- AMERICAN INSTITUTE FOR ECONOMIC RESEARCH - Phillip W. Magness - NOV 11, 2021 -
A wealth tax, recently redubbed a tax on “unrealized capital gains,” is all the rage in Washington, D.C. these days. While the economic implications of this proposal are sufficiently flimsy to discount its claimed purpose of revenue generation, the proposed wealth tax faces a greater obstacle to its adoption: it is blatantly unconstitutional.
It is true that a number of law professors have attempted to carve out a justification for wealth taxation through a combination of legal sophistry and bad history, but the certainty of a constitutional challenge remains in the event that Congress ever passes such a measure. To understand why such a challenge would likely doom the proposal, we must turn back to the economics of wealth taxation and – specifically – a little-noticed passage by Adam Smith.
First, let’s consider the constitutional issue at hand. Article I, Section 8 of the U.S. Constitution establishes the power of Congress “To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States,” however this power is not absolute. A second clause constrains this power, noting that “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.”
The “Capitation Clause,” as it is sometimes called, divides taxation into two categories: direct and indirect. Indirect taxes include those specified in the earlier clause, “Duties, Imposts and Excises.” A direct tax is a different instrument, constitutionally speaking. Before we get to the definition of that term though, suffice it to say that the Capitation Clause imposes substantial constraints on the enactment of direct taxation. In order to pass constitutional muster, the burdens of a direct tax must be apportioned across the individual states according to their share of the national population. This requirement would preclude a national tax policy, as that burden would be assessed for a state as a whole. Virginia would “owe” a sum commensurate with its population, as would California, as would Idaho and so forth. The rate of direct taxation on individuals living in each state would accordingly vary to the point of making such a tax system politically impractical if not impossible to administer.
The applications of the Capitation Clause have undergone some modification in our constitutional history. In 1909 Congress passed the 16th Amendment. This measure was intended as a workaround that would exempt the direct taxation of income from the apportionment requirement of the Capitation Clause. As the amendment reads, “Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”
The history of the 16th Amendment is complex, but its immediate occasion came from a revision to the tariff system – the main source of the federal government’s revenue for most of the 19th century. While debating the Payne-Aldrich Tariff Act of 1909, a group of anti-protectionist Democrats proposed a revenue swap that would replace the import tariff system with an income tax and thereby alleviate the former regime’s burdens on international trade.
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