Buried in the entrails of the reconciliation bill (H.R. 4872) that resulted in the passage of healthcare reform, is this insidious provision: Net investment income defined as “gross income from interest, dividends, annuities, royalties, and rents … attributable to the disposition of property” will be assessed 3.8% “Unearned Income Medicare Contribution”.
BusinessWeek estimates, “Overall tax rates on income from interest, annuities and royalties would rise to as much as 43.4%.” By taxing investment income, the new law launches an assault on capital formation and growth. It is also an ambitious reach by the federal government, beyond the current capital gains tax, into revenue sources heretofore reserved to the local communities: personal property.
Defenders of the tax will venture that it applies above the threshold income level of $250,000, therefore hits only the rich; but the fact remains that without indexing or other protections, the new tax may affect more Americans over time, just as Congress’ neglect will subject 30 million this year to the alternative minimum tax — originally intended for only 155 taxpayers.
If an increasing number send a portion of the proceeds of the sale of their homes to Washington, the new Medicare “contribution” could be viewed as a broad property tax, and the seeds of conflict between local and the federal governments will have been sown.
But there may be an incipient constitutional problem with federal property taxes. The framers thought restraining the way Congress applies such “direct” taxes so important, they wrote twice about it: “Representatives and direct taxes shall be apportioned among the several states” (Article 1, Sec. 2), and “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” (Article 1, Sec. 9).
In a series of cases beginning with Pollack v. Farmers’ Loan & Trust Co. (1895), the Supreme Court struggled to elucidate the framers’ original intent on taxes. Pollack established, “In the matter of taxation, the Constitution recognizes the two great classes of direct and indirect taxes, and lays down two rules by which their imposition must be governed, namely: The rule of apportionment as to direct taxes, and the rule of uniformity as to duties, imposts, and excises.” Pollack found that taxes on income derived from property, such as rents, are considered direct, hence subject to apportionment.
Ratification in 1913 of the 16th Amendment removed the apportionment requirement for income taxes: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”
In several cases, the Supreme Court clarified that the amendment serves only to remove the apportionment requirement on income taxes, but that Congress’ “plenary” authority to tax issues not comes from the amendment, rather from the original Articles in the Constitution.
While the Warren Court in 1955 defined gross income as "accessions to wealth, clearly realized, and over which the taxpayers have complete dominion", there are limits to the reach of the amendment. As recently as 2006, the U.S. Court of Appeals in D.C. stated, “The 16th Amendment simply does not authorize the Congress to tax as ‘incomes’ every sort of revenue a taxpayer may receive.” (Murphy v. IRS)
Such consistent references to the Articles as the guiding principles, allowed the constitutional requirement to apportion property taxes to survive even as court decisions over time deviated from original intent in other respects. In Penn Mutual v. Commissioner of Internal Revenue (1960), the Third Circuit Court of Appeals reaffirmed, “Indeed, the requirement for apportionment is pretty strictly limited to taxes on real and personal property and capitation taxes.”
If a reasonable case can be made that the new Medicare tax is indeed a property tax, then apportionment rules must apply, and the opportunity will have been spawned to limit government’s ambitions.
Unintended consequences need not always be negative. It would be fortuitously ironic if the healthcare reconciliation bill and Congress’ “land grab” ignites a debate on original intent and the utility of the 16th Amendment.