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The Supreme Court has accepted a sleeper case for review that could cost the Treasury seven trillion dollars over a decade if the justices agree with the most extreme constitutional claims about limiting the government’s power to tax. This is the latest front in the war to kill the modern administrative state by “starving the beast” for revenue.
The case, Moore v. U.S., challenges one of the few provisions in Trump’s massive 2017 tax cuts for the rich that actually collected revenue to offset some of the losses. The offset provision, known as the Mandatory Repatriation Tax, ended the unlimited deferral of foreign earnings from U.S. taxation when investors or corporations kept profits offshore.
At the time, tax avoidance schemes had accumulated about $2 trillion outside the U.S. With the closing of this loophole. the Joint Committee on Taxation (JCT) estimated that this new provision would increase federal revenues by $338 billion in the ten fiscal years from 2018 to 2027.
Here’s the rub. The tax applies whether or not the earnings are actually distributed to the investor. But the question of whether unrealized gains can be taxed has been a gray area of tax law. The premise that they should not be taxed is the basis for the capital gains loophole, which allows tax to be deferred indefinitely as long as the stock is not cashed in.
In the case that the Court accepted for review, Charles and Kathleen Moore had made a modest investment in a friend’s company in India. The retained earnings were left in India. Nonetheless, the IRS taxed them $14,729 as the tax on their share of the profits.
The Moores sued. Their suit cited a 1920 Supreme Court case, Eisner v. Macomber, in which the Court held that a gain in asset value qualifies as income only if it is “received or drawn” by the investor. Their suit was rejected by both the U.S. District Court and the U.S. Court of Appeals for the Ninth Circuit as being without merit because of long-standing tax collection practices that have been accepted by the courts. But in June, the Supreme Court took the case for review, in an unsigned opinion.
According to the Tax Foundation, if the Court strikes down the foreign repatriation provision, that would cost the government about $346 billion over the next decade. And there are other gray areas. For instance, many partnerships leave income earned by the partnership in the firm, but current practice deems it taxable income.
In the most extreme case, the Court could disallow all taxes on unrealized pass-through income and corporate retained earnings.
Also, if the Court were to hold that the Corporate Alternative Minimum Tax, which was just passed in a new form in the Inflation Reduction Act, is an unconstitutional tax on unrealized income, that would reduce government revenues by another estimated $247.8 billion over a decade.
The Court might also strike down other taxes that apply to foreign earnings, such as the regime known as Global Intangible Low-Taxed Income (GILTI), with a revenue loss of another $352 billion. And in the most extreme case, the Court could disallow all taxes on unrealized pass-through income and corporate retained earnings. The cost of that: $5.7 trillion over ten years, or almost $600 billion a year.
Tax scholar Reuven Avi-Yonah observes that if the ruling were made retroactive, the revenue loss (and the immediate windfall to multinational corporations) could be even higher. And the hit to government revenue could come before the election, creating an immediate fiscal crisis.
To put this in perspective, the Biden budget for FY2024 is $6.9 trillion. The amount of revenue lost over a decade in the worst-case scenario is almost exactly that. In the immediate terms, an extreme Supreme Court ruling would reduce revenue by something like 10 percent, increase the annual deficit by that amount, and create massive pressure for spending cuts. Such a ruling would also prohibit progressive proposals for some kind of wealth tax, because that would be yet another tax on unrealized gains.
What are the odds of this actually happening? Despite Eisner v. Macomber, for more than a hundred years, courts have allowed the government to tax various kinds of income, as noted above, that might be construed as technically unrealized.
Court watchers who have followed this case say, as in so many other cases, that Chief Justice Roberts will be key. The Court’s three liberals will likely uphold the Ninth Circuit. The most extremist justices will likely vote to do as much damage to government’s power to tax. (Justice Alito recently rejected calls to recuse himself from the case because he had participated in a Wall Street Journal interview that included one of the lawyers for the plaintiffs.)
That leaves Roberts, Gorsuch, Barrett, and Kavanaugh. The most likely alliance is Roberts and Kavanaugh plus the three liberals. But the price of such a decision could be a compromise ruling that disallows some currently permitted taxes as impermissible.
All of this mischief and more, of course, is a consequence of the Trump presidency and the most ideological Supreme Court in U.S. history.
