PrawfsBlawg

I Fought the Law (the IRS) and the Law Won

Perhaps you've read about the legislation to provide an additional $80 billion in funding for the IRS so that it can hire more agents to go after high income and corporate tax avoiders and evaders.  The first-world story you are about to read might not have occurred if I had been able to get in touch with one of those agents.

It is also a story that suggests perhaps, in my phase-out from full-time teaching, I have too much time on my hands.

The story is about a $311.82 issue I've had with the Internal Revenue Service since this past June.  Here is the punch line.  If the IRS penalizes you $311.82, you try to reach a live person via their 800 number.  But you cannot do so because there is no live person available at the other end. You write letters and get computer generated responses.  You contact the Taxpayer Advocate Office, and it declines to advocate for you.  

At that point, your only recourse is judicial and it turns out, as a practical matter, you have none.  Now that is probably an "access to justice" issue that affects millions of other cases - the legal system simply does not accommodate small matters very well.  And, as I just explained to my wife, there is no small claims court in the federal judicial system.  So even though I have cases indicating (if you keep reading, you can judge for yourself), that I have an open-and-shut winner against the IRS, unless I'm prepared to foot $640, more than double the amount at issue, to pursue it, I've reached the end of the line.  Hence, this cri de coeur.

And, to spare those of you who couldn't care less, it all comes after the break.

The story begins last April.  We have a CPA who does our taxes for us.  We are relatively old, so we've saved some money and it's invested in the markets.  2021 was a good year, but the first quarter of 2022 sucked, so the irony was that we had to pay a lot of money in federal income tax in April 2022 for investment gains that had long since disappeared.  (As I said, first world problem, but whatever....)  Our CPA e-filed four documents for which we were going to have write checks - 2021 income tax to the U.S. and Massachusetts and 2022 estimated taxes to the U.S. and Massachusetts.  On April 14, my wife wrote out four consecutive checks.  I put them in four correctly addressed envelopes and stamped them.  I walked down to the U.S. Post Office mailbox on the corner of Richdale Avenue and Walden Street in Cambridge and deposited all the envelopes.

Let's say that the four checks in the check register were numbered as follows:  1552 - Commonwealth of Massachusetts; 1553 - U.S. Treasury; 1554 - U.S. Treasury; 1555 - Commonwealth of Massachusetts.   When I looked at our bank statement two weeks later, I could see that checks 1552, 1554, and 1555 had cleared (including one of the checks to the U.S.).  Check 1553, the big one for 2021 income tax, had not.  

There is an 800 number to call the IRS about questions like this.  I tried it on several occasions.  One goes through a whole series of prompts before getting the following message and a hang-up: "We are sorry but due to volume we cannot take your call now."  I tried looking at my account in the IRS's online system and found that it was only current as of the end of 2020.

Now I felt like I was between a rock and a hard place.  I called our CPA. He told me the IRS was extremely slow because of COVID and its lack of staff.  The IRS website itself has a form for getting reimbursement for stopped check fees because it is so likely to have lost it.  But I didn't want to stop the check and pay again on the likely chance that the IRS was just ... slow ... and was ready to cash the check.

So I waited.

On June 6, the IRS issued us a CP14 notice for the unpaid taxes (i.e., the amount of check 1553), a late penalty of $311.82, and interest of $178.19.  I immediately stopped payment on the check, and paid via an electronic bank transfer the amount of check 1553.  I declined to pay the penalty and interest.  I looked up on the IRS website how to dispute a penalty.  It said that to dispute a penalty one should call the toll-free number in the upper-right hand corner of the notice.  The only problem was that the CP14 notice had no toll-free number.  And I called the general toll-free number (see above), which resulted in the same "sorry, too much volume" hang-up.  

Hence, on June 13, I wrote a long letter to the IRS office in New York that issued the notice (this time sending it certified mail).  It laid out all the facts and requested cancellation of the penalty and interest.  

There was no response until mid-August when I got a computerized form letter from somebody in the Memphis, Tennessee office of the IRS, acknowledging receipt of the June 13 letter, completely ignoring what it said, and stating that I now owed the penalty of $311.82 plus additional interest.  There was no phone number or any other instruction about how to dispute the finding.

I called my CPA.  It turns out there is a double-ultra secret practitioner phone number to the IRS.  We called it, and ended up with the same "sorry, too much volume" hang-up.

Then it occurred to me to contact my congressperson.  A real (and helpful) person in her office got back to me promptly and said he would contact the Taxpayer Advocate Office of the IRS on my behalf.  When I figured out what that was, I told him "thanks" but I could do it myself.  He told me it was already done and he'd get back to me with the answer.  

A few days later, the Taxpayer Advocate's response turned out to be: (a) I could submit evidence that I had sent the check (e.g. a certified or registered mail receipt), or (b) throw myself on the mercy of the IRS by filing the one-time in a lifetime request for waiver of a penalty for not having paid one's taxes.  I objected to (b) on the grounds that I had paid my taxes, and to (a), after a brief bit of research, on the grounds that (i) 26 U.S.C. §7502(a)(1) states that the date of postmark of something mailed to the IRS is the date of filing or payment, (ii) if the USPS or the IRS loses the envelope then there is no way to see the postmark, (iii) there is no requirement of mailing by certified or registered mail, (iv) in the normal course, the envelope should have been postmarked on the date I dropped it in the mailbox, and (v) there was evidence of mailing, i.e., my testimony that I had in fact mailed it.  That didn't get a rise out of the Taxpayer Advocate Office.

At this point, I was fed up and didn't want interest to keep piling up, so I paid the outstanding claim for penalty and interest with an electronic transfer.

But being, as I am, slightly obsessive about stuff like this, and a lawyer to boot,  I did some research. I quickly found several cases in which petitioners won against the IRS on the basis of their oral testimony that they had deposited the filing or the payment in the US mail.  (See Jones v. U.S., 226 F.2d 24, 28 (1955) ("We take judicial notice of the fact that the overwhelming majority of taxpayers who live elsewhere than in the centers where the offices of collectors are located make their returns and present their claims for refund, and the like, through the mails. Even great numbers of those living in the immediate neighborhood of a collector's office doubtless follow the same practice; and the procedure is encouraged by the collectors since it tends to conserve the time of those officials and their staffs. Reliance upon the mails as the medium through which such deliveries for filing are made may be said to be all but universal."; Wells v. C.I.R., 22 T.C.M. (CCH) 169 (1963); Walter M. Ferguson, Jr., 14 T.C. 846 (1950) ("The final issue has to do with the penalty determined for the alleged failure ... to file a return for 1945. The Commissioner makes and could make no sound argument in light of the evidence. It is unnecessary to decide whether there was a ‘filing.’ This would not be the first time that a collector had lost a return. Even if no return was filed, the failure was due to reasonable cause (failure of the mails) and not to willful neglect ..., so in no event would the penalty be proper.")

A miscarriage of justice and the law is on my side! Now I was prepared to do something I had never done in forty-three years of being a lawyer - file a lawsuit against someone on my own behalf. (The congressperson's office noted that, once I was litigating, House of Representative rules prohibited its further involvement.)

What I discovered is that filing a claim in the US Tax Court, particularly in the small cases division, is really easy.  You can do it in pro per even though I signed as the lawyer for my wife and me.  You can file electronically.  I checked off that I was filing in regard to a disputed notice of deficiency, put together a short but thorough statement.  The $60 filing fee seemed like a reasonable bet against my chances of winning this case.  On August 30,  I filed in the U.S. Tax Court, requesting trial in Boston, seeking reimbursement of the $311.82 penalty and the interest.  (I wasn't sure if the filing fee would be a taxable cost when I won, but I threw that in too.)

Let me note, at this point, that I understood I probably didn't have a good case on the interest.  It was set statutorily at five percent, and that seemed excessive to me versus what I would have earned on the money, but the government would have a reasonable position that I, and not it, had the use of the money for the couple months.  But I was prepared to go to the mat on the penalty.  Millions for defense but not a penny for tribute!

On October 4, I received an email notice that there was a new filing in my case.  I eagerly logged went into Dawson, the Tax Court case management system, expecting to see the government's groveling response.  What I found instead was a motion to dismiss my case for lack of jurisdiction in the U.S. Tax Court.  More quick research.  Well, it turns out I assumed (and we know what that stands for) that the August letter was a notice of deficiency for failure to pay the penalty and interest.  It was not.  Penalties are not deficiencies.  And the U.S. Tax Court has no jurisdiction over disputes about penalties.  I spoke to the lawyer for the IRS, agreed that he was right and that I would concur in the motion and a dismissal without prejudice, and vented to his sympathetic but powerless ear about the injustice of it all.

To be fair, even the Taxpayer Advocate Office within the IRS recognizes this particular unfairness, and have said so in a legislative recommendation recommending that the Tax Court be given jurisdiction over penalty disputes.

Nevertheless, where we stand now is this.  I recognize that I really only have a good case for recovering the $311.82 penalty.  There are courts with concurrent jurisdiction over this claim:  the US Court of Federal Claims and the US District Court for the District of Massachusetts.  The fee for filing a claim in either one of them is $402.  To use the electronic filing system in either one, I would need to become a member of the bar of that court (which I could do) at a cost of $238.  

I have thought about whether making the point is worth $640 and the burden of drafting and filing pleadings for a federal court, as well as burdening the dockets of already overburdened courts.  I decline to do that.  Rather, its value to me is as a story I can now use when telling others with relatively trivial claims that sometimes there's just no justice in the world, and the law can't do everything.

So I give up.

Lawsky Practice Problems - On-Line Tax Teaching and Learning Tool

I've put together an on-line teaching and learning tool for introductory tax courses at

https://www.lawskypracticeproblems.org/

Some questions and answers follow after the break.

Q: What does this website do?
A: It generates multiple-choice federal individual income tax practice problems. The problems are a random selection of facts, names, and randomly (but thoughtfully) generated numbers about a range of basic tax topics. You can pick a particular topic, or you can have the website to pick both  a topic and problem at random.

Q: Are the answers also random?
A: No. The multiple-choice answers are based on mistakes that students commonly make.

Q: What happens once the student picks an answer?
A: If the student picks a wrong answer, the website usually provides a substantive hint about what the student did wrong. A right answer usually returns a full explanation. In many of the explanations of answers both right and wrong, there is a link to the relevant code section. (There is usually a single answer that is randomly generated--if a student selects that, the feedback is the crushing, "This number was randomly generated.")

Q: What topics are covered?
A: Among others, restricted property as compensation; options as compensation; the principal residence sale exclusion; depreciation; recapture; like-kind exchanges; installment sales; and more. You can see the full current list, with information about what’s covered within each topic, here.

Q: Do the questions repeat?
A: Eventually--there are not an infinite number of problems--but there are a lot of different problems. Setting aside the numbers' changing, which doesn't necessarily provide conceptually different questions, different types of problems toggle a bunch of different facts and relationships between the numbers, all of which change the problem conceptually. For example, for like-kind exchanges, there are five different facts than can toggle (asset is personal use or business use, whether there is debt relief and whom that debt relief favors (someone who provides boot or not), etc.) and four different questions. For installment sales there are even more toggles; for unrestricted property as compensation, many fewer. Suffice it to say that so much changes that the most efficient way to solve these problems is to learn the law.

Q: What is this for?
A: Whatever you want. A professor can use to generate problems for teaching or you give students direct access to it; students can use it to practice for their tax classes--whatever works for you. The website is free and is made available under a Creative Commons Attribution-Share Alike 4.0 license, which means, roughly, that you can share this or use it for any purpose, just so long as you give appropriate credit, distribute the material so other people can use it under the same terms, and don't create any additional restrictions.

Q: Is it just problems?
A: No. There is also a page with rate graphs and a rate calculator (and of course some pages that are more on the administrative side—a list of all topics covered, for example).

Q: Does the website take into account inflation adjustments?
A: Yes. Problems, rate graphs, and rate calculations take into account inflation adjustments for 2019 and will, for the foreseeable future, update with the current year’s inflation adjustments.

Q: I found a mistake!
A: Yes! This website is in its early stages, so there are certainly errors. When you find an error, please let me know so I can correct it.

Q: I teach topic X, and I think it would really lend itself to problems like those on the website.
A: Great. Send it my way -- I can't make any guarantees, but I can give it a shot.

Q: This would work for tax classes other than basic tax.
A: Yes indeed! I currently plan to add a page that similarly generates partnership tax problems.

Q: I have another suggestion.
A: Awesome--please send it my way. I very much welcome any suggestions or thoughts.

The IRS Needs to Pay Attention to Pulpit Freedom Sunday 2016

In just over eight months, we'll be voting for our new president. Irrespective of who's on the ballot--and, for that matter, irrespective of who ultimately wins--one thing is for certain: in seven months or so, a bunch of church-goers are going to hear their spiritual leader endorse a candidate.

Sometime during the month leading up to the presidential election,[fn1] the ADF will sponsor its annual Pulpit Freedom Sunday, an act of civil disobedience by churches[fn2] and an attempt to challenge the campaigning prohibition in court.

Basically, in 1954, Congress added a short phrase to section 501(c)(3) of the Internal Revenue Code. That phrase prevents an organization from qualifying for a tax exemption unless it

does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.

The ADF believes that this campaigning prohibition is unconstitutional, at least as applied to churches. So for the last eight years, it has encouraged pastors to flout the rule, to include an explicit endorsement of a candidate in their sermons leading up to Election Day, and then to send a copy of the sermon to the IRS.

During the last presidential election, more than 1,500 pastors apparently participated. And how many churches lost their tax exemptions? None.

The ADF has organized Pulpit Freedom Sunday deliberately to create a test case that it can take to the courts. It expects the courts to strike the campaigning prohibition down as unconstitutional. But it's not just the ADF that wants the test case: Americans United for Separation of Church and State also wants the IRS to enforce the campaigning prohibition. 

Clearly, the two groups think the case will turn out differently. Which is right? It's unclear. Scholars (including me!) have argued extensively about whether the prohibition is constitutional as applied to churches. But the question has only been adjudicated once, by the D.C. Circuit. The D.C. Circuit upheld the prohibition as constitutional, and, for whatever reason, the church didn't appeal to the Supreme Court.

Note that, for various procedural reasons, nobody has standing to challenge the prohibition unless and until the IRS revokes a church's exemption.

Why hasn't the IRS acted until now? Probably because there's really no upside to revoking a church's tax exemption; it's not going to significantly increase the government's revenue, and it would likely be unpopular at best in a world where politicians run against the IRS as a central part of their platform.

But at some point, the reticence becomes too much, as it has here: in 2012, the Freedom From Religion Foundation sued the IRS for not enforcing the prohibition, and eventually settled with the understanding that the IRS would eventually start enforcing it.[fn3] 

And, as I lay out in my recent University of Colorado Law Review article, now's the time. Pulpit Freedom Sunday has reduced the search costs to nearly nothing--pastors send their sermons in to the IRS. I mean, the IRS has to actually look at the sermons, because there's no guarantee that participating pastors fully understand how to violate the campaigning prohibition. (Check out this sermon, for instance: the pastor makes a strong case for religious involvement in politics, but churches aren't prohibited from being involved in politics. Just from endorsing or opposing candidates, which the pastor doesn't do here.)

So what should the IRS do? It should announce, today, that is will revoke the tax exemption of every church that endorses or opposes an candidate for political office as part of Pulpit Freedom Sunday. Then it can sit back and wait for the sermons to arrive, follow through, and get ready to litigate.

That way, both the ADF and Americans United will be happy, and we can have closure on the constitutional status of the campaigning prohibition, at least as applied to religious organizations.

---

[fn1] I'm pretty sure that I read that the ADF is expanding Pulpit Freedom Sunday this year to encompass the whole month of October, but I can't currently find anything that gives a date or dates.

[fn2] Also, presumably, synagogues and mosques and other religious organizations. But honestly, the ADF seems to be thinking Christian-centric, with its choice of Sunday as the relevant day.

[fn3] BTW, though this has nothing to do with this post, isn't the perma.cc thing awesome? The link is already broken, but the University of Colorado Law Review has given it a permanently-findable home.

On Presidential Tax Returns

Last week, Mitt Romney suggested that presidential candidate Donald Trump hadn't released his tax returns yet because there was something--a "bombshell," according to Romney--hiding in them.

Then, over the weekend, Marco Rubio and Ted Cruz released their tax returns. And both used the occasion to follow up on Romney's insinuation by explicitly calling out Trump's intransigence in not releasing his returns.

Now, there's no law requiring presidential candidates to release their tax returns. Rather, it's been a tradition since the 1970s for sitting presidents to release their tax returns, and that tradition has been bleeding into presidential candidates more and more. Still, neither Trump nor any other presidential candidate has a legal obligation to release tax returns.

And the current crop of presidential candidates have bought into the tradition in wildly different ways; in fact, there appear to be three different types of disclosers when it comes to the current crop of presidential candidates: the full discloser, the partial discloser, and the nondiscloser. Without delving into the details of candidates' tax returns here, a quick taxonomy of the current crop:

Full Disclosers

Hillary Clinton has released eight years of tax returns.[fn1] And she released her full tax return. For 2014,[fn2] that means she released a 44-page document. That means it has her 1040, but it also has all of the schedules and supplements that give a full picture of her income and deductions for the year. For example, on page 2 of the PDF, we can see that she took $5,159,242 of itemized deductions. And what were those itemized deductions? Page 33 shows us that $2,819,599 were in state taxes and $3,022,700 were for charitable deductions. And page 33 tells us how those state taxes and charitable deductions were divided.[fn3]

Clinton is the only candidate still in the race who fully disclosed her tax returns.[fn4] Jeb Bush released his full returns from 1981-2014, and Carly Fiorina released her full returns from 2012-2013. Both are available at the Tax History Project.

Partial Disclosers

Ted Cruz, Marco Rubio, and Bernie Sanders have each released partial tax returns.

Rubio's campaign website includes his Forms 1040 from 2000-2014. The thing is, the Form 1040 is basically just the first two pages of a person's tax return. It lays out the relevant numbers (gross income, adjusted gross income, deductions, stuff like that), but it doesn't tell how to get there. His 1040 tells us, for example, that Rubio took $53,329 in itemized deductions in 2014, but it doesn't tell us what those itemized deductions were. Did he give to charity? pay mortgage interest? pay state taxes? We don't have that information. (The one interesting thing is that Rubio doesn't pay his quarterly estimated taxes, and so he pays a couple thousand dollars of penalties basically every year.)

Cruz's website also just includes Forms 1040, from 2011-2014. Like Rubio, Cruz itemizes his deductions, and, like Rubio, we have no idea what those deductions are.

Finally, Sanders doesn't appear to have his tax returns disclosure on his website. The only place I could find it was, again, at the Tax History Project, which includes his 2014 tax return.[fn5] He provided a little more information than just his Form 1040, but not much: in addition to the 1040, he included (part of?) his Vermont tax return. It doesn't provide any additional information, though; like Rubio and Cruz, Sanders itemizes his deductions, and, like Rubio and Cruz, we have no idea what those deductions are.

Nondisclosers

Right now, Trump is the most vocal of the nondisclosers. But John Kasich and Ben Carson are still both in the race, and neither has disclosed his tax returns. Yet, at least.

---

[fn1] You can find another eight years of her returns at the Tax History Project.

[fn2] Note that her 2014 return, as with all of the candidates, is her most recent return; tax returns for 2015 aren't due until April 15, 2016.
 
[fn3] Well, kind of, at least. $3 million of her charitable donations were to the Clinton Family Foundation. And, while Clinton didn't include the tax returns for the Clinton Family Foundation on her campaign website, they're publicly available, including at Guidestar.

[fn4] At least, as of 3:40 pm Central time on February 29, when I'm writing this.

[fn5] He apparently released it at the request of the Washington Post.

The Future of Tax Administration

        In my recent posts, I have been discussing the trend in tax law scholarship toward tax administration, and have suggested possible causes and fruitful areas of inquiry.  In this last post on the subject matter, I want to briefly ask: where might this be going?  My hope is that tax administration scholarship has as significant of a run as recent trends in tax law scholarship.  As a variety of tax scholars have recognized in recent years, how the tax system is administered may be as, if not (in some cases) more, important than what the law is.  And there are so many tax administration programs meriting examination.  To take just a few: the IRS has special programs for taxpayers in the Large Business and International Division (the nation’s largest taxpayers), such as collaborative, pre-filing issue resolution. In a different part of the taxpaying world, the IRS can settle tax debts for less than the amount owed with taxpayers who can’t pay their tax liability and who meet other requirements.  Corporate tax executives hang on the IRS’s every word at  ABA meetings to find out how the IRS intends to apply the law.  And the IRS gives tax advice (not entirely sure to be correct) to individual taxpayers on the phone.  Scholars have suggested in recent years that taxing authorities should play a more prominent role in setting defaults, such as by presumptively taxing or presumptively collecting tax.  How does all this comport with administrative law and scholarship regarding administrative discretion?  I look forward to all my colleagues’ work that will help me find out.

 

Line Drawing and Rulemaking

        As I suggested last post, I think that, as much as scholarship regarding tax law administration will benefit from relying on the (many) decades of administrative law scholarship, having fresh (tax law) eyes interacting with administrative law scholarship might also benefit the administrative law field.  To take one example, I have become fascinated by reading the administrative law scholarship regarding characterizing legislative rules, interpretive rules, and policy statements.  To put the matter simply, legislative rules must comply with notice and comment requirements.  Interpretive rules and policy statements need not.  Notice and comment is thought to integrate important values into the rulemaking process.  However, notice and comment is costly for agencies and, as a result, if it is required, agencies may avoid making rules.  Since it is very hard to distinguish between the three types of rules, many administrative law scholars worry that if too many things are characterized as legislative rules (thereby requiring notice and comment), agencies may reduce the amount of guidance that they issue. 

                One (among many) things that fascinates me about this issue is that, to the tax scholar (very much influenced by the decades of tax law and economics scholarship), this is a classic problem of linedrawing, and how to draw a line as efficiently as possible.  Essentially, we can reimagine the notice and comment requirements as a tax.  Rather than raising tax revenue (as an actual tax would), the notice and comment requirements serve a valuable goal.  However, if the tax (the application of the notice and comment requirements) is too high, people (in this case, agencies) will change their behavior to avoid it (in this case by not issuing guidance at all).  Changing behavior to avoid a tax is inefficient because (1) the tax isn’t raised, and (2) parties have changed their behavior from the optimal behavior they would have preferred in the non-tax world.  In the agency rulemaking context, the imposition of notice and comment requirements is inefficient when agencies simply avoid such requirements by not making rules because (1) the benefits of notice and comment procedures won’t be realized, and (2) the agency will not have issued the guidance it would have liked to issue absent the requirements.

                While it is fascinating to me just to see this problem through the linedrawing / efficiency lens, I think doing so may also yield helpful insights into the administrative law dilemma.  Inefficiencies are just a fact of life with taxes – when taxes are imposed, parties will shift their behavior to avoid them.  Similarly, the existence of notice and comment procedures will necessarily cause agencies to issue less guidance to avoid such procedures.  As a result, the very reduction in guidance shouldn’t cause hand-wringing.  On the other hand, the fact that agencies will inevitably change their behavior also shouldn’t be the end of the conversation.  Rather, the linedrawing scholarship in tax teaches that, while efficiency is not the only relevant criterion, all else equal, taxes should be imposed where behavior is least elastic.  Imposing tax where behavior is least elastic raises the most tax possible while engendering the least behavioral distortion.  Applying this principle to the context of agency rulemaking, then, notice and comment procedures should be imposed when the agency is least likely to change its behavior to avoid such requirements.  The question, then, is when is this likely to be the case?  I wonder whether empirical studies could help determine the likely elasticity of agencies’ responses to the imposition of notice and comment procedures in various situations.  While this may seem like quite a lot to ask as an empirical matter, many years of work in the tax context have revealed quite a lot regarding tax elasticities.  Perhaps merely posing the question at this point might yield some new opportunities for empirical study in the agency context.  At the very least, perhaps the linedrawing lens might be a new, helpful way to conceptualize a seemingly intractable problem in administrative law scholarship. 

The IRS's Dual Role (and Other Agencies' As Well)

        In my last several posts, I have explored a trend toward tax law administration scholarship and how the interest in this topic may be connected with recent, important coverage of administrative discretion generally.  As study of tax law administration continues to develop, I think it will be important to keep in mind the connections between the IRS and other agencies.  Recognizing such connections will allow for fruitful cross-pollination of ideas.  To the extent that commonalities exist between the IRS’s exercise of its administrative discretion and other agencies’ exercises of their discretion, studies of each can inform the other.  Tax law scholars newly thinking about administrative discretion can build on the many decades that administrative scholars have spent thinking about these issues, and administrative scholars may benefit from fresh eyes and detailed study of the IRS as a means of thinking about agencies.

        For instance, one aspect of the IRS’s administrative discretion that I think is currently understudied is the IRS’s dual role as a service agency and an enforcement agency, and how the IRS exercises its discretion in its service capacity.  A number of tax scholars in recent years (including myself) have examined how the IRS can exercise its enforcement discretion to change the scope of the law.  This focus makes sense.  I think that, typically, the IRS is thought of as an enforcement agency.  It is, after all, the agency responsible for enforcing the tax law.  However, as the IRS’s own mission statement acknowledges (and even highlights up front), the IRS is also charged with serving the public.  In particular, the IRS is obligated to help taxpayers fulfill their taxpaying obligations.  As Josh Blank and I are exploring in a new project, as a result of this service role, the IRS expends significant resources explaining what the tax law is in plain writing that many taxpayers can understand.  In so doing, of course, the IRS also exercises significant discretion.  As we show, the IRS’s exercise of this discretion gives the IRS a powerful platform to shape taxpayers’ views of the tax law.

        Other enforcement agencies of course also take on a service role.  Take, for instance, OSHA, which has as its mission “setting and enforcing standards” and “providing training, outreach, education and assistance.”   Similarly to the IRS explaining the tax law, OSHA creates best practices guides for employers, such as a recent Guide to Restroom Access for Transgender Workers.  Like the IRS’s explanations of the law, these explanations help regulated parties comply.  And yet, OSHA's role in creating these best practices guides also provides OSHA a powerful ability to shape regulated parties' views of the law in practice.               

        I tend to think that the sheer extent of the IRS’s service task is greater than most (if not all) other agencies’, making how the IRS exercises its discretion in the service context particularly noteworthy.  Whether or not that is the case, however, the IRS certainly serves as a good case-study for an agency that exercises significant, and important, discretion, in its service capacity.  As a result, hopefully further study of such exercises of IRS discretion can help inform work about the discretion, and power, that agencies exhibit in the context of helping regulated parties comply with the law. 

 

Trend in Tax Law Scholarship

            Hello to the PrawfsBlawg community!  I am a tax law scholar new to PrawfsBlawg blogging, and will explore what I perceive to be an increasingly prominent trend in tax law scholarship. Fields of scholarship, of course, have trends.  This makes sense, as scholars exist in a community of thinkers.  While each individual may be creating her own scholarship, she is undoubtedly influenced by the community of thinkers of which she is a part.  As the community moves in a certain direction, this move inevitably influences each scholar’s own thinking, further solidifying the trend.

                This inclination toward trends is of course true in tax law scholarship, as in other fields.  For quite some time, tax law scholarship (like many other fields) has been influenced by law and economics.  As a result, scholars have spent many years thinking about how to make the tax system more efficient.  Now, I believe that tax law scholarship seems to be undergoing a new trend, toward thinking more about tax law through the lens of administrative discretion and administrative law.  As recent conferences such as the Junior Tax Scholars Workshop and Law and Society reveal, panels addressing administration of the tax law have become a mainstay at tax law conferences.  Indeed, as another indication of this trend, Dan Shaviro recently noted that the NYU Tax Policy Colloquium papers this past year exhibited a somewhat unexpected shift away from economics and toward administration.

                What might be explaining this trend?  What administrative issues are ripe for examination?  Where might this scholarship be going?  As someone working on a new paper regarding administrative simplifications and the tax law (with Josh Blank), I am quite interested in these questions.  I’ll spend some of my next posts exploring this increasingly prominent trend in tax law scholarship.

Osofsky on tax nonenforcement (guest post)

The following is by Leigh Osofsky (Miami)

 

President Obama's recent immigration nonenforcement announcements have caused scholars to go searching for an appropriate lens through which to judge executive nonenforcement.  The problem is that each of the potential lenses relies on distinctions that are not coherent, or are almost impossible to apply.  

For instance, many constitutional scholars have suggested that categorical nonenforcement is impermissible, whereas merely setting priorities (or, some would say, case-by-case discretion) is permissible.  The President and the OLC have implicitly adopted this distinction, by taking pains to state that case-by-case discretion has been maintained in this case. However, the distinction between categorical nonenforcement and setting priorities (or case-by-case discretion) is more illusory than real.  Is a nonenforcement policy, like President Obama's recent immigration policies, really not categorical if it preserves some case-by-case discretion in a manner that nonetheless assures millions of people that the threat of deportation has, for all intents and purposes, been lifted? If it is so easy to disguise what is in reality a categorical policy as a case-by-case policy should the legitimacy of the action really turn on such a distinction? Another distinction that constitutional scholars often make is the distinction between nonenforcement motivated by enforcement resource limitations (widely believed to be legitimate) and nonenforcement motivated by policy (widely suggested to be illegitimate).  The OLC notes that it is not relying on this distinction alone in opining about President Obama's nonenforcement policies, and for good reason.  How it is possible to make this distinction in an intellectually coherent way when thinking about an agency that is perpetually resource-strapped?  While many instances of nonenforcement will save resources, there is inevitably going to be some policy reason why a particular nonenforcement strategy is chosen.  Should the legitimacy of nonenforcement rest on the distinction between policy and enforcement resource limitations when they are so often going to be intertwined?  Finally, the OLC introduces a new, and quite interesting test in its recent opinion.  The OLC looks to whether nonenforcement is consistent with Congress's intent, as expressed through the relevant statutory scheme. However, as Cristina Rodriguez and Adam Cox have suggested recently on Balkinization, making this determination in the context of a vast and complex statute is going to be exceedingly difficult.  

So how should we judge nonenforcement given the difficulties of the existing lenses?  I am not sure I have the final answer but I do believe that something important has been left out of the analysis thus far.  When an agency does not enforce the law, it is substantially affecting rights and obligations.  A long line of literature regarding administrative legitimacy has contemplated how an agency can have a substantial impact on rights and obligations under the law in a legitimate way.  Three hallmarks of agency legitimacy are: accountability (under political accountability theories of the legitimacy of the administrative state), deliberation (under civic republican theories of the legitimacy of the administrative state), and nonarbitrariness (under nonarbitrariness theories of the legitimacy of the administrative state).  

 

In a recent (working) Article http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2513349 , I argue that in certain circumstances categorical nonenforcement of the law can increase the accountability, deliberation, and nonarbitrariness of inevitable agency nonenforcement of the law.  The Article is intentionally rooted in agency nonenforcement (and in the tax law in particular), rather than an examination of the recent, highly-charged presidential nonenforcement of the law, but it nonetheless may have much to offer to the current debate.  In short, the Article suggests that the existing distinctions for analyzing nonenforcement may be insufficient, and that we should at the least integrate the lens of agency legitimacy into the analysis.

SEALS

Think about proposing programming for the annual meeting, or participating in a junior scholars workshop. And if you are ever interested in serving on a committee, let Russ Weaver (the executive director) know. The appointments usually happen in the summer, but he keeps track of volunteers all year long.

IRS: "sorry, can't produce" or a bad example of hiding the ball?

Last week, the IRS stated that it lost numerous emails from Lois Lerner concerning the targeting of conservative groups for tax exempt status because her computer crashed.  And this week, the IRS is now revealing that it has lost numerous additional emails from key IRS officials.  Politics aside, it is interesting to think how this discovery issue involving electronically stored information (ESI) would be addressed in a federal court under the Federal Rules of Civil Procedure (FRCP).

The facts surrounding this issue almost read like a law school exam hypothetical.  The IRS received a subpoena to produce emails between key IRS officials and other government agents that might suggest targeting.  The IRS knew months ago, in February, that it could not produce the emails, but failed to inform Congress that the emails were lost until just the last few days.  The IRS has taken the position that the emails were lost during a computer crash in 2011 but that the IRS has made a "good faith" effort to find them having spent $10 million dollars (of tax payer money) to deal with the investigation including the cost to piece together what could be found.  The IRS does not deny that the recipients, other government officials, may still be in possession of the emails.  The IRS, however, maintains that because the subpoena was only directed at the IRS, not other government agencies, the non-IRS recipients of the emails are not required to produce them.

If this issue arose in federal court, under FRCP 26, parties are required at the outset to submit a "discovery plan" that includes how ESI will be retained and exchanged in order to prevent unnecessary expense and waste.  The FRCP requires the parties to take reasonable steps to preserve relevant ESI (a litigation hold) or face possible sanctions.  Under Rule 37's so-called safe harbor provision, however, "absent exceptional circumstances, a court may not impose sanctions ... for failing to provide electronically stored information lost as a result of the routine, good-faith operation of an electronic information system."  The IRS is hanging its hat on this safe harbor rule by arguing that, despite a good-faith effort, the emails were lost.  Did the IRS, in fact, make a good faith effort?

While there is confusion among the courts on how to apply the good faith standard, there is precedent for a court to monetarily sanction the IRS if the court found that the IRS acted negligently when it lost the emails.  The court would also have the authority to issue an adverse inference instruction (inferring that the lost evidence would have negatively impacted the IRS's position), if it determined that the IRS acted grossly negligent or willful. 

An important fact which will probably be discussed during the next few hearings is whether the IRS violated its own electronic information retention policy.  The IRS was put on notice of the investigation last year, and so had a duty to put a litigation hold on the emails at that time (the very essence of what "good faith" means).  It seems that the general IRS retention policy of ESI was six months (although now it is longer), but emails of "official record" had to have a hard copy which would never be deleted.  Whether these emails constituted an "official record" is hard to determine since Lerner won't testify to their content. 

Even assuming the emails were lost before a litigation hold could be placed (or despite a litigation hold being in place), at the very minimum, it seems "good faith" means that the IRS should have notified Congress in February that it lost the emails.  Rule 26 would have required Congress to do so.  Indeed, such notice would have brought this issue to the forefront and could have saved a lot of money - the money it apparently has already cost to piece together some of the emails, and the money it will cost as the parties argue over whether the IRS negligently or willfully destroyed evidence.  If the IRS had been upfront from the beginning, then subpoenas could have been issued months ago to other agencies who, as employers of the lost email recipients, might have copies of the missing emails.

If this discovery issue had arisen in federal court, the IRS would have likely been subject to monetary sanctions and possibly an adverse inference instruction.  Shouldn't the IRS be held to these standards?

 

Wrap-Up for "Making the Modern American Fiscal State"

Many thanks for all our participants, especially Ajay Mehrotra, for our club on "Making the Modern American Fiscal State: Law, Politics, and the Rise of Progressive Taxation, 1877-1929."  Here is a list of the posts:

• Introduction
• Bank: The Rise of Progressive Taxation:  What Does it Mean to be Progressive?
• Parrillo: American Fiscal State-Building, Crisis, and Contingency
• Morse: Mehrotra tackles two mysteries in Making the Modern American Fiscal State
• Avi-Yonah: Avi-Yonah on "Making the Modern American Fiscal State"
• Lindsay: “You didn’t build that” and the “Benefits” Theory of Taxation
• Mehrotra: Making the Modern American Fiscal State, Central Themes and Claims
• Lindsay: The Citizen-Consumer and the Origins of Progressive Income Taxation
• Mehrotra: Taxation, Civic Identity, and the Future of Consumption Taxes

Many thanks to all our participants for a great club.  And if you enjoyed this club, check out the online symposium at Balkinization for Nick Parrillo's book, Against the Profit Motive: The Salary Revolution in American Government, 1780-1940.

Taxation, Civic Identity, and the Future of Consumption Taxes

Thanks again to Matt Bodie and Prawfsblawg for hosting this discussion of my book, and for the commentators for their thoughtful questions and critiques.  As I mentioned in my previous post, I thought I’d try to address some of the more specific questions raised by the readers and comments in their earlier posts. But before I do that I also want to reply to Matt Lindsay’s fascinating comment about the historical relationship between the rise of progressive taxation and consumer citizenship.

Matt makes the brilliant observation that the progressive critique of the tariff as a regressive consumption tax became more salient at the turn of the twentieth century, and not earlier, because by then one’s capacity to consume became more central to new notions of civic identity.  I think Matt is absolutely correct, and this is a parallel that is, admittedly, rather under-developed in my book.

I do make reference, as Matt notes, to the neo-Jacksonian critique of the tariff as the “mother of all trusts,” and thus as a form of “state capitalism” that many nineteenth-century reformers adamantly opposed.  But I don’t do enough with the literature on shifting notions of civic identity between production and consumption.  Part of the reason was because I had a hard time squaring my periodization with the historiography which frequently contends that the rise of consumer citizenship came later, generally in the mid-twentieth century.  Matt is quite right that the movement for a living wage, which many of the progressive economists I study supported, is the early version of this shift in civic identity.  I just didn’t see many of my historical actors making this connection.

What I tried to do, instead, was frame this change in civic identity as part and parcel of a broader shift in visions of state power.  Unlike the neo-Jacksonians who were critical of government from a “classical liberal” perspective, the reformers in my book were more open to the exercise of public power.  The University of Wisconsin political economist famously noted that he and his cohort of “new school” economists believed that the state was “an ethical agency whose positive aid was an indispensable condition of human progress.” In this sense, these reformers were an essential part of what historian Mary Furner has referred to as the rise of a “new liberalism” in American law and political economy. Progressive taxation based on the principle of “ability to pay” was, I argue, a key element of that new liberalism.

Matt’s observation also reminds me that part of what I’m trying to do in the book is stress the importance of pre-WWI foundations.  Nick Parrillo also draws attention to this pre-crisis institution-building.  I try to show in the book that these pre-war tasks – from laying the intellectual and emotional spadework, to creating the constitutional and legal foundations, to implementing administrative innovations (like a crude form of withholding) – were all absolutely crucial to the accelerating development of the modern fiscal state during the war, and also responsible for its resiliency after the war.  Thus, what might appear as comparatively small-scale changes (though amending the constitution was hardly small scale), were in the long duree quite significant.

Reuven Avi-Yonah raises another important, historically-specific question about Edwin Seligman and how he seemed to take an inconsistent position on the different theories underlying early twentieth-century tax policy.  Reuven rightly notes that Seligman played a major role in the 1920s and later in shaping the international tax regime based on the benefits principle of taxation, not ability to pay.

This is a critical observation.  Although I do not deal directly in the book with the development of 1920s international tax policy, I can say that Seligman and his cohort of “new school” economists did not believe that any one theory could be used transhistorically to support all tax policies everywhere.  As German-trained historicists, they firmly believed that policy was a function of changing contexts and conditions, and they were quite clear in arguing that while the ability to pay rational was appropriate in supporting progressive income and wealth-transfer taxes at the national level, benefits theory still had an important part to play at other levels of government, particular the local level.

From this, I think we can extrapolate that the new school economists led by Seligman would have been more than comfortable in using benefits theory for international tax policy, without seeing their move as somehow intellectually inconsistent.  International tax policy was fundamentally different from national tax policy, especially during the height of industrial capitalism, and thus they would have been open to alternative theoretical justifications.

Let me conclude by addressing a couple of questions raised by Susie Morse, Reuven, and Matt Lindsay about what my tale may tell us about today’s tax debates.  In the conclusion, I gesture to how the “fiscal myopia” I trace in the book may be partially responsible for why American tax theorists and policy analysts continue to fixate on the progressivity of our tax system, while neglecting how a more holistic view of the tax-and-transfer system could address issues of inequality and regressive taxation.  Susie, Matt, and Reuven each wonder whether the bias I identify has locked us into a resistance to consumption taxes and a neglect of how progressive spending can outweigh regressive revenue extraction.  The book has a rather pessimistic view, listing several reasons why we might be locked-into this bias – not the least of which is the kind of American exceptionalism that Matt identifies.

Recently, though, I’ve become slightly more optimistic about this issue.  If we’ve learned anything from American political or policy history, it’s that moments of crisis can lead to transformative changes.  And if the policy analysts are correct that the U.S. is about to face a major fiscal imbalance when entitlement spending far outstrips revenue projections, perhaps we will be able to overcome this fiscal myopia – perhaps we will see something like a VAT that can generate the revenue necessary to underwrite our commitment to a modern regulatory, administrative, social-welfare state.

We’ll have to see.  My book is just a humble story about the past – it’s not a bold prediction about the future.

Thanks again to Matt and PrawfsBlawg for hosting this discussion.

Making the Modern American Fiscal State, Central Themes and Claims

First, let me begin by thanking Matt Bodie and the other folks at PrawfsBlawg for hosting this online book symposium, and the readers for their insightful commentaries.  Many of the readers/commentators have seen this book project evolve over time and I’ve learned immensely from their earlier feedback and their own scholarship.  I’ve also enjoyed reading the other book club posts at this blog, and I’m honored and delighted to have the opportunity to discuss my new book with PrawfsBlawg readers.

With this initial post, I thought I’d try to address some of the book’s more general themes and central claims – many of which have already been eloquently summarized by several of the commentators.  I’ll follow up soon with a second post addressing some of the more, historically-specific questions posed by the readers and comments.

So, let me begin by addressing two key issues drawn from the commentators’ posts: (1) the political consequences of the rise of the modern fiscal state – intended and unintended; and (2) the importance of crisis and contingency – as they relate to theories of historical change.

Political consequences – intended and unintended.  Steve Bank accurately notes that the reformers and state-builders who are the key protagonists of my story were seeking to create a moderate fiscal state.  Although there were calls from the far left for more radically redistributive taxes, it was the middle-ground progressive activists, thinkers, lawmakers and administrators who ultimately prevailed.  One reason they did so, as Matt Lindsay notes in his commentary, is because they had to work within the confines of an American political culture that was suspicious of centralized state power.  The existing historiography tends to overemphasize, in my view, the strength of this anti-statist strand of American politics.  And thus one of the main objectives of my book is to show that turn-of-the-century progressive reformers were able to take advantage of economic crises and national emergencies to overcome conservative resistance and create a more social-democratic fiscal state.  Indeed, Thomas Piketty seems to agree that the United States in the early twentieth century was pioneer in adopting direct and graduated taxation.

In this sense, I do not believe that many of the historical actors in my account intended the new tax regime to be a temporary or fleeting part of the revenue system.  To be sure, they advocated graduated income and wealth-transfer taxes as a counter-balance to the regressive incidence of the existing regime of national tariffs and excise taxes – at a time (the first Gilded Age) when American society was riddled with massive economic inequalities.  But many of my historical characters contended that this new tax system would be essential for much more than just raising revenue or recalibrating the distribution of tax burdens.  They sincerely believed that taxes, as part of the social contract, could also reconfigure notions of civic identity – or what I refer to as “fiscal citizenship.”  Many of them also came to see direct and progressive taxes as a way to shape political institutions by building a vital administrative infrastructure, as Nick Parrillo has observed in his comments, and as he has argued in parts of his recent book.  These were the intended consequences of the progressive fiscal state-building agenda.

But there were also several unintended consequences.  Indeed, one of the great ironies that frame the book is how the so-called “success” of the “ability-to-pay” logic supporting the progressive income tax may have forestalled a more holistic American understanding of the tax-and-transfer process. In the book, I argue that by rejecting the “benefits theory” of taxation and exalting the “ability to pay” rationale, reformers severed the link between state spending and revenue generation. By stigmatizing nearly all consumption taxes as regressive and outdated expressions of the benefits principle, they limited the imagination of future American tax theorists and reformers.  By defining fiscal justice exclusively by the progressivity of a tax system based on ability to pay, reformers created what I refer to as a kind of “fiscal myopia” that foreclosed the consideration of broad-based, European-style consumption taxes as a means to finance modern social-welfare spending.  Thus, one of the “presentist” upshots of my book, as Susie Morse and Reuven Avi-Yonah note, is to explain how the origins of our current tax system may partially explain why the U.S. tax system, which lacks a value-added tax (VAT), is such an outlier compared to its OECD counterparts.  Incidentally, in the book’s introduction, I gesture toward how intellectual currents may have contributed to other causes explaining why the U.S. has not adopted a VAT.

Matt Lindsay acutely notes another irony or unintended consequence in my story.  By referencing the recent “you didn’t build that” controversy, Matt makes a great case for how “the defeat of the benefits theory a century ago has made it possible to deny any element of reciprocity, and thus to assert a kind of fiscal atomism that’s more strident than ever.”  I think he is absolutely correct.  But I’m not sure if this is a legacy of the progressive period, or whether it is a representation of a more recent fiscal transformation.  As I try to explain in the book’s conclusion, I believe that since the 1960s, we have entered a new fiscal epoch – one in which there is a diminished sense of social responsibility and democratic obligation.  Whether we refer to this period as an era of Bowling Alone or as Age of Fracture, there’s no denying that we’ve witnessed the growing disintegration of the social.  In this sense, my book is really about a lost moment in American history – a moment when progressive reformers, thinkers, lawmakers, administrators and ordinary citizens believed in social solidarity and collective obligations.

Crisis and contingency – theories of historical change.  In his thought-provoking commentary, Nick Parrillo has pushed me to elaborate on my theory of American political development, or more broadly on my understanding of historical change.  Nick and Susie both correctly observe that WWI is in some ways the climax or linchpin of my story, but that I’m also resistant to the conventional account of war as the handmaiden of state-formation (a la Charles Tilly, et al.).  Indeed, just as I am skeptical of the existing literature’s overemphasis on American anti-statism, I have been equally uncomfortable with the claims of historical social scientists that “war makes states” (Tilly 1985).  Thus, the book tries to show that war is not simply an exogenous variable that ineluctably determines the size and shape of nation-states.  In contrast to this Darwin logic of natural selection, I try to show how social movements, political activists, public intellectuals, power lawmakers, and key government administrators all engaged in a highly contested, contingent, and uncertain battle over the ideas, laws, and institutions that would come to define the new fiscal polity.

Still, one may wonder, as Nick does, whether my account would have been dramatically different if the United States had not adopted the intellectual and legal foundations for direct and progressive taxation before the national crisis of the Great War.  Nick poses just such a counterfactual.  This is an intriguing question.  And as Nick no doubt knows historical counterfactuals can be both illuminating and dangerous.  If I had to guess, I would think that the U.S. would have adopted a more moderate and perhaps temporary income tax, based on the Civil War precedents, to raise the revenue to wage a global war.  The other options seem less likely. 

All this, of course, raises the central question whether my historical narrative is in tension with my theory of historical change.  Susie and Nick have both pushed me to re-examine whether war is or is not the explanatory variable.  To answer this critical question, I think one needs to draw a distinction between fundamental causes of historical change versus triggering or catalytic events.  As I see it, the fundamental causes of the fiscal transformation I have set out to explain were afoot well before the war emergency: the pre-crisis conceptual shift, which itself was rooted in the rise of industrialization and a more interdependent society; a constitutional amendment (16^th); a new legislative basis; and the beginnings of an administrative apparatus – all these were the drivers of the fiscal revolution.  The war was mainly a triggering event that accelerated a process that had begun much earlier.  I’m not sure if I make this distinction between causes and triggers clear in the book, but this might be one way to reconcile my historical account with my theory of American political development.

In my next post, I hope to take on the more specific questions raised (or yet to be raised) by my thoughtful interlocutors and any other commentators.

 

American Fiscal State-Building, Crisis, and Contingency

 

In his sweeping and sophisticated new book, Making the Modern American Fiscal State, Ajay Mehrotra takes on a transformation of profound and enduring importance: America’s shift from a tax regime that was relatively regressive and indirect (centered on the federal tariff) to one that is relatively progressive and direct (centered on the federal income tax).  Chapter 1 of the book sets the stage by introducing us to the old tax regime that prevailed as of the 1880s, especially the tariff.  Chapters 2 through 5 explain how the new regime first gained a foothold in American government -- in the spheres of intellectual discourse, law, and government institutional capacity.  At the end of Chapter 5, the year is 1915: the Sixteenth Amendment has been ratified, Congress has enacted an income tax targeted at the highest earners and corporations, and the Treasury Department has begun its collections, using the crucial administrative technology known as “stoppage-at-source” -- a crude early form of withholding.  We can, at this point in the story, recognize the essential features of our present regime.  Yet they exist only in embryo: the income tax itself is still tiny, with a top rate of 7%, accounting for only 8% of federal revenue (p. 352).  It takes the crisis of the First World War -- with its tremendous revenue demands -- to cause the federal income tax to grow from a mere embryo into the workhorse of the American state.  The Great War takes up Chapter 6, and it is the climax of Mehrotra’s story.  The income tax's top rate skyrockets to 77%, and it ends up providing most federal revenue (p. 300, 352).  The revolution is locked in: even in the putatively reactionary 1920s, as Mehrotra argues in his concluding Chapter 7, the top rate doesn’t go below 25% (more than triple the prewar figure), and the tax accounts for about 50% of federal revenue (p. 352). 

Yet despite the centrality of the WWI crisis to the transformation Mehrotra chronicles, he is keen to resist a simple functionalist account in which (to paraphrase Charles Tilly) the war makes the state.  As Mehrotra insists: “the wartime fiscal revolution was not merely a functionalist response to the need for revenue ....  The wartime tax regime embodied, instead, a complex continuation of the conceptual shift in public finance advanced by prewar progressive intellectuals and political leaders ....” (p. 295; see also pp. 22-25).  Mehrotra assigns great importance to this pre-crisis conceptual shift -- he devotes more than half the book to it (Chapter 2-5), in which he explains how reformers provided the income tax with a well-articulated economic and moral justification, a constitutional space, a legislative basis, and the beginnings of a bureaucratic apparatus. 

I think that Mehrotra’s rendering of this story reflects (or, at least, can be invoked to support) a certain theory of political development, one that I would like to discuss in this post. To do so, let me pose a counter-factual.  Say that WWI had occurred just ten years earlier.  Had the United States gone to war against Germany in 1907, rather than 1917, the prospect of ramping up the income tax to pay for the war would’ve looked very different.  It would’ve been constitutionally doubtful, would’ve demanded a much bigger leap in terms of new legislation, and would’ve required building a collection apparatus (e.g., stoppage at source) from scratch, rather than scaling-up a prototype.  Further, the intellectual justifications would’ve been less developed.  One can imagine that, in such circumstances, the U.S. government might’ve tried to finance the war by intensifying the old regressive regime, paying for the conflict with heightened tariffs, expanded excises, and borrowing.  This might’ve entrenched the old regime further and/or made the U.S. war effort less successful.  Alternatively (or in addition), the U.S. government might’ve tried an income tax, but it would’ve had to be “on the fly,” without the foundation-laying that Mehrotra emphasizes in Chapters 2-5.  That is, it would’ve been similar to what did in fact happen in 1917-18 with the War Industries Board, whose management of production and procurement was far less successful than the Treasury’s financing operations (and note the WIB didn’t survive once the crisis ended). 

That the income tax performed so well in WWI suggests that a comparatively small amount of pre-crisis institution-building -- consisting mostly of pre-organizational tasks like justifying the policy, carving out the constitutional space, and enacting the statute, plus a few initial organizational tasks like implementing stoppage-at-source on a small scale -- can go a long way in terms of intra-crisis (and post-crisis) operations.  

On this point, it’s illuminating to compare Mehrotra’s book with a classic study of crisis-driven American state-building, Theda Skocpol and Kenneth Finegold, “State Capacity and Economic Intervention in the Early New Deal,” Political Science Quarterly 97 (1982): 255-278, elaborated in their book, State and Party in America’s New Deal (Madison: Univ. of Wisconsin Press, 1995).  Focusing on the economic crisis of 1933, Skocpol and Finegold argue that the Agricultural Adjustment Act succeeded while the National Industrial Recovery Act failed because the AAA drew upon the mature, long-developed policy thinking and implementational knowhow of the U.S. Department of Agriculture, whereas the NRA had no mature state apparatus to rely upon.  Personally, I find Skocpol and Finegold’s account of these two programs compelling.  But their study is limited in what it can tell us, because their two cases are both so extreme.  NRA had zero pre-crisis institutional capacity, whereas the USDA was extraordinary in that regard, having built routinized and attractive career paths for its personnel over the preceding decades. 

The Treasury Department’s income-tax apparatus in WWI, as reconstructed by Mehrotra, presents an intermediate case: it had not enjoyed nearly as deep a process of maturation as USDA had by 1933, but neither was it forced to start from zero like NRA.  When it comes to institution-building, crisis is opportunity (to paraphrase Rahm Emanuel).  But laying the foundations for institutions -- even if these are largely intellectual or legal (i.e., merely “on paper”) -- may determine what kinds of opportunities the crisis presents. 

Seen in this light, the exact timing of WWI (determined by events exogenous to America and thus arbitrary from the American perspective) seems fortuitous and highly consequential for American political development.  Consistent with path-dependence theory (to which Mehrotra is sensitive, e.g., p. 354), major consequences arise from relatively small initial events and are to some degree random.  I’d like to hear what Mehrotra thinks of this reading.  How much is our present-day fiscal regime an accident of timing?  Had the Treasury Department’s progress not happened to be a few years ahead of the German U-boats, would we all be paying different taxes today?  

The Rise of Progressive Taxation: What Does it Mean to be Progressive?

                Ajay Mehrotra is a leader of a new generation of tax historians and a pioneer in the field of fiscal sociology.  Befitting his richly interdisciplinary training and acculturation, Ajay’s work is not merely a history of the tax laws, but offers an almost anthropological peek at the development of the fiscal architecture in this country.  Indeed, Ajay is one of those writers where I’m tempted to read the footnotes before I read the main text.  His citations to authority often provide an unparalleled literature review of the field.  As an added bonus, many of his footnotes actually have pinpoint cites, unlike some historical books where the reader is left to wonder whether the author has actually read the books he is citing.  With Ajay, there is no such worry.  He reminds me of fellow tax historian Assaf Likhovski of Tel Aviv University in his polyglot-like fluency in the literature of multiple disciplines.

In Making the Modern American Fiscal State:  Law, Politics, and the Rise of Progressive Taxation, 1877-1929, all of the best qualities of Ajay’s work are on display.  The book is careful, nuanced, informative, and comprehensive.  Although Ajay is not the first to observe this, the book beautifully describes how the revenue system was radically re-made over this period and beyond, shifting from a system focused on regressive customs duties and excise taxes (based upon the “necessity to consume”) to a system primarily based on taxing incomes and intergenerational wealth transfers (based upon the “ability to pay”).  As befitting someone steeped in the Elliot Brownlee tradition of economic history, Ajay devotes ample time to profiling the pioneering public finance economists who Ajay gives credit for this progressive transformation, including Henry Carter Adams, Richard T. Ely, and Edwin R.A. Seligman.  Perhaps his greatest contribution is in the book’s detailed description of the centralization of fiscal authority and the concomitant development of the administrative apparatus to operate the new system.

 

What I fear what may be lost amidst the subtitle and the momentous nature of the transformation is the extent to which the progressivism involved in the shift was more contextual, political, and contingent than the rhetoric might suggest.  Although there were certainly those who envisioned a radically redistributive type of progressive taxation, they weren’t exactly the winners in this debate.  Arguably, the prevailing theory of income taxation was one that is hardly ever discussed today and I did not see mentioned in Making the Modern American Fiscal State – one Edwin Seligman called the “special compensatory theory.”  This was distinguished from the general compensatory theory, which posited that the income tax was necessary to offset “the inequalities consecrated by custom and by law” whereby “the legal conditions of society naturally favor the rich.”  Under the special compensatory theory, the revenue system is viewed as a whole and one form of taxation is made progressive to make up for the regressive effects of another specific form of taxation.  As Seligman wrote in the 1908 edition of his treatise on Progressive Taxation in Theory and Practice, the income tax and other similar direct taxes are “designed to act as an engine of reparation” against the regressivity of the customs duties and excise taxes.  “In order to obtain equal treatment the regressive indirect taxes must be counterbalanced by the progressive direct tax.” (Seligman, pp. 144-146)

It’s not that Ajay ignores this part of the story.  For example, Ajay explains that in 1894 “[income tax advocates . . . reminded their opponents that the proposed income tax was merely a supplement to a larger tariff regime, and that national taxation was just one part of a broader fiscal order that included many forms of regressive taxation.” (p. 128).  It’s just that Ajay characterizes this as a political compromise that served as a weigh station on the road to the true progressivity of an income-centric tax system, rather than being a part of the design itself.  Under this latter perspective, the transformation in the revenue system that began during this period envisioned an income tax in which the base and the rates ratcheted up or down based on the makeup of the remainder of the system.  Indeed, during the debates over the first post-Sixteenth Amendment income tax bill in 1913, Senator John Sharp Williams, the leader of the Democratic caucus, argued that “when the good day comes – the golden day – when there will be no taxes upon consumption at all . . . and no import duties at all except countervailing duties to offset them [then] everybody will pay in proportion to his income,” meaning a flat rate.  In effect, the transformation Ajay describes was important and it was progressive (in no small part due to the advance of fiscal citizenship that is one of Ajay’s themes), but it was not necessarily designed to lead to progressive income taxation as a permanent feature of the revenue system.

Perhaps this is why the “retrenchment” Ajay describes in the 1920s was not really a retreat from the principles of progressivity that helped motivate the original income tax.  Instead, it was more a reflection of the post-World War I return to the mean for income taxation in its service as a mild counterbalance to the continued presence of regressive features, including, in more modern times, the regressivity arising from the unequal distribution of tax evasion opportunities.  In many respects, the fundamentally moderate or even conservative underpinnings of the original income tax continues to describe the tax system and frustrate reformers, such as those who see Thomas Piketty’s recent tome as a clarion call for new forms of wealth taxation.  

Book club on "Making the Modern American Fiscal State"

Just wanted to provide a heads-up that on Tuesday, June 10, we'll be hosting a book club on Ajay Mehrotra's new book, "Making the Modern American Fiscal State: Law, Politics, and the Rise of Progressive Taxation, 1877-1929."  Joining us for the club will be:

• Reuven Avi-Yonah, University of Michigan Law School
• Steven Bank, UCLA School of Law
• Matthew Lindsay, University of Baltimore School of Law
• Susan Morse, University of Texas School of Law
• Julia Ott, The New School
• Nicholas Parrillo, Yale Law School

Hope you can join us.

Inside the Mind of Mankiw: A Dialogue

Over the weekend Greg Mankiw was moved once again to speak out against increases in the top marginal income tax rate.  Rather than threatening a massive withdrawal of human capital, Mankiw took a different approach.  Instead he created an imaginary internal dialogue between a "moderate" Obama and a "liberal" Obama.  I've always enjoyed this type of dramatic device, so I thought it'd be fun to imagine the dialogue between "libertarian advocate" Greg Mankiw and "rational actor" Greg Mankiw.  Here we go!

 

 LIBERTARIAN MANKIW: Oh boy -- it looks like the top tax brackets are about to get jacked up!  This is terrible!

RATIONAL ACTOR MANKIW: Just like in 2008 and 2010, when we predicted that the John Galts of the world would deprive the world of their talents?  Wake me in another two years.

LIB: But this time it might actually happen!  Obama is talking tough, Boehner is showing signs of weakness, and most people actually think it's not a bad idea!

RAT:  Sorry, but I can't get too worked up over this.  Maybe we can just run that 2010 column again.

LIB: For a third time?  I'm not sure it was so persuasive the first two times.  I think we need a new strategy.

RAT: The Times doesn't pay us nearly enough for these columns.  I don't get out of bed for less than $10,000.

LIB: But this is our chance to shape the minds of America!

RAT: You mean the minds of Times readers. These are folks who advocate for higher taxes while reading about "reasonably priced" Massimo Dutti fashions.

LIB: Yes, precisely! They're torn between an ideological desire for higher tax rates and a personal desire to have more money.

RAT: Everyone wants more money.

LIB: Exactly!  So we have to come up with some excuse to get them off this line in the sand about raising the marginal rates for incomes over $250,000.  Obama doesn't really want to raise taxes, either -- he wants some sort of Grand Bargain that shows compromise and bipartisanship.  How do we do this?

RAT: This sounds too hard.  Are you sure we can't three-peat?

LIB: Hmmm.  We just need some literary device . . . .

RAT: How about a column set in the future, designed as a warning about the present?  Those always have the subtlety of a sledgehammer.

LIB: We did that already.

RAT: I know -- but when has that stopped us?

LIB: Hmmm. . . . If I could only get inside Obama's mind, and know what would be most convincing . . . .  That's it!

RAT: What?

LIB: I'll write a column as if I'm inside Obama's mind!

RAT: But what do you know about Obama?  You were an advisor to Romney.

LIB: It's a dramatic device!  I can put words in his mouth, and they'll sound like he's saying them.

RAT: So we're going to have the President parrot our economic policies?  Sounds convincing.

LIB: Don't be sarcastic.  We'll have a "moderate" Obama who parrots our positions.  But then we'll have a "liberal" Obama who represents the left.

RAT: You mean a caricature to which we can attribute extreme positions? Like a desire to raise taxes to 73%?  To create a European-style safety net?  To push the country into recession?  To make the country more like California and . . . France?!?

LIB: You betcha!  The "moderate" positions will look positively benign in comparison.

RAT: But the moderate policies will just be a warmed-over version on Romnomics, no?

LIB: Sure.  What's your point?

RAT: I'm sure that'll be convincing.  I better go make some real money before the tax rates go up.  I'm extremely sensitive to those, you know.  Oh, one last thing -- are you sure this won't sound like a stilted version of a sixth-grade play?

LIB: Well, these imagined dialogues are tough to pull off.  I'll do my best.  Let's see --"It’s fun to make the plutocrats squirm."  That's great -- liberal Obama would totally say something like that.

RAT: Hey, if this thing actually does take off, make sure we own the rights to these characters.  I can see "liberal and moderate Obama" T-shirts, mugs, salt and pepper shakers . . . .  Can we start a couple Twitter feeds?

LIB: "Are you nuts? I don’t want to become France."  You get 'em, moderate Obama!

The Missing Argument on the Tax Anti-Injunction Act

The following is a guest post from Yale 3L, Daniel Hemel. 

During the March oral arguments in the health care cases, the Justices seemed skeptical of the claim that the individual mandate was a “tax” for the purposes of the Tax Anti-Injunction Act (TAIA). (If the Justices find that the Tax Anti-Injunction Act applies, they presumably would withhold a ruling on the constitutional questions.) The Tax Anti-Injunction Act states that unless one of the enumerated exceptions applies, “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.” But as Justice Breyer said of the individual mandate: “Now, here, Congress has nowhere used the word ‘tax.’ What it says is penalty. . . . And so why is this a tax?”  His colleagues on the Court were similarly unwilling to countenance the claim that the penalty provision of the Patient Protection and Affordable Care Act (ACA) was a “tax” for the purposes of the TAIA.

Yet while the oral arguments focused on whether the individual mandate is a tax for the purposes of the TAIA, no one seems to have remembered that the lawsuit in question—Florida v. HHS—is not simply a suit to restrain the enforcement of the individual mandate. The complaint in Florida v. HHS “requests that the Court . . . [d]eclare the Patient Protection and Affordable Care Act, as amended, to be unconstitutional.”  The plaintiffs explicitly argue that the mandate is not severable from the rest of the Act, and thus that “[t]he Court should hold the ACA invalid in its entirety.”

So for TAIA purposes, the relevant question is not whether the individual mandate meets the TAIA’s definition of a “tax.”

Rather, the relevant question is whether anything in the Patient Protection and Affordable Care Act meets the TAIA”s definition of a “tax.” If it does, then Florida v. HHS is a “suit for the purposes of restraining the assessment or collection of a[] tax,” since it is a suit for the purposes of restraining the enforcement of every single provision in the ACA.
This latter question is not a terribly difficult one. Section 1402 of the ACA, entitled “Unearned Income Medicare Contribution,” imposes a 3.8% tax on the non-wage income of high-income individuals. It is clearly a tax; indeed, it contains the words “there is hereby imposed . . . a tax.” Section 1405 imposes a 2.3% tax on the sale of certain medical devices (again, using the magic words “[t]here is hereby imposed . . . a tax”). Section 1409 codifies the common-law “economic substance doctrine” and imposes penalties for purely tax-motivated transactions. Congress has unambiguously called these provisions “taxes,” and the plaintiffs in Florida v. HHS have unambiguously sought to restrain their assessment and collection.
Even if the Court rejects the plaintiffs’ claim that the individual mandate is inseverable from the remainder of the Affordable Care Act, that doesn’t save their suit from the TAIA. As the Solicitor General argued, and as at least some of the Justices seemed willing to accept, the TAIA is a jurisdictional statute.  When the Court decides whether it has subject matter jurisdiction over a case, it must “take[] the allegations of the complaint as true.” Warth v. Seldin, 422 U.S. 490, 502 (1975).  If, as the plaintiffs allege, the whole Act is unconstitutional, then the challenge to the individual mandate cannot be separated from the challenge to the rest of the ACA (including the sections that clearly impose taxes). In other words, taking the allegations of the complaint as true, a ruling for the plaintiffs in Florida v. HHS would restrain the assessment and collection of several sections that walk like a tax and talk like a tax. According to this logic, the Court should throw the suit out on TAIA grounds regardless of whether it finds that the individual mandate is itself a tax.

It may be too late in the day to revive the argument that the TAIA bars a ruling on the merits of the constitutional challenges. And even if the Court did buy the argument laid out here, a future plaintiff could circumvent the TAIA by styling her suit as a challenge to the individual mandate specifically, rather than the Affordable Care Act as a whole. But given that the plaintiffs in Florida v. HHS decided to shoot for the moon and seek the invalidation of the Affordable Care Act in toto, it is difficult to see how their suit survives the TAIA. The irony is that, because the plaintiffs in Florida v. HHS asked the Court for too much, the TAIA may prevent them from receiving anything at all.

Is Being Endorsed an Endorsement?

Some prawfs readers may have heard of this fellow, Newt Gingrich.  It seems that in some circles, having your university praised in glowing terms by Mr. Gingrich is seen as a splended promotional opportunity, perhaps surpassing even the efficacy of an enormous inflatable gorilla  (warning:audio) or a 30-minute late-night infomercial in commanding the consumer's attention.  And evidently this endorsement is especially valuable in a state where that gentleman is currently the star of roughly 65% of the non-programmed television time (Iowa).  Since universities such as the one in question are usually 501(c)(3) organizations, and are therefore absolutely prohibited from engaging in "electioneering" activity, you might ask, "Hey, is that legal?"  (Or, as one recent report put it, "I hope they have good tax lawyers.")

In realist terms, the answer turns out to be likely "yes" on both fronts (they have good lawyers, and therefore it is effectively legal).  Here's the deal.  The IRS has issued a ruling setting out examples of activity that would either definitely cross the line or would definitely be ok.  For example, it's kosher for a rabbi to invite a candidate to visit a shul, as long as the visit is in the candidate's "individual capacity" (I guess she has to leave her campaign button at the door?) and the rabbi doesn't mention the candidate's candidacy to others during official temple events.   So we have existing law that the mere imprimatur of associating candidate with organization, albeit indirectly, is ok. 

Were I a lawyer for Liberty, I'd argue that Newt's commercial "on their behalf" is a sort of digital version of the kosher visit: they're not necessarily endorsing him.  Of course, there's the remarkable coincidence that this ad runs during the Iowa primary.  The IRS guidance does take into account the possibility that innocent-seeming statements can take on different meaning when they're made in the heat of a campaign. 

But -- and here's the brilliance, I think, of the lawyering.  Given that the ad falls into such a gray area, any enforcement action is going to leave the IRS open to charges of playing politics.  If Newt wins the primary, can the IRS really bring this action before Nov. 2012 without a firestorm?  And after that, if any of Newt's rivals, red or blue, is sitting in the White House, won't an enforcement action look like payback?  The legal arguments in defense of running the ad certainly aren't airtight.  But, given that dynamic in the background, they're good enough to make the Service think a long, long time before they open an auduit.  And Liberty's lawyers are good enough to know it. 

So, if you didn't know anything about the regulation of nonprofit politics, and were wondering, "Hey, is it like one of those cool fractals where it has infinite surface area but zero actual volume?"  The answer is yes. 

 

What will Congress do regarding the tax treatment of punitive damages?

For the last couple years, I've been interested in the proper tax treatment of punitive damages as a consequence of my collaboration with my erstwhile colleague, Gregg Polsky, who's now at UNC. There have been some developments on this front that should be of interest to both practitioners and legal academics interested in litigation, tax, and torts. And that's why I'm curious, as the title of the post suggests, what Congress will do. To begin, Gregg and I wrote a piece that came out last fall in which we argued that (1) plaintiffs should be able to introduce evidence to the jury or judge regarding the marginal tax rate associated with business defendants in punitive damages cases so as to allow a tax-informed "gross-up" of punitive damages, and (2) that the tax-informed jury/judge (with an ability to gross-up) was a better solution to "the insufficient sting" concern than the option touted by President Obama, which was simply to remove the ability of businesses to deduct payments of punitive damages as ordinary business expenses. The arguments we made in this piece were largely analytic and prescriptive given the constraints and goals established by the current doctrine as we saw it. Importantly, we think the arguments of our paper should trigger lots more interest by plaintiffs' tort lawyers, since they now have a set of tools that can increase the recovery for their clients in a variety of tort cases involving malicious or reckless misconduct.* In response to these arguments, we were delighted to see that Professor Larry Zelenak from Duke and Paul Mogin (from Williams and Connolly) wrote responses to our piece for Virginia Law Review's online companion, In Brief. Gregg and I now have a working draft of our reply up on SSRN, entitled, Revisiting the Taxation of Punitive Damages. Thus, in an Escheresque-turn, we now invite comments on our comments on their comments on our paper :-)

On a related note, I earlier this year published a companion paper that took a more expressly normative perspective on the optimal design of the tax treatment of punitive damages. That piece -- Overcoming Tradeoffs in the Taxation of Punitive Damages -- is now out, and I've just recently put up a final version on SSRN. In that article, I explained that the tradeoffs created under current law between ostensibly unnecessary plaintiff enrichment and proper tax incentives for business defendants could be overcome by implementing the punitive damages reforms of the sort I have recommended elsewhere.  These reforms would disaggregate the purposes of punitive damages more clearly so that the optimal deterrence function and the victim vindication function could be separated cleanly from the function of vindicating the public's interest in meting out a retributive intermediate civil sanction. More specifically, I argued that the proper tax treatment of the punitive damages (with respect to whether the defendant's payments should be deductible or not) will depend on what goals states have for their punitive damages regimes, and what goals the federal government has with respect to subsidizing those regimes.  Now, if I were you, I'd be wondering, what's Markel know about tax? That's not an unsound intuition. But I had a lot of help from Gregg and a gaggle of other tax prawfs, and my hope is that this piece will be of interest to anyone intent on understanding the full tax dimensions of punitive damages design specifically (and penalties more generally), especially and insofar as these penalties relate to optimal deterrence, victim-vindication, or public-interested retributive justice. 

Last, Gregg and I have just seen one of Congress' Joint Committee on Taxation reports for 2011, and we noticed that the Committee has acknowledged our argument, but hasn't really grappled with its implications fully. So, at this point, we are waiting to see what happens. Our hope is that the Obama Administration and folks in Congress (and the relevant lobbyists too!) read our work and realize that a repeal of the deductibility of punitive damages will interfere with both the appropriate punishment of business defendants and the states' choices to run their tort system in a way that achieves the goals they intend to set out for themselves.   

* Here's how a friend of mine described to his partners at a prominent class action firm the gist of the claim Gregg and I advance with respect to settlement dynamics and the benefits of our argument.

I think the upshot is that if Ds know you have a credible threat of getting the jury to award more in punis because of the gross-up threat, they'll settle for a higher amount.  Same logic as when you try to get a high pre-trial settlement based on the argument that the jury pool in the particular area is plaintiff-friendly.  Eg:

 

1.  expected compensatories = 1m

2.  expected punis (with jury unaware of tax issues) = 3m

    expected punis (with jury informed about tax deductibility) = 4m (because they know the pain to D is only gonna be 2m)

3.  chance of victory = 25%

 

settlement value under old scenario = (1+3)*25% = 1.00m

 

settlement value under new scenario = (1+4)*25% = 1.25m

 

A Few Words About Judge Sutton's Tax Analysis

I'm going to extend my (ahem) mandate by talking a little bit about the health care litigation.

I largely admire Judge Sutton's concurring opinion in the Sixth Circuit's Affordable Care Act decision.  He clearly has reservations about the law, but wrestles with them in what looks to be an intellectually honest way.  I thought he was wrong, though, to conclude that the statute couldn't be justified under the taxing power.  As he notes, "Few doubt that Congress could pass an equally coercive law under its taxing power by imposing a healthcare tax on everyone and freeing them from the tax if they purchased health insurance."  (slip op. at 51)  But he rejects the taxing-power theory because, he claims, Congress didn't call the enactment a tax.  (Id. at 28).

Unusually for courts that have considered this point, Judge Sutton gives evidence of having actually read the statute.  He notes that the word "tax" appears a number of other times in the section imposing additional costs on those who fail to buy insurance.  (slip op. at 30).  From this he infers that Congress must have meant to distinguish between taxes and what it called a "penalty."  But most of these other appearances of "tax," as well as other usages such as "taxpayer" and "taxable year," are clearly intended to refer to the penalty.  For example, the amount of the "penalty" is determined by taking a percentage of the "taxpayer's household income for the taxable year."  Who is the taxpayer here, except the person who must pay the price for failing to buy insurance?       

In any event, given the perfect economic equivalence between the ACA and the provision Sutton says would easily be constitutional, one is left to wonder why formalism must prevail.  I've argued not only that it shouldn't, but that the Supreme Court has actually held it doesn't.  (Edit):  Even better, read Akhil Amar on this point.   

Arizona Tax Standing Case and the Kagan dissent

This case is within Rick Garnett's baliwick and if he is torn, as his post indicates, far be it from me to offer any wisdom.  But I do commend to you Justice Kagan's remarkably coherent, rigorous, and lawlerly dissent.  Kennedy v. Kagan . . . "it's on," the wrestling referee might say!

The insistence by the newest justice that there is an equivalence between an appropriation and a tax credit (captured shrewedly by Harvard's Stanley Surrey in his original conception of tax expenditures) seems accurate.  There may well be compelling policy arguments to configure a difference for the purpose of taxpayer standing in Establishment clause jurisprudence, but EK seems sharply persuasive in suggesting that AK hasn't conjured up much in his florid (!) majority opinion. 

In any case, there's just a lot of stuff packed into this well-written dissent.  There is an interesting exegesis on the purposes behind state tax policymaking; there are some meaningful comments about the survivability of Flast; there are some lucid notes about Madison and the concerns about expropriation in the religious context; and there are hard-hitting, though mannerly, criticisms of the majority's reasoning.  One should be cautious about tea leave reading in the middle part of a justice's freshman year I suppose, but this well-composed dissent in (perhaps) an otherwise unremarkable taxpayer standing controversy intrigues nonetheless.

Measuring Federalism

Modern federalism, as it is practiced in U.S. courts, depends heavily on untested empirical propositions.  For instance, as everyone knows, the Supreme Court has swung back and forth a few times on whether states need some kind of judicial protection to preserve their policy autonomy, or whether instead the political process is good enough.  Similarly, the Court seems to lean more and more towards Justice Thomas' view that courts should not enforce the "dormant" commerce clause, and should leave protection of the national open market to Congress, apparently on the assumption that Congress would do a better job. 

These assumptions are testable, but until now no one has tested them.  I have.   And I find that political self-interest seems to outweigh the influence of states at least in situations when the choice between the two is presented most starkly: when Congress is deciding whether to grant a break from state taxation to a special-interest group. 

I started the study intending just to test the Justice Thomas argument (also presented in the academic liteature by folks like Marty Redish, David Super, and Ed Zelinsky): that Congress can be trusted to oversee state taxing power, and so the courts should just get out of the way.  This seemed implausible to me for two reasons: 1.  granting a *state* tax cut is costless (absent some state lobbying influence) for federal officials, and so we should expect that the feds will not fully internalize the costs of the cuts; and 2. to the extent Congress believes that there is "vertical tax competition" -- that is, if it's harder for the feds to tax if state taxes are already high -- then reducing state taxes actually benefits Congress even if there are no other rents to be earned. 

I then realized that in essence what I was looking at was an unfunded mandate.  In both "commandeering" and federal control of state taxation, the federal official can obtain political rents from a constituency without incurring any budget costs for herself.  (Many forms of preemption also have a similar political-economy dynamic, as rick h. has described).  So if I could test the tax theory, I could also test theories about whether the "political safeguards of federalism" work against commandeering and other actions that look like it. 

So what I did was find, read, and then (wtih some help from my RA's) code every federal statute Congress has ever enacted affecting state taxing power.  This took a while.  Like, two years.  Then I gathered data for some controls.  When I was done, I regressed the changes in state taxing authority on a variety of factors, including a variable indicating whether a concentrated political group stood to benefit, and another one indicating whether the state tax in question fell on an indian tribe or its property. 

Both of these, I found, were strongly statistically significant.  Conditional on enactment, if a state tax affected a special interest, congress was a lot more likely to restrict that tax.  And, if the state tax affected an indian tribe, congress was more likely to *expand* the state's authority.  There are a few stories one can tell about that, but I argue this supports my "vertical tax competition" argument: indian tribes are exempt from federal tax (arguably by the terms of the Constitution itself), and so they represent one of the few sources of income over which states and the feds do not compete.  And whaddya know?  Congress is a lot more generous when states try to tax tribes.

Interpreting these findings is complicated, and there's an extensive discussion of that in the paper.  Even if you totally buy my findings, it still doesn't necessarily follow that the "political safeguards" theory is wrong as a general matter -- I look at only a tiny sliver of all federalism-related legislation.  And even as it pertains to commandeering, all I show is that the safeguards don't work -- there are certainly arguments that that isn't necessarily a bad thing (arguments with which I largely agree).  But I think it's helpful to move on to those arguments, rather than simply slinging dueling empirical assumptions past one another. 

Comments, questions, and suggestions are very welcome. 

Lessons for Health Care from the UI Experience

When I started out in my efforts to alleviate sleep-debt across the blog-reading world, I promised that my boring unemployment posts would have an exciting payoff in lessons for the affordable care act.  Well, get your lunesta, my friends.  Because one lesson from UI is that the ACA is obviously constitutional.  When the UI system of taxing employers to twist the arms of their local state officials was challenged in 1937, Cardozo, famously, responded that to condemn conditional taxation as "coercive" would be to plunge law into "endless difficulties."  

That was a typically glib Cardozoism, but there was a more substantive analysis, too.  Cardozo argued that, left on their own, states could never implement UI because of the threat of competition with neighboring states.  So the court ultimately held that, even if there were some limits on what the federal government could do with its conditional taxing power, enacting UI surely fell within them: without federal action, the race to the bottom would cripple state efforts, and ultimately the economy.  Swap some letters around -- say, "ACA" for "UI," and you're describing the federal tax on folks who don't buy insurance, as I've argued. 

After the jump, lessons for the relationship between the states and the feds in administering the new health care system.        

For obscure reasons that probably have something to do with making the legislation look somewhat more centrist, the core of the ACA is a cooperative venture between states and the federal government.  States continue to regulate health insurance and insurance providers, and administer "exchanges" where those who do not have other forms of insurance can purchase at a group rate.  Folks who can't afford that rate, either, will get subsidies from the federal government. 

It's hard to see anywhere in this system where states have incentives to hold down costs.  As with UI, states have federal insurance against rising costs associated with their other policy choices.   The legislation contains a basket of great experiments to lower costs (as Atul Gawande and more recently Krugman have written about), but it looks for now like we shouldn't expect states to jump on board. 

Arguably, that incentive structure is the price to be paid for higher enrollment: if states bore some of the costs of paying for new enrollees, they might be disinclined to push to sign up people who are now uninsured.  But that's a false choice, I think.  There are ways to get states to internalize insurance costs without deterring enrollment.  For example, why not increase the federal subsidy for other state health costs for Medicaid families (the "FMAP") in states that reduce costs per patient in the exchange? 

States can be important experimental partners, but the UI story tells us that gains from experimentation can be swamped by other factors if we're not careful.

Did UI Funding Contribute to the Recession?

In response to (cough) overwhelming demand, coverage of the unemployment insurance system will now resume.   The Great Recession has staggered state UI funds; projections are that more than 30 will go broke and have to turn to the federal government for aid.  As I argued last time, it's not clear that in itself is a bad thing.  But it's possible that the system of UI financing needlessly increased the costs to the feds, and maybe even made the recession deeper than it would have been.  The new Obama administration proposal arguably worsens the problem.      

Below the fold: um, we should fix that. 

State incentives both to under-save and also to take too little care with their own economic management derive from the moral hazard created by the federal lending pool.  If you've already forgotten, the way UI works is that both states and feds tax state employers a percentage of the salaries they pay.  States use these monies to fund benefits paid out to unemployed workers, while the feds use their portion, among other things, to make loans to states whose accumulated balances are insufficient to meet demand.  In effect, the state is promised an easy bailout if it fails to save enough to cover unemployment claims.  So why not take bigger risks, knowing that the feds will clean up the mess?  And, once bad events happen, why undertake costly efforts to mitigate the downside?

Typically, the way insurers curb these kinds of moral hazards costs is with co-pays and deductibles.  The UI system has a kind of co-pay system, but it turns out to be incredibly weak.  If states fail to repay their federal loans within 2 years, their businesses can get hit with an additional federal tax of $21 per employee per year.  That's less than 10% of the average tax each employer pays to the feds annually.  And it won't hit until years after the risky behavior -- possibly well after the risk-taking official has left office. 

There is some rough qualititative evidence to suggest that this $21 figure is way too low, and is encouraging growth of  the moral hazard problem.  The penalty has been $21 since 1983.  Over time, as the real value of the penalty has declined, state fund balances have declined, while incidents of state borrowing and states triggering federal penalties have increased.  As I say, this is just qualitative evidence, since obviously to make this point more rigorously we'd want to control for economic conditions and so on.  (Watch this space next year for reports on how that turns out...) But I think what we have is pretty suggestive.

So, step one to reforming UI insurance is to raise the penalty, and to index it.  The administration's proposal (accidentally?) increases the penalty amount, by increasing the federal "taxable amount" that all federal taxes, including the penalty, are based on.  But it doesn't index that amount, which based on what I've just said seems like a mistake.  

Another problem is that the proposal on the table would extend the period for state repayments without penalty, which again is a form of bailout.  If we're going to do things that increase the likelihood of moral hazard, we should also put in place reforms that would tend to counteract it.

Quick Reax to the FL Dist. Ct. Health Care Ruling

Unsurprisingly to those who read its earlier opinion, the federal district court in Florida has held that portions of the Affordable Care Act are unconstitutional.  Also unsurprisingly to those who may recall my blogging last year on this subject, I think the court's all wet.   

To begin with, the court asserts again (at p. 39) the fallacy that the additional tax on those who do not purchase health insurance is "unprecedented."  As I explain in a new draft (page 8, at the top of Part III), that just isn't remotely true; there are literally hundreds of other statutes that do exactly what the ACA does, which is to impose a higher tax on someone who elects not to do what Congress wants.  In fact, there is already more than one statute that imposes higher taxes on folks who don't buy insurance.  While the Court claims this point isn't determinative, it is the first thing the court says in its analysis, and certainly flavors the discussion.

Things get slippery, and start to smell like over-cooked broccoli, after the jump. 

As for the rest of the court's argument, basically, the whole thing is just a slippery-slope: if Congress can do this, what can't it do, etc.  (p.43-56).  The Court says the link between requiring an insurance purchase and other provisions of the act is just as attenuated as the link between buying broccoli and health care, and says it is "piling inference on inference."   It waives aside (50-51)  the government's argument that must-carry provisions collapse into death spirals with no real explanation, except to say that five things have to happen before that occurs.   (But, um, those five things happen millions of times every year...) And it repeats its bizarre claim that the necessary & proper clause cannot allow Congress to enact provisions that would extend beyond what is enumerated (p.62), even though that of course makes the entire clause redundant. 

To keep this short, the one point I'll make is that the ACA and its accompanying incentives to buy insurance overcome a collective action problem among states (see pp. 3-4).  Thus,  the ACA is easily distinguished from the court's parade of broccoli horribles; even if one thought that the federal government should deal only with uniquely national problems, the ACA easily meets that standard. 

Nation Braces for Productivity Boom from Randian Economists

Since the election of President Obama, Americans have lived with the fear that libertarian economists across the country would no longer have the same incentives to write, consult, or otherwise contribute to the economy.  The president's promise to end the Bush-era tax cuts for the wealthy, along with the expiration of restrictions on the estate tax, had raised concerns that these uber-productive members of society would take their talents and withdraw from society.  However, with both Houses passing the $850 billion "stimulating taxes" bill and President Obama expected to sign it into law, economists are now looking forward to a boom in their own productivity.

"Certainly, we can now expect more movies, novels, concerts, and even orthodontia," predicted one Randian economist, who asked not to be named because he was embarrassed not to be working that very moment.  "But we can expect the highest productivity jump from economists.  We are the most sensitive to the slightest change in incentives, so from now on it's Katy bar the door!"

It was unclear what immediate effects the change in productivity will have on such economic markers as GDP, the trade deficit, or the unemployment rate.  But the nation's mood is expected to brighten as this talented group of thinkers begins to participate in the labor market to their fullest economic ability.

"The possibilities are endless," said the economist.  "It could be giving a talk, writing an article, editing a journal, and so on.  These contributions will have a huge impact on the economy.  We may even write original op-ed pieces."

One group, however, had mixed feelings about the passage of the tax compromise.  Although children of Randian economists can now look forward to a larger inheritance, they no longer expect to spend more time playing with their parents.  "My father said he was going to build a tree fort with us after Obama was elected," said one child who asked for anonymity, in fear of getting a time-out if named.  "But just yesterday, he said his incentives had changed.  At least the taxes he takes out of my allowance won't go up, either."

Taxes and Marginal Utility

This post by Stephen Bainbridge quotes approvingly from a WSJ editorial entitled "'Billionaires on the Warpath'?":

In fact, the desire for higher taxes often seems to justify itself solely by the motive to level down. . . . . For all the talk about "fairness," Mr. Obama, Mr. Sanders and their fellow Democrats never really tell us what the magic number for fairness is. Is it 35% of income? 50%? 75%? Though they never commit themselves to an actual number, in each and every case we get the same answer: Taxes should be higher than they are now, for their own sake.

... [T]he politics of higher taxes now rests almost purely on stoking resentment. If Republicans hope to regain the moral high ground, they need to remind citizens that the argument for lower taxes and government that lives within its means is not an argument about numbers or federal revenues. It's an argument about the ability of all our citizens to realize their dreams and opportunities.

Why is anyone who suggests higher taxes on income over $250,000 "stoking class warfare"?  Isn't it a matter of simple economics?

One of the basic principles of economics is diminishing marginal utility.  Marginal utility represents the change in utility from the increase in consumption of a particular good or service.  As you get more and more of a good, your marginal utility with each increment generally decreases.  Eventually, you can have so much that an additional increment adds nothing to your overall utility.  Money is not a good or service, but it represents the ability to obtain goods and services.  And thus one would expect money to have diminishing marginal utility as well.  The more money you have, the less utility you get from each addition dollar.  

So if you're constructing a tax code, it makes sense to keep this in mind.  The lower the income, the higher the utility each dollar represents to that individual.  Since the government is indifferent as to which dollar it takes, it makes sense to take more money that has a lower utility to the taxpayer.  Doesn't $100 mean something different to someone who makes $30,000, as opposed to someone who make $30,000,000?  Isn't that what the parable of the widow's mite is all about?

There are reasons not to have higher taxes on higher income -- they may hurt productivity or investment.  But to claim that their only justification is class warfare ignores some basic economics.

UPDATE: Sarah Lawsky has a paper that challenges the assumption of diminishing marginal utility.  Here's an abstract, which claims: "while some evidence does support declining marginal utility, other evidence suggests that a significant number of people actually experience increasing marginal utility, at least over some range of wealth."  I'm curious about this evidence.  The paper is apparently forthcoming in Minn. L. Rev., but I could not find a copy on the Interwebs.  If anyone has any evidence contra diminishing marginal utility, please chime in.

Why Allowing States to Go Bankrupt is a Horrible Idea

At the end of November, an article by David Skeel in the Weekly Standard got many conservative folks a-chattering about letting states go into bankruptcy.  The new meme apparently has already had policy ramifications, as James Pethokoukis reports:

Congressional Republicans appear to be quietly but methodically executing a plan that would a) avoid a federal bailout of spendthrift states and b) cripple public employee unions by pushing cash-strapped states such as California and Illinois to declare bankruptcy. This may be the biggest political battle in Washington, my Capitol Hill sources tell me, of 2011.

That’s why the most intriguing aspect of President Barack Obama’s tax deal with Republicans is what the compromise fails to include — a provision to continue the Build America Bonds program.  BABs now account for more than 20 percent of new debt sold by states and local governments thanks to a federal rebate equal to 35 percent of interest costs on the bonds. The subsidy program ends on Dec. 31.  And my Reuters colleagues report that a GOP congressional aide said Republicans “have a very firm line on BABS — we are not going to allow them to be included.”

In short, the lack of a BAB program would make it harder for states to borrow to cover a $140 billion budgetary shortfall next year, as estimated by the Center for Budget and Policy Priorities. The long-term numbers are even scarier. Estimates of states’ unfunded liabilities to pay for retiree benefits range from $750 billion to more than $3 trillion.

It's clear that states like California and Illinois are much closer to financial default than anytime in the recent past.  But allowing states to go bankrupt -- i.e., creating a mechanism which would allow a court to restructure a state's future financial commitments -- is a bad idea with terrible consequences.

Why is bankruptcy necessary?  As Skeel makes clear throughout the article, the main culprits are overpaid public employees:

California—recently dubbed the “Lindsay Lohan of states” in the Wall Street Journal—has a deficit that could reach $25.4 billion next year, and Illinois’s deficit for the 2011 fiscal year may be in the neighborhood of $15 billion. There is little evidence that either state has a recipe for bringing down its runaway expenses, a large portion of which are wages and benefits owed to public employees. . . .

With liquidation off the table, the effectiveness of state bankruptcy would depend a great deal on the state’s willingness to play hardball with its creditors. The principal candidates for restructuring in states like California or Illinois are the state’s bonds and its contracts with public employees. . . .

California’s most important creditors are its bondholders and its unionized public employees.  . . . 

Are public employees overpaid?  Well, it depends what you mean.  If you mean that they are paid more than the states can afford, given the current tax revenue, the answer seems to be "yes" in many states.  But are they paid more than they negotiated?  No.  Are they paid more than comparable private employees?  The evidence is mixed.   For example, look at this article in the Oregonian about public employee pay:

Yet one fundamental question underlying the debate is whether Oregon's public employees are overpaid. 

The objective answer is generally no. Not yet anyway. 

It's true that on average, state employees make more than private-sector workers. But the average says more about the professional-type jobs dominating the public work force, and the vast number of unskilled, low-paying jobs in the private sector, than it does about state pay practices. 

When the analysis focuses on comparable jobs and education levels, the total compensation of state employees is slightly less than their private-sector counterparts and slightly more than public employees at other levels of government and in neighboring states. That conclusion is consistent whether the data comes from the state's compensation surveys, academic and private-sector analyses, or federal data.

Moreover, look at this graph from the Oregonian:

The highest point on the graph -- the 2004 pay and benefits to the average employee -- is $61,301.  That's the highest point on the graph.  Average 2009 salary is $41,200.  The average California public employee salary is $57, 536.  By the way, click on that link and you'll see that the five highest paid public employees are two head coaches (each making over $2 million) and three med school professors.

So yeah, let's allow states to go bankrupt.  The bondholders would likely get killed -- and who knows what the interest rates on state bonds would go up to.  Skeel is sanguine: "The bond market wouldn’t be happy with a California bankruptcy, but it is already beginning to take account of the possibility of a default."  Um -- I think the possibility of bondholders losing money is MUCH greater once Congress allows states to go bankrupt, and I think the bond market would "take account" of that much differently.  Oh -- "And bondholders can’t pull their funding the way a bank’s short-term lenders or derivatives creditors can."  So that's nice -- they're trapped like rats, so what they do about it doesn't really matter.  And state bondholders are usually older folks who need "safer" holdings, but I guess that only means they won't be around so long to complain about it!

What about that other group of creditors?  

As for California’s public employees, there is little reason to suspect they will be running anywhere.

Do I hear a little chuckling after that?

If the public thinks it's overpaying its public employees, there's an easy remedy -- elect representatives who won't pay as much.  Of course, this is when the same folks who defend Citizens United will bemoan the awesome political power of public unions -- like this, perhaps:

During his recent campaign, Governor-elect Jerry Brown promised to take a hard look at California’s out-of-control pension costs. But it is difficult to imagine Brown taking a tough stance with the unions. Even in his reincarnation as a sensible politician who has left his Governor Moonbeam days behind, Brown depends heavily on labor support. He doesn’t seem likely to bring the gravy train to an end, or even to slow it down much.

So the only answer is to cut off federal assistance.  And rather than raising taxes or slashing expenses, the current leadership of states like California and Illinois can take the state into bankruptcy and tell its bondholders and employees to go jump off a pier.

I'll give Skeel one point for consistency -- he was against the AIG and Bear Stearns bailouts; he thought they should have gone bankrupt, too.  But they didn't.  To me, the case for a federal bailout of a state is much stronger than a bailout of a financial institution.  The state isn't going anywhere.  The feds can get their money back in a variety of ways.  And whereas a bankrupt business cannot get more money out of non-existent customers, a state can always raise taxes or even sell off public holdings.  It may not be pretty, but the money is there.

One final note -- a point that shows the absurdity of where we are.  If this federal government bails out AIG so that Goldman can get a $1 for every $1, but then lets states restructure their debts so that a 65-year-old ex-cop get $0.25 on the dollar, there may in fact be rioting in the streets.  And that would be bad for the economy, no?

UPDATE:  Felix Salmon also thinks the bond market would freak out.

Obama's Harriet Miers Moment

The modern legal blogosphere was born in 2005 when President Bush nominated Harriet Miers for the Supreme Court.  (In fact, I composed a ditty about it.)  The outrage from bloggers -- including prominent voices in the legal blogosphere -- drove her nomination from a sure thing to a footnote in history.  It's hard to remember now, but at the time the nomination seemed destined for success with the support of both moderates and conservatives.  And those conservatives who initially spoke out against it were harshly criticized for turning on the President.

One of the most prominent conservative law bloggers who opposed Miers' nomination was Stephen Bainbridge.  The good professor recently had occasion to reflect on the episode:

In addition to being a highlight of my blogging career, it was the straw that broke this particular camel's back when it came to George Bush. It was the moment I shifted from reluctant and disgruntled supporter to hater. . . .

It wasn't the wolves of Washington that stopped Miers. The GOP establishment would have gone along if it hadn't been for a grass roots rebellion. It was the base that bucked first. Only after the base blew up did the establishment turn on Miers. Indeed, establishment figures like Hewitt kept their lips firmly attached to Bush's butt on this issue (as with so much else) to the very end.

I think this proposed tax compromise might be President Obama's Harriet Miers moment.

Here's my narrative: a presidency has gone from fairly broad popularity to a much narrower base of support -- primarily the base.  The president has had legislative successes, but he's suffered through various difficulties and his approval ratings, especially with independents, are down.  He proposes something that seems like a move to the middle -- a conciliatory step designed to get a wide swath of support.  But instead of acting as a compromise to assuage independents and the other party, it instead comes across as a crass move, a cynical play that sells out core principles.  The elites assume that the base will grumble but go along -- what else can they do?  But the base supporters become so disenchanted that they revolt.  The president is no longer loved by anyone.  He's politically irrelevant, because he no longer has popular support from any quarter.

Are there differences between this compromise and the Miers nomination?  Of course.  I think President Obama has been significantly more successful than President Bush to this point, and he has a deeper well of good feelings to draw from.  But of course, I'm an Obama supporter -- Bush supporters might have said the same thing about him in 2005.  Again, it's hard to remember in retrospect, but Bush's approval ratings didn't really sink into the 30s until 2006.

In addition, it's unclear what will happen next.  President Bush ended up withdrawing Miers' nomination once she had lost all support.  Perhaps the same will happen with this compromise.  Certainly, Congressional Democrats have the power to defeat this.  But regardless, the damage has to a large extent already been done, just like it was with Miers.  Progressives will no longer trust that President Obama has their principles at heart.

If the tax cuts cuts go through, unemployment gets down to 5-6%, and the President holds the line on other progressive issues, perhaps this will all be water under the bridge by the next election.  But if unemployment stays at 8-10% through mid-2012 despite the tax cuts, I think the President's political fortunes will be largely sunk.  As the Miers' nomination demonstrates, you can only push your base so far before you lose it.

Say No to the Bush Tax Cuts

I think this is a line of demarcation.  If Democrats in the House, Senate, and White House go along with any "compromise" that includes extending the Bush tax cuts to all income classes, including those over $250K, then they've sacrificed too much.  It's a baseline question -- what do you believe in?  If you combine this compromise with the President's willingness to unilaterally freeze the pay of federal workers -- out of the blue, with no context -- then progressive folks have to question why they care about who is in the White House.

Of course, some will point to sentiments like this as evidence that the president is doing the right thing -- he's triangulating! he's working the middle!  he's compromising to help the unemployed!  But the fact remains that middle class tax cuts have passed both houses; there's just not enough in the Senate to break a filibuster.  Middle-class tax cuts -- cuts limited to the middle class -- have been the backbone of every Democratic platform for the past two decades.  For a Democrat-controlled House and Senate to pass the entire Bush tax cuts as essentially their last acts while in control -- well, it boggles the mind.

If this compromise passes, I fear we'll look back on this as a point at which our future changed, and not for the better.  This is an opportunity to call for shared sacrifice on a number of different important goals: reducing government debt, putting entitlement programs on stronger footing,  saving our planet from global warming.  This compromise reeks of political expediency and short-term thinking.  I'd like to hear a counterargument -- maybe I'm wrong on this.  But I feel pretty strongly that this is a change for the worse.

Things You Oughta Know If You Teach Tax

As a new tax professor, you have joined an active and friendly community. Tax law professors are a diverse bunch, but because we are bound together by a love incomprehensible to many others--love of the tax code, of course--we are, I think, an unusually cohesive and supportive group.

You will find many resources for tax professors on the internet.

The most important set of tax prof internet resources is maintained by Paul Caron, of the University of Cincinnati. Because of Paul, you can:

• Read TaxProf Blog. In addition to providing constant updates on the most current tax news and tax scholarship, TaxProf Blog offers many useful links, including a list of the blogs of various tax professors and of tax colloquia around the country.
• Join the active (and almost always on point) TaxProf mailing list.
• Draw on the resources of the TaxProf exam bank.
• Examine other tax professors' syllabi in the TaxProf syllabi bank.

More generally, as you probably already know, the weekly publication Tax Notes, and its daily counterpart, Tax Notes Today, are incredible resources for tax news. The website is by subscription only, but I believe you can also access Tax Notes through Lexis (or perhaps you can ask your library to subscribe to the Tax Notes website). Tax Notes also keeps an amazing and free tax history archive, which includes many presidential tax returns. I find these to be not only fascinating browsing, but also useful for teaching.

In the real world:

You might want to check out the ABA Section of Taxation's Committee on Teaching Taxation. This active committee has nearly 300 members and sponsors various programs at ABA meetings throughout the year.

Try to sign up for the Junior Tax Scholars' Workshop, which is held every summer. The number of participants is limited, but people get tenure every year, so there are always slots opening up. You get to talk tax nonstop for two days, plus it's a great way to get to know your fellow junior tax scholars. (Here is the call for papers for the most recent workshop, and here are the two days' schedules.) 

Finally, you should take every opportunity to talk to other tax professors, especially local tax profs. You might find out, for example, that tax folks in your area meet for informal lunches every now and then, or that a regional tax prof conference meets a few times a year. Or maybe there's a local coffee shop that has a special tax professor discount (or maybe not).

Anyhow, welcome to the tax professor community. As our numbers grow, we come ever closer to world domination which, is, of course, our ultimate goal. So we're happy you're on board!

(I look forward to corrections and additions in the comments.)

Greg Mankiw is threatening to stop working (again)

Two years ago, Greg Mankiw threatened to stop working if Obama was elected, basically on the theory that his tax rates would go up and his incentives would thereby go down.  It was one of those "Going Galt" threats that looks ridiculous in retrospect.  Mankiw, of course, is still a professor at Harvard.  But he has stopped working in one respect -- he's recycled that old blog post into an op-ed for the New York Times.  A few thoughts:

• First, if you're looking for reasons why the print media continues to lose importance and market share, compare this and this.  The New York Times essentially ran a two-year-old blog post in its Sunday edition.  I can't even really blame Mankiw for this -- where are the editors?  In fact, I think Mankiw's op-ed is an elaborate inside joke on his part.  "Two years ago, I threatened to stop working.  And I made good on that threat!  Of course, if people want to pay me for not working, I'm happy to accept it, even with higher taxes.  I just won't do any new work."
• I'm willing to offer the Times this two-year-old blog post, which was my response to Mankiw's original post.  I could summarize it here, but I'm not getting paid for it, so what's the point?  You can read DeLong, Ezra Klein, etc., etc.  Frankly, they take his argument far too seriously.  I still think Mankiw's blog should have the banner headline, "I'M BLOGGING AWAY MY CHILDREN'S INHERITANCE."
• The man still needs a course in basic taxation.  Can I recommend this one next spring, with Louis Kaplow?  You can learn about tax goodies.
• Todd Henderson got a ton of grief for a blog post that was far more open and personal about the effect of the tax cuts than Mankiw's op-ed.  I disagree with Todd's perspective, but at least he was being honest about his personal concerns.  Mankiw should get a lot more grief for this pseudo-threat to stop making the world a better place because he will lose some small percentage of any additional income he brings in.  Mankiw admits: "Paying an extra few percent in taxes wouldn’t create a lot of hardship."  And yet he claims that percentage will dictate whether he gives a guest lecture, takes on consulting work, or writes an article.  That, my friends, is someone with a strange set of utility curves.

Oped on Taxing Punitive Damages

Happy Canada Day!

Well, I guess now that summer's indisputably here, it's the season for prawfs to start writing more opeds.

As you saw the last few days, Ethan and Eduardo recently penned something for a broader audience. And Ethan also deserves a shout-out for a SCOTUS citation to his criminal juries piece. See McDonald v. Chicago, slip op. 34 n. 28. 

Anyway, here's a link to a short piece in today's NYT by Gregg Polsky, my patient and wise co-author of our forthcoming Taxing Punitive Damages article, and me. I'll post the text below the jump.

Damages Control

By GREGG POLSKY and DAN MARKEL

WHEN corporations like Exxon, State Farm and Phillip Morris lose tort cases, juries occasionally award, in addition to compensation for the plaintiff’s injuries, extensive punitive damages.

But jurors are often unaware that companies are able to deduct those punitive damages in calculating their federal income taxes, saving them millions of dollars and undermining the original goal of the damages: to punish reprehensible corporate behavior.

BP might soon be added to the list of payers of punitive damages for its role in the Gulf oil spill. Perhaps with that in mind, the Senate recently approved a measure to repeal deductibility for punitive damages.

The measure is well intentioned. But because most cases are settled before they reach a jury, it won’t work. Fortunately, there’s a better approach.

When plaintiffs and defendants reach a settlement before a trial, which happens in most cases, they aren’t required to specify which parts of the settlement are punitive and which are compensatory; there is typically just one number. That allows defendants to disguise the amounts that they would have paid as punitive damages as additional compensatory damages.

And because the measure maintains the deductible status of compensatory damages, nearly all punitive damages will remain, as a practical matter, deductible. This easy circumvention surely explains the meager revenue projections from the measure: $315 million over 10 years.

While the Internal Revenue Service might try to dissect settlements and classify portions of them as punitive damages, to do so it needs help from both parties to the negotiation. The problem here is that plaintiffs have no incentive to characterize the settlement correctly. Indeed, in cases involving personal physical injury, plaintiffs are better off tax-wise by characterizing the settlement as entirely non-punitive because, while the punitive damages they receive are subject to tax, the compensatory damages are not.

Put a different way, the root of the problem is that jurors tend to believe that punitive damages are not deductible, even though they are. So why not have plaintiffs’ lawyers make jurors aware of the tax deductibility of punitive damages, and teach them how to adjust their awards to offset the deduction’s effect? While plaintiffs’ lawyers don’t do this now, there is no precedent or persuasive legal argument that prevents them from doing so.

Such “tax-aware” juries would probably award higher punitive damages to offset the fact that punitive damages were tax-deductible. But more important, the prospect of tax-aware jurors would also raise the amounts of settlements before trial — when, again, most cases are actually resolved. This is because the amount of a settlement depends on the amount that a jury is expected to award after a trial. If tax-aware juries became the norm, plaintiffs would push for higher settlements, and thus both settling and non-settling defendants would bear the correct amount of punishment. Under the Senate’s approach, in contrast, only the very few non-settling defendants would bear that punishment.

The tax-awareness approach is by no means perfect. It requires juries to determine yet another fact during punitive-damages proceedings, namely the defendant’s marginal tax rate. It also increases the sizes of recoveries to punitive-damage plaintiffs and their lawyers, which is either a good or a bad thing, depending on your perspective. Nevertheless, given the practical futility of the Senate measure, tax-awareness is a far better approach to solving the problem of under-punishment.

There is a good chance that the Senate measure will become law, if only because the public is exasperated by the BP fiasco and Congress desperately needs revenue, even a relatively small amount. But if it does, it will be yet another example of expedient politics trumping sound policy.

Gregg Polsky and Dan Markel are, respectively, law professors at the University of North Carolina at Chapel Hill and Florida State University.

The Senate has mucked things up--hopefully the House won't follow suit

(This post is by Prof. Gregg Polsky and me.) 

Yesterday, the Senate passed an amendment that would make punitive damages paid by businesses nondeductible for tax purposes.  The nondeductible rule is intended to pay for a 90 day extension of the home buyer's tax credit.  On the face of it, this seems like a great idea--after all, why should defendants get tax breaks for malicious or reckless wrongdoing?

But as we've recently argued in our forthcoming paper, Taxing Punitive Damages,  a rule of nondeductibility is the wrong approach. It would be easily circumvented by defendants through settlements that disguise punitive damages as additional compensatory damages. Indeed, easy circumvention is fully consistent with the measly revenue projections from the rule:  a mere $315 million over 10 years.  It would be far, far more effective, in our opinion, to allow plaintiffs to introduce tax evidence against the defendant in the punitive damages phase and encourage juries to "gross up" damage awards to offset the effect of deductibility.  As we explain, a number of other factors (including concerns for federalism and regulatory diversity) also push in favor of our proposed solution over a rule of nondeductibility.      

To be sure, a nondeductibility rule looks good superficially (especially at a time when people are foaming at the mouth for Obama and the feds to do *something*). And no question, the need for immediate projected revenue (no matter how pitifully small) is great.  So while we think there's a decent chance the Senate's proposal will go through, despite its significant real-world flaws, we will be trying to explain along the way why the better strategy in this case is to do nothing and let the states work this out on their own. If it passes, we'll be joining the Office of the Repealer for these limited purposes!  

P.S. The new draft on SSRN contains a response to Professor Geistfeld's interesting critique of our paper. 

States in Fiscal Crisis: How Did We Get Here?

Ok, state budgets suck right now.  We know this.  For instance, the New York Times reports (again) this week on the vicious cycle of state budgets and the economy.  As fiscally-strapped states cut jobs and other spending, their economies weaken, pushing their own revenues and those of their neighbors lower yet.  And then the states call for federal assistance.  This is a familiar story, although one that the size of the current recession makes more dramatic.  Why don't states ever learn?  Are we doomed to replay this gloomy story over and over, like a recording of Gotterdamerung stuck on repeat?  Will the plus-sized lady ever, finally, sing?   

Although there is no magic ring or other neat solution to crises as big as the one we have now, there are solid policies the federal government and states could pursue together that would help a good bit.  That's the argument of a new paper by me and my erstwhile FSU colleague Jon Klick.  And, thanks to Jon, we've got the data to support our noodling.   You're at least mildly intrigued, no?  Read more...

So, the basic problem is that state revenures are "pro-cyclical": when the economy is good, revenues go up, spending goes up, the economy improves (although there's a danger of inflation).  When it stinks, then eh, not so much.  Rational actors should want to insure themselves against the risk of being out of work during one of these economic slowdowns, but because of imperfections in the insurance market, they often can't.  So we have alternatives, like social insurance.  But these are exactly the kinds of things that states cut during downturns. 

Zoinks!  Why do they do that?  Well, what they ought to do is borrow.  That's what an individual would do: she would move money from when she's richer (the future) to when she really, really needs the cash (now).   (Aside to people who remember their econ 101: Keynesian economists would also say that there are macroeconomic reasons for borrowing during downturns, but since there is debate about that, we rest our argument purely on the microeconomic income-smoothing rationale.)  But states can't really borrow effectively.  Since public officials have limited times in office, there's a significant danger that unlimited borrowing authority could lead to excess indebtedness, as officials discount the costs to the public of future debt obligations.  So states tie their own hands through legal rules that make it hard for their officials to borrow, as with so-called "balanced budget" requirements.  (These turn out to be not especially effective at limiting borrowing, but pretty good at raising the cost of borrowing.) 

On the flip side, states could also get out of this mess by saving.  But none of them have ever done that to nearly the degree they'd need to mitigate later recessions.  Really, ever.  And that's not so surprising, because again the benefits of savings are later, while the officials have to win elections and collect other goodies of being in office now.   

All of this is bad news for people who live in a state hit by a fiscal crisis.  But, worse, it's also bad news for that state's neighbors and trading partners.  When the crisis state cuts its spending and lays off workers, that reduces spending in other states, too.  So another, predictable reason that states under-protect themselves against downturns is because a large part of the social harm that results is an externality.  

So, yes, there's a case for federal intervention.  But we don't think it should necessarily be just a jobs bill. Tune in next time for the solution and the data on whether it would work.     

Estate Taxes and Natural Experiments

As the NYT reports this morning, the controversial estate tax is going to enjoy a one year repeal before it arises again in 2011. Empiricists: now's your chance to start looking at the tax effects on death. As the Congressman says, "If you are at the checkout counter, you might want to expedite things."

More on Tax and Good Cards

Over at The Conglomerate, Christine Hurt discusses the tax treatment of "The Good Card," available from Network for Good:

You...give someone a gift card, which they can then use to donate to the charity of their choosing. It's not quite like a universal gift card -- it has to be used for a charitable donation. This could be a little easier than making a donation in someone's name, especially if you don't know which charities that person supports....Who gets the deduction?....[T]he gift card buyer gets the deduction, which I think is the best incentive policy, if you want people to buy the gift card. The gift card recipient either uses or looses the earmarked funds, so they need no further incentives.

From a tax law perspective, here's why (I think) the gift card buyer gets the deduction. (This is based on information from Network for Good's website; I have no particular knowledge of this organization.)

When you buy a Good Card, you are making a donation to what's known as a "donor-advised fund." (Network for Good's 2007 tax return tells us that over $54 million of their roughly $58 million in revenue in 2007 consisted of contributions to donor-advised funds.)  A donor-advised fund is an account that is owned by a tax-exempt organization (in particular, the sort of tax-exempt organization where, if you contribute to it, your contributions are deductible), if the donor, or someone designated by the donor, is allowed to advise where the funds will be distributed or invested.

Network for Good's tax-exempt purpose is supporting other tax-exempt organizations (or, as they put it on their 2007 tax return, to "increase charitable giving...and decrease the cost of fundraising for nonprofits").  Although this might not seem like the usual definition of a charity, the IRS has ruled that this is in fact a good tax-exempt purpose.  Donations to Network for Good are in general deductible, and Network for Good can own and administer donor-advised funds.

Making a donation to a donor-advised fund is tax deductible, and "buying" a Good Card is really just making a donation to a donor-advised fund controlled by Network for Good. So "buying" a Good Card is tax deductible. The person who uses the gift card is simply advising the fund--that is, directing Network for Good to which public charity the funds in the donor-advised fund are to be transferred.  That is not, obviously, deductible.  

(If the Good Card is not "redeemed" within a certain time period--usually six months--the funds go into Network for Good's general account, where they are used for Network for Good's general charitable purpose of assisting other charities.  This doesn't affect their tax treatment, because donations to Network for Good are in general deductible, and the rules for donor-advised funds are actually stricter, not more permissive, than the rules governing donations to charities in general.)

That's my take on it--any thoughts or amendments from other tax or non-tax folks?

(H/T: Paul Caron.)

Why Declining Marginal Utility Matters

Before any more about declining marginal utility, let me explain why the assumption of declining marginal utility matters so much to tax policy.  (This post will, I hope, begin to reply to some of the comments on an earlier post, which asked me to explain why I was talking about individual utilities at all.)

One popular approach to distributive justice within the tax legal academy is welfarism.  (Sometimes this commitment is explicit, sometimes not.)  In a welfarist approach, redistribution is desirable only if it increases overall social welfare.  

Thus there are two steps to the welfarist analysis: a welfarist first determines individuals’ utilities, and, second, to arrive at overall social welfare, the welfarist aggregates those individual utilities in some way.  (My earlier post described a sort of step zero: before all this utility determining and aggregating, a welfarist has to figure out what she means by "utility.") 

Step 1 (determining individual utility) and Step 2 (aggregating those utilities) are very different.  Utility is a fact about the world.  Once utility is defined, people have a certain level of utility, whether that level can be measured or not.  So Step 1 is descriptive. 

But while individual utilities are a fact about the world, how the welfarist chooses to aggregate these utilities--his "social welfare function"--is a judgment.  Thus Step 2 is normative.  For example, a utilitarian approach weights each individual’s utility equally and adds up individual utilities to arrive at overall social welfare.  A completely egalitarian social welfare function requires complete equality of welfare.  A moderately egalitarian social welfare function weights the utility of the less-well-off more than the utility of the more-well-off.  Tax legal scholarship sometimes explicitly adopts or assumes a utilitarian social welfare function, but more often does not specify a social welfare function.

If we assume that all individuals have the same utility curve (yes, I know that is a huge assumption--but it's also a very common one in the literature, so bear with me!), declining marginal utility means that even a welfarist who gives no explicit weight to equality will support redistributive taxation that transfers money from the rich to the poor (or the more-well-off to the less-well-off).  The reasoning is simple: ignoring transaction costs, the dollar will “do more good” in the hands of the poor person than in the hands of the rich person.  If Rich (who is rich) and Penny (who has only pennies) have the same utility curve, and that curve has declining marginal utility, taking $100,000 from Rich and giving it to Penny increases overall utility, because getting $100,000 increases Penny’s utility more than losing $100,000 reduces Rich’s. In other words, declining marginal utility can, assuming that all individuals have the same utility function, justify redistributive taxation.

Declining Marginal What?

Yesterday I described some intuitive support for declining marginal utility.  But commenter freight train demands that I back up:  "What is the definition of marginal utility?" he asks.

Is...[utility] measured across the desire or across the fulfillment of the desire? What's the measure of that "worth?" ....Is [it] measured by what someone wants - ie, thinks will result from an additional dollar - or what they actually get from that additional dollar?

I agree: I cheated.  We can't figure out whether the marginal utility of income declines until we know what utility is.  After the jump, I expand upon and ultimately avoid the question.

"I demand that you define your terms and defend your
fundamental assumptions, or I will RUN YOU THE HELL OVER."

Some people take the position laid out by GJELBlogger in the comments to my previous post and say that utility (or well-being) is equivalent to happiness (also sometimes referred to as "subjective well-being").  This is an older view that has recently been revived in the legal academy and elsewhere. 

Most economists and many law professors equate well-being with preference satisfaction, whether actual preferences or “laundered” preferences (that is, preferences for things that informed, rational individuals acting only out of self-interest would prefer).

Still others believe welfare to consist in the satisfaction of certain “capacities,” or objective goods.

I'm not going to take a position on the definition of utility, at least for this series of posts, but freight train is right that this matters tremendously for lots of reasons.  Some of the supposedly relevant studies that I'll discuss in a subsequent post are of only limited importance if you take the view that, say, utility is equivalent to preference-satisfaction.

And then freight train takes it to the next level:

[S]hould tax policy be based on what individuals want most? A poor person may feel the lack of a loaf of bread, while a rich person may feel the lack of a private jet, but does that mean that redistributive tax policy needs to respect both desires equally?

So freight train is challenging this whole way of thinking about tax policy: why focus on maximizing utility, he asks, instead of on, say, fairness?  There is a lot to say on this topic, but for this series of posts I will just say that much current tax legal scholarship focuses on maximizing utility.  Thus, whether you agree with that approach or not, you (by which I mean, of course, me) might want to grapple with the key assumptions that often accompany it.  And one of those assumptions is that income has declining marginal utility.

Image credit: Hunter-Desportes, Freight train (1975) (Flickr.com); used under a Creative Commons Attribution-Noncommercial-Share Alike 2.0 Generic License.

My Most Awesomest PrawfsBlawg Post Ever

“Why can’t we end a successful video game series at its peak? Here’s the problem: It’s hard to keep a property fresh and exciting over a long period of time. Memorable gameplay elements are joyful the first time they happen, but their allure wanes each time they are implemented…. Economists call it declining marginal utility.”

-Ben Reeves, "Why Some Franchises Need to Accept Death," Game Informer, Sept. 2009

The idea that the more you have of something, the less the next bit of it is worth, that the next dollar is always worth less to a wealthier person than to a less wealthy person--that is, the idea of declining marginal utility--seems intuitively right, even obvious.  And declining marginal utility is a key assumption in tax policy and scholarship, because (as is probably obvious, and as I will discuss in a future post) it provides an easy justification for redistributive taxation. 

But is it true that everyone experiences declining marginal utility of income?  As I explain after the jump, intuitive support for declining marginal utility is not actually as strong as it might initially seem.  (This is not to deny, however, that while Lego Indiana Jones for the Wii is awesome, it is not as awesome as Lego Star Wars.)

We might begin by noticing that many commodities have declining marginal utility: the first chocolate chip cookie tastes wonderful, the tenth not as good, and the hundredth downright unpleasant.

 

But not all commodities are like chocolate chip cookies.  Some commodities might even have increasing marginal utility.  You might crave heroin, for example, more and more over time.  And your desire for chocolate chip cookies would change if you could not only eat them, but also trade them for almost anything else.

It does seem, though, that income has declining marginal utility.  If you buy the things you value more first, and buy less important things later, it seems like you must get more pleasure from the first dollars you spend. But this is true only if people's wants and needs don't change.  Rigorous field study (i.e., an interview with my seven-year-old) suggests that desires aren't in fact fixed: 100% of participants in my study wanted Bakugan balls last June and Pokemon cards this September.

A third common defense of declining marginal utility is that some rich people buy very expensive, frivolous, strange things. Malcolm Forbes, for example, threw himself an extravagant 70th birthday party in Morocco that cost about $2 million (in 1989 dollars). Forbes chartered jets to fly 800 friends to Morocco where he presented them with, among other attractions, a firework display, 600 belly-dancers, a staged Moroccan cavalry charge, and Beverly Sills singing “Happy Birthday.”

Surely a dollar that buys a poor person bread does more good than a dollar buys one two-millionth of Malcolm Forbes’ birthday party. But even if comparing the tastes of a few very wealthy people to the needs of the very poor shows that the wealthy (at least, certain very wealthy people) have lower marginal utility than the poor, this doesn't give us a way to compare the marginal utility of the vast majority of income levels, which fall between the extremes of impoverished and blindingly wealthy.

So, if intuition doesn't provide a knock-down argument for declining marginal utility, what do actual studies and research say?  Tune in next time, for what will be, if declining marginal utility always holds, a somewhat less enjoyable post.

Image credits: Cookies: modified and original versions of cobalt123, Epic Cafe Chocolate Chip Cookies (Flickr.com); used under a Creative Commons Attribution-Noncommercial 2.0 Generic license; Bakugan balls: Neeta Lind, IMG-8943 (Flickr.com); used under a Creative Commons Attribution 2.0 Generic License; Pokemon cards: Kichigai Mentat, Pokemon Trading cards; used under a Creative Commons Attribution-Share Alike 2.0 Generic License.