Sep 9, 2024 Emily Satterthwaite
Goldburn Maynard & Clint Wallace,
Penalizing Precarity, 123
Mich. L. Rev. __ (forthcoming, 2024), available at
SSRN (March 28, 2024).
Those who are committed to strengthening safety nets for economically precarious workers at modest revenue cost should look no further than Goldburn Maynard and Clint Wallace’s paper on hardship-related early withdrawals by employees from their 401(k)/403(b) qualified retirement plans. Employees who need to make an early withdrawal due to hardship are, by definition, encountering difficulties and have lower ability to pay. Nonetheless, as Maynard and Wallace describe, a subset of hardship distributees may be surprised by a mismatch in the law that can heap further hardship upon them in the form of penalties.
The mismatch occurs between two sets of rules: first, the “hardship distribution” rules addressed to qualified plans under Code subsection 401(k), which allow a plan administrator to permit withdrawals before the employee reaches retirement age and, second, the rules addressed to taxpayers under Code subsection 72(t), which apply a 10 percent “early withdrawal” penalty. The regulations under 401(k) list various safe harbored-payments that constitute an allowable hardship distribution in response to “immediate and heavy financial need” that cannot be satisfied using other resources. (Pp. 3-4.) These payments include those for medical care that would be deductible under Code subsection 213(d), costs related to the purchase of a home for the employee, tuition expenses for post-secondary education, as well as payments to prevent eviction or foreclosure, for funeral expenses, and for a natural disaster or casualty loss. (Pp. 3-4, 26.) However, those same safe harbored-payments are not fully mirrored in the subsection 72(t) penalty framework, which contains a divergent list that doesn’t include eviction and foreclosure, limits qualifying medical care expenses, and allows payment for post-secondary educational expenses only in the case of individual retirement account holders, not those who have 401(k)/403(b) qualified plans. (Pp. 30-31.) As a result, some hardship distributees fall between the cracks: “[d]espite qualifying for the hardship distribution safe harbor, [they can avail themselves of] no exception to this separate penalty…” (P. 4.)
This mismatch might seem like a minor issue likely to affect few employees, but those who are affected constitute a group that has revealed itself to be struggling to make ends meet. Maynard and Wallace cite 2019 IRS and GAO studies documenting that, among the 1.7 million who received about $17 billion in hardship distributions, there is a higher likelihood of having total retirement assets of $5,000 or less, being low-income or somewhat low-income, being African American or Hispanic (i.e., not “White, Asian or Other”), being less-educated, having a larger family, and being widowed, divorced or separated. (Pp. 23-24.) Of this group, a whopping 1.2 million paid the 10 percent penalty (P. 23); those who are penalized are “poorer and nonwhite taxpayers who have the smallest account balances.” (P. 6.) For those ensnared by the mismatch, the penalty is almost guaranteed to exacerbate financial precarity. As Maynard and Wallace write, “the taxpayers who fall into the gap between hardship distribution rules and early withdrawal penalties constitute the most vulnerable account holders.” (P. 25.)
One of the aspects of the paper that makes it so engaging is its profile of a mother of three called Tiffany (all names in the paper were changed to protect privacy), who was assisted by the Low Income Taxpayer Clinic at South Carolina Law (round of applause to Clint and each LITC law school!). Tiffany needed funds because she “had fallen behind on her housing payments and was facing eviction; the withdrawal was necessary to keep her and her three young children from becoming homeless.” (P. 3.) Luckily, Tiffany’s plan permitted hardship distributions (bafflingly, plan administrators are not required to offer them). (P. 27.) Tiffany was permitted to make an early withdrawal from her employer’s 401(k) plan in accordance with the hardship distribution rules that contain the eviction safe harbor. But she wasn’t told that the same rules didn’t apply to the 10 percent penalty, or that eviction payments were not covered. Thus, Tiffany found out at tax time that she was responsible for a 10 percent penalty on her early withdrawal.
Maynard and Wallace point out that the application of the 10 percent penalty in cases like Tiffany’s fails to advance the dual policy goals identified in the penalty provision’s legislative history. (Pp. 4-5.) First, the penalty is supposed to function as a commitment device to prevent employees from shortsightedly draining their retirement savings. (P. 37.) However, it could not work as a deterrent in this regard for Tiffany: she gained knowledge of the penalty only after taking the action that triggered it, and was operating under the impression that she was not subject to the penalty because of her hardship situation. Second, the penalty is designed to recapture tax benefits that employees had reaped from having their savings grow tax-free in the qualified plan. (Pp. 4-5.) But because a low-income employee like Tiffany would likely be subject to the statutory zero percent rate on long-term capital gains, the penalty put Tiffany in a worse position than if she had forgone the use of her 401(k) entirely (Maynard and Wallace walk through an enlightening numerical example specific to low-bracket taxpayers). (Pp. 24-25.) The only thing it accomplished was raising a small amount of revenue from someone who could ill-afford to pay and understandably might feel misled by the mismatch.
Maynard and Wallace make a strong case that the IRS and Treasury, without any action by Congress, should improve communication, including using better vocabulary, about these two closely-related sets of rules. (Pp. 10-11, 39-40.) They argue that the use of clearer language would help employees understand that receiving approval for a hardship withdrawal is insufficient for waiving the penalty. On the legislative front, they propose a detailed set of reforms, two of which I’ll highlight. First, they recommend adopting a default income tax withholding obligation for plan administrators to avoid saddling employees with surprise tax bills. Second, they propose harmonizing the hardship withdrawal and penalty rules so that the same criteria that permit a plan administrator to make a hardship distribution could waive the early withdrawal penalty. (P. 36.) They point out that this has been accomplished to some extent by SECURE Act 2.0’s adoption of a $1,000 penalty-free hardship withdrawal provision (see recently-released Notice here), but Maynard and Wallace take issue with the meagre permitted amount.
As a supplement to this for the most vulnerable employees, they propose a resource-based waiver of the early withdrawal penalty in the case of a hardship distribution; their preferred approach is to offer a penalty waiver to those with lower total retirement assets. Here, the tricky part is defining what that means and addressing the discontinuity in treatment implied by a bright-line threshold. Moreover, they acknowledge that “this [resource-based waiver] approach might curtail the commitment device effect of the penalty for some.” (P. 37.) In not advocating for the abolition of the penalty in the case of all hardship withdrawals, the authors seem to endorse the commitment function of the penalty, even in the case of hardship, for better-resourced employees. However, they argue, eliminating the hardship withdrawal penalty for under-resourced employees may augment the propensity of this population to use the qualified plan vehicle for retirement savings “by giving some employees comfort that they can make contributions without later suffering consequences of depositing funds in an account [that is] out of reach in case of emergency.” (P. 37.) This is ultimately an empirical question and it would be fascinating to test this via an experiment or other study.
The article concludes by linking the maladies of the qualified plan hardship distribution regime with the larger themes of complexity, uncertainty, and unworkability in U.S. retirement saving policy for those with lower incomes. As the authors point out: “401(k) plans have been designed with an expectation that individuals can make and stick with long-term commitments, consider the time value of money, evaluate different investment options, and shoulder the burden of significant uncertainty about their investment decisions and their future preferences—all dubious expectations in the real world.” (P. 19.) Few will come away from this work unconvinced that low-income employees, and particularly those who are experiencing hardship, are poorly-served by the status quo retirement savings system.
Jul 30, 2024 Adam Rosenzweig
Rebecca M. Kysar,
The Global Tax Deal and the New International Economic Governance, __
N.Y.U. Tax L. Rev. __ (forthcoming), available at
SSRN (May 16, 2024).
In 1944 forty-four nations signed an agreement in Bretton Woods, New Hampshire, which laid the foundation for what would become the modern international economic system. The so-called Bretton Woods system was built on the commitments to free and open trade, stable monetary exchange markets, and investments in global public goods. One of the motivating factors underlying the Bretton Woods agreement was to prevent the kind of trade protectionism, isolationism, and hyperinflation that had been seen as some of the geopolitical factors ultimately leading to World War II. While the Bretton Woods agreement itself only lasted until 1971, the commitment to liberalized trade, liquid currency markets, and investments in global public goods continued and came to be known collectively as the “Washington Consensus.”
In recent years, however, cracks have begun to emerge in the Washington Consensus under the stress of the Financial Crisis, the COVID pandemic, and increased protectionism and trade wars. At the same time, the Organization for Economic Cooperation and Development (OECD) began the single most significant overhaul of the global tax regime since its inception through its Base Erosion and Profit Shifting (BEPS) project. Over one hundred and forty countries eventually reached near universal agreement on fifteen separate Action Items fundamentally overhauling the international tax regime. This success stands in stark contrast to the otherwise perceived crumbling of the Washington Consensus. Was this merely another notable example of tax exceptionalism? Or could the success of BEPS serve as a model for revitalizing the Washington Consensus?
Professor Rebecca M. Kysar intervenes in this debate in her new article, The Global Tax Deal and the New International Economic Governance. The underlying premise of the article provides that the success of the BEPS negotiations proves the demise of the Washington Consensus, not its survival.
On its face this might come across as a surprising, if not controversial, claim. After all, despite their faults the World Bank, IMF, etc. remain the backbone of the modern international economy and the US dollar remains the world’s reserve currency, etc. Yet the article convincingly proclaims the end of the Washington Consensus by situating the question within the context of broader global macroeconomic and geopolitical trends, in particular a clearly emerging commitment throughout the global community to a more equitable distribution of the benefits of any new global economic order. To this end, Kysar defines a number of features of this new order as contrasted with the Washington Consensus, briefly summarized as follows: (1) replacing the unwavering commitment to open markets and free trade with a general distrust of markets and stronger preference for state regulation, (2) expanding beyond trade and economic liberalization to incorporate global distributional considerations as a core policy goal, and (3) relaxing the commitment to one-size-fits-all global institutions to allow for more regional cooperation and adoption of non-reciprocal duties and benefits.
Ultimately the most powerful impact of the article even by its own terms doesn’t lie in the persuasive power of any of its details but rather in its broader claim that such details are growing almost anachronistic because the global community has already moved past the fundamental tradeoff between efficiency and equity underlying the Washington Consensus. More specifically, to date (for the most part) equitable considerations have routinely lost to efficiency considerations whether framed as open markets, free trade, capital neutrality, or other forms. As a result, calls for equitable proposals have not only failed to gain traction in the face of this “thumb on the scale” for efficiency but worse too often have been dismissed as “payoffs” to “bad” actors precisely because they depart from the efficiency baseline of the Washington Consensus. For this reason, the core thesis of the article that equitable and distributional considerations can no longer be considered departures from the consensus efficiency baseline but rather co-equal components of that baseline proves far more radical than may appear to many at first glance. Without fear of hyperbole, perhaps no other scholar could be better suited to undertake such a profound paradigm shift. Not only is Professor Kysar a widely published and influential expert in the field, but as noted in the article she co-led global tax negotiations for the United States from 2020 through 2021. From this combined perspective, the article does not merely serve as a form of oral history, on the one hand, or a purely theoretical model, on the other, but rather a combination of the best of both worlds—to powerful effect.
Of course, this does not mean there are no details or specifics over which reasonable people could disagree. In particular, some might not buy the contention that the emergence of the Washington Consensus strongly parallels the themes emerging out of the BEPS negotiations. After all, the Bretton-Woods conference explicitly centered on the creation of a wholly new post-War economic system while the BEPS negotiations by their own terms were meant to shore up that same system. Of course, the US Constitutional Convention was similarly convened only to amend the Articles of Confederation yet there can be little doubt an entirely new structure of government was embodied in the Constitution that emerged at its conclusion. It is possible others may doubt the extent of similarity between the international tax system and the international trade system, especially given the pervasiveness of so-called “tax exceptionalism” within those systems themselves which has kept the two mostly distinct since their post-War emergence. Even the best of articles will include details that some could criticize or specific examples that could be nitpicked. But the article by its own terms recognizes this and attempts to avoid getting caught up in the quicksand of these debates by keeping its focus on the unique perspective of what has actually worked in the real world over the past decade. For this reason, perhaps the best compliment I can give to Kysar’s article is that it may not be the piece of scholarship any one of us may have wanted, but it assuredly is the piece of scholarship we all need.
Jul 3, 2024 Dorothy Brown
Professor Richard Winchester’s Essay, A Simple Tax Case Complicated by Race, is a very enlightening and quick read. His Essay details a Tax Court decision about whether a sale of land by a real estate developer is eligible for favorable tax treatment. And while most law students who have taken a single individual income tax class would rightly tell us the answer is no, Professor Winchester takes us through an opinion that finds otherwise—because of race! First, a primer for my non-tax-geek readers.
For most of our modern income tax history, the gain applicable to the sale of capital assets like stock or real estate held by investors, has been eligible for a low, preferential tax rate. Sales of inventory, or property “primarily for sale to customers” on the other hand are taxed at the highest ordinary income tax rates available. Real estate developers therefore are selling property they hold for sale to customers and generally ineligible for the lower, preferential tax rate. Except, Tax Court Judge Withey did not get the memo. Why? Professor Winchester argues that it is because of race.
The decision, Pontchartrain Park Homes, Inc. v. CIR, holds that the gain from the sale of real estate by a developer is eligible for the lower preferential tax rate—because the developer was doing something extra risky: building a subdivision of homes for sale to prospective black homebuyers during Jim Crow.
The story of how the development came to be is alone a valuable contribution to the literature. In 1950, a white Baton-Rouge based builder, Hamilton Crawford, along with the white mayor of New Orleans, deLesseps Story Morrison (the name alone deserves its own movie), agreed to build two communities: one white (Gentilly Woods) and one black (Pontchartrain Park) separated by a ditch. (Plessy v. Ferguson allowing “separate but equal” was still good law.) The purpose of Pontchartrain Park was to ease the housing shortage faced by black Americans and potentially prevent protests. (P. 38.) Financing for both were provided by the Federal Housing Administration (FHA). During this time FHA insurance generally flowed to developments that excluded black Americans. In this case an exception was made because of pressure applied by Mayor deLesseps Story Morrison on the FHA.
In 1951, Hamilton Crawford and a business partner bought the land. (P. 40.) By 1954, he teamed up with two New Orleans philanthropists to build Pontchartrain Park through a new company aptly called Pontchartrain Park Homes, Inc. (PPHI). Within a year, PPHI purchased the land from Crawford and his business partner, and construction soon started. By 1957, PPHI had completed installing improvements on about half the land, but it still had 188 unsold homesites. It took a pause and accepted an unsolicited offer from the state to buy seventeen acres of undeveloped land to build a satellite campus of Southern University, a Historically Black College and University. PPHI turned a profit of $154,019 on the sale and the issue was whether that profit was subject to the lower, preferential tax rate that applies to capital gains. The taxpayer claimed the lower preferential tax rate on their tax return and the Internal Revenue Service (IRS) disagreed. Tax court Judge Withey found for the taxpayer as did the Fifth Circuit on appeal albeit with a different analysis.
The Tax Court according to Professor Winchester (and any law student who took the introductory course) “incorrectly observ[ed] that raw land is generally a capital asset in the hands of a real estate developer.” (P. 41.) Professor Winchester notes that Judge Withey’s language describing how PPHI served “a market, the potentialities of which were a virtually unknown and untested factor in its experience or that of its incorporators,” meant in Winchester’s words that PPHI’s “customer base of Black buyers made it unique.” (P. 41.)
Because the development was for black homebuyers—something unheard of in the Jim Crow South—PPHI was not like the ordinary real estate developer who had a history of selling real estate to these customers. Their customer base was white. The market for white homebuyers was well established. Not so for the black homebuying market. Judge Withey concluded that any raw land was an investment when acquired by PPHI, making it a capital asset from the beginning. (P. 42.)
As Professor Winchester points out though, the facts do not support that conclusion. PPHI’s charter looked like “that of any other real estate developer.” (P. 42.) And “the company always classified its undeveloped land as ‘inventory’ in its books.” (P. 42.) The IRS naturally appealed and a three-judge panel of the U. S. Court of Appeals for the Fifth Circuit issued a per curiam opinion rejecting the Tax Court’s theory that the land was not primarily held for sale to customers when the company acquired it, but because PPHI’s purpose was changed substantially after acquisition, the Fifth Circuit concluded that it “was no longer held primarily for sale to customers” by the time the actual unsolicited offer to sell was received. The appellate court expressly rejected the Tax Court’s analysis that the land was an investment from the very beginning. (P. 43.)
Professor Winchester notes the role that race played in the Tax Court opinion. He argues that race made Tax Court Judge Withey interpret the law against precedent and in favor of the white developer’s company that was developing homes for sale to black Americans. Professor Winchester in effect describes the “market risk” discussed in the opinion as a dog whistle for race and notes how the Judge’s assumptions about black homeowners were the ultimate driving factor in his opinion. I might add that the Judge may have also seen PPHI as a sympathetic taxpayer, trying “to do the right thing” and therefore deserving of the capital gain tax break—a tax break that recent Treasury Department research shows is disproportionately received by white Americans.
Professor Winchester points to current research that shows a tendency for Americans to associate “homeownership with whiteness.” (P. 44.) (Perhaps Judge Withey associated eligibility for the low, preferential rate with whiteness as well.) Professor Winchester discusses research that the FHA’s bias against insuring homes owned by black Americans is replicated in today’s market even though that bias has long been made illegal under the 1968 Fair Housing Act. “[H]omes located in racially integrated areas receiv[e] substantially lower bank appraisals than the ones for comparable homes in all-white areas.” (P. 44.) As Professor Winchester points out, that has real substantive economic impact.
In case you think this case is old and cold, Professor Winchester notes how Judge Withey’s decision was cited in a 2018 IRS brief, where the government argued the sale by PPHI was of raw land treated as a capital asset because “the company was in the business of selling improved lots, as opposed to raw land.” Of course, as he notes, this comports with the Tax Court opinion but not the Fifth Circuit’s decision. As Professor Winchester observes, “Withey’s rationale in PPHI’s case has retained some persuasive power, despite the Fifth Circuit’s admonition.” (P. 46.)
Professor Winchester urges all judges to be aware of and sensitive to any implicit racial bias that might cloud their thinking. Otherwise, there may be more simple cases…“complicated by race.” (P. 47.)
Jun 7, 2024 Jon Choi
John R. Brooks & David Gamage,
The Original Meaning of the Sixteenth Amendment, __
Wash. Univ. L. Rev. __ (forthcoming), available at
SSRN (February 23, 2024).
The Sixteenth Amendment is one of the most thoroughly studied texts in U.S. federal tax law—economists, historians, and luminaries of constitutional law and taxation have all sliced and diced its meaning for more than a century. Making an original discovery about the historical meaning of the Amendment has consequently taken on the dimensions of a mythic quest, like discovering an Eleventh Commandment or the secret dryer compartment containing all those lost socks.
Remarkably, this is exactly what John R. Brooks and David Gamage accomplish in their timely forthcoming article, The Original Meaning of the Sixteenth Amendment. Brooks and Gamage marshal a wide variety of evidence, including new historical evidence on the technical meaning of “income,” to argue that the income taxable without apportionment under the Sixteenth Amendment includes unrealized gains. This has huge implications for policy, given that many current and proposed taxes are imposed on unrealized gains, including some of the most important recommendations to tax the very rich. Brooks and Gamage’s work is especially timely given that the Supreme Court will rule on Moore v. United States in the next month or so, possibly deciding the constitutionality of taxes on unrealized capital gains—although Brooks and Gamage’s contribution goes far beyond the current case, especially if it is decided on narrow grounds.
Brooks and Gamage’s article is remarkably thorough in its examination of the historical context and public meaning of the Sixteenth Amendment at the time of its ratification. They make two main contributions. First is a purposivist analysis of the meaning of the Sixteenth Amendment, arguing that it was understood as a specific measure to overrule Pollock v. Farmers’ Loan and Trust Co. and should be interpreted as such. Second, the authors present extensive contemporary textual evidence on the meaning of the term “income,” including evidence so far neglected in constitutional debates.
The article’s exposition of the purpose of the Sixteenth Amendment is thorough and compelling, although presumably less so to textualists (obviously an important interpretive bloc on the current Supreme Court). But the real coup de maître comes in the second contribution. Most significantly, the authors unearth new historical evidence showing that varieties of income taxation in effect at the time the Sixteenth Amendment was ratified included elements of “mark-to-market” taxation of unrealized gains. For example, they show that the federal Corporate Excise Tax of 1909 required including the appreciation in value of unsold property in income if it was recorded on a corporation’s books. They also show that accounting standards in place at the time of the Sixteenth Amendment included unrealized gains in income. Taken together, the evidence suggests that the contemporary technical meaning of “income” in the context of taxation did include unrealized gains.
Brooks and Gamage take a sophisticated interpretive position here, and they acknowledge doubters on the other side. Perhaps most prominently, a team of corpus linguists who have analyzed contemporary language usage at the time of the Sixteenth Amendment’s passage conclude that “income” was commonly understood to require realization. Brooks and Gamage have some points of disagreement with the corpus linguistic analysis. Moreover, they argue that it is beside the point—that the ordinary meaning of “income” is not relevant when we have good evidence of the technical meaning of “income,” which as used in the Sixteenth Amendment is a tax law term of art.
Constitutional and textual interpretation are subtle, and cases sufficiently ambiguous to make their way to the Supreme Court do not admit of easy answers. Slam dunk arguments on these matters are therefore almost impossible, and there are grounds on which reasonable interpreters could disagree. But Brooks and Gamage’s article is as persuasive and original as I have seen on these issues, and makes interpretive contributions that will resonate for decades to come.
Apr 19, 2024 Adam Thimmesch
The stark contrast between the United States’ widespread prosperity and the deep-seated poverty afflicting many of its people and communities underscores the nation’s complex economic landscape. Equally complex are the political and legal landscapes surrounding our nation’s anti-poverty efforts. States currently have much of the responsibility for administering federal anti-poverty programming and for directly serving the people and places suffering from economic hardship. Simultaneously, however, states are restricted in their abilities to pursue social welfare goals because of the mobility of capital and labor within the United States. States have responded to these challenges by turning to investment-based tax credits to drive development, but that approach has been disfavored by many progressives and often fails to deliver help to the in-state people and places in need.
Michelle D. Layser offers a unique assessment of this difficult situation in her recent article, Removing Barriers to State Tax Incentive Reform. In that piece, Layser weaves together her knowledge of the political economy of community development, place-based tax incentives, and the federal constitutional restrictions under which states operate to argue that tax incentives likely remain the best path forward states under current conditions. However, states will need help to overcome some key barriers, including the dormant Commerce Clause, to ensure the success of those programs.
Layser and others have previously explored the many problems that exist with the federal government’s place-based tax credit programs, and there is no shortage of criticism for provisions like the Opportunity Zone Tax Credit that was implemented as part of the 2017 Tax Cuts and Jobs Act. Those programs tend to increase investments in the targeted locations, but often without helping the current residents in those areas. Against this backdrop, we might expect that Layser would promote an entirely different approach for the states, but she identifies a critical factor suggesting caution in abandoning place-based tax incentives at the state and local level—the political economy of community economic development. Her article is thus unique and refreshing in that it does not just dwell in the negative aspects of the current system. Instead, she offers a new way to think about reform from within the current construct.
Layser does not just concede the field to those focused on economic growth. Instead, she makes the case that place-based incentives, properly tailored, can serve efficiency ends while also resulting in social welfare gains. Here, she draws from economic research and from her own prior work to help to sway progressive reformers to think more openly about place-based incentives. She is of course careful to note that only reformed incentives are likely to bring long-term success on social-welfare metrics.
From that point in the article, Layser shifts to a detailed analysis of two major aspects of state-level reform. She first analyzes the strengths and weaknesses of three different types of state-level place-based incentives—state enterprise zone laws, state opportunity zone laws, and state new markets tax credit laws. Her critical insight in this analysis is that states’ programs often are either not limited to, or do not actually result in, investments that benefit in-state places or people. Instead, state tax credits can be obtained for investments that benefit workers from outside a targeted place or even for investments made in other states. That extraterritorial flow of state funds likely undermines a state’s goal of helping those most in need within its own borders—a critical flaw.
Layser next identifies the types of reforms that might make those incentives better suited to promoting social welfare within a state’s borders. She breaks those reforms into two categories, minor and major, and evaluates each with the goals of better serving low-income residents and of serving local distressed places. Her next point is critical and one of the key insights of her article. She recognizes that, although states would best serve their own interests by limiting their tax incentives to investments specifically directed at in-state persons or places, the Supreme Court’s dormant Commerce Clause doctrine prohibits tax incentives that discriminate in that way. And while that doctrine allows for direct spending of that kind, states face significant obstacles to making those types of appropriations. Ultimately, then, the dormant Commerce Clause stands as a significant barrier to the types of reforms that Layser identifies, and state tax-incentive programs suffer as a consequence. (It is worth noting that the article is comprehensive in that Layser also analyzes the potential limitations of the Privileges and Immunities Clause and the Equal Protection Clause, but the dormant Commerce Clause is the real impediment to the reforms that she suggests.)
So, what do we do about these issues? Layser concludes by providing suggestions for overcoming the legal and political impediments to reform. On the law, she rightfully notes that Congress can override the Supreme Court’s dormant Commerce Clause doctrine and allow states to discriminate against interstate commerce. Congress could thus allow states to tailor their programs to in-state residents or in-state places and thereby help states to better fulfill their anti-poverty responsibilities within their borders. States can also take advantage of the disconnect in the Supreme Court’s doctrine between discriminatory taxes and discriminatory cash subsidies. If the political process allows for direct spending—a far from assured thing—this route might help states to target their incentives more appropriately. Layser also addresses the politics of these proposals at the state and federal level and provides ways to engage with politicians at both levels.
Despite the “War on Poverty” being waged in America since the 1960s, deeply impoverished people and places continue to exist throughout the country. Layser’s article provides an important explanation of how state-level approaches are being undermined by the political economy of community economic development, by poorly designed state incentives, and by federal law that prevents states from doing better. Her article is a must read for anyone interested in helping to improve place-based tax incentives and our overall national approach to addressing poverty in America.
Mar 8, 2024 Susan Morse
Ariel Jurow Kleiman and Shayak Sarkar & Emily Satterthwaite, Taxing Nannies, Loyola Law School, Los Angeles Legal Studies Research Paper No. 2024-03, available at
SSRN (January 26, 2024).
Workers who provide child care in children’ homes—that is, nannies—should almost always be “formal” workers based on existing law. But in fact they are almost always treated as “informal” workers paid off the books and not as employees. Formality would mean more work law protection – that is, from labor, employment, and social insurance law. But it would also mean more income and payroll taxes.
Is going formal worth it?
In Taxing Nannies, Ariel Jurow Kleiman, Shayak Sarkar, and Emily Satterthwaite consider this question from an obvious yet original perspective. They focus on the preferences and welfare of nannies, not hirers. Their empirical work shows that some nannies strongly prefer formality. It also suggests that the market assumes informality and quotes compensation on an after-tax basis. A tax incidence negotiation between nannies and hirers results over how to split the tax burden of going formal, and diverse solutions follow.
The authors analyzed data from the online platform Reddit, using a strategy similar to that used by Shu-Yi Oei and Diane Ring to investigate the tax lives of rideshare drivers. Kleiman, Sarkar, and Satterthwaite examined about three hundred posts from the “r/nanny” subreddit. They found that 81% of the 150 or so posts that consider worker classification express a preference for formal employee status, for reasons including legal compliance and needing documentation. The documentation preference connected to both public benefits reasons, for instance unemployment insurance or Section 8 housing vouchers; and private market reasons, for example apartment or mortgage loan applications. The authors found a similar result when they survey 57 predominantly female, white, documented, and highly paid nannies. Seventy-five percent of their survey respondents preferred formal employee treatment, and most of these offered legal or tax compliance—not, for example, dignity or professionalism—to explain their preference.
Kleiman, Sarkar, and Satterthwaite also interviewed 15 experts, including from payroll service providers, nanny membership groups, and workers’ rights organizations. (P. 54.) Some interviewees characterized the nanny work sector as a “cash industry” (P. 56.) with a strong default norm of informality. But others observed a sea change toward formality, especially because of the collateral benefits of documentation for public benefit and private market purposes. The experts also cited hirer-side motivations such as reputational concerns.
Kleiman, Sarkar, and Satterthwaite are careful not to generalize their finding of a preference for formal work among some nannies. They acknowledge that lower-wage nannies might have different preferences, and that undocumented workers in particular might prefer informal status. (P. 38.) But they write that their work invalidates “the null hypothesis that nannies as a whole prefer informality over formality.” (P. 9.)
If some nannies prefer formal work, then who will pay for the taxes that are the price of formality? Some of the most interesting posts uncovered by the paper reveal the negotiation over the tax incidence of going formal. Nannies’ wages historically have been quoted after tax—a practice that “diverges from nearly all employment sectors” (P. 46.) since employee wages are almost always quoted on a gross basis, before income tax or employee-side payroll tax. Thus, going formal raises an unusual incidence question: How to split the burden of a voluntary agreement to pay more in tax.
The paper suggests that nannies often focus on the practice of quoting post-tax wages, which implies that hirers should bear the tax burden, while hirers sometimes focus on the practice of quoting pre-tax wages in the rest of the employment market, which implies that nannies should bear most of the tax burden. For instance, one Reddit post endorsed by 232 upvotes compared a nanny’s belief that her hirer was “responsible for taxes as an employer” to the hirer’s statement that “I don’t know if we can afford to pay you $25 and pay your taxes.” (P. 46.) When nannies and hirers negotiate over such disagreements, a diversity of agreements results.
For instance, some hirers agree to “gross up” nannies’ pay, by paying in cash the amount of tax withheld. (P. 46.) (The gross-up cash is, of course, also taxable compensation income that should be reported.) Other hirers may offer some compensation on the books and some off the books; cash payments might be made for overtime, for instance, or, in some carefully negotiated cases, for amounts that would cause compensation to exceed benefit cliff limits for programs such as Section 8 housing vouchers or Medicaid. Other hirers may consider a nanny to be an independent contractor subject to tax reporting requirements but may allow the nanny to believe that their arrangement is off the books; later, when the hirer presents the nanny with a 1099, it is often an unpleasant surprise.
The evidence presented by the paper shows that some nannies prefer formal arrangements, and that these preferences may also assume that hirers will bear the resulting tax burden. But the paper also presents evidence of nanny-hirer negotiations, which shows that going formal often requires nannies, as well as hirers, to bear some of the burden of the increase in tax. The work law protections may come at a price, counter to the assumptions of at least some proponents of greater enforcement and formality.
The authors make three policy suggestions intended to ease this tension. First, they propose to save on transaction costs by simplifying compliance. Second, they endorse immigration reform, including a special path to work status for caregivers. Increasing the proportion of documented nannies should encourage more unified support of the move toward formal work and perhaps improve the bargaining position of nannies in general. Third, they suggest expanded public benefit systems, including specific benefits for caregivers, to mitigate the effect of benefits cliffs that encourage some off-the-books compensation for nannies.
The last idea of expanded public benefits specifically targets the problem of going formal. It injects value into the hirer-worker negotiation to offset the value lost to the burden of paying tax in a formal arrangement. The authors do not detail a social reproduction theory or other justification for singling out the child care labor market for extra government support. But regardless of any theoretical takeaway, this paper’s fascinating empirical analysis is highly recommended. It reveals key details about this important corner of the labor market, and about that market’s ongoing struggle with the benefits, costs, and tax incidence of going formal.
Cite as: Susan Morse,
Going Formal: The Tax Lives of Nannies, JOTWELL
(March 8, 2024) (reviewing Ariel Jurow Kleiman and Shayak Sarkar & Emily Satterthwaite, Taxing Nannies, Loyola Law School, Los Angeles Legal Studies Research Paper No. 2024-03, available at SSRN (January 26, 2024)),
https://tax.jotwell.com/going-formal-the-tax-lives-of-nannies/.
Feb 9, 2024 Charlene D. Luke
Luís Calderón Gómez,
Whose Debit Is It Anyway?, 76
Tax L. Rev. 159 (2022) availible on
SSRN.
Luís Calderón Gómez asks the question, “Whose Debt Is It Anyway?,” to frame his analysis of a situation that, while common, remains understudied and undertheorized: the tax treatment of debt co-obligors.
Calderón Gómez’s initial contribution is to demonstrate that there is, in fact, a problem. Co-obligated debt offered by corporate issuers alone is “in the hundreds of billions” of dollars under a “conservative estimate” based on SEC documentation. Yet, tax law generally assumes a conceptual paradigm “where one creditor lends money to one borrower.” Calderón Gómez begins the article by illustrating the inconsistent and incoherent tax treatment that results when a loan arrangement departs from this paradigm.
In the course of highlighting the uncertainties of the tax treatment of co-obligated debt, Calderón Gómez uses case law and administrative authorities to construct a descriptive framework “categorizing the problems the law faces and the different rules available to legal authorities to resolving such problems.” He focuses on three contexts—debt modification, interest deductions, and cancellation of indebtedness income—and identifies three recurring and interrelated problems that arise in these contexts.
First, the cases and administrative authorities take “radically inconsistent approaches” in the extent to which substance should control over form (and vice versa). Luís Calderón Gómez gives the example of the debt modification regulations, which determine when an amendment to a debt obligation results in a taxable exchange. These regulations appear highly form-driven, but they do not define key terms. The regulations specify that the substitution of a new “obligor” on a recourse debt is generally a significant modification, but the addition or deletion of a “co-obligor” or a “guarantor” is instead generally tested by assessing whether there has been a change to payment expectations. Calderón Gómez shows that a close review of IRS rulings reveals that the agency has used the regulations’ failure to define basic terms like obligor, co-obligor, and guarantor to inject substantive analysis and to “blur[] the line” among these categories.
The second recurring problem is a tendency for courts and administrative authorities to demonstrate a “strong aesthetic preference” for a single, “true” obligor instead of dealing with the messy reality of multiple obligors and guarantors. In the context of cancellation of indebtedness income, Calderón Gómez demonstrates how certain court decisions fail to deal directly with joint obligations and instead superimpose the one-debtor paradigm in order to assign all of the income to one obligor, typically the last obligor standing.
Whether and how legal authorities should handle contribution and reimbursement agreements among obligors is the third recurring problem. For example, if a co-obligor pays the interest on a loan but has a contractual right to be reimbursed in whole or in part by another co-obligor, should that payor still be able to take an interest deduction (to the extent otherwise available)? Calderón Gómez points out that courts tend to favor the approach of focusing on whichever co-obligor actually makes the payment, but depending on the situation, may show “unease at the tax results” if a nominal co-obligor has no ultimate responsibility once reimbursement rights are taken into account.
After providing a framework that reveals the puzzle of co-obligated debt, Calderón Gómez advances reform proposals. As an initial step, he recommends a uniform approach to identifying co-obligors and distinguishing them from guarantors. To be a co-obligor, two characteristics would control: (1) the creditor would need to have “a direct right to repayment against the party in question under the contract,” and (2) the obligor would need to “bear[] at least some portion of the ultimate liability of the debt as a result of their contractual obligations.”
All those identified as co-obligors would be treated as primary obligors without distinguishing among them by, for example, using a fact-and-circumstances approach. While the “IRS and the courts should focus on the contracts,” tax authorities and courts would remain able to rely on other doctrines, such as a substance-over-form inquiry into whether an arrangement is debt at all. Calderón Gómez persuasively argues that this first step would resolve substantial ambiguity, would be administrable, and would consistently balance form and substance.
As a second proposal, Calderón Gómez would allocate any tax consequences arising from the debt by presuming that the co-obligors have “equal shares of liability on the debt,” but he also would permit express contribution and reimbursement agreements rebutting that presumption. In order to avoid whipsawing the IRS via duplicate interest deductions or other benefits, taxpayers would be required to disclose such agreements contemporaneously with the debt issuance; as Calderón Gómez points out, this approach is similar to that required for identifying hedging transactions. In contrast to his first proposal, “legal authorities should look beyond contracts when determining whether the underlying debt allocations have substance for purpose of allocating the tax consequences on co-obligated debt.” This would include an inquiry into whether a co-obligor “has the wherewithal to be a ‘true’ co-obligor with respect to its portion of the debt.”
As a final proposal, Calderón Gómez recommends adding an approach for handling modifications vis-à-vis the co-obligors while retaining the current debt modification regulations for changes vis-à-vis the creditor. His proposal “would center on whether there was a transfer of value from one obligor to another,” with the resulting consequences driven by general tax principles and rules. For example, depending on the context, a transfer from one co-obligor to another could be treated as compensation, a gift, or a dividend.
In the concluding sections of his article, Calderón Gómez shows how his proposals operate both by providing a stylized example and by examining their potential application in resolving three real-world situations. Such situations include using the proposals to bring greater coherence to the determination of the source of interest income. Calderón Gómez quotes language from a prospectus to highlight the uncertainty in sourcing interest income and argues convincingly that his approach would be less manipulable than one focused solely on the payor of the interest. He also demonstrates how his proposals may also help resolve difficult questions regarding whether a disregarded entity should be an obligor.
Calderón Gómez acknowledges that his proposals may at times result in only a “partial victory” if one focuses on revenue raising but argues convincingly that they “would still be a significant improvement from the status quo.” Calderón Gómez is highly persuasive in demonstrating the need for additional attention to this area, and his framework and proposals will serve as a strong foundation for future scholarship.
Jan 12, 2024 Charlotte Crane
The recent work of David Weisbach and Daniel Hemel, including the Legal Envelope Theorem, engages with traditional questions about tax systems in important new ways. Legal tax scholarship has long explored the interactions between tax law and taxpayer behavior and has often used intuitions from economics in doing so. But only haphazardly has this work touched on the effects of nontax institutions on the functioning of tax systems. The Legal Envelope Theorem looks at these interactions in very deliberate ways.
At the risk of oversimplifying, Weisbach and Hemel’s thesis is that changes in non-tax legal rules and institutions that at first might appear to be undesirable can be desirable when their effects on tax systems are taken into account. More precisely, a nontax change that makes almost no change in overall well-being can make a significant after-tax increase in overall well-being if the non-tax change increases taxable income, increases collection of taxes, or increases potential for redistribution.
For instance, imagine a nontax rule change that increases the likelihood that an individual will participate in a market transaction that produces taxable income rather than in a nonmarket or otherwise untaxed activity. It is entirely possible that the overall benefit to society created by the additional taxable income will be greater than the small detriment to the individual whose behavior is affected.
More specifically, to use the article’s first example, assume an individual can choose to use land to raise cattle for sale for $10, or to raise vegetables for home consumption for a benefit of $7. The income from raising cattle is taxed at 30%; the consumption of vegetables is not taxed. Assume further that there is a change in the non-tax rules, perhaps a tightening of the limitations on fertilizer use that will increase the value of the drinking water on the land but raise the cost of producing vegetables. This rule change causes the individual to use more land for taxable cattle raising and less for nontaxable vegetable growing, producing $10 of additional taxable income but at a loss of $7 worth of vegetable production. We can infer from this choice that the after-tax benefit to the individual of $7 ($10 in income less $3 in tax) from cattle production is slightly better than the after-tax benefit to her of remaining in vegetable production given the increase in the cost of vegetable production (reduced by the fertilizer limit to slightly below $7). But there is now an additional $3 in tax revenue. This tax revenue represents a resource available to society; in particular, revenue that can be used for redistribution.
Thus a rule change can reduce inequality not only by directly redistributing as a result of the application of the rule, but by enhancing the government’s ability to collect revenues that can then be used for redistribution. In focusing on the creation of revenue for redistribution, Weisbach and Hemel position their work as a continuation of the long running debate about the appropriateness of shaping substantive legal rules with an end toward reduction of inequality. The conclusions of economists, most notably Louis Kaplow and Steven Shavell in several works (the most recent of which is Should Legal Rules Favor the Poor?, 29 J. Legal Stud. 821 (2000)), soundly reject this idea. They argue instead that the most efficient results can be achieved if legal rules are set independently of distributional concerns, with any resulting inequality addressed through taxation. Weisbach and Hemel counter that legal rules should also minimize the efficiency costs of redistribution through the tax system. They raise the possibility that legal rule changes that enhance the effectiveness of tax systems can be desirable even if they deviate from simple efficiency before tax collection is taken into account.
Two aspects of the above discussion may seem unintuitive, but should not affect a reader’s understanding. if she is forewarned. The first is the assumption that the collection of $1 of tax revenue does not effectively destroy that value. In the article’s terms, “the value of $1 in the hands of the individual and the government is the same,” p. 457. All too many economic analyses seem to assume that the mere collection of tax destroys the full value of the amount collected.
An additional way in which the reader’s intuitions may result in confusion is the unfortunate use of the cattle/vegetable tradeoff in the first example in the article—unfortunate simply because the current understanding of the impact of cattle raising on the environment and human well-being more generally suggests that any change that increases cattle production would not be beneficial. The example seems to have been chosen to help readers already familiar with similar examples in the economic literature.
The article does introduce other examples of interactions that will seem more intuitive to the reader: any rules that discourage the use of cash for nontax purposes are likely to have a positive effect on revenue collection simply as the result of a reduction in gray market transactions; any rules that encourage the creation of business records, including the Statute of Frauds, are likely to make auditing for tax collection purposes more effective; rules that impose standard terms on corporate charters are likely to improve tracing the values the corporation creates to its owners for tax purposes; mandated benefits in the employment context can result in an increase in the return to marketplace labor and thus to taxable product; rules that improve records of property ownership can permit more effective tax collection. (This last was previously identified by James C. Scott in Seeing Like a State (1998) although Scott viewed this as likely producing a reduction in well-being as a result of enhanced state tyranny.)
Weisbach and Hemel have made a significant contribution merely by identifying these interactions between non-tax rules and tax systems. Their additional analysis in this article shows that these interactions can produce desirable results, and that changes in legal rules should be made (and may in the past have been made) deliberately to enhance the operation of tax systems, since such changes can involve a trade-off between a small non-tax cost and a large increase in tax revenue as a result of indirect enhancements in the operation of the tax system. There is a lot more to do for those interested in working through the theoretical economic insights on which this analysis rests, including the relationship between the Legal Envelope Theorem and the more general Envelope Theorem of microeconomics. Some of this work is also outlined in greater detail in other papers, including The Behaviorial Elasticity of Tax Revenue, 13 J. Legal Analysis 381 (2021) and, with Jennifer Nou, Appendix to “The Marginal Revenue Rule in Cost-Benefit Analysis.”, available at SSRN (Aug. 13, 2018).
Nov 24, 2023 Leigh Osofsky
Natasha Sarin & Mark J. Mazur,
The Inflation Reduction Act's Impact on Tax Compliance—and Fiscal Sustainability (2023), available on
SSRN (May 15, 2023).
In the Inflation Reduction Act, Congress made a monumental investment in the IRS, reversing a decades-long trend of inadequate funding. A critical question is: how much was this investment worth? Government scorekeepers came up with a number of about $200 billion (yielding a $120 billion net amount, after taking into account the cost of the increased funding). But, in a new paper, The Inflation Reduction Act’s Impact on Tax Compliance—and Fiscal Sustainability, Natasha Sarin and Mark Mazur argue that these official estimates significantly understate the return on investment in the IRS. They estimate that the funding would enable the IRS to raise at least $560 billion ($480 billion, net) over the next ten years, and that, depending on taxpayers’ behavioral response, it is possible the return may actually be closer to $1 trillion.
Sarin and Mazur’s analysis is compelling for a number of reasons. Sarin and Mazur are highly qualified experts, with a blend of extensive government, as well as academic, and other, experience, including recent stints in the Treasury Department in the Biden Administration, during formulation of the Inflation Reduction Act. Their analysis reflects this deep well of experience and training, in that it draws on government data as well as academic work regarding compliance. The result is a particularly nuanced picture of how the Inflation Reduction Act funding will affect the IRS and its collection capacity. Their conclusion – that the return on IRS funding could be approximately $500 billion in the first decade and $1 trillion in the ten years thereafter – is an important one; so is their description of all the particular ways that the IRS will improve, and why this improvement is an essential part of good governance.
The analysis begins with the somewhat grim picture of IRS capacity in recent years. In addressing this history, Sarin and Mazur provide some widely known statistics, such as the very low rate of phone calls that the IRS has answered, and the high costs to taxpayers in the United States of filing their tax returns. They mix in other, striking, and less well-known information, such as the fact that antiquated IRS technology has required IRS employees to keypunch millions of tax returns by hand, simply to include the information in a tax return database. The resulting stark picture they draw of a revenue agency operating with both hands tied behind its back despite eye-popping deficit figures, is solid motivation for a better understanding of what can be gained from increased funding for the IRS.
Sarin and Mazur then expertly describe the variety of ways that official estimates likely understate the full impact of the Inflation Reduction Act’s funding of the IRS. Official estimates key off of existing estimates of the tax gap – or the amount of taxes that taxpayers owe, but do not pay. But Sarin and Mazur illustrate how these estimates of the tax gap are themselves outdated and fail to take into account some of the biggest areas of noncompliance. For instance, pass-through businesses, which have exploded in popularity since the last time they were subject to official noncompliance estimates, likely result in very high amounts of unpaid tax liability (in particular by high-income taxpayers). The difficulty the IRS has had in auditing these taxpayers means there is likely much more revenue on table than current tax gap estimates reveal, and therefore much more to be gained from the increased IRS funding.
Moreover, due to uncertainty about revenue returns from non-enforcement investments in the IRS (including in service and IT), official estimates have not attributed any return from such investments. Sarin and Mazur acknowledge that there is some uncertainty around returns from non-enforcement investments, but the return is also not likely to be zero. Instead, these investments will likely increase IRS efficiency, reduce the incidence of taxpayer mistakes, and better enable the IRS to estimate, and therefore respond to, areas of noncompliance.
Official estimates of return on funding the IRS also fail to account for the ways that a change from historically low funding levels to significantly higher funding levels is likely to have increasing, rather than decreasing, marginal returns. The IRS also now has more sources of data than in the past to help its enforcement efforts, such as more 1099-K reporting, more information from foreign financial institutions, and more K-1s reporting partnership income. Improved technology infrastructure from increased funding should allow the IRS to better leverage this data to significantly increase collections from tax enforcement.
Finally, building on academic literature about compliance, Sarin and Mazur argue that all of these direct effects of greater IRS funding may be multiplied up to three times by the indirect, general deterrence effect of increased IRS funding. Official estimates of return from increased IRS funding significantly downplay this general deterrence effect.
Importantly, Sarin and Mazur make the case that the return on increased IRS funding is not just monetary. Another important return is an improved sense of basic fairness in the tax system. At present, there are two tax systems. Most Americans, who earn income from wages paid by an employer, have their taxes automatically withheld, and therefore have little opportunity to evade. In contrast, taxpayers with income from other sources (who often are higher-income taxpayers), have more opportunities to avoid tax liability, often with the help of sophisticated tax counsel. Sarin and Mazur argue that this two-tiered system, and the distortions in the economy that result, undermine confidence in the tax system.
There is certainly a lot more to think about in terms of return on IRS funding. For instance, how should we think about allocating IRS enforcement (and service, and other) dollars among groups? How might we better incorporate non-revenue returns into the analysis? Sarin and Mazur’s analysis does not address questions such as these. But it does illustrate extremely well how much the details of the tax enforcement and compliance landscape matter in estimating the likely impact of changes in IRS funding. In this way, Sarin and Mazur model the careful analysis needed to make informed change to the IRS.
This type of analysis will continue to be critical in the coming years. The IRS’s new source of funding is far from secure. Indeed, a significant portion of it was already carved back by the debt ceiling negotiations. This, alone, means that the IRS is unlikely to be able to produce the extent of returns that Sarin and Mazur predicted. Moreover, the IRS’s operations will continue to depend on annual appropriations amounts. If Congress reduces these amounts, gains made by the IRS from the Inflation Reduction Act funding will soon be lost. Sarin and Mazur’s excellent analysis, here, and elsewhere, will be a critical part of the inevitable, continuing discussions about IRS funding in the coming years. Tax scholars, commentators, and policymakers would be well-advised to pay attention to their findings and approach.
Oct 25, 2023 Emily Satterthwaite
Following the January release of a groundbreaking study by Hadi Elzayn, Robin Fisher, Jacob Goldin, Thomas Hertz, Daniel E. Ho, Arun Ramesh, and Evelyn Smith and the resulting media, Congressional, and IRS attention, it is now well-known that Black taxpayers are audited at rates three to five times the rates of non-Black taxpayers. The audit study is a landmark both for its results (which contradict past IRS statements) and also for its novel methodology, which uses individually-estimated taxpayer race probabilities to obtain informative bounds on the racial audit rate disparity. In addition to illuminating problematic patterns in current IRS audit selection procedures, the study’s methodology offers promise for the future in investigating other race-based patterns in tax enforcement.
In what non-audit enforcement areas might such patterns arise? Here is where the prescient work of Jeremy Bearer-Friend (as cited in the audit study, P. 41) comes in, building on the work of other scholars working at the intersection of race and tax. In “Colorblind Tax Enforcement,” Bearer-Friend refutes on first principles the now-debunked claim that because the IRS does not collect race data, it cannot discriminate by race when enforcing tax laws. He points out that, for IRS agents, making inferences about the race of a taxpayer on the basis of the information provided on the return (names of taxpayer, spouse, and children, address including zip code, family structure, and occupation) is plausible and probable: “[e]ach of these datapoints can lead to inferences of racial identity in the mind of the relevant IRS personnel, with the combination of data points creating a stronger likelihood of inference” (P. 19). Moreover, at many points in the enforcement process there are telephonic or in-person conferences that allow for further racial inferences.
The paper then provides two models of racial bias that can produce racially disparate tax enforcement where IRS personnel do make racial inferences: racial animus (intentional harm on basis of race, P. 17) and implicit racial bias (harm on the basis of race that is unconscious or unintentional, P. 21). However, even if no racial inferences are made or neither of these models apply, Bearer-Friend offers a third model that can produce harmful disparate results by race: transmitted bias. This is where racial animus in another area of life determines taxpayer characteristics that intersect with tax enforcement. For example, having unstable housing as a result of racial discrimination or racially-skewed mass incarceration is associated with unstable mailing addresses, which in turn compromises a taxpayer’s ability to respond to IRS communications that are distributed by mail (of which there are many; P. 25). Transmitted bias requires neither informational inferences nor discretion on the part of an IRS agent: it operates through broader societal forces that affect taxpayers differentially by race.
Bearer-Friend goes on to identify seven tax enforcement settings that are vulnerable to racial bias as operationalized through each of the three models. He emphasizes that the seven settings are “representative” and thus non-exhaustive, but they suggest particularly promising areas of investigation. I summarize them below and offer questions that flow from Bearer-Friend’s observations.
- Summonses: The IRS has broad discretion in determining the scope of information to be summoned (e.g., range of financial documents and tax years). Such information can support racial inferences as well as determine the compliance burden of the summons. The IRS also has discretion concerning who to summon, such as the taxpayer’s business counterparty, which might have ramifications for the counterparty’s trust in or future willingness to do business with the taxpayer, and whether to enforce the summons. Thus, there is scope for racial animus and implicit racial bias. In addition, summons issuance is an area ripe for transmitted bias because a summons relies on a taxpayer’s last known address. Does the summons enforcement rate vary by the race of the taxpayer?
- Civil penalties: Many civil penalties are automated, but IRS personnel have discretion on some and can choose to abate billions of dollars in penalties. Where a taxpayer’s race can be inferred on the basis of information provided on the return, this context is vulnerable to racial animus and implicit bias. Transmitted bias also may be present here: in the case of the penalty for civil fraud, for example, the taxpayer’s use of cash is a factor that weighs in favor of finding fraud. However, the use of cash is racially non-neutral due to a history of racial animus in banking. Do penalty abatement rates vary by the race of the taxpayer?
- Appeals: The IRS Independent Office of Appeals is instructed by the Internal Revenue Manual to use their “experience and judgement” when reviewing the merits of a case for settlement. This discretion, plus the fact that settlement conferences are held telephonically, virtually, in person, or through correspondence, opens the door to disparate racial treatment via racial animus and implicit racial bias. While many difficult-to-observe aspects of cases are likely to affect settlement rates, investigating which cases settle and whether race appears to be a factor might be revealing.
- Offers in compromise: The decision to accept an offer in compromise is discretionary and, regardless of the grounds on which it may be requested, the Internal Revenue Manual instructs collections officers to contact a taxpayer telephonically to collect additional information necessary to consider the offer. Here again, there is scope for racial animus and implicit racial bias. Do rates of acceptance of offers in compromise vary by race?
- Collection due process hearings: Taxpayers who receive a notice of collections (a lien or a levy) from the IRS can request, in writing within 30 days, a Collection Due Process (CDP) hearing. The hearing occurs in person or telephonically with a settlement officer in the IRS Appeals Office, who exercises discretion in proposing or agreeing to a settlement. Thus, racial animus or implicit racial bias may be present. Transmitted bias may also arise: the notice of collections is valid if sent by certified mail to a taxpayer’s last known address, even if the taxpayer has no actual knowledge of the notice. Among taxpayers who are mailed a notice of collections, do rates of requests for CDP hearings vary by race?
- Innocent spouse relief: To request relief from a spouse’s tax liabilities for taxpayers deemed to be innocent spouses, a taxpayer must file Form 8857, which is evaluated by an IRS technician. The form has narrative sections that can “include qualitative information and natural language patterns;” the technician may also review “personal financial information that might also imply racial identity” (P. 43), thus allowing for racial animus or implicit racial bias. In addition, transmitted bias may occur if there are behavioral patterns in who feels empowered to submit a form in which substantial personal disclosure is required. In cases where joint and several liability of a spouse is at issue, do filing rates for Form 8857 vary by race?
- Criminal tax referrals: Although no single CI agent can make a recommendation to DOJ’s Tax Division without review by a supervisor (P. 45), agents have substantial discretion regarding which referrals to pursue and how much investigating to do, a process which often involves the IRS’s broad summons power, which can produce racially-revealing information (discussed above). In addition, to the extent that certain kinds of cases are less likely to be recommended for prosecution, and the defendants in those cases are more likely to be white (i.e., recipients of pass-through income, according to a Tax Policy Center study that Bearer-Friend cites), racially disparate outcomes may occur through transmitted bias. DOJ collects and reports the race and ethnicity of defendants in its prosecutions. How would a similar report by CI look? Are there racial patterns in the referrals that are chosen for investigation?
Bearer-Friend is clear that his review of the scope for racial bias in these tax enforcement settings “is not an assertion that such racial bias is already occurring at the IRS” (P. 47). The problem, rather, is that at the time that Bearer-Friend was writing, current data practices at the IRS inhibited such an inquiry. To address this, Bearer-Friend recommends exactly the kind of imputation techniques that both the audit study and a Treasury Department analysis of tax expenditures have since performed. Analyzing IRS enforcement procedures for possible racial bias is thus feasible (although it is far from costless, which is one more reason that IRS funding increases must be preserved). Bearer-Friend’s article gives us tremendously fruitful suggestions for where such analyses should start.
