Category Archives: Uncategorized

A Treasure-Trove of Data on Inequality

May 11, 2021 Theodore P. SetoAdd a Comment

One of the hottest issues in fiscal policy today is how to reduce economic inequality. Louis Kaplow and Steven Shavell have famously asserted (here and here) that redistribution should be limited to the tax system. Edward Kleinbard urged a more expansive consideration of tax and transfer systems, admitting the possibility of regressive taxation to fund progressive spending. Daniel Hemel has raised the possibility of considering distributive consequences in cost-benefit analysis generally, not merely in the tax and transfer context – a move that President Biden authorized on his first day in office. I have argued that we cannot understand inequality without understanding a society’s nontax extractive rules – what I call “implicit taxation.” A recent Wall Street Journal op-ed claims, by contrast, that: “Not only is income inequality in America not growing, it is lower today than it was 50 years ago.” The op-ed reports a current U.S. income Gini index, after federal taxes and transfers, of less than 0.34, lower than the corresponding figure for 1970, when the top marginal income tax rate was 71.75%. (The Gini is a measure of inequality. A Gini of 0 means perfect equality; a Gini of 1 means perfect inequality.)

To date, this debate has been based primarily on data from the 19th and 20th centuries. In Economic Inequality in Preindustrial Times: Europe and Beyond, Guido Alfani reviews a new and rapidly expanding literature on wealth and income inequality in earlier eras and explores implications of that literature for existing theories of the causes and sources of inequality.

Alfani reports that Athens in its heyday boasted an income Gini of 0.4 – 0.45. The early Roman empire clocked in at 0.364 – 0.394, becoming more unequal (0.413) at its apogee, and declining to close to complete equality (0.13 – 0.15) by 600 or 700 CE, after its collapse. (Ginis tend to decline as societies approach Malthusian limits.) In its early years, the United States suffered from significantly more income inequality than it does today, 0.441 in 1774 rising to 0.511 in 1860, although the U.S. was more egalitarian than much of Europe at the time of the Revolution. In the late 1700s, the Gini coefficient of England and Wales was 0.52 – 0.53, of Holland 0.63, and of the southern Low Countries 0.57 – all higher than in the United States.

For theorists, however, the core finding that emerges from Alfani’s literature review is that European income inequality rose consistently and linearly from about 1450 (upon the recovery from the bubonic plague in the 14th century) to the First and Second World Wars. It did so regardless of whether economies were growing, stagnating, or shrinking, and regardless of what populations were doing. For half a millennium, bracketed by two great catastrophes – the bubonic plague and the two World Wars – income inequality grew consistently.

This presents a tension with the view that wealth and income inequality is a relatively benign side-effect of increasing prosperity. Some who take this view rely on a portion of the argument made by Simon Kuznets and depicted in his famous inverted U curve. But perhaps the Kuznets theory is an artifact of the two World Wars. Alfani argues that “the idea that preindustrial inequality growth was just a side effect of economic growth, and maybe even supported such growth, does not fit well the cumulative evidence of the tendency of preindustrial inequality to grow even in phases of stagnation or decline.” (P. 20.)

More recently, Thomas Piketty has argued that income and wealth inequality result from the fact that the rate of return on capital (r) is higher than the growth rate of national income (g), if wealth is highly inheritable. Alfani notes that the emerging literature does not always support Piketty’s proposed relationship between inequality and r > g. During the period from 1450 to about 1900, even when the growth rate was greater than the rate of return, inequality still increased.

Alfani’s analysis of other economic theories of inequality merits close reading. He concludes, however, that multiple factors have affected the history of economic inequality – among the most important, regressive taxation and changes in inheritance rules. The rise of strong fiscal-military states led to increases in the per capita fiscal burden, concentrated at lower income and wealth strata: “the increase in per capita taxation in the presence of a regressive fiscal system can be taken as a general explanation for the tendency toward inequality growth that characterized the early modern period.” (P. 27.) Moreover, “changes in the degree of inheritability of wealth seem to explain much of the variation in inequality levels detected both through prehistory and when analyzing the conditions experienced by different kinds of small-scale societies today.” In other words, when it is easier to bequeath wealth, inequality increases.

One need not be persuaded by his analysis to find great value in Alfani’s work. I, for one, suspect that there is a political economy story to be told, a story of how those already wealthy shift society’s extractive ground-rules in their favor. Regardless, the paper catalogues an extraordinary number of new articles in the field – each of which adds its own insights to our understanding of economic inequality. For tax scholars interested in equality or the history of the relationship between tax and economics, Alfani’s article is an invaluable resource.

A Hand Up in International Tax: Brauner’s Research Handbook on International Taxation

Apr 19, 2021 Kim BrooksAdd a Comment

Handbooks are the best. A good one tells you something about how the discipline is organized, identifies major debates, showcases thoughtful researchers, and captures the momentum of the field. Brauner’s editorial work on the Research Handbook on International Taxation achieves all those advantages.

The volume has twenty chapters, organized in five parts. Part I, Fundamentals, digs into some of the issues that situate the discipline as a whole. Is there such a thing as international tax law? How did we get here? Who is responsible? And is there an international doctrine of tax fairness that can serve as a platform for constructive engagement?

Part II samples some of the major doctrinal building blocks. Given the breadth of possible topics, selection was necessary, and it would be impossible to do more than tease the reader in this part. Naturally there are chapters on the taxation of employment and services. The collection focuses in on the major challenges introduced by the transfer of goods and services between related entities (transfer pricing). And because everyone is always interested, Part II concludes with a chapter on the high-stakes game of taxing international entertainers and sportspersons.

In Part III four chapters pick up thorny and contested international tax issues of the day. Should countries work together to reduce tax arbitrage and competition? Have our stylized assumptions about how to measure and allocate value outlived their usefulness? Do we have a shared understanding of how tax treaties should be read and interpreted? And are there ways to resolve disputes between countries that adequately address the power imbalances between the country-players?

Part IV is a creative and unexpected addition – external perspectives that inform the international tax system. These perspectives are labelled “feedback systems”. The chapters look to political science, international trade law, international environmental law, and comparative law to see how those systems affect international tax law. How do we explain global tax governance? How do international tax and international trade law co-exist and are the destined to work at cross-purposes? Is there a role for international taxation in environmental protection? And what is the potential for the study of international tax systems in comparative context?

Not surprisingly, the collection ends with four chapters that stare into the future. Is there hope for greater multilateralism? How should we deal with illicitly obtained information? What is the effect of a rise in and changes to the type of human movement between countries? And – everyone’s favorite – are tax robots part of the solution?

After reading the collection, you’ll know something of the distinctions of the discipline. It continues to suffer from some lack of identity and its history of political maneuvering and power imbalance has created path dependencies that resonate through modern debates. International tax systems cannot be abstracted from other major social, economic, ecological and political systems. We struggle to come to grips with a shared sense of what is fair. And it’s definitely clear that scholars of international tax ask rich, juicy, seemingly unsolvable questions as part of their daily bread.

On showcasing thoughtful researchers, the collection is a tour de force. Brauner is a brilliant curator. Chapters were contributed by scholars in the US, Spain, Canada, Israel, Germany, Brazil, Italy, the UK, Australia, Serbia, Austria, and Poland. The list is not quite half women, but it’s not far from it. And although most of the contributors are distinguished senior scholars – leaders in their fields – there are a few emerging voices that showcase the promise of the field.

As for momentum, when I first started reading work on international tax in the mid-1990s, it felt like you could read almost everything written in a couple of devoted years. Now it’s impossible to keep up with the research and policy reports that are produced each year. The world of international tax is exploding with new players and new ideas. The stakes are higher than ever. And so is the need for a handbook. Especially one this good.

Your Tax Software Doesn’t Know You’re Lying

Mar 11, 2021 Kathleen DeLaney Thomas1 comment

Imagine your accountant asks you if you earned any income that wasn’t reported on a 1099 or W-2 this year, and you know that you have an extra $5000 of such income. Do you tell her? Probably. For starters, you might be worried that she is going to be suspicious if you lie to her. Something in your voice might give it away, or perhaps your income this year is lower than last year and she wants to know why. Further, you might have developed a rapport with your accountant, and lying to her might cause psychological discomfort.

Now imagine that you are debating whether to report the same income without an accountant’s help, using tax return preparation software. The software isn’t suspicious of your omission and doesn’t harbor any ill feelings about whether you are telling it the truth. In that case, you might be more likely to lie and not report the income. A fascinating new study by Ethan LaMothe and Donna Bobek confirms this intuition. In a survey of 211 participants, LaMothe and Bobek find that individuals may be more willing to lie to tax preparation software than they are to a human tax return preparer.

Survey respondents were presented with a hypothetical scenario where a taxpayer had earned $5000 of unreported income and was asked, by either a tax software program or a human preparer, if she had any additional income to report. The subjects were then asked how likely they thought it would be for the taxpayer to report all or none of the income. Those presented with the tax software scenario were significantly more likely to think the income would go unreported as compared to the human tax return preparer scenario.

LaMothe and Bobek posit two explanations for this increased willingness to lie to tax preparation software. First, people may perceive that human tax return preparers are more likely to detect a lie than tax software, noting that tax software programs are not designed to try to detect deception. Second, the authors hypothesize that individuals will feel greater “social presence” if they are dealing with a human, which may deter them from lying. The idea of social presence is that the salience of the relationship with the other person may make the psychological cost of lying higher. In other words, it may be harder to lie to a human in a social interaction than it is to lie to a cold, unfeeling machine. Further survey questions confirmed that participants generally believed that a human tax preparer would be more likely to detect deception than software, and there was higher social presence in the interaction with the human preparer as compared to the software. Social presence was gauged by asking participants Likert-scale questions rating whether the interaction with the preparer/software was cold-warm, impersonal-personal, passive-active, as well as asking whether there was rapport with the preparer/software and whether there was anonymity.

The study, like any survey, is not without limitations (as acknowledged by the authors). Survey participants answered questions about a hypothetical taxpayer, which may not accurately reflect real world behavior. It’s possible, for example, that many taxpayers report cash income on tax software regardless of whether the software can detect the omission or regardless of personal interaction. On the other hand, the effects of human interaction on taxpayer’s willingness to lie may be even stronger than the survey results suggest. This is because survey participants read about a fictional email interaction with a return preparer, whereas actual taxpayers often have live conversations with their tax return preparers.

This article should be of great interest to tax compliance scholars and those interested in the impact of technology on the tax system. As LaMothe and Bobek note, policymakers “should consider the tradeoffs inherent to tax software usage and perhaps view preparation method as a relevant risk factor when developing enforcement strategies.” The study also has interesting implications for tax software design. While it may be impossible to replicate true human interaction, software designers could consider ways to compensate. For example, the author’s findings arguably support proposals to make ethics more salient when individuals use tax software (such as those found here, here, and here). While automated tax preparation has tremendous efficiency advantages, the potential compliance costs of using tax software should not be overlooked.

Race and Tax: Colorblind No More

Feb 25, 2021 Dorothy BrownAdd a Comment

The summer of 2020 opened the eyes of many to the concept of systemic racism, and some even started looking in unlikely places – like tax law. Senator Sherrod Brown (D-Ohio) acknowledged in a June 2020 hearing that “Congress writes the tax laws. If there are ways that our current tax code exacerbates racial inequity, then it’s our job to fix it.”

Senator Brown’s articulated vision will be difficult to achieve because the Internal Revenue Service (“IRS”) does not collect or publish statistics by race. I confirmed this fact in a telephone interview with an IRS employee when I was writing one of my first pieces about systemic racism and tax policy over two decades ago. I was most interested in the distribution question – whether or not taxpayers were treated differently by race. (The answer is yes — they are treated differently. I write about this in a forthcoming book, The Whiteness of Wealth: How the Tax System Impoverishes Black Americans—And How We Can Fix It.) But equally important questions were asked and answered by George Washington University Associate Professor of Law Jeremy Bearer-Friend, in his article: Should the IRS Know Your Race? The Challenge of Colorblind Tax Data.

Those questions included: (i) how the IRS came to ignore statistics on race; (ii) why is tax colorblind?; and (iii) how did tax become colorblind? In other words, how is it that our federal government that collects and publishes an enormous amount of information by race has never published tax statistics by race, whether we are talking about the IRS Statistics of Income Division (“SOI”), the Treasury Office of Tax Analysis (“OTA”), or the Joint Committee on Taxation (“JCT”)? I had glided over these.

It is a brilliant work of legal scholarship documenting the long history of the federal government’s fairly consistent failure to provide tax statistics by race. His painstaking research included not only combing through a myriad of forms and reports looking for race and ethnic data, but also using freedom of information act requests. (P. 16.) But the article’s most important contribution lies in the even-handed approach he takes as he provides potential explanations for the colorblind policy and that policy’s equally “troublesome consequences.” (P. 66.)

Professor Bearer-Friend’s research documents the history of the federal government’s colorblind approach in its publication of tax data. Here he becomes a world-class detective, scouring through a hundred years of tax reports, forms, etc. to document the exceptional nature of how tax data is treated when compared with non-tax data where publishing race and ethnicity have been the long-established norm. He highlights the serious problem that the lack of data brings – namely that it renders invisible any racially disparate impact of our tax laws, which means the likely continuance of such disparities. For example, he compares the tax treatment of race by the SOI, OTA, and JCT with other government agencies like the United States Census Bureau that has included questions on race since 1790, or the Social Security Administration which began collecting such data in 1936. In short, other agencies collect data on race, but the IRS does not. In 1977, the Office of Management and Budget issued a directive to “standardize federal statistics and administrative reporting on race collected and ethnicity.” (Pp. 3-4.) But this did not trickle down to our tax administrators.

Professor Bearer-Friend points out how the lack of racial and ethnic data collection and/or publication is all the more exceptional given how the SOI, OTA, and/or JCT have included published analyses based on gender and age. He observes how their tax staff have ironically “described their own awareness of the importance of racial and ethnic inequality in the same tax analysis publications in which they omit race and ethnicity.” (Pp. 8-9.) The one consistent exception on race and the IRS is when it comes to reporting statistics of its own workforce. The IRS began this practice in 1962. Professor Bearer-Friend points out the leadership of the IRS in the 1960s was actively trying to integrate its southern offices. The IRS collected data on race of its personnel to comply with Title VII of the Civil Rights Act of 1964. Yet it wasn’t until 2015 that the IRS proposed regulations implementing Title VI of the same Civil Rights Act and those regulations were finalized in 2016.

Two contrasting examples demonstrate Professor Bearer-Friend’s thesis that colorblindness was a choice. One JCT project that studied future taxable estates drew on census data which included population estimates by race and ethnicity but then did not include race or ethnicity in its published projections. The JCT had the race data but didn’t do anything with it. The second example comes from an OTA working paper in 1977 on income averaging that did include race data.

The harm done by not unpacking effects of tax policy on different racial and ethnic groups is staggering given the ubiquitous nature of tax policy and the “breadth of the taxing power” (P. 38.) And as Professor Bearer-Friend correctly observes, the government’s failure to deal with race has not stopped racially discriminatory harms. Many of these harms have been documented by scholars.

Professor Bearer-Friend concludes that there are three reasons why the colorblind approach continued for over 100 years: (i) privacy requirements afforded individual tax return data; (ii) path dependence, meaning that once colorblindness got a good head of steam, a course correction was difficult; and (iii) the belief long held by tax administrators in the “racial neutrality of tax laws.” (P. 66.)

Professor Bearer-Friend discusses the pros and cons of the different ways of collecting race and ethnicity tax data. Should a box be added to the 1040? Should existing collectors of race data add 1040 questions to their surveys? Should the IRS add race and ethnicity questions to their existing surveys?

Making race and tax data publicly available is a choice whose time has come. In January President Biden signed an executive order requiring that racial equity become a focus of all government agencies. Professor Bearer-Friend’s path-breaking article can serve as a guide in the area of tax administration.

Troubling Legislation

Feb 11, 2021 Leigh Osofsky1 comment

Clint Wallace’s short essay, The Troubling Case of the Unlimited Pass-Through Deduction: Section 2304 of the CARES Act, is well worth a read for tax scholars, non-tax scholars, and non-scholars alike. The essay addresses what may be thought of by some as one of the “esoteric” provisions of the CARES Act. The upshot is that, by using the very esoteric nature of the provision as cover, Congress slipped costly, regressive, unjustifiable legislation into the CARES Act, which was sold to the public as progressive, emergency relief from the COVID-19 disaster.

The essay is important for a number of reasons. First, it educates readers about how the CARES Act resurrects an unlimited pass-through deduction for high-income taxpayers. Second, by doing so, it helps readers understand how the CARES Act was actually regressive in important ways. Third, it more broadly cautions readers about some of the unseemly aspects of legislation, in which legislators benefit favored groups in ways that the public is unlikely to understand. Finally, by writing this short essay, Wallace models how scholars have a duty to shine a light on these aspects of the legislative process.

As Wallace describes, section 2304 of the CARES Act suspends section 461(l) of the tax Code. Passed as part of the Tax Cuts and Jobs Act in 2017, section 461(l) of the tax Code limited the ability of high-income taxpayers to use losses from pass-through businesses to offset other income. While not free from doubt, section 461(l) seemed to have been passed as a way to pay for other tax breaks for businesses enacted as part of the Tax Cuts and Jobs Act, including the qualified business income deduction. In any event, section 461(l) was clearly costly for high-income taxpayers and increased the overall progressivity of the Tax Cuts and Jobs Act. But section 2304 of the CARES Act undid such progressivity, and at a high cost. As Wallace details, congressional staff estimated that the revenue loss from section 2304 of the CARES Act was $70.3 billion in 2020. By definition, this lost revenue to the government all benefitted very high-income taxpayers, who were earning more than $1 million.

By exploring these details about section 2304 of the CARES Act, Wallace undermines the myth that the CARES Act was progressive legislation that helped low and middle-income individuals survive the COVID-19 economic disaster. The CARES Act did include large cash payments to struggling Americans, increased unemployment payments, and offered a forgivable loan program. However, Wallace describes that the over $70 billion in direct payments to some of the highest-income taxpayers as a result of section 2304 of the CARES Act exceeded the payments made to any other income band.

By unearthing this more nuanced story about the CARES Act, Wallace shares a broader cautionary tale about how legislation actually works. Even at the height of an international health crisis that threatened homelessness, hunger, and many other problems that would be felt most acutely by the nation’s most needy, Congress found a way to slip in a provision to help some of its most powerful constituents. While this is an old story, it merits remembering again and again. In this case, the fact that the Tax Cuts and Jobs Act contained a progressive provision designed to limit deductions for some of the highest income taxpayers predictably set the stage for well-connected taxpayers lobbying Congress to eliminate the provision at one of the first possible opportunities. Emergency legislation, combined with esoteric tax provisions that few would understand, provided just that chance. The fact that the change happened so predictably makes it no less important. Rather, understanding the natural tendencies for congresspeople to use emergency and complexity as cover to help favored constituents remains important for the very reason that it so predictably happens and will happen again.

Wallace isn’t the only person to have noticed what section 2304 of the CARES Act accomplished. The New York Times, for instance, ran an article, Bonanza for Rich Real Estate Investors, Tucked Into Stimulus Package. Americans for Tax Fairness lambasted the “millionaires giveaway.” And other media and advocacy sources chimed in as well. But the fact that Wallace wrote a scholarly essay about the provision is significant. In so doing, Wallace modeled how it is the job of scholars, and not just reporters or advocates, to examine and critique the work that Congress is actually doing. By engaging in this work in this short but consequential essay, Wallace contributes to scholars’ understanding of what is really happening in the world, as well as the public’s understanding of scholars’ place in it.

The Upside of Investigating Taxpayers’ Approaches to the Downside Risks of Tax Law Change

Jan 12, 2021 Charlene D. LukeAdd a Comment

Heather M. Field’s Tax MACs: A Study of M&A Termination Rights Triggered by Material Adverse Changes in Law presents information and insights about tax-specific material adverse change provisions in publicly filed mergers and acquisitions (M&A) agreements from May 2014–May 2019. Field identified and primarily focused on 13 agreements with “Tax MAC Out” provisions, meaning that these agreements provided an exit right that could be exercised unilaterally because of adverse tax law changes. Field also located 6 agreements that contained express Tax MAC provisions but that did not provide a unilateral ability to exit; most in this group were in the form of requiring the parties to work to address the tax change through restructuring, with termination expressly not following from an inability to complete such restructuring.

The article highlights the bespoke nature of Tax MAC provisions; while Field found that some boilerplate language recurred, there were also substantial differences among the agreements, and the article suggests explanations for the variability, tied to specific instances of difference. As Field notes, the heterogeneity suggests ample “opportunities for nuanced bargaining and value-added lawyering.”

The small number of agreements (dictated by the realities of public filings) means that the article’s qualitative analysis is heavily dependent on the particular transactions and parties (and their legal counsel). But this does not make the article overly narrow; rather, the agreements provide a foundation from which Field is able to reach several audiences, and those audiences will be able to use Field’s information and analysis to engage productively and creatively within their respective areas of tax interest. This reach makes the article much more than a wonderfully clear description (which it also is) of what Field uncovered in this group of M&A agreements.

First, the article will undoubtedly be instructive to taxpayers and their counsel, and this is the primary audience identified by Field: “[T]his Article provides insights into both strategies for empowering taxpayers to proceed with desirable transactions that might otherwise by stymied by uncertainty about possible future tax reforms and deal-making practices when tax laws may change.” At a practical level, taxpayers could use the article to develop tax-change risk-assessment procedures, including checklists for assessing the completeness of proposed agreement terms.

For example, Field highlights how the agreements vary in how they define “tax law,” from those that are highly detailed—containing some evidence of discussion and thought about how to handle IRS notices, proposed regulations, and similar early stage or informal “law”—to those that contain no specific definition, thereby requiring reliance on a general, potentially inadequate, definition of “law.” The agreements also were highly varied with respect to identifying whether a particular confidence level about the effects of a tax law change would be required to trigger the Tax MAC Out. This is particularly surprising, as Field notes, given the availability of a framework (albeit one subject to critique) for expressing levels of confidence (e.g., substantial authority, more likely than not) in tax opinion letters. Further, some of the agreements contained both a Tax MAC Out and a requirement for a tax opinion letter as a condition to closing. These and other examples highlighted by Field suggest areas where attorneys in advising taxpayers may need to take additional care in ensuring the tax provisions of the agreement function as intended when taking into account the entirety of the deal agreement and the larger context of tax practice.

Second, the article could be used not only to assist taxpayers and their counsel but also could be used in the classroom to facilitate the type of excellent, research-based tax teaching that Field has championed elsewhere (e.g., Heather M. Field, A Tax Professor’s Guide to Formative Assessment, 22 Fla. Tax Rev. 363 (2019), available at SSRN). While tax LL.M. programs, including the one at which I teach, rely on a cadre of practitioners to provide practical, cutting-edge tools and examples for students who need to learn how to think like a tax lawyer, it is also critical that the courses taught by those of us many years out from practice draw on real-world, current examples that are accessible to students—and professors.

For those teaching classes on business entity tax (especially tax aspects of M&A) or on tax planning more generally, Field’s article and the agreements listed in its appendices could be used as the backbone of a module to facilitate student learning about the different types of tax authorities, the impact of mid-deal changes in these authorities, the inherent difficulties in handling tax uncertainty and tax risk, and the intersection of tax uncertainty and tax risk with other types of deal uncertainties and risks—and then how to weigh all of that in advising clients.

Third, this article could be used to inform and suggest new avenues of tax scholarship. Field has, for example, used the Tax MAC research to inform portions of a second, companion article about the use of private contracts to manage tax transition risk (Heather M. Field, Allocating Tax Transition Risk, 73 Tax L. Rev. __ (forthcoming 2020), available at SSRN). The agreements gathered by Field might also provide insight into how taxpayers and their attorneys weigh the differences among proposed, temporary, and final (but unpopular) regulations, which could inform theorizing about administrative guidance.

The tax changes that worry taxpayers, as evidenced by these agreements, could suggest new approaches to anti-tax avoidance policies, standards, or rules (which also suggests a fourth audience: government actors charged with issuing guidance and enforcing tax law, a possibility Field touches on in her companion article). The variance among the agreements could prove useful in considering whether there is equitable access to understanding (and exploiting) the complexity inherent in the tax system.

Field’s method provides a useful roadmap for advancing tax research grounded in taxpayers’ revealed preferences. To be sure, Field is not the first to consult public filings in tax scholarship, but it is a reminder that there is a considerable opportunity to advance tax scholarship by using this approach.