The Supreme Court Should Leave the Tax Code Alone
Alex Brill, Kyle Pomerleau, Michael R. Strain, Stan Veuger and Alan D. Viard | AEIdeas
In December, the Supreme Court will hear oral arguments in Moore v. United States, a case to determine whether the mandatory repatriation tax (MRT) is constitutional. We have submitted an amicus brief in support of the respondent (the US government) arguing that the MRT is constitutional as an indirect tax. Moreover, we also explain that any ruling that introduces a realization requirement would disrupt the US income tax system and the US economy.
The MRT, which was introduced in 2017 as part of the Tax Cuts and Jobs Act (TCJA), imposed a one-time transition tax on undistributed foreign profits. The purpose of this tax was to transition from the previous regime, which taxed the foreign profits of US-based multinational corporations but allowed corporations to defer the tax as long as the foreign profits were reinvested in ongoing foreign operations, to a new tax system that mostly exempted foreign profits from taxation.
The Moores are shareholders in a foreign manufacturing business and were subject to the MRT on the business’s undistributed profits. They argue that the tax is an unconstitutional direct tax because the 16th amendment, which authorizes income taxation without apportionment among the states, only applies to taxes on realized income while the MRT taxes unrealized income. The Moores and several amici further argue that this also means that a wealth tax would be unconstitutional.
Although we agree that a wealth tax is likely unconstitutional (and undesirable), we think that the MRT is nothing like a wealth tax and that the court should not use this case to reopen the constitutional meaning of “income” under the 16th Amendment.
Our brief makes two main arguments.
First, the MRT is an indirect tax, not a direct tax. Court precedent does not support the argument that a tax on foreign commerce is a direct tax. Historical sources are clear that all direct taxes are internal. In addition, the MRT is not a direct tax, because it is a tax on the use of a certain business entity. Indeed, the court cited similar grounds when, prior to the adoption of the 16th Amendment, it upheld the corporate income tax as an indirect tax.
Second, any constitutional realization requirement would wreak havoc on the tax system and the US economy. The current income tax includes numerous provisions that deviate from the realization principle. For example, partners in subchapter K partnerships are taxed on their share of business profits whether or not those profits are distributed. In addition, accelerated depreciation and expensing allow businesses to take deductions prior to disposing or selling property. A realization requirement would put these, and potentially many more, provisions of the tax code at risk.
More fundamentally, a realization requirement is undesirable because a realization-based tax system is economically incoherent. Economists generally favor one of two coherent tax bases: income or consumption. A realization-based income tax is neither. As a result, it creates both economic distortions and opportunities for tax avoidance.
Economists have long understood that whether or not income is realized, it is still income. Nevertheless, it is reasonable and prudent for administrative and other reasons for Congress to distinguish between realized and unrealized income in some situations. For example, measuring income from the appreciation of certain closely held businesses is difficult and Congress has reasonably decided not to subject those gains to tax until they are realized. On the other hand, it could be reasonable for Congress to design a system to tax unrealized gains that are easy to measure, such as those that arise from the appreciation of publicly traded assets.
A decision that invalidates the MRT may or may not immediately implicate other parts of the tax code. However, the decision would open the door to years of lawsuits over other provisions, throwing a cloud of uncertainty over a broad swath of the US economy.
Given the risks and economic shortcomings of a realization requirement, we believe it should not be enshrined in the Constitution. Instead, Congress should be free to decide whether and how to tax unrealized income.