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

This week, David Elkins (Netanya; Google Scholar) reviews 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 (2023). 

On June 26, 2023, the Supreme Court granted certiorari in Moore v. United States. With the exception of National Federation of Independent Business v. Sebelius (2012) (which upheld the Affordable Care Act and in the which the question of whether it was indeed a tax case was the key to the decision), it would be difficult to cite a tax case in the last century that can compete with the potential impact of Moore. Petitioners argue that Congress does not have the constitutional authority to tax unrealized gain. A broadly worded decision accepting that argument could invalidate large portions of the Internal Revenue Code, in addition to stymying efforts to impose a wealth tax or a tax on unrealized appreciation.

The familiar story is that the Constitution distinguishes between direct taxes and indirect taxes (although as Profs. Brooks and Gamage point out, the Constitution does not use the term “indirect tax,” instead referring to taxes that are not direct as “duties, imposts, and excises”).

Indirect taxes must be imposed uniformly. Direct taxes must be apportioned among the states by population. However, the Constitution does not define the term “direct tax.” In Pollock v. Farmer’s Loan and Trust (1895), the Supreme Court held that the personal income tax, to the extent that it is imposed on income from property, is a direct tax and, as it was not apportioned, is unconstitutional (apportioning an income tax is unfeasible, as in order for the total tax paid by the citizens of each state to be proportionate to their population, tax rates in poor states would need to be significantly higher than tax rates in rich states). To overcome the obstacle imposed by Pollock, the 16^th Amendment permitted Congress to impose tax on income without apportionment. However, just as the original text of the Constitution had failed to define “direct tax,” the 16^th Amendment failed to define the term “income.” In Eisner v. Macomber (1920), the Court held that unrealized gain is not “income” in the constitutional sense of the term, and therefore Congress cannot in practice tax unrealized gain. Although Macomber was never explicitly overturned, other cases referred to the realization doctrine in terms of administration convenience and thus seemed to call Macomber‘s continuing validity into question. In fact, although Congress does not generally attempt to take unrealized gain, there are a growing number of provisions that, at least arguably, do so. The petitioners in Moore are attempting to revive Macomber.

This week’s feature article contains a thorough historical analysis of the relevant Constitutional provisions and case law. In this short review I can hardly do justice to their 98 pages, but I will describe what appears to me to be the key points that they raise. To my mind (and apparently to theirs also, as evidenced from the title of the article), the most interesting concerns the phrase from the 16^th Amendment, “income from whatever source derived.” Following Pollock, the Macomber Court understood the word “source” to refer to the property from which the income derived and then focused on the word “derived:”

“Derived from capital...[is] not a gain accruing to capital, not a growth or increment of value in the investment; but a gain…proceeding from…[or] severed from the capital…. [R]eceived or drawn by the recipient…for his separate use, benefit and disposal; – that is income derived from the property. Nothing else answers the description.”

However, as the authors note, this is a misunderstanding of the language in the 16^th Amendment. Pollock held that when income derives from property, a tax on the income is effectively a tax on the property. Because a tax on property is a direct tax, a tax on the income derived from property is also a direct tax and is unconstitutional unless apportioned by population. Since the tax in question was not apportioned, it was unconstitutional, and since the tax on income from property was not severable from the tax on labor and business income, the entire income tax was unconstitutional. In authorizing Congress to tax income from whatever source derived, the 16^th Amendment was saying that it does not matter from what source the income derives. Even if derived from property (as opposed to labor), it is still not subject to the requirement of apportionment. In other words, Pollock made the connection between the property and the income derived from it. The purpose of the 16^th Amendment was simply to overturn Pollock. “[F]rom whatever source derived” was not intended to impose an additional requirement that the income be severed or separated from the source.

Further delving into the historical data, the authors examine the federal income tax, as it had existed at various times from the Civil War until the ratification of the 16^th Amendment in 1913 (there was at the time a corporate income tax, which the Court had held to be constitutional) and the state income taxes that had been enacted prior to ratification. They show that these all included taxes on various forms of unrealized gain and that the 1909 Corporate Excise Tax went so far as to impose a tax on “[a]ny increase in the value of capital assets.” From this they conclude that at the time of ratification, the common understanding of the term “income” for the purpose of income taxation included unrealized gain. This, they claim, refutes the argument that, at the time the amendment was ratified, “income” was understood to include only realized gain.

This article is an impressive research project that makes a number of important contributions to the literature on the subject. In my humble opinion, the respondent in Moore would do well to incorporate the key points when arguing its case before the Supreme Court.

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

• Bruna Alvarez (Getulio Vargas Foundation), Employees or Entrepreneurs? Uncovering the pejotização phenomenon in Brazil (2023)
• Bruna Alvarez (Getulio Vargas Foundation), Joao Paulo Pessoa (Getulio Vargas Foundation) & André Souzza (Getulio Vargas Foundation), Distributional consequences of a Revenue-Dependent Taxation: A Dynamic Approach (2023)
• Andrew D. Appleby (Stetson), Taxing Tokens, 91 Tenn. L. Rev. __ (2024)
• Sebastian Gazmuri Barker (London School of Economics), A Paradox of Tax Systems in Developing Countries, 43 Va. Tax Rev. __ (2023)
• Jinyan Li (York), Interlinking between Income Tax, Citizenship and Democracy? A Case Study of Canada and China (2023)
• Antonio Lopo Martinez (Coimbra), Sin Taxes: Between Public Health and the Risk of Disguised Protectionism (2023)
• Antonio Lopo Martinez (Coimbra) & Julia Leite Coutinho (FUCAPE), Determinants of Corporate Tax Litigation: A Multifactor Analysis (2023)
• Antonio Lopo Martinez (Coimbra) & Lennilton Viana Leal (UFPI), Analyst Coverage and its Impact on Tax Aggressiveness: A Study on B3-listed Brazilian Companies (2023)
• Andea Musselli (Studio Musselli), Periodic Adjustment of Transfer Prices of Intangible Properties: Lessons from Amazon and Microsoft, _ Tax Notes Int’l _ (Oct. 23, 2023)
• Aitor Navarro (Max Plank Institute), Complying with BEPS Substance Requirements Through Remote Personnel: Business Profit Allocation, the PPT and ATAD 3 (2023)
• João Félix Pinto Nogueira (IBFD), Georg Kofler (Vienna), Francisco Alfredo Garcia Prats (Valéncia) & Werner C. Haslehner (Luxembourg), Right to be paid interest on overpayment of taxes in breach of EU Law – Opinion Statement ECJ-TF 3/2023 on the ECJ decision of 8 June 2023 in Case C-322/22, E. v Dyrektor Izby Administracji Skarbowej we Wroclawiu (2023)
• João Félix Pinto Nogueira (IBFD), Pasquale Pistone (IBFD), Ivan Lazarov (IBFD), Alessandro Turina (IBFD) & Sergio Messina (IBFD), Proposal for a Council Directive on BEFIT: an Initial Assessment (2023)