Why Wealth Taxes Are Unconstitutional

Senator Elizabeth Warren, a Democratic presidential candidate, is calling for an annual 2% wealth tax on any individual’s net worth above $50 million. The justification/rationale is that great income and wealth inequality (actually due to the development of enormous new markets globally and technological advances, not to something nefarious) is not only immoral, but a hindrance to economic growth and to solving societal problems. Arguably that premise is seriously mistaken, but the debate, while worthwhile and desirable, is preempted by the fact that wealth taxes are clearly unconstitutional, though no one seems to realize it for the moment.

Why are wealth taxes unconstitutional? For various straightforward reasons, all derived from a careful reading of the Constitution. For starters, the 5th Amendment states that there shall be “no taking of private property without just compensation.” Clearly, a person’s assets are property. Therefore, taxes based on a person’s net worth are in clear violation of the “no taking” clause. It is also significant that there never has been a federal wealth tax, or at least not during the entire 20th Century. With the federal government often in need of more tax revenues, had wealth taxes been perceived as constitutional, they would no doubt have been enacted. The same argument can be made regarding real estate taxes, explaining why there never has been a federal real estate tax. Why would a federal real estate tax be unconstitutional, whereas local real estate taxes are constitutional? Because local real estate taxes are not really wealth taxes, they are essentially fees for services rendered by local governments to the properties, such as schools, police and fire departments, sewage infrastructure, roads, etc. But a federal real estate tax would be a wealth tax, plain and simple, and therefore unconstitutional. That’s why it doesn’t exist.

Of relevance and very revealing is how legislators framed estate taxes (“death taxes”). They clearly were aware of the constitutionality problem, that if an estate tax were deemed a tax on the deceased’s property, it would be unconstitutional on its face. So, what was the subterfuge employed by Congress to ensure that estate taxes were not obviously unconstitutional for being “a taking of private property”? The estate tax was explicitly defined as not being a tax on property (a dead give-away if there ever was one!), but rather as being a tax on the transfer of estate assets. (The IRS informally uses the term “transfer tax”, in a conscious effort to avoid using the term “estate tax” which clearly suggests a tax on property.)

The Congressional deceit with regard to the framing of the estate tax becomes transparent when one carefully studies the details of the tax, revealing stark internal inconsistencies. Those details make clear that the legislators kept thinking of the estate tax as a property tax, not as a transfer tax. If the estate tax were truly a transfer tax, then all points of reference would be to the date of transfer(s), not to the date of death. (A parallel is sales taxes: they are due and calculated at the time of sale, not at the time goods entered a merchant’s inventory.) If the estate tax were truly a transfer tax, it would become due some time after the date of transfer(s), not sometime after the date of death; and it would be calculated on the value of the assets on the date of transfer, not on the date of death. Instead, illogically, the estate tax’s points of reference are all on the date of death, not on the date of transfer(s), revealing that the estate tax is not truly a tax on the transfer of estate assets, but rather is precisely a tax on estate assets, in other words a tax on property. In fact, the estate tax is due 9 months after the date of death, even if no transfer(s) has yet occurred. And the estate tax is calculated on the value of the estate assets at the time of death, not at the time of transfer(s). (As a practical matter, many estates do not transfer out all of their assets to the beneficiaries for various years after the date of death, yet the tax is due 9 months after the date of death whether or not a transfer has taken place, and the amount of the tax is calculated with reference to the date of death, not to the date of transfer(s), which will generally be quite different. In fact, the value of stocks, real estate, and precious metals fluctuate over time, even over just a few months, either up or down.)

So, it is not an exaggeration to deduce that enactment of the estate tax was a fraud on American citizens, a violation of their constitutional right not to have their property “taken”, not even partially through taxation, no matter whether at high or low rates.

Significantly, the income tax required a constitutional amendment, the 16th Amendment in 1913. Why was that necessary? Precisely because income taxes are a “taking of private property”. A citizen’s earnings are clearly property. A salary earned by a citizen is that citizen’s property. So taxing income is taxing property. That is why Congress enacted the 16th Amendment, to offset the 5th Amendment’s “no taking” clause, apart from removing the “apportionment” requirement of all “direct” taxes (income taxes being direct taxes, as opposed to “indirect” taxes, such as sales taxes). One could logically conclude that a constitutional amendment is required to make the estate tax constitutional as well. A wealth tax would similarly require a constitutional amendment, but then what validity or force would be left for the 5th Amendment’s “no taking” clause? None. The “no taking clause” would have been abrogated, for all intents and purposes by later amendments.

Also significant is that the main body of the Constitution itself only foresees indirect taxes, specifically duties, imposts, and excises as the way for the federal government to raise money without the need for “apportionment” (Article I, Section 8). It follows that to be consistent with the intent of our original Constitution to exempt private property from taxation, federal income and estate taxes should be replaced by a 10% federal sales tax. That would greatly simplify the federal tax system and greatly reduce administrative and compliance costs, while being much fairer and progressive. In fact, there would be no more tax shelters which only the very wealthy use, thereby avoiding an enormous amount of income taxes. The elimination of tax shelters, which serve no purpose except to avoid income taxes and actually retard productive investments by misallocating capital towards unproductive investments, would lead to significantly stronger economic growth beyond ensuring tax fairness. And since the very wealthy spend a lot, they would be paying lots of sales taxes. To make such a system even more progressive, on January 2 of each year the Treasury could send all low-income taxpayers a check for $3,000, thereby completely reimbursing all sales taxes incurred on $30,000 of spending.

A 10% federal sales tax would probably generate more tax revenues to the federal government than income and estate taxes do currently. States and cities should also replace their income and estate taxes by raising their sales tax rate by a few percentage points, and send their low-income residents a sales tax reimbursement check on January 2 of each year calculated on an annual spending of $30,000. The end result would be much stronger economic growth on a sustained basis and tax fairness. A further significant feature of a federal sales tax would be its use as a very effective fiscal tool to immediately stimulate the economy by lowering its rate whenever the economy slows down and unemployment starts rising. Such a fiscal policy tool would be far preferable to monetary policy, being much more effective and precise, and without monetary policy’s negative side effects (v. creating bubbles through ultra-low interest rates).

© Edward Sonnino 2019

February 5, 2019