This week, the Supreme Court will hear oral arguments in Moore v. United States, a case that centers on the mandatory repatriation tax (MRT). The MRT was enacted as part of the 2017 Tax Cuts and Jobs Act (TCJA) and required corporations to a pay a one-time tax on deferred foreign profits. These are profits that were earned by foreign subsidiaries of American businesses, but not returned home and therefore not yet subjected to U.S. taxation.
The plaintiffs, Charles and Kathleen Moore, argue that a ruling in their favor would ensure Congress could never impose a wealth tax. Many on the right oppose such a tax, most famously proposed by Sen. Elizabeth Warren (D-Mass.) and thus organizations like Americans for Tax Reform, the Cato Institute, FreedomWorks, and the Manhattan Institute have filed amicus briefs in support of the plaintiffs. In reality, the case has little to do with such a tax.
Rather, a ruling in favor of the Moores risks upending key elements of the current federal income tax and wreaking havoc on parts of the U.S. economy. As we detail with additional colleagues in an amicus brief in support of the respondent, the federal government, the Court should rule against the Moores and affirm the lower court ruling.
The Moores, shareholders in a manufacturing business based in India, were subject to the MRT on the business’s profits that had not yet been distributed to shareholders. The MRT rate is 15.5 percent if such profits were held in liquid assets such as cash or 8 percent if such profits were illiquid (invested in a factory abroad, for example). The TCJA allows taxpayers to pay the MRT in installments over eight years. The Moores’ MRT liability was approximately $15,000.
At enactment, the MTR was estimated to raise $338.8 billion and was used, in part, to finance the transition to a new system of taxing foreign profits of U.S. multinational corporations. To give a sense of the magnitude involved here: the entire TCJA was estimated to reduce revenue by $1.456 trillion, or just about four times the amount involved here.
Prior to the TCJA, the United States had a “worldwide” corporate income tax with deferred taxation of foreign profits. This meant that profits earned in a foreign country by U.S.-based multinational corporations first faced that jurisdiction’s corporate income tax. If and when those profits were repatriated to the United States, they were subject to additional taxation: the U.S. corporate tax minus a tax credit for any foreign income taxes paid. Because the U.S. corporate tax rate was among the highest in the world (35 percent), any foreign tax credit was almost never sufficient to fully offset additional U.S. tax.
This system created several perverse incentives. Corporations could avoid the additional U.S. tax by holding foreign profits overseas, which led to a significant accumulation of overseas profits. Prior to the TCJA, the Joint Committee on Taxation estimated that there were more than $3 trillion in retained foreign profits. The system also encouraged corporations to shift profits, mobile assets, and their headquarters overseas as strategies to minimize their tax liability.
The TCJA addressed these issues by moving to a “quasi-territorial” system. Under this system, U.S. corporations no longer face an additional U.S. tax when they repatriate earnings. At the same time, the TCJA enacted a minimum tax, without deferral, on foreign profits as a backstop. U.S. corporations now either pay a low-rate U.S. tax immediately on their foreign profits or not at all.
For foreign profits that were earned under the previous system but had yet to face U.S. tax, lawmakers decided that it would be an unfair windfall to completely excuse them from U.S. taxation. These profits had, after all, been earned with the expectation that they would eventually be subject to U.S. tax. And it would have been too complex to require corporations to track two stocks of profits for years or decades: pre-TCJA profits that would face tax when repatriated and post-TCJA profits that face no tax. It was far simpler and fairer to immediately wipe the slate clean with a one-time low tax on all existing unrepatriated profits.
The Moores disagree. They argue that the MRT is “an unapportioned direct tax in violation of the Constitution’s apportionment requirements.” There is an exception to this requirement: the 16th Amendment, which authorizes income taxation without apportionment among the states. But that amendment, they argue, only applies to taxes on realized income, while the MRT taxes unrealized income.
There is, however, no reason to think the MRT is unconstitutional. In fact, the Court need not even consider whether the 16th Amendment applies only to realized income for the simple reason that the MRT is not a direct tax. As an indirect tax, the MRT does not need to be apportioned among the states.
Court precedent clearly does not support the argument that a tax on foreign commerce is a direct tax. Historical sources are clear that all direct taxes are internal. In addition, the MRT is not a direct tax because it is a tax on the use of a certain business entity. Indeed, the Court cited similar grounds when, prior to the adoption of the 16th Amendment, it upheld the corporate income tax as an indirect tax.
Leaving aside any question of constitutionality, a ruling in favor of the Moores risks upending key elements of the income tax. A constitutional requirement that income be realized in order to be subject to tax would increase economic distortions, create policy uncertainty, and reduce federal revenue.
A realization requirement is undesirable because a realization-based tax system is economically incoherent. Economists generally favor one of two coherent tax bases: income or consumption. A realization-based income tax is neither. As a result, it creates economic distortions, such as an incentive to hold on to assets that have gone up in value, as well as unfairness, as equally well-off individuals are taxed differently based on when they buy and sell, and opportunities to avoid paying tax altogether.
A realization requirement would also introduce significant economic uncertainty by calling into question numerous provisions of the income tax that currently deviate from the realization principle. For example, partners in Subchapter K partnerships are taxed on their share of business profits whether or not those profits are distributed. This provision and many more could be subject to years of litigation. During this time, businesses could delay or forgo important investments.
A ruling in favor of the Moores could also put important pro-growth tax policy at risk. The current income tax system deviates from the realization principle by providing depreciation deductions. These provisions allow businesses to deduct the value of an asset prior to its disposal. Under a strict realization requirement, a taxpayer would need to wait until they sold or otherwise disposed of a fixed asset to deduct its cost, similar to how a corporate stock is treated under current law. Many proponents of pro-growth tax reform advocate for the immediate write-off (expensing) of some or all of the cost of these assets as an effective means of lowering the marginal effective tax rate on new investment. In fact, a key provision of the TCJA significantly strengthened this policy. A strict realization rule would risk upending this policy and would raise the effective tax burden on new investment.
A Moore victory could also reintroduce many of the problems with the taxation of multinational corporations that the TCJA sought to address. A realization requirement could undo elements known as Subpart F and GILTI, or global intangible low-taxed income, which tax foreign profits of U.S. multinational corporations without realization. Without these backstops, corporations would have a much greater incentive to shift profits and intellectual property into low-tax jurisdictions.
Besides introducing new economic distortions, a realization requirement could threaten a significant amount of federal revenue. The direct effect of a ruling would be a loss of hundreds of billions of dollars in revenue due to invalidation of the MRT. On top of that, the federal government also risks losing much more depending on the breadth of the ruling. Economist Eric Toder at the Tax Policy Center estimates that the federal government could lose more than $87 billion in 2024 and more than $124 billion by 2028 and every year thereafter. Congress may respond to this lost revenue by enacting taxes that are even more distortionary or by incurring even larger, and less sustainable, budget deficits.
Economists have long understood that whether or not income is realized, it is still income. Nevertheless, it is reasonable and prudent for administrative and other reasons for Congress to distinguish between realized and unrealized income in some situations. For example, measuring income from the appreciation of certain closely held businesses or other illiquid assets is difficult and Congress has reasonably decided not to subject those gains to tax until they are realized. On the other hand, the current tax treatment of partnerships is appropriate to avoid obvious tax avoidance: Such taxpayers could otherwise park their income in their business to avoid tax. It could also be reasonable for Congress to design a system to tax unrealized gains that are easy to measure, such as those that arise from the appreciation of publicly traded assets.
Finally, there is an additional, and somewhat peculiar, aspect to this case. The Moores and several amici argue that the realization requirement they believe is inherent to the 16th Amendment means that a wealth tax, unless apportioned, would also be unconstitutional. It appears as if this logic has served to motivate much of the support behind them.
While we agree that any plausible wealth tax would likely be unconstitutional, there are obvious problems with the Moores’ claim that the MRT is nothing like a wealth tax. A wealth tax applies to the full value of an asset each year. As such, it would not matter whether an asset appreciates or not: A taxpayer would be subject to tax as long as the asset had positive value. In contrast, the MRT applies to earnings and profits of a foreign enterprise, not the value of the foreign enterprise. If the Moores’ foreign business earned no profit or if prior profits had already been repatriated, they would have owed no additional tax.
Given the risks and economic shortcomings of a realization requirement, the Supreme Court should not enshrine it in the Constitution. Instead, Congress should be free to decide whether and how to tax unrealized income.
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