the authors’ arguments about what the Sixteenth Amendment’s text and original intent is trying to achieve.

The authors then argue that a realization-based conception does not pose a significant barrier to a wealth tax. For example, under a realization approach, one could create a realization-based retrospective tax that has a formula like an annual wealth tax during the holding period. To prevent some gaming, the taxpayer can be given a choice to take current wealth tax assessment or a more punishing retrospective tax, much like the current PFIC regime or the proposed Unliquidated Tax Reserve Account (ULTRA). If an economic-gains conception were put in place, though, that would prevent such measures of posing a retrospective tax solely on the value of assets rather than the economic gains over that period.

Mark-to-market systems can also exist under the realization-based conception with careful design. Court precedent has ruled taxes on using a certain public market or creating an entity with limited liability are excise taxes. Thus, one could design a mark-to-market tax that creates an excise on publicly traded entities and any other business entities with limited-liability and create a mark-to-market ULTRA method for all other assets outside of these categories, where all the measures here are instead based on economic gain.

The only thing that a realization-based tax would do would create chaos on the existing regime. The tax at issue in Moore, the Mandatory Repatriation Tax, is quite hard to distinguish from other key aspects of the international tax system, like Subpart F. The result then would be to undo a lot of these provisions. But it also would not provide protection from wealth taxes, meaning there is no real upside for a win for the petitioners.

In the end this thorough article shows that a lot of those pushing for the realization-based conception in Moore are often viewing matters too narrowly or asking the wrong question. The authors, by drawing on so many sources, make a strong argument that the Sixteenth Amendment was designed to allow Congress to, if it stated clearly in the statute, tax unrealized gains. The force of the arguments should close the doubt in most people’s mind that the Sixteenth Amendment would allow mark-to-market taxation. Furthermore, it raises questions as to whether petitioners and certain amici are actually trying to present the Court with the full set of information about the original intent.

The article also shows that a win for the petitioners in Moore may be a pyric victory. The case may not stop a wealth tax. So long as there was political will, one could arise. But the case would visit chaos on the income tax system. That very chaos though, may actually push political will toward a wealth tax.

Finally, the article reveals a frustration I have with the whole issue of the Moore litigation. What this thorough article reveals is that overly constitutionalizing matters weakens our tax discourse. Rather than discussing important values in our system like distributive justice or economic efficiency, the debate here is crimped. Even more than other areas of Supreme Court constitutional litigation, tax is rife with nuance and tradeoffs that are required. Even with strong value concepts, details continue to matter because life itself is messy. In many ways, the political sphere, and the political branches, as well as broader civil society, are far better areas to address these areas than the Constitution or the Courts interpreting that document. By seeking a constitutional end-run around that political process, we move into a reified area that cannot craft solutions or hold the conflicting values and complexities of life in tension effectively. That in the end should worry us all, not just as people who care about taxation, but as citizens.

Here’s the rest of this week’s SSRN Tax Roundup:

• Jonathan Grossberg (Thompson Reuters) and Andrew Gradman (Independent), Book Review and Interview with the Author: Miranda Stewart, Tax and Government in the 21st Century, 42 ABA Tax Times, Sept. 2023, at 34 (Oct. 24, 2023).
• Vincent Ooi (Singapore Management University), ‘99-to-1’ Property Deals: Stamp Duty Avoidance or Honest Mistake, Straits Times (Apr. 7, 2023) (Oct. 24, 2023).
• Robert W. McGee (Fayetteville State), Jovan Shopovski (European Scientific Institute), and Monika Bolek (Lodz), Attitudes Toward Tax Evasion in Sub-Saharan Africa (Oct. 24, 2023).
• Bradley T. Borden (Brooklyn), Refuting the Notion of a General Holding Period Requirement for Section 1031, 39 Practical Real Estate Law. 21 (2023) (Oct. 20, 2023).
• Alex Rathke (University of São Paulo), Profit Shifting Under the Arm’s Length Principle (Oct. 19, 2023).