Tax
Bridging the Book-Tax Accounting Gap
115 Yale L.J. 680 (2005) The book-tax accounting gap allows corporations to minimize their earnings for tax purposes while maximizing them in reports to investors, all within the letter of the law. Although the U.S. Treasury has reported the rising divergence between book and taxable income with alarm, scholars and policymakers have yet to consider fundamental reform. This Note proposes eliminating the book-tax divide by moving to a book-conformed system. Implementing this proposal will both cut down on rampant corporate tax sheltering and help restore the integrity of the financial accounting system.
Limiting the Federal Forum: The Dangers of an Expansive Interpretation of the Tax Injunction Act
115 Yale L.J. 727 (2005) In Henderson v. Stalder, the Court of Appeals for the Fifth Circuit held that the Tax Injunction Act (TIA) of 1937 prevents the federal courts from exercising jurisdiction over any case in which a victory for the plaintiff might reduce state revenues. In reaching this result, the Fifth Circuit did more than diminish its own power: It gave state legislatures a potentially powerful tool to insulate their actions from constitutional review in the federal courts. The Fifth Circuit's holding is troubling because it threatens the ability of the federal courts to fulfill their historic role in safeguarding rights created under federal law. This Comment argues that Henderson was wrongly decided. By holding that the court lacked jurisdiction to hear the plaintiffs' claims, the Fifth Circuit needlessly limited the power of the federal courts vis- -vis state legislatures and opened a door to state legislatures intentionally crafting legislation so that it will be immune from review in the federal courts. Part I describes the legislative program the plaintiffs challenged in Henderson. Part II argues that in reaching its decision, the Fifth Circuit not only critically misinterpreted existing Supreme Court precedent, but also gave the TIA a construction that is at odds with the enacting Congress's intent. Part III discusses the dangerous possibility that the Fifth Circuit's abdication of jurisdiction will spur states to structure legislative programs as "taxes" specifically to insulate them from constitutional review in the federal courts.
Jurisdictional Competition for Trust Funds: An Empirical Analysis of Perpetuities and Taxes
115 Yale L.J. 356 (2005) This Article presents the first empirical study of the domestic jurisdictional competition for trust funds. To allow donors to exploit a loophole in the federal estate tax, since 1986 a host of states have abolished the Rule Against Perpetuities as applied to interests in trust. To allow individuals to shield assets from creditors, since 1997 a handful of states have validated self-settled asset protection trusts. Based on reports to federal banking authorities, we find that, on average, through 2003 a state's abolition of the Rule increased its reported trust assets by $6 billion (a 20% increase) and increased its average trust account size by $200,000. By contrast, our examination of validating self-settled asset protection trusts yielded indeterminate results. Our perpetuities findings imply that roughly $100 billion in trust funds have moved to take advantage of the abolition of the Rule. Interestingly, states that levied an income tax on trust funds attracted from out of state experienced no observable increase in trust business after abolishing the Rule. Because this finding implies that abolishing the Rule does not directly increase a state's tax revenue, it bears on the study of jurisdictional competition. In spite of the lack of direct tax revenue from attracting trust business, the jurisdictional competition for trust funds is patently real and intense. Our findings also speak to unresolved issues of policy concerning state property law and federal tax law.
The Defined Contribution Paradigm
114 Yale L.J. 451 (2004) Pension cognoscenti have frequently remarked on the stagnation of defined benefit pensions and the concomitant rise of defined contribution plans. This Article suggests that over the last generation something more fundamental, which can justly be called a paradigm shift, has occurred. Americans today primarily conceive of and implement retirement savings in the form of individual accounts. Such accounts have become primary instruments of public policy, not just for retirement savings, but increasingly for health care and education as well. This Article contends that the defined contribution society as it has emerged today constitutes a fundamental transformation of the way Americans think about and implement tax and social policy. The defined contribution paradigm began to emerge with ERISA's creation of the IRA and evolved further with the creation and popularization of 401(k) accounts. During the 1990s, policymakers adapted defined contribution accounts to cover savings for health care and education. To varying extents, Americans today can undertake the bulk of their most significant savings--for retirement, health care, and education--in defined-contribution-style accounts. Today, the policies likely to be adopted are those that channel government subsidies through individual accounts controlled by the taxpayer herself. In contrast, defined benefit arrangements--as exemplified by the traditional pension plan and the federal Social Security system--are less likely to be proposed, adopted, or expanded. The defined contribution paradigm has major tax policy implications as well. As a result of the increasing prevalence of defined contribution programs, upper-middle-class taxpayers can undertake most of their significant financial savings through these tax-favored accounts. If Congress ever formally transformed the Internal Revenue Code into a federal consumption tax, the defined contribution paradigm would have paved the way by acclimating the public to a system in which savings may be undertaken on a tax-free or tax-advantaged basis.
Lottery Winnings as Capital Gains
114 Yale L.J. 195 (2004) Pity J. Michael Maginnis. In 1991, he had the misfortune to win $9 million in the lottery. Five years later, he sold his remaining winnings--fifteen annual payments of $450,000 each--to Woodbridge Financial Corporation for a $3.95 million lump sum. He reported this payment on his tax return as ordinary income, but he changed his mind several years later and sought a refund of some $305,000, claiming that the lottery payment was a capital gain. Strangely, the IRS agreed and refunded his money. Then the IRS had its own change of heart--again several years later--and, in 2001, sued Maginnis, claiming that the refund was erroneous. An Oregon district court agreed with the Service, the Ninth Circuit affirmed, and poor Maginnis had to return his refund. There is little debate that this is the right result: Maginnis's attempt to convert gambling income into capital gain was a fairly transparent ploy. Nonetheless, Judge Fisher's opinion for the Ninth Circuit, which sets out a two-factor test for whether a gain is ordinary income under the "substitute for ordinary income" doctrine, is problematic. This Comment argues that an alternative approach that analyzes the transaction by which Maginnis received his lottery right may better explain and confine the use of the notoriously murky "substitute for ordinary income" doctrine. Part I of the Comment discusses the "substitute for ordinary income" doctrine. Part II describes Maginnis's two-pronged test for applying the doctrine and points out the economic and doctrinal difficulties with that test. Part III proposes an alternate analysis that better achieves the policies of the "substitute for ordinary income" doctrine.
Taxing Political Donations: The Case for Corrective Taxes in Campaign Finance
113 Yale L.J. 1283 (2004) Incentive-based regulations are generally more efficient than command-and-control measures. One of the primary categories of incentive-based regulations--and one that has gained significant support of economics scholars over the past few decades--is corrective taxation. Corrective taxes, under various guises, are used in numerous areas of the law: "Sin taxes" are the method of choice for regulating goods such as cigarettes and alcohol, pollution taxes are familiar tools of environmental law, and liability rules play a central role in tort law. Nevertheless, the potential of corrective taxes has been overlooked in the debates over campaign finance reform. The equivalent of command-and-control measures in campaign finance law are contribution ceilings, which lie at the heart of the American approach to regulating campaign finance. Current law places a $2000 ceiling on donations from individuals to political candidates. This limit is supplemented by a $5000 ceiling on donations from individuals to political action committees, a $25,000 ceiling on donations from individuals to national party committees, and an assortment of additional ceilings on numerous other forms of political donations. Contribution ceilings have become an enduring component of our system of campaign finance regulation. There are critics of this reliance on contribution ceilings. Some argue that caps on campaign contributions violate First Amendment rights, help incumbents against challengers, and lead donors to divert their contributions through regulatory loopholes. The (mostly conservative) adherents of this position favor allowing donors to contribute unlimited sums to political campaigns. Meanwhile, others argue that permitting even moderately sized donations is incompatible with true political equality. The (mostly liberal) adherents of this position would replace private donations with government-financed campaigns or a regulated system of public debates. This Note is not directed at either of these positions. Instead, I begin with the premise that political donations are neither categorically harmful nor categorically benign. I accept the underlying purpose of contribution ceilings: to limit the size of political donations without completely banning them. In order to achieve such an end, this Note applies the logic of corrective taxes to the problem of campaign finance. Specifically, I argue for replacing contribution ceilings with "contribution taxes." Rather than capping the size of political donations at a specified dollar level, I propose taxing donations based on a schedule of graduated rates--the larger the size of a contribution, the higher the rate of taxation. The argument proceeds on a highly theoretical level; questions about design variables are largely outside the scope of this Note. Instead, I present an economic argument for why contribution taxes are superior to contribution ceilings. My argument stems from a single observation: As compared to contribution ceilings, contribution taxes affirmatively select for donors with a greater willingness to pay taxes on their donations. To demonstrate this point, imagine that donors were required to obtain government permits before contributing any given amount to a candidate. Under this hypothetical, a contribution ceiling would grant every donor a permit to contribute up to the amount of the ceiling. In contrast, contribution taxes would distribute permits based on a donor's willingness to pay the tax. Donors with greater willingness to pay taxes would receive permits allowing them to donate larger amounts, while donors who were unwilling to pay the taxes would be allowed to donate only small amounts. Instead of capping all donors at the same level, contribution taxes allow donors to contribute up to the maximum amount at which they are still willing to pay the associated tax. There are two advantages to allowing donors with greater willingness to pay taxes to contribute larger amounts. First, in a sense, these donors derive greater value from contributing. According to microeconomic theory, the value someone receives from purchasing a good or service can be measured by the amount the person would be willing to pay for the good or service. The difference between the amount a consumer would be willing to pay for a good and the cost of producing the good equals the economic surplus created by the transaction. In the case of campaign donations, a donor's economic surplus equals the maximum level of contribution taxes the donor would be willing to pay for the privilege of making a donation. As compared to contribution ceilings, contribution taxes create more total surplus by affirmatively selecting for donors with greater willingness to pay taxes--donors who derive greater surplus from contributing. The second advantage comes from the possibility of donors diverting their contributions through "regulatory loopholes" when prevented from contributing directly. The regulatory system has proven unable to block all of the ways in which donors can spend money on behalf of a candidate. When prevented from contributing directly, some donors divert their funds into independent expenditures or other methods of indirectly aiding their favored candidates. Diversions of this sort are an endemic problem of campaign finance regulation. Still, not all donors will divert their funds when prevented from contributing directly. Ideally, a system of campaign finance regulation would only block donations to the extent they can be limited without causing donors to divert their funds. Contribution taxes come much closer to this goal than contribution ceilings. Contribution ceilings prevent all donors from contributing more than a fixed amount, regardless of the likelihood that donors will divert their funds in response. In contrast, contribution taxes only block donors who are unwilling to pay the tax. All else being equal, we can expect a strong correlation between donors who are willing to pay large taxes and donors who are likely to divert their funds. Hence, when the two policies are set based on the same goals, contribution taxes should cause less diversion than contribution ceilings. My argument proceeds on two levels. Part I models the advantages of contribution taxes in greater detail. As compared to contribution ceilings, contribution taxes generate more total surplus and less overall diversion. The Introduction has already explained the basic intuitions behind these two advantages. Part I demonstrates that these intuitions are robust in the face of more rigorous economic analysis. Part II relaxes some of my assumptions to argue that contribution taxes remain superior to contribution ceilings in the real world. Hence, Part II discusses questions that my model assumes away: Would contribution taxes exacerbate the problems of corruption or inequality? Are contribution taxes constitutional? Can we actually quantify the harms caused by donations? This Part does not attempt to fully resolve these questions nor to respond to all possible objections, but merely aims to show that contribution taxes do not generate any disadvantages serious enough to overpower the two advantages demonstrated by Part I.
The Integration of Tax and Spending Programs
113 Yale L.J. 955 (2004) This Article provides a theory for deciding when a spending program should be implemented through the tax system. The decision is traditionally thought to be based on considerations of tax policy. The most common theories are the comprehensive tax base theory and the tax expenditures theory, both of which rely on tax policy to make the determination. This Article argues instead that the decision should be based solely on considerations of organizational design. Activities should be grouped together in a way that achieves the best performance, much like how a corporation decides to divide its business into divisions. Tax policy is entirely irrelevant to the decision. This Article begins the process of applying organizational design theory to the integration problem, considering theories of hierarchies based on the needs for specialization in and coordination of activities. It then analyzes whether food stamps and the Earned Income Tax Credit should be implemented through the tax system based on this analysis.
100 Million Unnecessary Returns: A Fresh Start for the U.S. Tax System
112 Yale L.J. 261 (2002) We are now in a quiet interlude awaiting the next serious political debate over the nation's tax system. No fundamental tax policy concerns were at stake in the 2002 disputes over economic stimulus or the political huffing and puffing about postponing or accelerating the income tax rate cuts of the 2001 Act. Those arguments were concerned principally with positioning Democratic and Republican candidates for the 2002 congressional election, not tax policy. But the coming decade, with its paint-by-numbers phase-ins and phase-outs of 2001 Act tax changes, the tax cuts waiting to spring into effect, and the sunset of the entire Act in 2011, makes this a propitious time to take a hard look at the nation's tax system. Describing the nation's current federal tax system in anything other than tentative and uncertain terms is impossible. Even the most sophisticated tax lawyer cannot be sure what the current statute means for the future. Should we, for example, believe that more than thirty-five million taxpayers--nearly one-third of all individual filers--will be subject to the alternative minimum tax (AMT), as the current law implies? Or should we instead be confident that some future Congress will avert that train wreck? The 2001 Act repeals the estate tax only for the year 2010. That is why Paul Krugman described that year as an auspicious time to throw Momma from the train --at least if she is rich. But has the estate tax really been repealed? There will be four congressional and two presidential elections before the 2001 Act sunsets in 2011. Absent constitutional amendment, President Bush cannot serve past January 2009. Congress has enacted nearly one hundred different laws amending the tax code in the past fifteen years. The structure of the 2001 Act makes congressional reexamination of the nation's tax law inevitable. People with an abiding interest in the nation's tax policy should treat the 2001 Act's sunset in 2011--its "Ax-the-Act" provision--as a unique opportunity to debate what kind of tax law should govern the nation in the twenty-first century. We need to be prepared when a tax reform opportunity knocks. We have no stable status quo. Nor has it been easy to embrace the status quo for quite a long time. No politician spearheaded a "Save the Code" movement in opposition to Republicans' recent efforts to "scrap the code" by terminating it a decade hence. But if we cannot admire the tax law we have, what should we wish for? In this Essay, I offer observations about the nation's current tax law and my recommendations for change.
Why Tax the Rich? Efficiency, Equity, and Progressive Taxation
111 Yale L.J. 1391 (2002) In Greek mythology, Atlas was a giant who carried the world on his shoulders. In Ayn Rand's 1957 novel Atlas Shrugged, Atlas represents the "prime movers"--the talented few who bear the weight of the world's economy. In the novel, the prime movers go on strike against the oppressive burden of excessive regulation and taxation, leaving the world in disarray and demonstrating how indispensable they are to the rest of us (the "second handers"). Rand wrote in a world in which the top marginal federal income tax rate in the United States was 91% (beginning at taxable income of $400,000). This is an unimaginably high rate by today's standards, when the dominant view in Washington is that a marginal rate of 39.6% (the top rate from 1993 to 2001) is too high. The key turning point in the process of abandoning high marginal tax rates occurred in the presidency of Ronald Reagan. When Reagan became President in 1981, the top marginal federal income tax rate was 70%; when he left office in 1989, the top rate was 28%. The reduction of marginal tax rates in the Reagan years was driven by a new policy consensus that still persists today. That consensus is that high marginal tax rates on the rich come with an unaffordably high price for the U.S. economy in the form of reduced incentives for the rich to work and to save, and increased incentives to engage in socially wasteful tax planning. And yet 1957, when Rand wrote Atlas Shrugged and the top income tax rate was 91%, falls in the middle of the period from 1951 through 1963. Those were the golden years of the U.S. economy, in which the average annual rate of productivity growth was 3.1% (compared with about 1.5% after 1981). Of course, the growth might have been even faster had the marginal tax rates been lower, but the coincidence of high rates and high productivity raises challenging questions for those who believe that high marginal tax rates carry an unacceptable cost. Thus, the question of whether high marginal tax rates come with an unaffordably high cost to the U.S. economy remains unsettled. Does Atlas Shrug?, a recent collection of papers written mostly by public finance economists and superbly edited by Joel Slemrod, represents the most recent attempt to answer this question. Unfortunately, no clear-cut answer is forthcoming in the book, and the debate is sure to rage on. This Review is divided into three Parts. In Part I, I summarize the main findings of Does Atlas Shrug?, emphasizing their contribution to the debate on taxing the rich. In Parts II and III, I discuss a question that is only briefly touched on in the book: Why should the rich be taxed? Part II surveys the existing--and to me incomplete--legal literature on this issue, while Part III begins to outline some tentative alternative answers. In my view, the debate about the economic consequences of taxing the rich has obscured this fundamental normative question, and answering it is essential to assessing the merits and relevance of the findings contained in Slemrod's book.