Democrats have proposed partly funding some of their multitrillion-dollar spending plan with a tax on the “unrealized capital gains” of anyone who makes more than $100 million per year or is worth at least $1 billion.

That proposed tax is likely unconstitutional.

To understand why, we first must understand how such a tax would work. The tax targets “unrealized capital gains,” which are oxymorons that exist only in the minds of tax law enthusiasts.

A capital gain is the profit you make when you sell an investment asset for more than you paid for it. Once that profit is in hand, a tax lawyer would call it “realized,” and the IRS would take its share.

If, however, your investment increases in value and you choose not to sell it, you have an “unrealized” capital gain, because the “profit” exists only on paper.

Under the Democrats’ proposed tax, the IRS would take its share even if that money isn’t in hand.

And that’s likely unconstitutional.

Article I, Sections 8 and 9 of the Constitution deny Congress the power to levy a direct tax unless it’s “apportioned among the several states” in proportion to population. That means that the tax must be spread evenly among every person in every state.

In Pollock v. Farmers’ Loan & Trust (1895), the Supreme Court held that a tax is direct if it’s “upon property holders in respect of their estates, whether real or personal, or of the income yielded by such estates, and the payment of which cannot be avoided.”

More recently, in NFIB v. Sebelius (2012), the court reaffirmed that taxes on personal property are direct taxes.

A tax on unrealized capital gains would be a direct tax because it’s a tax on personal property paid by someone who cannot—quoting the Pollock decision—“shift the burden upon some one [sic] else.” As a direct tax, Democrats’ proposed tax must be spread equally among the populations of the states to pass constitutional muster, but it isn’t.

Pollock held that an income tax was a direct tax and struck it down because, by definition, an income tax can’t be spread equally among the population. That case led to the ratification of the 16th Amendment, which allows Congress to levy “taxes on incomes” without apportionment.

But income taxes are all it covers. It does not cover wealth taxes, and that’s probably why Democrats—notably Treasury Secretary Janet Yellen—are denying that the proposed tax is a wealth tax.

But it sure looks like one.

Income, the Supreme Court held in Commissioner v. Glenshaw Glass (1955), means “undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”

Tax law enthusiasts and finance gurus can quibble over whether an increase in the price of an unsold stock is an undeniable accession to wealth over which a taxpayer has complete dominion, but not even the world’s best lawyer could argue that “unrealized” actually means “realized.”

Another Supreme Court opinion, Eisner v. Macomber (1920), bears on that argument. There, the Supreme Court held that a stock dividend was not income because the dividend didn’t put any money into the investor’s hands. It was an unrealized gain because “every dollar of his investment, together with whatever accretions and accumulations have resulted … still remains the property of the company, and subject to the business risks which may result in wiping out the entire investment.”

The same goes for any other unrealized capital gains, and so, they aren’t income.

Defenders of wealth taxes have tried a different argument. They argue that wealth taxes are constitutional based on an opinion that predates the 16th Amendment, Knowlton v. Moore (1900). There, the court upheld an inheritance tax. Proponents of wealth taxes say inheritance taxes are the same thing.

But they aren’t.

Critically, the court in Knowlton held that “[a]n inheritance tax is not one on property, but one on the succession.” The court viewed the tax as attaching to the transfer of wealth. 

In other words, when the money moved into the heirs’ hands, the government could take its share. That’s analogous to the IRS taking its share when you realize profit from selling stock. It’s not analogous to the IRS demanding a share of money you don’t yet have.

In sum, the Democrats’ proposed new tax on unrealized capital gains is likely an unconstitutional wealth tax, and if it passes, the Treasury may find itself forced to spend trillions of dollars without an adequate source of funding.

With the national debt poised to skyrocket, and Americans nervously watching inflation numbers, it would be unwise to put the Treasury in that position.

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