Can the government tax charitable assets? A court case put before the U.S. Supreme Court may hold the answer to this question. By considering whether unrealized assets can be taxed, the courts could open the door for a new wealth tax covering assets within private foundations or charitable trusts.
The U.S. Court of Appeals for the Ninth Circuit recently sidestepped the equal apportionment clause of the 16th amendment by becoming the first court in the country to state that an “income tax” doesn’t require that a “taxpayer has realized income.” In other words, this opens the door to the possibility that you can be taxed on income you didn’t receive (yes, you read that right).
Last week, Competitive Enterprise Institute petitioned the U.S. Supreme Court to take up the issue in Moore v. United States.
To understand what is at stake, we begin with investments. When the value of stocks and investments rise but are yet to be sold, they are called unrealized investment gains. These gains are not taxed according to current tax regulations until the investment is sold and the capital gains are realized.
To illustrate, let’s say you purchased a painting for $1,000, and after a year, its market value rose to $1,500. As long as you haven’t sold the painting, the $500 increase in value is considered an unrealized gain, and you don’t need to pay taxes on it.
The decision by the Ninth Circuit, if not overturned, could usher in a new era of federal taxes being imposed on properties, stocks, appreciating assets, possibly even jewelry, artwork, vehicles and household furniture.
What’s more, opening the door to the possibility of imposing federal taxes on wealth would have profound implications for the charitable sector.
Emmanuel Saez and Gabriel Zucman, two well-known French economists who have provided advice to Senators Elizabeth Warren and Bernie Sanders regarding their proposed wealth tax plans, have suggested a new approach to calculating tax bills for wealthy Americans. This new approach would consider not only the personal assets of these individuals, but also the assets of their charitable foundations.
The change would be significant, given that American charitable foundations provided $91 billion to nonprofit organizations in the previous year. If wealthy individuals’ foundations were to see a reduction in assets, the communities currently benefiting from those donations would experience a substantial (negative) impact.
In 2019, the National Taxpayers Union Foundation conducted an analysis of Warren’s proposed wealth tax on charitable foundation assets and found the tax would consume between 6% and 25% of the annual disbursements of five selected foundations, including the Dell Foundation, the Omidyar Network and Dalio Philanthropies.
The history of wealth taxes suggests they are not effective and are frequently abandoned due to the economic damage they cause. Fifteen European countries have introduced wealth taxes over the last century, but only three still enforce them.
In 2017, France eliminated its wealth tax after the prime minister acknowledged it was prompting the departure of 10,000 to 12,000 millionaires each year. This tax impeded economic growth and contributed to just over 1% of overall tax revenue, which is an inadequate return for the cost.
Sweden, which is often cited as a progressive policy model, had a wealth tax for almost 100 years before abandoning it in 2007. The tax had virtually no effect on government finances while being blamed for significant capital flight. Germany also had a wealth tax, but it was deemed unconstitutional and abolished in 1996. Wealth taxes have not proven successful worldwide, and it remains uncertain whether the U.S. Constitution grants Congress the authority to impose such a tax.
The 16th Amendment says “taxes on income” do not need to be apportioned among the states. This likely means that other federal taxes, such as a tax on unrealized capital gains and other wealth taxes, must be applied equally to all 50 states, according to population.
Alabama, which makes up roughly 1.5% of the nation’s population, would have to produce roughly 1.5% of the revenue raised by the tax. But Alabama and seven other states have no billionaires, and California and New York combined have 43% of them, so equally apportioning the tax among the states would be impossible.
As the decision by the Ninth Circuit Court is petitioned, the Supreme Court may issue a decision on this matter — it could have profound implications on the possibility of federal wealth taxes being imposed on the unrealized assets of Americans.
Whether we consider the economic costs of a tax on unrealized capital gains, the historical precedent of nations abandoning wealth taxes or the question of constitutionality, the result would be less economic growth, fewer jobs and a significant reduction in philanthropic giving.
To learn more about the impact of wealth taxes on charitable giving, read our policy primer here.