The Low and High Stakes of Moore

Daniel J. Hemel

Daniel J. Hemel is a professor of law at New York University School of Law. He thanks Ari Glogower, David Kamin, and Susie Morse for helpful comments.

In this article, Hemel argues that the ultimate outcome in Moore — whether the taxpayers win or lose — will matter less for the federal tax system than the reasoning that the majority adopts.

Copyright 2023 Daniel J. Hemel.
All rights reserved.

Moore,¹ the challenge to the constitutionality of the mandatory repatriation tax slated for argument at the Supreme Court next term, looks at first glance like a battle between two different definitions of income.

On one side, petitioners Charles and Kathleen Moore — cheered on by the Chamber of Commerce and the Wall Street Journal editorial board — argue that, for 16th Amendment purposes, “income” requires a realization event such as the receipt of money or an exchange of property. That theory, if it prevails, would cast doubt on numerous code provisions ranging from the original issue discount rules to the mark-to-market regime for regulated futures contracts.

On the other side, the solicitor general argues that the 16th Amendment allows Congress to tax income on a realization basis and an accrual basis, with both types of taxes passing constitutional muster. That view has represented the conventional wisdom among tax scholars for decades, though the Supreme Court has never endorsed it in as many words.

But there is more to Moore than meets the eye. Even if the Moores persuade the Court that the 16th Amendment embeds a realization requirement, the petitioners won’t necessarily prevail on their refund claim — the justices could hold that income taxation requires realization and that the mandatory repatriation tax satisfies that requirement, though many other code provisions might not.

Inversely, even if the justices agree with the government that the 16th Amendment authorizes accrual-based as well as realization-based taxation, the Moores might still win their case: The Court could hold that the 16th Amendment allows an accrual tax like an annual mark-to-market income tax but that the mandatory repatriation tax, because of its unusually long temporal reach, lies outside Congress’s 16th Amendment power.

The upshot is that for almost everyone except the Moores themselves, the outcome in the case matters less than the reasoning that the justices embrace. A win for the government may turn out to be a Pyrrhic victory for proponents of expansive congressional power under the 16th Amendment. And a win for the Moores on a narrow theory of the case might leave Congress’s taxing power largely intact.

The Case in Brief

The immediate issue in the case is the constitutionality of the mandatory repatriation tax as applied to individuals like the Moores. The repatriation tax — enacted as part of the Tax Cuts and Jobs Act signed into law by President Trump in December 2017 — applies to U.S. persons owning at least 10 percent of a controlled foreign corporation. It requires those U.S. shareholders to pay a one-time tax on the undistributed earnings and profits of the foreign corporation dating back to the end of 1986. The tax rate is 15.5 percent for earnings held in cash and 8 percent otherwise, and taxpayers have the option to pay the tax in interest-free installments over eight years. The Joint Committee on Taxation estimated that the tax will raise $339 billion over a decade.²

The Moores own slightly more than 10 percent of an Indian agricultural toolmaker named KisanKraft; they now seek a refund of the roughly $15,000 they paid under the mandatory repatriation tax. They argue that the mandatory repatriation tax lies outside the 16th Amendment’s conception of income because it applies to earnings and profits accumulated by KisanKraft that were never distributed to shareholders. And because the mandatory repatriation tax isn’t an income tax within the meaning of the 16th Amendment, the Moores say, Congress cannot levy the tax unless it apportions the burden among the states based on population.

Importantly, even if the Court were to accept the Moores’ theory as it pertains to the mandatory repatriation tax on individuals, the mandatory repatriation tax on corporate shareholders could and should survive. Nearly all the revenue raised by that tax comes from U.S. corporations that own stakes in foreign corporations — companies like Apple that stashed billions of dollars in overseas affiliates before the December 2017 tax law.

Congress’s power to tax corporations doesn’t rest on the 16th Amendment. Even before that amendment’s ratification, the Supreme Court held that a corporate income tax was an “excise” that isn’t subject to apportionment. Congress can continue to tax corporations even if elements of the corporate income tax fall outside Congress’s 16th Amendment authority.³

There are, moreover, strategic reasons why the Moores and their supporters would be well-advised to clarify that corporate taxation lies outside their realization theory’s scope. A decision that struck down the mandatory repatriation tax in its entirety — as it applies both to corporations and to individuals — would raise difficult questions about severability, since the Tax Cuts and Jobs Act wouldn’t have satisfied Congress’s budget reconciliation instructions if not for the revenue raised from the mandatory repatriation tax on corporations.

The Moores’ cheerleaders presumably don’t want to take down the entire Tax Cuts and Jobs Act — including its 14 percentage point reduction in the corporate income tax rate and its 2.6 percentage point cut in the top statutory rate on individuals. And conservative justices who are sympathetic to the Moores’ claim may balk at a holding that would place Trump’s signature economic policy achievement in constitutional limbo.

No Taxation Without Realization?

As the Moores see it, the central issue in their case is whether the 16th Amendment authorizes taxation without realization. They rely chiefly on Eisner v. Macomber,⁴ a 1920 decision in which the Court held that the 16th Amendment did not allow Congress to tax a shareholder on the earnings of a corporation until the shareholder had “realized” those earnings (for example, through a cash dividend). Later cases have cast doubt on Macomber’s realization requirement, but the Supreme Court has never explicitly overruled the relevant portion of Macomber.

Even if the Court agrees with the Moores that the 16th Amendment embeds a realization requirement, though, the Moores won’t necessarily win. As the government noted in its brief opposing certiorari, KisanKraft unquestionably has “realized” the E&P in dispute. In Macomber itself, the Court contemplated the possibility that Congress could look through the corporate form and tax shareholders on their pro rata portion of a corporation’s realized income.⁵

The Macomber majority ultimately rejected the look-through approach, noting that it wouldn’t justify an additional tax on cash dividends. “If there were an entire identity between [shareholders] and the company,” Justice Mahlon Pitney wrote for the Macomber majority, the shareholders “could not be regarded as receiving anything from it, any more than if one’s money were to be removed from one pocket to another.”⁶

But notably, Congress has provided that earnings and profits subject to the mandatory repatriation tax won’t be included in a shareholder’s income later — a subsequent distribution will indeed be regarded as a transfer of money from one pocket to the other. The Court in Moore conceivably could say that realization remains a 16th Amendment requirement but that Congress is free to disregard the form of a foreign corporation and tax shareholders on their pro rata portion of a foreign corporation’s realized earnings.

A holding along those lines — that the 16th Amendment requires realization but that Congress is free to look through the foreign corporate form — would amount to a win for the government in Moore, but it would cast a shadow over other established and proposed tax provisions. Other accrual-based features of federal tax law — including the OID rules and the mark-to-market regime for regulated futures contracts — probably can’t be salvaged with a look-through theory.

Moreover, mark-to-market income taxes along the lines proposed by President Biden and Senate Finance Chair Ron Wyden, D-Ore., would be in serious jeopardy. Under the mark-to-market income tax proposals from Biden and Wyden, a billionaire like Jeff Bezos would owe tax on the increase in the market value of his Amazon shares — an amount that historically has far exceeded Bezos’s pro rata portion of Amazon’s realized earnings. In other words, the mandatory repatriation tax as applied to individual shareholders may survive under a realization requirement supplemented by a look-through theory, but a mark-to-market income tax most likely would not.

The Ambiguity of Accrual

Just as the Court could adopt a realization requirement and still come down against the Moores, it could embrace an accrual theory and still decide in the Moores’ favor.

The accrual conception of income is often associated with the early 20th century economist Robert Haig, who famously defined income as “the increase or accretion in one’s power to satisfy his wants in a given period.”⁷ The solicitor general’s brief opposing certiorari in Moore specifically invokes Haig’s accrual concept. But Haig also emphasized “the theoretical distinction between income on the one hand and capital, or property, or wealth on the other” — a distinction that Haig’s contemporaries evidently embraced as well.⁸ In their minds, income taxes and wealth taxes were qualitatively different.

The problem for Haig and his latter-day followers is that a conception of accrual with no time limit would blur the distinction between an accrual-based income tax and a wealth tax — a distinction that proponents of the accrual conception considered to be fundamental. A wealth tax is, after all, a tax on all unconsumed items of income — realized or not — accruing to a taxpayer up to that point. All our wealth reflects an increase in our economic power from the moment of birth. Without some temporal limitation on accrual, a wealth tax would be an accrual-based income tax by another name.

The mandatory repatriation tax stress-tests the income/wealth distinction. The tax reaches the increase in the economic power of U.S. shareholders over a given period — in that sense, it seems to satisfy Haig’s definition of income. But that given period stretches all the way back to the end of 1986. If Congress can stretch back that far, why can’t it reach all the way back to a taxpayer’s birth? (After all, Mark Zuckerberg was born in 1984, just two years before the mandatory repatriation tax starts its E&P clock.) And if a tax on the increase in a taxpayer’s economic power since birth qualifies as an income tax, the theoretical distinction between an income tax and a wealth tax would seem to be no distinction at all.

To be sure, the Supreme Court could conclude that even though Haig and his contemporaries believed that income taxes and wealth taxes were distinguishable, they were all wrong and the 16th Amendment — by authorizing income taxation — opened the door to wealth taxation. That outcome is not only unlikely as a prediction about the current Court but also not obviously desirable as a normative matter.

For decades, economists have emphasized the problem of time inconsistency in taxation — a legislature might cut capital tax rates today, but what’s to stop the same legislature from ratcheting rates up once investments are already sunk? Unless the legislature can credibly commit that it won’t impose high wealth taxes in the future, then any investment incentives it implements now will have limited efficacy.

As Finn Kydland and Edward Prescott wrote in a 1977 article that helped to win both men a Nobel prize, workers therefore “might rationally choose to have a constitution which limits their power, say, to expropriate the wealth of the capitalist class,”⁹ because workers will benefit from the resulting increase in capital investment. Perhaps, then, we should want the Court to adopt an interpretation of the 16th Amendment that limits Congress’s power to tax wealth.

Alternatively, the Court could hold that accrual-based income taxes and wealth taxes are distinguishable because “income” — unlike “wealth” — implies some notion of basis. According to this theory, the mandatory repatriation tax still is an income tax — and not a wealth tax — because it applies only to each shareholder’s portion of E&P, leaving the shareholder’s portion of the corporation’s capital untouched. But imbuing basis with a constitutional dimension is a risky venture. If the 16th Amendment embeds some idea of basis, does it require Congress to adhere to a specific idea of basis? The basis theory could allow the government to prevail in Moore while maintaining an income tax/wealth tax distinction, but the basis theory’s implications might not be so innocuous.

Finally, the justices could say that an accrual-based income tax must be limited to increases in economic power over a reasonable period. Where, exactly, to draw the line is a difficult question, but it is a question that the Court need not resolve once and for all in Moore. As Justice Oliver Wendell Holmes memorably wrote in another one of the Supreme Court’s early income tax cases: “Where to draw the line . . . is the question in pretty much everything worth arguing in the law. Day and night, youth and age, are only types.”¹⁰

The Court could say, for example, that the Constitution does not necessarily require Congress to limit the tax period to a single year but that the mandatory repatriation tax’s three-decade lookback period is too long for it to count as an income tax. Macomber would be a dead letter, but the Moores would still receive their refund.

A temporally limited conception of accrual would tie Congress’s hands somewhat. A future Congress still could impose a mark-to-market income tax, but it would not be able to impose an immediate tax on all unrealized gains that have accrued from the beginning of time. The mark-to-market income taxes proposed by Biden and Wyden both include a one-time tax on unrealized gains that have accrued before the year of enactment. That element of the Biden and Wyden proposals would be endangered if the Court adopted a temporally limited conception of accrual.

Yet a narrow holding for the Moores — one that interprets the 16th Amendment to allow accrual-based income taxes but incorporates a temporal limitation into the accrual concept — would leave the rest of the code largely intact. Congress still could, for example, tax OID as it accrues and maintain the mark-to-market tax regimes already on the books. Those provisions rest soundly on accrual principles without any temporal stretch.

The argument for a temporally limited conception of accrual is distinct from the Fifth Amendment claim that the Moores argued in the Ninth Circuit — that the mandatory repatriation tax, because of its retroactive application to earnings many years back, violates the due process clause.¹¹ At bottom, the accrual argument is about the meaning of “incomes” under the 16th Amendment — specifically, whether an accrual conception of income implies a temporal limitation — and not whether a thirty-year lookback would independently violate due process.

The distinction is more than a technicality. The due process theory advanced and then abandoned by the Moores would have limited the ability of states to impose wealth taxes because states are also subject to the due process clause. And it would have invalidated the mandatory repatriation tax even as applied to corporate shareholders because corporate taxes are subject to the due process clause’s strictures. By contrast, a temporally limited conception of accrual would apply only to federal taxes enacted under Congress’s 16th Amendment power — not to federal excise taxes and not to state taxes.

Déjà Vu

The Moore case calls to mind an earlier dispute about the bounds of congressional authority: United States v. Lopez,¹² in which the Court considered the constitutionality of the Gun-Free School Zones Act of 1990. At oral argument in Lopez, Justice Sandra Day O’Connor pressed the solicitor general for an example of a statute that would lie beyond Congress’s commerce power under the government’s theory of the case. The solicitor general demurred, and O’Connor — unwilling to give Congress limitless leeway — cast a decisive vote to strike down the law.

Conservative justices are likely to ask a similar question in Moore: If the mandatory repatriation tax is an income tax within the meaning of the 16th Amendment, then what isn’t? And if the solicitor general demurs, the rest of the argument won’t go well for the government.

The justices will be searching for some constraint on Congress’s 16th Amendment power — whether it be a realization requirement or a basis theory or a temporally limited conception of accrual. And if advocates of a capacious interpretation of the 16th Amendment must pick their poison, a temporally limited conception of accrual may turn out to be less toxic than the alternatives. Several code sections entail taxation without realization, and dozens of provisions involve basis adjustments of various sorts, but far fewer impose accrual-based taxes with multiyear lookbacks.

In sum, observers with a rooting interest in a broad construction of Congress’s 16th Amendment power should care deeply about the Moore case. But they should care less about the bottom-line result — whether the Moores receive a refund — than about the reasoning that carries the Court to its conclusion. The lasting impact of the Moore case will depend not on who wins, but on how. And a narrow victory for the Moores — one that recognizes accrual-based taxes along with realization-based taxes as income taxes within the meaning of the 16th Amendment but maintains the income tax/wealth tax distinction — would cause far less collateral damage than many other realistic outcomes.