Taxing Billionaires: New Proposal Would Violate the Constitution, Hits U.S. Entrepreneurship

By SBE Council at 26 October, 2021, 1:59 pm

by Raymond J. Keating –

President Biden and Democrats in Congress are unrelenting in their assumptions that they can raise taxes on the wealthy without any negative consequences for the economy. In reality, of course, to paraphrase English poet and clergyman John Donne, no one is an economic island.

Raising taxes on those with the necessary wealth accumulation to provide investment for the entrepreneurs and businesses that generate innovation, and economic, income and employment growth, ranks as a clear economic negative.

Class Warfare Never Makes for Sound Economics

The latest example, according to assorted reports, is a proposal to impose an annual tax on unrealized capital gains for individuals with a net worth of at least $1 billion, or with income of at least $100 million for three consecutive years.

This is class warfare, and class warfare never makes for sound economics. It is a political ploy to increase taxes – to try to fund a sliver of a massive increase in government spending being proposed – in the hopes that envy will generate support for such measures and/or people will assume that higher taxes on the wealthy simply don’t matter to anyone but the wealthy themselves.

In reality, there are major problems with this rather bizarre, proposed tax increase.

It’s NOT Income

First, calling something “income” does not make it income. In this case, saying that an increase in the value of an asset over a certain period of time is capital gains income, subject to the capital gains tax, when, in fact, no action has been taken to realize a gain (i.e., nothing has been sold), is simply the creation of a political fiction.

Why go through this effort of ignoring or changing the meaning of income?

A tax on simply the increase in the value of assets is a direct tax, and according to the U.S. Constitution, a direct tax must be apportioned among the states, that is, it must be the same amount per person in every state. The 16^th Amendment to the Constitution allowed for an income tax on individuals, and it was adopted to circumvent the direct tax requirement. As explained by Neil S. Siegel and Steven J. Williams, writing for the National Constitution Center (“Direct and Indirect Taxes”):

“Income taxes may be imposed only on ‘derived’ income. This ‘realization event’ requirement generally refers to a transaction other than the mere passage of time. Thus the Sixteenth Amendment permits taxation of gains from sales or exchanges of property, but not those resulting merely from increased values. It also permits taxes on rents and interest. Although direct, such taxes need not be apportioned because the Amendment eliminated the apportionment requirement for income taxes.”

Given that there is no realization event, it cannot seriously be argued that “unrealized” gains are “income” in any sense of the word, and that being the case, this proposed levy would be a direct tax not allowed by the Constitution.

Implications for U.S. Investment

Second, even if the Constitution is ignored (it’s happened many times before, after all), there’s the fact that this proposed tax would take a real toll on investment.

The normal capital gains tax is a destructive levy. It reduces the amount of resources and incentives for starting up and growing businesses. And understanding that entrepreneurship and the financing of entrepreneurial ventures are endeavors fraught with risk and uncertainty, while at the same time such activities are essential to economic growth, the problem with the capital gains tax – a direct tax on the returns on entrepreneurship and investment – becomes, or should become, quite clear.

Now, all of these problems would be multiplied many times over with an annual tax on unrealized capital gains. Indeed, it must be kept in mind that it is high-income earners who have the resources to make investments in starting up and building businesses.

Shifting those dollars away from those who earned them in the private sector and away from the disciplining forces of prices, profits, losses, competition and consumer sovereignty, and handing them over to politicians to be spent according to political and governmental incentives mean that those resources are used far less efficiently, with growth undermined.

So, yes, a new tax on unrealized gains for the very wealthy will have very real effects well down the income scale, including the entrepreneurs who need funding to grow their businesses, as well as the individuals who would be employed by such businesses, and the consumers being served by these enterprises.

Let’s Not Forget History!

One last point is worth highlighting: The personal income tax was first imposed on only the very wealthy. But once put into effect, it didn’t take very long for the income tax to be directly applied far down the income scale.

There is little doubt that this strange annual gain-in-wealth tax, if approved, would apply to more and more people with the passage of time and the persistent longing of politicians to tax and spend. As Elon Musk tweeted: “Eventually, they run out of other people’s money and then they come for you.”

John Donne lived from 1572 to 1631, and his most famous and lasting phrase – that “No man is an island” – should be understood as a fundamental principle of the economics of taxation.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.